The Tax Code contains a variety of statutes designed to protect taxpayers from unreasonable and arbitrary decisions by the IRS. I think of them as quality control measures: they require supervisory approval of certain decisions, such as the decision to impose a penalty (§6751) or the decision to open a second examination (§7605(b)). One can also think of quality control as any procedure that allows a different decision-maker to enter the picture, not just a supervisor. That was the lesson last week, when the Office of Chief Counsel entered the picture and fixed a problem.
But no matter what quality controls the IRS uses, or what training it gives its employees, final decisions about either the assessment or collection of taxes are sometimes simply not defensible. Getting such decisions corrected in court costs taxpayer both time and money. Section 7430 permits such taxpayers to recover the costs they incurred to fix an unreasonable decision. In that sense, it is another quality control measure.
In Tung Dang and Hieu Pham Dang v. Commissioner, T.C. Memo. 2020-150 (Nov. 9, 2020) Judge Marvel teaches a lesson on the limits a taxpayer’s ability to recover costs under §7430. There, the Office of Appeals made an indefensible decision about the collection of the Dangs’ unpaid taxes and the IRS conceded the case in Tax Court. Nonetheless, the Dangs were not eligible to recover the costs they incurred in fixing that unreasonable CDP decision. Details below the fold.
Law: Section 7430
Under long-standing general principals in U.S. law, parties generally bear their own costs in litigation. In contrast to this “American rule” the “English rule” requires the loser in court to pay the winner’s costs, including those all-important attorneys fees. There is a robust academic debate on which rule is better and why. Readers who are interested will find fun reading in John Leubsdorf, Does The American Rule Promote Access to Justice? Was That Why It Was Adopted? 67 Duke L.J. Online 257 (Jan. 2019).
Section 7430 modifies the American rule. The idea is that taxpayers bear their own costs in a dispute with the government, but only up to a certain point. Taxpayers can recover reasonable administrative and litigation costs if the taxpayer is a “prevailing party” in the relevant administrative or court proceeding. §7430(a). To be a prevailing party, the taxpayer must show that they “substantially prevailed with respect to the amount in controversy” or “with respect to the most significant issue or set of issues presented.” §7430(c)(4)(A). The taxpayer will not be a prevailing party, however, if the government can show that its loser position---called “the position of the United States”---was substantially justified at the relevant time. §7430(c)(4)(B).
I teach §7430 as a quality control measure. Its purpose is to ensure that the IRS takes responsible precautions to ensure that formal decisions about tax liability or tax collection are within the bounds of reason.
The substantial justification requirement for the position of the United States is the quality control component and it contains a timing aspect that is important to today’s lesson. That requirement does not just address whether someone in the IRS messed up and why. It also looks to see whether another function in the IRS was able to fix the error before the error became so fixed that the government ought to reimburse the taxpayer for the extra costs the taxpayer had to incur. It has a timing aspect.
You can see that timing aspect to the substantial justification requirement in the definition of “position of the United States” in §7430(c)(4)(B)(1). Channeling Yogi Berra, the law recognizes that the bureaucratic process is not over until it is over. Thus, the timing requirement is different for purposes of reimbursing administrative costs than for purposes of reimbursing litigation costs once a taxpayer is in court.
With respect to administrative proceedings, taxpayers can recover only those costs incurred after the “position of the United States” is fixed in the earlier of two dates: (i) the date taxpayer receives “the decision of the Internal Revenue Service Independent Office of Appeals,” or (ii) the date of the NOD. §7430(c)(4)(B). Treas. Reg. 301.7430-3(c)(1) gives a taxpayer-friendly interpretation to the statute and adds an even earlier date: the date of a 30-day letter.
Thus, the “position of the United States” that is evaluated for reasonableness in the administrative proceeding is the position taken at the earliest of those three time periods. What happened before those dates is not relevant, only what happens afterwards. The Court will ignore whatever position was taken before the earliest of those three dates for purposes of determining whether the taxpayer was a prevailing party. What it cost the taxpayer to engage in the administrative process before those dates is not reimbursable. It’s the American rule up until the earlier of those events, and then a modified English rule afterwards.
With respect to court proceedings, the timing changes. Now the “position of the United States” that counts for determining whether a taxpayer can recover litigation costs is not simply the position maintained by IRS offices up to that point. Section 7430(c)(7)(A) says instead that the relevant position is “the position taken by the United States in a judicial proceeding.” The reason that application of the statute makes sense is because a new office representing the United States comes into the picture when litigation starts: either the DOJ Tax Division or the IRS Office of Chief Counsel.
Courts are in agreement that that the “the position taken...in a judicial proceeding” is presumed established once the government files its formal answer in response to the taxpayer’s initial pleading. See Huffman v. Commissioner, 978 F2d 1139, 1148 (9th Cir. 1992)(“if the Government concedes the petitioner's case in its answer, its conduct is reasonable”); Grant v. Commissioner, 103 F.3d 948 (11th Cir. 1996). That is just a presumption, however, and can be overcome. For a good explanation see Friends of Benedictines in Holy Land, Inc. v. Commissioner, 150 T.C. 107, 116 (2018).
Accordingly, if the IRS concedes a case in its first responsive pleading, the “position of the United States” courts generally find the government is substantially justified as to the litigation and the taxpayer will not be a prevailing party entitled to litigation costs. This makes sense because the government is not forcing the taxpayer to engage in litigation. Again, as we saw in last week’s lesson, this allows the Office of Chief Counsel to enter as a new administrative decision-maker and impose some quality control on an otherwise unreasonable IRS position. That's what happened in today's case, but with a twist.
The IRS audited the Dangs' 2008 and 2009 returns, found deficiencies and issued an NOD. The Dangs went to Tax Court and eventually the parties entered into a stipulated decision in February 2105, whereby the IRS assessed some $91,000 in tax, but no penalties.
When the IRS started collection action against the Dangs, the Dangs asked that the IRS levy Mr. Dang’s IRA. The IRS employees working the case refused to do that because they thought the Dangs should pay using other assets. Eventually, the collection function filed an Notice of Federal Tax Lien, and sent the Dangs both the NFTL CDP notice and a levy CDP notice. The Dangs timely asked for a CDP hearing. During the CDP hearing the Dangs again asked Appeals to approve the collection alternative of seizing Mr. Dang’s IRA.
On September 8, 2017, Appeals issued a Notice of Determination. It refused to consider the Dangs’ collection alternative and sustained the IRS ability to levy and maintaining the NFTL.
On October 10, 2017, the Dangs petitioned Tax Court for review, thus triggering the involvement of Chief Counsel. As we saw last week, that can be very helpful and so it was here.
On December 1, 2017, the Office of Chief Counsel filed the government’s Answer in Tax Court, fully conceding that Appeals abused its discretion and noting that it would ask for a remand so Appeals could correct its error and consider the Dangs’ request for what was, in effect, a substitution of assets. On May 17, 2018, after remand, Appeals approved the request. By then, however, the Dangs had been able to borrow the money needed to pay off the 2008 and 2009 liabilities and so they were able to pay in full.
On August 10, 2018, the Tax Court case was closed as to all issues except the Dangs’ request for reasonable litigation and administrative costs.
Lesson: It’s All In the Timing
Judge Marvel first addresses whether the Dangs are entitled to administrative costs. She concludes they are not because there was simply no unreasonable “position of the United States” after the Notice of Determination. Recall that the relevant position of the United States” to be evaluated is the position taken in the earliest of three dates. Two of those dates are relevant to only the deficiency process. The other relevant date is the date on which Appeals issues its determination. Here, that was the CDP Notice of Determination. As Judge Marvel writes: “the date of the notice of determination is the only applicable date under the statute for a claim of administrative costs in section 6330/6320 cases to begin accruing.” Op. at 8. She then finds there were no further administrative proceedings after the CDP Notice of Determination. “And, because the notice of determination in section 6330/6320 cases also concludes the administrative proceeding, a taxpayer cannot recover an award for administrative costs arising in a section 6330/6320 proceeding.” Id. It’s all in the timing.
Judge Marvel then addresses whether the Dangs are entitled to litigation costs. She concludes they are not because the IRS conceded the merits in its Answer and asked that the case be sent back so Appeals could correct its error. The prompt concession thus made the government’s litigating position substantially justified. It’s all in the timing.
Comment: Section 7430 As A Quality Control Statute
One might well believe that the Dangs should recover the costs associated with the remand to Appeals. If the purpose of §7430 is really to ensure that the IRS makes quality decisions by compensating taxpayers for the costs of correcting a manifestly erroneous IRS decision, then such an argument has merit. After all, the result of the Chief Counsel’s concession in Tax Court was not to end the Dangs’ costly legal journey, but simply to put them back in front of the same Appeals Office that had concededly abused its discretion in the first go-around. On this view, Judge Marvel’s comment that the initial CDP Notice of Determination was the conclusion of the administrative proceeding seems incorrect. There were indeed further administrative proceedings after that CDP Notice of Determination. They came because of the remand. Sure, there were no further litigation costs. But I would consider these further administrative costs.
One might say the case shows that the administrative quality control worked, just like last week. The difference this week, however, is that the Chief Counsel's review did not end the taxpayers' journey. The result was not an outright reversal, but was a do-over in Appeals. This would be the same result if the taxpayers had been able to get help from TAS.
We see here how limited §7430 is. It’s a cautious modification of the American Rule, not a wholesale reversal. The caution is that the cost of getting a bureaucracy like the IRS to fix an error is normally borne by the taxpayer. The statute gives generous room to let the IRS fix its mistakes without being forced to pay out costs.
It might be that the Court was considering the Dangs' costs on remand as part of their litigation costs, which were not recoverable because the government had conceded. But nothing in the statute says that administrative procedures might not occur after litigation. What puzzles me here is why the remanded CDP proceeding would not count as an administrative proceeding. After all, the statute says that taxpayers may recover costs for “any administrative or court proceeding... in connection with the determination, collection, or refund of any tax.” True, the regulation says CDP hearings are not administrative proceedings within the scope of §7430. Treas. Reg. 301.7430-3(a)(4), (b). But I am not entirely sure why. I obviously am missing something and probably this is explained in the regulation’s preamble. But maybe not. The same regulation says tax exemption proceedings are also not within the scope of §7430. The Tax Court dodged ruling on whether that is a proper interpretation of the statute in Friends of the Benedictines, supra. See Keith Fogg’s great post on that case over at Procedurally Taxing blog.
It may be a court should give this part of the regulation more scrutiny. The IRS makes mistakes in tax collection proceedings as well as tax determination proceedings. The Office of Appeals is itself an important quality control measure in the IRS. When it screws up, as it did here, the quality control measures failed. Whether Appeals commits egregious error in a deficiency case or a CDP case does not seem to be relevant to the purpose of §7430 as a quality control measure. It seems more consistent with the purpose of §7430 to make the government reimburse a taxpayer for the additional costs the taxpayer incurs to fix a failure with the very part of the bureaucracy that is supposed to perform the quality review!
Bryan T. Camp is the George H. Mahon Professor of Law at Texas Tech University School Thereof. He invites readers to return each week for another quality Lesson From The Tax Court.