CDP officially stands for Collection Due Process. I snark that it really stands for Collection Delay Process, because delay in administrative collection activities is really the main result taxpayers get from CDP. But it’s not all snark. At the administrative level, delaying the automated collection processes can be good for everyone. Taxpayers can use that delay to work out collection alternatives and thus avoid the disruption of random ACS levies and NFTLs. The IRS can bring more folks into ongoing compliance. Win-win.
At the Tax Court level, however, delay generally helps neither taxpayers nor the IRS. That is the lesson I see from two Tax Court cases decided last week: (1) Jevon Kearse v. Commissioner, T.C. Memo. 2019-53 (May 20, 2019) (Judge Ashford); and (2) Linda J. Romano-Murphy v. Commissioner, 152 T.C. No. 16 (May 21, 2019) (Judge Morrison). In both cases, the taxpayers “won” the case; the Tax Court entered a judgment for the taxpayers because of IRS screw-ups. It is not clear, however, that the decisions did anything more than delay collection. It appears the IRS can fix the procedural errors and then re-start collection. If so, then the delay might actually hurt the taxpayers because of increased interest and penalties. Or it might hurt the increasingly underwater federal fisc (and the rest of us) because delay increases the risk of taxpayers hiding or dissipating assets.
I will discuss Kearse this week and will discuss Romano-Murphy next week, when I’ve had more time to think on and condense that 87 page (!) opinion.
The Law: Collection and CDP
The IRS can collect an assessed tax with or without judicial help. Section 6502 gives the IRS 10 years to collect a properly assessed tax without judicial assistance. However, the IRS (through the Department of Justice) can always choose to file suit in court to reduce the assessment to judgment. When that happens, the limitation period for collection basically becomes unlimited. Worse, the federal tax lien remains latched onto all the taxpayer’s property and, in addition, a judgment lien hops up and attaches. For a good explanation of the sad details, see U.S. v. Overman, 424 F.2d 1142 (9th Cir. 1970).
The IRS tends not to seek judicial help because it’s got some pretty awesome collection powers that it implements mostly through the ACS, its collection machine. Those powers include the power to file a Notice of Federal Tax Lien (NFTL), which helps the IRS beat out competing creditors, and the power to seize any of the taxpayer’s property it can find, including amounts that others are obligated to pay the taxpayer, such as wages, financial accounts, and social security payments.
Before the IRS cranks up its collection machine, §6320 and §6330 require it to tell the taxpayer that bad stuff is about to go down, and give the taxpayer an opportunity for a hearing before the Office of Appeals. This is called the Collection Due Process (CDP) hearing. Formally, the purpose of the hearing is for Appeals to review the case and make sure that administrative collection actions are appropriate. Informally, it is a chance for the taxpayer to work out a deal with the IRS, as I explained in this prior Lesson. As part of the CDP hearing, Appeals is supposed to double-check to be sure the IRS has not screwed up the procedure. In legal lingo, §6330(c)(1) requires Appeals to “obtain verification from the Secretary that the requirements of any applicable law or administrative procedure have been met.” IRM Part 8, Chapter 22, §5.4 gives Appeals employees instructions on how to perform the required verification. IRM 18.104.22.168.
In Kearse, the Tax Court found that the of Office Appeals failed to make the required verification.
Facts of the Case
Mr. Kearse was a gifted football player. His lucrative football career ended in 2010. Being good on the gridiron, however, does not necessarily equate to being good with money. On his 2010 return Mr. Kearse took a $1.4 million bad debt deduction. The IRS audited the return and denied the deduction. It sent out the NOD in May 2012. When Mr. Kearse did not petition the Tax Court, the IRS assessed the resulting tax liability of $432,015.
The assessment came in November 2012. In December 2012 the IRS filed an NFTL and sent Mr. Kearse the required CDP Notice. He timely requested a CDP hearing. Mr. Kearse used the resulting administrative delay to offer to settle the tax liability for....wait for it.... $1. He thought that was fair because he said the IRS never sent him the NOD. Without a properly mailed NOD, the assessment would be invalid and he would owe zippo. Hence, the $1 offer, based on doubt as to liability.
The screw-up was that the IRS lost US Post Office Form 3877, the form it typically uses to prove that it properly mailed a document. The document was not available to Appeals during the CDP hearing. Nor could the Appeals Office find the relevant certified mailing list (CML). The Appeals officer instead relied on IRS records in its Integrated Data Retrieval System (IDRS) to perform the required verification. Appeals issued its final Notice of Determination in May 2014. The final Notice of Determination says “Assessment was properly made....”
