We worked through Spring and Winter, through Summer and through Fall,
But the mortgage worked the hardest and the steadiest of us all.
It worked on nights and Sundays, it worked each holiday,
Settled down among us and it never went away.
-Ry Cooder, “The Taxes on The Farmer Feeds Us All,” Into The Purple Valley (1972)
Today’s lesson is the taxpayer version of that famous Depression-era song: the accumulation of interest on tax liabilities is relentless, and difficult to reverse. In Kannarkat P. Verghese et al. v. Commissioner, T.C. Memo. 2021-70 (June 7, 2021) (Judge Gustafson), the taxpayers were assessed a deficiency in 2014 for their tax years 1997 and 1998, as a result of over 13 years of audit and litigation between the IRS and three partnerships in which the taxpayers held an interest. The taxpayers promptly asked for most of the accumulated interest to be abated per §6404. They diligently pursued that request through 7 years of administrative and judicial proceedings. Finally, last week, the Tax Court largely upheld the IRS’s refusal to abate the interest, teaching us our lesson. The lesson cost these taxpayers over $80,000 in accrued interest (on liabilities of $54,000). Not to mention attorneys fees. But you can learn this lesson for free. Just click on "continue reading..."
Oh, and we also get a bonus lesson on §6603. Apparently no one told these taxpayers they could suspend the running of interest by making a deposit in the nature of a cash bond. Whoops.
Law: Interest Is Relentless
Section 6601 gives us the basic rule: “if any amount of tax...is not paid on or before the last date prescribed for payment, interest on such amount...shall be paid for the period from such last date to the date paid.” Other statutes give more details. For example, the interest rate is set every three months, at 3% above the federal short-term rate. §6621. It is compounded daily. §6622(a).
That all seems simple enough but taxpayers repeatedly fail to understand three key points: (1) interest generally accrues on liabilities, not assessments; (2) interest never stops until “the date paid”; and (3) the IRS can collect interest even before formally assessing it. Let’s take a quick look at each.
First, taxpayers need to know that interest rolls merrily along during all the pre-assessment tax determination process of a taxpayer’s proper income tax, including audit, protest, Appeals, and Tax Court litigation. All of that tax determination process happens before an actual assessment of a tax liability. And interest accrues during that entire pre-assessment time. True, for some penalties such as the Trust Fund Recovery Penalty interest does not start until assessment. See §6601(e)(2). However, even for most additions to tax and for penalties that are associated with positions taken on the return, such as the §6662 set of penalties, interest starts accruing under the general rule in §6601(a), starting on the “last date prescribed for payment” of the underlying tax.
Second, taxpayer need to know that interest just does not stop until the underlying liability is fully paid. