Collection Due Process (CDP) is designed to protect taxpayers from abusive collection actions by the IRS. American Limousines, Inc. v. Commissioner, T.C. Memo. 2121-36 (Mar. 25, 2021) (Judge Halpern), teaches that CDP does not require the IRS to stop trying to collect from a business just because the business was failing. There the taxpayer owed over $1.1 million in employment taxes. The Office of Appeals rejected both the taxpayer’s installment payment offer of $2,000 per month, and its alternative proposal to be placed in CNC. The taxpayer said that the Office of Appeals should have put it into CNC to allow its business to improve. The Tax Court upheld the Appeals determination, finding that Appeals satisfactorily balanced the need for collection against the difficulties enforced collection would create for the taxpayer. Details below the fold.
Background: The Employment Tax Gap
Last week's post discussed how the Federal Insurance Contributions Act (FICA) imposes taxes on both employers and their employees to fund the various benefits provided by the Social Security Administration and how those tax obligations are imposed on shareholders of S Corporations. Today’s post focuses on the collection of those taxes.
The taxes on employers are an excise tax imposed by §3111(a) and (b) for the act of employment, and are measured by the amount of wages paid. An additional excise tax imposed by §3301(a) goes to help fund state unemployment benefits and services. The taxes on employees are an income tax, imposed by §3101.
Employers have the responsibility to pay both set of taxes. Employers must pay over the taxes imposed on employees by withholding those taxes from employee paychecks. I am sure we all remember our first paycheck! Employers must also withhold and pay over their employees’ income tax obligations. Both sets of taxes on employees---employment taxes and income taxes---are amounts owed by the employees but collected on behalf of the government by employers. They are known as "trust fund" taxes because the money collected is deemed to be held in trust for the United States. §7501(a).
Employers have the same payment obligations for both sets of taxes: the taxes imposed directly on them and the trust fund taxes they are supposed to collect from employees. They report all of this quarterly on Form 941.
Employers do not always meet their responsibilities. This DOJ Tax Division website says that “When last measured, employment tax violations represented more than $91 billion of the gross Tax Gap and, after collection efforts, $79 billion of the net Tax Gap in this country.” That statement combines both direct taxes and trust fund taxes. So it is not entirely clearly how much of the tax gap is due to employers failing to pay their own taxes and how much is due to employers failing to pay over the trust fund taxes withheld from employees’ paychecks. See also IRS Publication 5364 (Revised 9-2019).
How many of us have heard a client say “we’ll catch up our taxes later when business improves”? But later never comes. This Small Business Administration website says that about half of all small businesses fail within their first five years of operations. These statistics from Bureau of Labor Statistics bear that out. Cash-flow problems cause some 80% of small business failures. See G. Dautovic, “Why Small Businesses Fail” (May 27, 2020)(citing to studies). These cash flow problems tempt employers to borrow from Peter (the federal government) to pay Paul (more immediately important creditors such as utilities and suppliers).
When employers consistently and repeatedly fail to meet their employment tax obligations, those liabilities begin to pyramid into an unholy mess. In particular, when the IRS receives only a partial payment of the employment taxes due, it allocates those payments to the employer’s obligations first. That is because the IRS has a back-up collection tool for trust fund taxes in the form of the §6672 Trust Fund Recovery Penalty. See e.g. Stevens v. United States, 49 F.3d 331 (7th Cir. 1995), where in rejecting the taxpayer’s objection to that practice, Judge Posner explains that “[t]he government's motive was transparent but not disreputable. Every dollar it allocated to trust fund taxes would reduce by one dollar the amount it could collect in penalties from the responsible person, while every dollar it allocated to non-trust-fund taxes would reduce the unpaid amount of those taxes by one dollar.” The Tax Court has taught us several lessons about the §6672 penalty over the years. See e.g. Bryan Camp, Lesson From The Tax Court: The Misunderstood Trust Fund Recovery Penalty, TaxProf Blog (Aug. 27, 2018), and Bryan Camp, Lesson From The Tax Court: §6672 Trust Fund Recovery Penalty Is Really A Penalty...Sort Of, TaxProf Blog (Jan. 27, 2020).
Background: The Collection Due Process Balancing Requirement
In the mid-1990’s the Senate Finance Committee conducted widely publicized hearings showcasing lurid allegations of abuses in the collection process. Most of those allegations were later proved false. But it was the allegations, rather then their truth or falsity, that prompted the creation of the CDP provisions now contained in §6320 and 6330. Internal Revenue Service Restructuring and Reform Act of 1998 (“RRA 1998”). See generally, Danshera Cords, How Much Process is Due? I.R.C. Sections 6320 and 6330 Collection Due Process Hearings, 29 Vermont L. Rev. 51 (2004). See also, David Cay Johnston, Inquiries Find Little Abuse By Tax Agents, N.Y. Times (Aug. 15, 2000).
As we learned a few weeks ago, the CDP process that Congress created allows taxpayers the important benefit of explaining to a high-level IRS employee (called a Settlement Office or SO) why they cannot fully and immediately pay the assessed tax. Taxpayers can argue for what are called “collection alternatives,” which include an Offer In Compromise (OIC), an Installment Agreement (IA), a Partial Pay Installment Agreement (PPIA), or relegation to Currently Not Collectible (CNC) status. These are alternatives to full-bore collection efforts against the taxpayer’s assets. See Lesson From The Tax Court: No Second Bite In CDP For Rejected OIC, TaxProf Blog (Mar. 1, 2021).
But CDP promises more Section 6330(c)(3) requires that in addition to making sure the IRS collection function properly crossed all the “t’s” and dotted all the “i’s” and in addition to giving the taxpayer an opportunity to propose collection alternatives, the SO conduct a balancing inquiry, by making sure that "any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary.”
This balancing requirement in the statute does not get fleshed out much in other guidance. The Senate Finance Committee Report to the legislation that created §6330 does explain that the purpose of the balancing requirement was to ensure that “[a] proposed collection action [is] not be approved solely because the IRS shows that it has followed appropriate procedures.” S. Rept. 105-174 (1998), at 68. The IRM also gives some guidance. IRM 184.108.40.206.7 (11-13-2013)(“Balancing”) explains that the balancing decision is “tied to the taxpayer's: Actions or inaction; Compliance history; Financial circumstance.” It gives no further instruction. There is almost no case law.
Today’s case gives us a nice lesson on that balancing requirement, at least as applied to business taxpayers.
American Limousines, Inc. (ALI) advertises itself as “the premier provider of ground transportation for corporate, wedding and leisure activities in the Baltimore Metro Area and beyond.” It was also a premier noncompliant taxpayer, having pyramided over $1.1 million in unpaid employment taxes over the years 2009-2016. Op. at 2.
In 2017 the IRS sent levy CDP notice and ALI timely requested a CDP hearing. During the course of the hearing, ALI made two proposals: an IA proposal and a CNC proposal.
First, it proposed to pay off the $1.1 million debt at the rate of $2,000 per month. The SO sent the proposal to Collection for evaluation. That evaluation required a Revenue Officer to determine the reasonable collection potential (RCP). Doing so, the RO found that ALI had an RCP such that it would take an IA of $22,877 per month to justify not proceeding with immediate levy. Op. at 6.
ALI’s attorney disputed the RCP calculations and offered an alternative analysis that showed cash flow of “just about breakeven.” He then said that ALI could nonetheless pay $2,000 per month but “was not interested in an installment agreement requiring monthly payments of $22,877.” Op. at 7. The SO rejected the $2,000 offer for two reasons. First, nowhere did ALI explain how it could come up with $2,000 per month. ALI’s own analysis showed monthly negative cash flow. The taxpayer’s only argument for how it could meet the $2,000 obligation was that time-tested canard “business will improve.” Second, the SO was doubtful that the taxpayer would stick to any agreement. She noted that two years previously the taxpayer had owned 20 vehicles in its business and had the cash flow ability to pay down the tax debt but instead chose to expand its fleet to 28 vehicles. That raised a question about the intent of the taxpayer to keep compliant.
The second collection alternative ALI offered was CNC. Basically it said “well, if you don’t really think we can afford even the $2,000 per month, then you should put us into a currently not collectible status.” The SO was not willing to do that, noting that the company appeared to be on the brink of bankruptcy and concluding that collecting from the assets of the company would be a better choice for collection than waiting for uncertain improvement in the taxpayer’s business.
Lesson: Collecting Assets of Failing Business Is Not Abusive
Before the Tax Court, the taxpayer argued that the SO had abused her discretion by, firstly, rejecting the proposed installment agreement and, secondly, refusing to put the taxpayer into a CNC status.
Judge Halpern disagreed. As to the proposed installment agreement, note that the taxpayer basically poor-mouthed itself into a corner. Its disagreement with the IRS was about how to account for its vehicles in determining a reasonable collection potential. But there was no reason for Judge Halpern to review that disagreement because the purpose of CDP is not to force the IRS to propose a collection alternative to the taxpayer. It is rather on the taxpayer to persuade the IRS to accept the collection alternative the taxpayer proposes. Here, the taxpayer’s own analysis showed a monthly cash deficit of $935. Judge Halpern said that the SO did not abuse her discretion in rejecting the $2000 per month when the SO found that “based on your own evaluation, you are unable to fund it.” Op. at 14.
As to the CNC decision, Judge Halpern noted that ALI’s “claim on brief, unsupported by any citation of the record, that it is ‘optimistic about its prospects’ is insufficient to raise a question in our mind that [the SO] abused her discretion in determining not to classify petitioner’s past-due account as currently not collectible.” Judge Halpern concludes by citing to prior case law to support the proposition that “the government is not required to continue subsidizing failing businesses by foregoing tax collection.”
Comment: Scope of CDP For Business v. Individual Taxpayers
A potentially important point here is that this was a business taxpayer, not an individual. Thus, the thumb on the scale favors collection action to stop the taxpayer from pyramiding employment tax liabilities. Capitalism is harsh. Failure is a feature, not a bug, of a robust capitalist system. It is not the job of the tax collector to subsidize businesses. That is what Congress does by direct legislation! But allowing businesses to pyramid employment taxes is an indirect subsidy. When business fail to keep current on employment taxes, that essentially forces the government to lend money. That is why the thumb is on the side of collection from failing businesses.
But that thumb is not as important when the Tax Court reviews the balancing requirement in CDP cases involving individuals and their income tax liabilities. Keith Fogg has good commentary on this point in Appeals Abuses Discretion in a Collection Due Process Case by Failing to Engage in Financial Analysis, Procedurally Taxing Blog (Feb. 15, 2017).
Bryan Camp is the George H. Mahon Prof. of Law at Texas Tech University School of Law. He invites readers to return each Monday to TaxProf Blog for another Lesson From The Tax Court