Mr. Kearse petitioned the Tax Court in 2014. He maintained that the IRS had not sent him an NOD and said that Appeals had not performed the proper verification. For those who need it, I explained the legal rules for what the IRS must do to prove a valid NOD in Tax Court in this post last November about Gregory v. Commissioner, where the taxpayer had also argued that Appeals failed to conduct a proper verification. There, the lack of a Form 3877 proved harmless. Not so here.
At some early point during the 4-5 years the matter was pending in Tax Court, at a time not disclosed by the opinion, “the parties stipulated that respondent cannot produce a United States Postal Service (USPS) Form 3877 to show proof of mailing of the notice of deficiency or otherwise establish that it was delivered to petitioner.”
At some later point during the 4-5 years the matter was pending in Tax Court, again at a time not disclosed by the opinion, the IRS found the Form 3877. The Form showed that the NOD had been properly mailed. The IRS proffered the Form 3877 to the Court. In addition, the IRS argued that even though the Appeals Officer did not see or use that document to perform the verification, the Appeals Officer had checked the relevant computer databases, which showed that an NOD had been sent. That fulfilled the §6230(c) verification requirement. All good!
Holding: Too late and too little.
The proffer was too late. Judge Ashford held the IRS to its stipulation, declaring them sacred. That may seem petty, but it most certainly is not. As those who practice before the Tax Court know, stipulations are critical to the Tax Court being able to move cases in an orderly and expedited fashion. Consequently, Judge Ashford could, without embarrassment, declare “the record before us does not contain a USPS Form 3877 or equivalent IRS certified mailing list (CML)... Indeed the parties stipulated that respondent cannot produce that form (or list).”
The verification was too little. Checking the computer records is sufficient when the taxpayer has not raised the issued of proper mailing, said Judge Ashford, but not when the taxpayer has “been calling into question (albeit somewhat inartfully)...whether the May 11, 2012 notice of deficiency was properly mailed to him before assessment....” She concluded: “On the basis of the record before us, it is clear that the Appeals officer failed to properly perform the verification mandated by section 6330(c). *** Consequently, we conclude that Appeals abused its discretion.”
Lesson: The Taxpayer’s Pyrrhic Victory
Mr. Kearse was represented by three lawyers from Taylor English Duma LLP, an Atlanta law firm. The law firm's website brags “we measure success from our clients’ perspective, seeking every opportunity to enhance their return on investment and earn their retention and satisfaction.” I assume Mr. Kearse paid for their services (although since he was the prevailing party he might be able to shift attorneys fees to the IRS under §7430—more on that in the Coda). So ... what exactly did he get for his money? How did this law firm enhance the return on the investment he made for its legal services?
He got delay. That’s it.
The entire assessed liability of $432,015 plus accrued interest and penalties since 2012 is still on the line. It’s just that the line has moved. That may be a good result for him. Delay is often the friend of the debtor. Perhaps the IRS will give up on collection. Perhaps his case will get lost, like the Form 3877. But even though he scored some points against the IRS with this outcome, the odds of winning the collection game are still not in his favor.
To understand the paucity of his win, let’s look at what Mr. Kearse did not get.
First, he did not get the assessment invalidated. At least I don't see how. If I am wrong on that, then this would be a great victory because the limitation period for assessment is long expired. But as I read the opinion, the Court’s judgment was simply that the Office of Appeals abused its discretion by failing to properly verify that the IRS had followed all applicable administrative procedures. In footnote #3 the Court says that it had “ordered respondent to address whether the resulting assessment against petitioner for 2010 is invalid.” But the Court gives no opinion on that question. And, in fact, the Court says in footnote #5 that it was “unnecessary” to either (1) review the underlying tax liability or (2) “consider whether Appeals’ decision to reject his offer-in-compromise constituted an abuse of discretion.” So I think the assessment is still valid. If anyone thinks otherwise, I'd love to hear about it in the comments section.
How did the IRS dodge the bullet? I think it was because the IRS attorney—Ashley Y. Smith—was very careful to stipulate only that the IRS could not produce the Form 3877, and then the IRS continued to look for the Form and eventually found it. That’s good lawyering. The stipulation was not that the Form did not exist or that the NOD had not been properly mailed. It was only that the IRS could not produce it to the Court. If the IRS had stipulated that the Form did not exist, or if IRS had not eventually found it, then I think it likely that Judge Ashford would have found that the Office of Appeals abused its discretion in refusing the $1 OIC/DATL. That decision would, I think (but am not totally sure) box the IRS into accepting the $1 offer, while avoiding the necessity for re-determining the underlying merits. That would have also been a good result for the taxpayer.
