If Jesus had been a tax practitioner, he might have said “I tell you it is easier for a camel to go through the eye of a needle than for a taxpayer to contest a tax liability in a CDP hearing.” That is the lesson we learn from two recent Tax Court decisions: (1) Jason E. Shepherd v. Commissioner, T.C. Memo. 2020-45 (Apr. 13, 2020) (Judge Guy); and Patrick’s Payroll Services, Inc. v. Commissioner, T.C. Memo. 2020-47 (Apr. 14, 2020) (Judge Urda). Mr. Shepherd wanted the Tax Court to review the merits of a Trust Fund Recovery Penalty assessed against him. Patrick’s Payroll Services wanted the Tax Court to review assessed employment tax liabilities. In both cases the Tax Court refused, holding that both taxpayers had had a prior “opportunity to dispute such tax liability” within the meaning of §6330(c)(2)(B). The Court’s idea of what constitutes a prior opportunity might surprise you at first, but makes sense once you think about it, particularly for these two types of tax liabilities. Details below the fold.
Law: Challenging a Tax Liability in CDP
One useful way to think about tax administration is that it consists of two boxes: (1) a box of tax determination processes; and (2) a box of tax collection processes. The bridge between the two boxes is the assessment. It is always helpful to know what box you are in. My students tend to like this graphic:
is part of the tax collection box. Sections 6320 and 6330 require the IRS to give taxpayers an opportunity to ask for a Collection Due Process (CDP) hearing at the front end of the tax collection process. As I have written about before, the main purpose of CDP is to allow taxpayers breathing room to work out some payment arrangement for the unpaid taxes. See e.g. “Lesson From The Tax Court: The Proper Role of Delay in CDP,” (Sept. 19, 2019).
While the focus of the CDP hearing is on the appropriateness of collection, §6330(c)(2)(B) permits a taxpayer to ask for a review of the underlying tax liability 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.”
At first blush, this language seems pretty broad. That is because the Service makes a lot of tax assessments without being required to send taxpayers a statutory notice of deficiency (SNOD). Go look at my graphic (or go read §6201). Congress requires the SNOD only for certain types of assessments (generally assessments of income, gift, and estate taxes). For all other assessments Congress may sometimes require the Service to give taxpayers an administrative review (such as for some penalties) before the assessment, but mostly the Service is free to fashion its own assessment procedure. Certainly that is true for employment taxes, excise taxes, and income taxes self-reported by taxpayers on their returns. For those taxes the Service has a variety of internal administrative practices for taxpayers to give input before the Service assesses the tax.
Some Tax Court cases have read language in §6330(c)(2)(B) to expand taxpayers’ ability to challenge a tax liability in a CDP proceeding. Notably, in Montgomery v. Commissioner, 122 T.C. 1, 36 (2004) the Tax Court said taxpayers could contest self-reported liabilities in CDP hearings because, by definition, they had not received an NOD and, therefore, had no opportunity to contest the liability they themselves reported! Similarly, focusing on the word “receive,” the Court has said that if a taxpayer can show they did not actually receive an SNOD in time to effectively petition Tax Court, they can contest the liability in CDP hearings because the statute requires actual receipt. See Kuykendall v. Commissioner, 129 T.C. 77, 80 (2007)(taxpayer who showed actual receipt was only 12 days before the end of the 90 day period did not “receive” an SNOD within the meaning of §6330(c)(2)(B). The Tax Court has taken a similar position with respect to any other qualifying “opportunity.” Mason v. Commissioner, 132 T.C. 301, 318 (2009) (“a section 6672(b)(1) notice that was not received, but not deliberately refused, by a taxpayer does not constitute an opportunity to dispute that taxpayer's liability.”) Thus an prior “opportunity to dispute” does not foreclose attacking the merits of an assessment in a CDP hearing if that prior opportunity was meaningless.
The regulations, unsurprisingly, interpret §6330(c)(2)(B) so as to limit CDP contests of liability. For example, the regulation takes the position that the word “otherwise” means that the the “opportunity to dispute” does not simply refer to a judicial opportunity but refers to any administrative opportunity given taxpayers to get to the Office of Appeals, whether or not that opportunity is mandated by statute or purely discretionary. Treas. Reg. 301.6330-1(e), Q&A E-2 (“An opportunity to dispute the underlying liability includes a prior opportunity for a conference with Appeals that was offered either before or after the assessment of the liability.”). The Tax Court approved this interpretation in Lewis v. Commissioner, 128 T.C. 48, 50-61 (2007). Heck, the Tax Court has even gone further. As I recently blogged, even if the Office of Appeals wrongfully ignores a proper challenge to the tax liability, the Tax Court says the taxpayer has nonetheless had an opportunity within the meaning of §6330(c)(2)(B) because the taxpayer can always seek Tax Court review of a CDP hearing! See, "Lesson From the Tax Court: One Plus One Equals One," (Mar. 30, 2020).
