Author’s Note: Like so many others I am now working from home and climbing various learning curves, some steeper than others. So please accept my apologies if today’s post contains more errors than normal. Hopefully they will just be errors of the fingers and not of the brain.
The case of Sean McNamee v. Commissioner, T.C. Memo. 2020-37 (Mar. 18, 2020) (Judge Lauber) teaches us that taxpayers have only one opportunity to challenge a tax liability in a Collection Due Process (CDP) hearing, even though the Tax Code provides for up to two CDP hearings for any given tax liability. In today's case the IRS erroneously refused to let Mr. McNamee challenge a tax liability in his first CDP hearing. He did not obtain Tax Court review of that decision. Instead, he re-challenged the liability in a second, later, CDP hearing involving the same underlying liability. Mistake. The Court held that even though the IRS screwed up the first time, the taxpayer’s failure to obtain judicial review of the first hearing precluded him from challenging the underlying liability in the second. The lesson here centers on a tricky quirk in the CDP rules. Details below the fold.
Law: Of Liens, Levies, and CDP
When the IRS seeks to collect an unpaid tax liability, it chiefly relies on three big collection tools: liens, levies, and offsets. The CDP procedures are triggered by the IRS use of the first two tools. But those triggers may well happen at different times. That is what creates today’s lesson. Let’s look briefly at each.
Liens. Section 6321 creates a lien in favor of the government as a matter of law once the IRS has properly assessed a tax, given the taxpayer proper notice of the unpaid tax, and the taxpayer fails to fully pay. The lien attaches to all the taxpayer’s property or rights to property. I teach students to think of a “lien” as just a fancy word for “claim.” It’s virtual sticky note that says “You Owe Me” and it sticks to all the taxpayer’s property. Section 6322 says the lien arises as of the assessment date. The Supreme Court has said that this general tax lien is perfected as of the date it arises. United States v. City of New Britain, 347 U.S. 81 (1954). That means the general tax lien would beat out all other creditors, even though it is secret, absent any other statutes.
But there are other statutes.
First, §6323 provides that this secret general federal tax lien cannot be enforced as against four types of competing creditors (typically called the four horsemen for unclear reasons but, hey, it’s catchy) until after the IRS provides a proper public notice of the lien. The IRS does so by filing a “Notice of Federal Tax Lien” (NFTL) in the places directed by statute.
So when someone says that the IRS did or did not file a lien, that is crazy talk. Please correct them. The IRS does not ever have to file “a lien” (unlike other types of creditors such as judgment creditors or mortgagees). What the IRS must file is a NOTICE of the lien and then only to protect the federal fisc against again the four horsemen. See details in 6323(f) and Treas. Reg. 301.6323(f)-1. [Side note: this ancient statutory procedure often makes it a pain in the bahooney for competing creditors to discover tax liens. Prof. Keith Fogg’s article here make an excellent, commonsense, argument for a single centralized registry of federal tax liens.]
Second, §6320 provides CDP Rules for NFTLs. It provides that within five business days after IRS files the first NFTL relating to a particular taxpayer for a particular tax for a particular tax period, it must tell the taxpayer it has filed the NFTL. The taxpayer then has 30 days, starting on the day after the 5th business day, to ask for a CDP hearing. If the taxpayer successfully requests a CDP hearing, the taxpayer then gets full CDP rights, including the right to petition the Tax Court if the Office of Appeals approves the NFTL filing.
If the taxpayer misses the deadline, or if the taxpayer asks for a hearing with respect to an NFTL filing after the first one, the IRS will give the taxpayer what the regulations call an “equivalent hearing.” That is basically the same opportunity to go to Appeals as in a CDP hearing, but the taxpayer will not be able to petition for Tax Court for review of Appeal’s decision. Treas. Reg. 301.6320-1(i).
Levies. Section 6331 permits the IRS to levy on all the taxpayer’s property or rights to property once it has properly assessed the tax, and given the taxpayer proper notice of the unpaid tax as well as another notice of a general intent to levy. Section 6331(b) clarifies that the term “levy” just means “the power of distraint and seizure by any means.” Absent any other statute, the IRS could start on its collection Easter egg hunt as soon as it gave the proper notices. But there is another statute: §6330.
Section 6330 gives the CDP rules for levies. It forbids the IRS from making any levy until it first notifies the targeted taxpayer that it will start levying. The taxpayer then has 30 days from the date of the notice to ask for a CDP hearing. If the taxpayer successfully requests a CDP hearing, the taxpayer then gets full CDP rights, including the right to petition the Tax Court if the Office of Appeals sustains the decision to use the levy powers. As will CDP hearings for NFTLs, if the taxpayer misses the small window of opportunity to request a CDP hearing, the IRS will give taxpayers an equivalent hearing. Treas. Reg. 310.6330-1(i). Again, that is the same procedure before Appeals but with no opportunity for court review.
So you see that for any given tax liability, a taxpayer might be entitled to two CDP hearings, one to contest a decision to file an NFTL and the other to contest a decision to use levy powers.
In both types of CDP hearings taxpayer may contest the underlying liabilities if the taxpayer “did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability.” §6330(c)(2)(B). If properly raised, the Tax Court will review the Office of Appeals’ decision about liability using the same standards it uses when taxpayer contest a proposed deficiency: de novo. Goza v. Commissioner, 114 T.C. 176 (U.S.T.C. 2000).
Mr. McNamee was a CPA and return preparer. In March 2013 the IRS finished an examination about his preparation of various 2009 returns. It proposed to assess penalties under both §6694(a) and (b). Note that unlike the assessment of income, estate or gift taxes, assessments of §6694 penalties are not subject to the deficiency procedures. So there would be no NOD for Mr. McNamee. Nor, unlike §6672, does the statute provide for any time of guaranteed administrative hearing before assessment.
However, the regulations do provide taxpayers an opportunity to protest to Appeals, if there is enough time on the assessment clock. Treas. Reg. 1.6994-4(a)(1). Here, the IRS did send Mr. McNamee a letter telling him of its intent to assess the penalties and giving him the opportunity to protest the determination to Appeals. He asked for an extension to file the protest. Because that extension would extend beyond the expiration date for assessment, the IRS agent asked him to sign a Form 872-D to extend the time for assessment of the penalties. Mr. McNamee said no. So the agent assessed the penalties.
This situation meant that while one part of the IRS (Office of Appeals) was reviewing the appropriateness of the penalties, another part (Collection) was moving ahead to collect. And it appears that Mr. McNamee’s protest got lost in cyberspace after the Appeals Officer sent the matter back for Exam to rework some of the penalties. So Appeals never actually made a decision about the appropriateness of all the penalties.
The IRS eventually filed an NFTL to secure various tax liabilities owed by Mr. McNamee (both income taxes as well as these §6694 penalties). It sent Mr. McNamee a CDP Notice and he timely requested and received a CDP hearing with Appeals. Although Mr. McNamee found himself back in Appeals, it was through a different process and he got a different reviewer.
In this NFTL CDP hearing Mr. McNamee once again question the appropriateness of §6694 penalties for the 2009 tax returns he prepared. The Settlement Officer, however, decided he could not contest the §6684 liabilities. I am guessing the SO thought his prior opportunity in Appeals precluded him raising the issue, but the opinion is silent on the point. At any rate the IRS conceded that the SO’s decision was wrong with the result that everyone agreed: Mr. McNamee should have been able to get a review on the merit of the §6694 penalties in this first CDP hearing.
Here’s where things get gnarly. After losing his NFTL CDP hearing before Appeals in 2014, Mr. McNamee failed to timely petition the Tax Court for review. Instead he filed a petition four months late, so late that he did not even try to defend it. See McNamee v. Commissioner, T.C. Dkt. No. 104-15L (order of dismissal by Judge Thornton dated May 29, 2015).
Eventually, the IRS gave him a second CDP opportunity in March 2018 when a field Revenue Officer decided to start trying to levy. Mr. McNamee timely requested a second CDP hearing and, once again, objected to the merits of the §6694 assessments. The new Settlement Officer (SO2) also refused to let him contest the merits, but now on the grounds that he could have done so had he properly appealed the first SO’s erroneous decision.
This time Mr. McNamee acted timely to petition the Court. He ran into some trouble because he attempt to file just as the government shut down between December 28, 2018 and January 25, 2019. But he eventually got it done and the details of that are beyond today's lesson.
Lesson: Opportunity To Contest Liability in CDP Only Comes Once
Recall that a taxpayer may not contest the underlying merits of an assessment in a CDP case if the taxpayer has either received an NOD or otherwise had “an opportunity to dispute such tax liability.”
Mr. McNamee’s lawyers argued that Mr. McNamee had not had any prior opportunity to contest the merits of the §6694 liabilities. That is certainly true if one looks simply at his prior administrative opportunities. Three times he went to Appeals and three times Appeals did not consider his protest on the merits. The first time was his initial protest where Exam never sent back his file to Appeals. The second time was his first CDP hearing where Appeals erroneously thought his first trip to Appeals precluded him. The third time was the second CDP hearing where Appeals concluded that his first CDP hearing was his opportunity.
Judge Lauber rejected the argument. Mr. McNamee did in fact have an opportunity to contest the penalties: his opportunity was to petition the Tax Court to correct the first SO’s error. Writes Judge Lauber: “Petitioner could have challenged SO1’s determination, as well as his underlying liability for the penalties, by filing a timely petition for review in this Court, which he failed to do. Because he failed to take advantage of a prior opportunity to contest the penalties, his underlying liability for the penalties was not properly before SO2 during the second CDP hearing, and he is thus precluded from now advancing that challenge in this Court.”
So, folks, learn the lesson: if you can contest a liability in your first CDP hearing, that is your only opportunity, even though you may be entitled to a second CDP hearing. One plus one adds up to only one.
Coda 1: Mr. McNamee bears some responsibility for this mess. I do not mean his blown Tax Court petition. I mean he could have signed the Form 872-D extension of time and thus gained time to work out the merits before assessment. Perhaps he had some good reason to refuse the extension. Perhaps he was just pissed. I do not know. But I almost titled this Lesson “Sign The Extension” because if he indeed had any decent argument on the merits, his best shot at getting heard would be in a pre-assessment process.
Coda 2: Mr. McNamee also appears to have ignored another more salubrious procedural path. The statute and regulations allow return preparers to pay just 15% of the assessed penalties and then file a claim for refund. The opinion is silent on how much was originally assessed but the accumulated liability totaled $107,000 in March 2018. So even assuming it was $100,000 at the time of the March 2013 assessment, Mr. M. could have paid $15,000 to (a) stop collection and (b) obtain a review on the merits through the refund process. See §6694(c). He would have had to have done this with within 30 days of the assessment. This seems another good reason to sign that extension of the ASED!
Bryan Camp is the George H. Mahon Professor of Law at His Temporary Home Office in Lubbock Texas