So while Judge Ashford may have been displeased enough to deny admitting the Form into evidence, she seems to have made the judgment that, if the Office of Appeals re-does the verification, it will now have the proper evidence to verify that the IRS sent the NOD to Mr. Kearse.
Second, Mr. Kearse did not get a merits determination. The proper place for him to do that was in the CDP hearing, followed by de novo review in Tax Court. As the case stands, we have no idea if his attempted deduction was legit or not. If Mr. Kearse had obtained a merits determination and taken that to Tax Court, he would be in no worse a position than if he had petitioned for review of the NOD. That is one of the actual good points about—taxpayers can get a second chance for a first bite at the apple. But that was not the result for Mr. Kearse.
Mr. Kearse could have tried to argue the merits before Appeals by conceding that the IRS sent the NOD but denying receipt. Even if the IRS properly sends an NOD, if the taxpayer shows that they did not actually receive the NOD, then §6330(c) permits the taxpayer to contest the merits of the tax liability. You can find further explanation in my Lesson From The Tax Court: When Non-Receipt Of An IRS Notice Matters from last October.
But instead of doing that, Mr. Kearse went all-in on an alleged IRS procedural screw-up. Hmmmm. Perhaps that says something about the strength of his position on the merits (which appears to have morphed from a bad debt deduction to a theft loss)?
Third, Mr. Kearse did not kill collection. Since the assessment is still valid, the IRS can still collect and has plenty of time to do so. His seven year adventure (from the CDP hearing in 2012 to the Tax Court decision in 2019) did not eat up any of the collection clock, thanks to §6330(e). In fact, it added 90 days to the clock. Section 6330(c) suspends the period of limitations for collection until the end of the CDP process, including court appeals, plus 90 days.
Unlike Mr. Kearse, the IRS does not grow old. I assume the IRS must withdraw the NFTL it filed. And perhaps there is some IRS policy or fear of judicial disapproval that prevents re-filing the NFTL or filing a new one in a new location to cover other assets. The inability to file an NFTL affects the tax lien's priority as against certain other creditors. But it has zero effect on the tax lien's existence. The federal tax lien still attaches to all of Mr. Kearse’s property and rights to property, including his brokerage accounts, his bank accounts, and all sorts of other assets that will, generally, not have the kind of competing creditors who can beat out the tax lien in its secret, unfiled, state.
The IRS can also use its levy powers to seize any of Mr. Kearse's property it can find and to vindicate the tax lien that remains attached to any of his transferees, alter-egos, or nominees. I have no idea if it will do so. If it does, it would need to give Mr. Kearse another CDP hearing. Maybe I'll be blogging about that in another five years. Collection Delay Process.
Finally, the IRS can ask DOJ to file suit to reduce the assessment to judgment. By this time I would guess the total tax liability, including accrued interest and penalties, is north of $1 million (I would be delighted if anyone could run the numbers and put that in the comments). That’s worth suing over.
Mr. Kearse did win delay. I don’t know whether that is good for him or not. But to me it just looks like Mr. Kearse, the IRS, and the Tax Court wasted a whole bunch of time—five years—to end up pretty much where they started. That is an all-too common result of the CDP provisions. Delay is baked right into the statutory scheme. Next week we will look at a case that spent over 10 years in litigation...and still may not be over.
Coda: I think Mr. Kearse has a good shot at attorneys fees under §7430 assuming he meets the net worth restrictions in §7430(c)(4)(A)(ii) (i.e. that he is not too rich). So perhaps he can recover some of the costs of his five-year CDP adventure. He was the prevailing party and the question will likely be whether the IRS's litigating position was substantially justified. Section 7430(c)(4)(B)(ii) provides that when the IRS has violated applicable internal guidance, that creates a presumption that its position was not substantially justified. Here, Judge Ashford ruled that the Appeals Officer violated IRM 22.214.171.124.2.1.1(6). The provision requires more than relying on the relevant IRS computer system when the “taxpayer alleges an irregularity” which the IRM says includes denying receipt of the NOD. Mr. Kearse denied receiving the NOD.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law