Today’s cases teach us just how small a taxpayer’s “opportunity to dispute” can be to prevent the taxpayer from contesting the merits of a tax assessment during the CDP hearing. To amend my opening analogy, if finding and timely responding to a CDP notice is like finding a needle in the haystack of notices from the IRS, then obtaining Tax Court review of the merits is like threading the eye of that needle.
As I tell you the facts of each case, see if you can spot just where the taxpayer had an “opportunity to dispute” the merits of the liability prior to the CDP hearing under review.
Facts of Shepherd
Tax Determination Process: Mr. Shepherd ran a company. For some number of tax periods not stated in the opinion, the company properly filed quarterly Form 941 returns but failed to pay the taxes reported. While Judge Guy refers to these unpaid taxes as “employment taxes” I think he really means trust fund taxes because a Revenue Officer (RO) eventually conducted a Trust Fund Recovery Penalty (TFRP) investigation and obtained proper approval for assessing Mr. Shepherd §6672 penalties of over $165,000.
On January 30, 2013, the IRS sent a 30-day letter to Mr. Shepherd’s last known address explaining it was about to assess the penalties. It’s called a 30-day letter because, as required by §6672(b)(1), the letter gave Mr. Shepherd 30 days to get the Independent Office of Appeals to review the proposal. On February 19, 2013, the US Post Office returned the letter as “Unclaimed Unable to Forward.” The IRS then assessed the penalty on July 22, 2013.
The assessment was both the end of the tax determination process and the start of the tax collection process.
Tax Collection Process: In October 2013, the IRS mailed a CDP notice to Mr. Shepherd’s last known address. This time he responded and convinced the Settlement Officer (SO) that he was a turnip. So the SO 53’d Mr. Shepherd’s liability, designating it as “currently not collectible” (CNC).
In March 2016, Mr. Shepherd submitted an offer to compromise his liability for $1 because, he said, there was doubt as to his liability. About one year later the IRS rejected the offer and Mr. Shepherd elected to go to Appeals.
In December 2017 Appeals also rejected the offer, although it noted that if Mr. Shepherd would withdraw the offer he made, that would allow Appeals to reduce part of the liability. Mr. Shepherd did not withdraw his offer.
In January 2018 the IRS removed Mr. Shepherd’s account from CNC status and filed a NFTL, sending him a second CDP notice. Mr. Shepherd timely requested a CDP hearing and his only argument was that the assessment was incorrect.
Facts of Patrick’s Payroll
Tax Determination Process: Patrick’s Payroll was a jicky company that purported to be an employee leasing company. It’s only client for the periods at issue (all quarters in 2010 and 2011) was its owner’s boss, a company for whom he worked as a security guard. It seems Patrick’s Payroll pretended to employee all the security company’s workers and thus assumed responsibility for making payroll, including paying employment taxes and doing the proper withholding.
We do not know how well Patrick’s Payroll complied with the trust fund tax requirements because, unlike Shepherd, this is a case about employment taxes. Patrick’s Payroll simply failed to file any quarterly returns or make any employment tax payments for all quarters of 2010 and 2011.
In 2015 the IRS opened an examination of Patrick’s Payroll 2010 and 2011 tax periods. The taxpayer was uncooperative, natch. Some two years later, in April 2017, the Revenue Agent sent Patrick’s Payroll a 30-day letter proposing to assess employment taxes and various penalties totaling just under $1,000,000 for 2010 and 2011. Again, it’s called a 30-day letter because it gave the taxpayer 30 days to dispute the proposal with the Independent Office of Appeals, even though there is no statutory requirement for the Service to give taxpayer’s that opportunity and there is no Tax Court review available. Actually, the taxpayer had longer because the RA did not close the case until August 2017 after which the IRS assessed the taxes and penalties. Again, the assessment marks the end of the tax determination process and the start of the tax collection process.
Tax Collection Process: At a time not stated in the opinion, the IRS sent Patrick’s Payroll a CDP notice and the taxpayer timely requested a CDP hearing. The taxpayer, apparently now represented, had a “telephone CDP hearing” on July 24, 2018. The representative basically made the following points: the company had become “defunct” in October 2011; it had no assets; and, by the way, while it owed some taxes, the IRS had mis-allocated various amounts to the wrong quarters. At a time not stated in the opinion, but sometime after my birthday in 2018 Appeals issued its Notice of Determination sustaining collection activity for the assessed liability. The taxpayer, still represented, petitioned Tax Court for review.
Recall that §6330(c)(2)(B) allows taxpayers to challenge the merits of a tax liability when they "did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability.” In both of these cases the Tax Court refused to let the taxpayers dispute the liabilities because each taxpayer had blown a prior “opportunity” to do that.
So, did you spot where each taxpayer “otherwise” had “an opportunity to dispute such tax liability”? Let’s look closely.
Mr. Shepherd’s opportunity come in the tax collection process and not in the tax determination process. That is because Mr. Shepherd did not actually receive the 30-day letter pre-assessment. So while the letter complied with the notice provisions of §6672(b)(1) by being sent to the last known address, its non-receipt meant it was not an “opportunity” sufficient to prevent Mr. Shepherd from later contesting the liability in a CDP hearing. Mason v. Commissioner, supra.
Mr. Shepherd’s prior opportunity instead came in his first CDP hearing. Even though he may then have seen no reason to litigate a liability he could not pay at that time, that was indeed his prior “opportunity to dispute” his liability for the TFRP. If he had been represented, one would hope the representative would have done so. But notice this: even if he had raised the merits objection there and then Appeals refused to deal with it because it put him in CNC, he would need to appeal the CNC decision to Tax Court. McNamee v. Commissioner, T.C. Memo 2020-37.
In contrast to Mr. Shepherd, Patrick’s Payroll’s opportunity did come in the tax determination process. The 30-day letter to it did constitute an “opportunity to dispute” the assertion of employment taxes and related penalties. As Judge Urda notes: “Patrick’s Payroll does not dispute that it received a 30-day letter affording it the opportunity to contest is 2010 and 2011 underlying liabilities before the Office of Appeals.” Instead, Patrick’s Payroll’s main argument was the 30-day letter was an "opportunity" within the meaning of the statute because it carried with it no opportunity for judicial review. Treas. Reg. 301.6630-1(e)’s interpretation to the contrary was an invalid interpretation of the statute. It appears the argument was made simply to preserve it for appeal to the 6th Circuit (the taxpayer was based in Michigan), a circuit which has not yet ruled on the issue. Well, good luck with that! As Judge Urda points out, the four circuits to have considered this argument have upheld the Treasury's regulatory interpretation.
I admit to being confused as to why either of these taxpayers were really in Tax Court. Notice that both taxpayers purport to dispute the merits of their liabilities. However, if they truly wanted a merits determination, trying to squeeze through the eye of the CDP needle is an exceedingly strange way to do that. That is because both taxpayers are on the hook for divisible taxes. Sure, the totals are big ($165,000) and bigger ($1,000,000). But to get a merits determination they need only pay the tax for one employee for one quarter and then file a refund claim, followed by a refund suit, in their choice of federal district court or the Court of Federal Claims. In fact, if they did that, §6331(i) would also likely prohibit levies once they filed suit. To my untrained eye, it seems these taxpayers are simply just want to delay collection for the sake of delay. I welcome comments on what might be their purpose here other than delay for the sake of delay.
For taxpayers like Mr. Shepard or Patrick’s Payroll, the Service’s mingy interpretation of “opportunity to dispute” does little harm. In contrast, it does great harm to those I call the “inarticulate can’t-pays”: those taxpayers who lack the ability to deal with what life is throwing at them, whether at the moment or continuously. I like the way Bill Timm puts it: “A taxpayer’s lack of affordable representation, education, or English comprehension can render meaningless his opportunity to dispute.” See Effectively Representing Your Client Before the IRS (6th Ed.) Chapter 10 “Handling Tax Collection matters---Procedures and Strategies” at 10-53. Such taxpayers need a better system. The key problem for them is the Flora full pay rule. It’s time for that rule to be revised. But that’s a subject for a different blog and a different time.
Bryan Camp is the George H. Mahon Professor of Law In His Residence near the Texas Tech University School of Law.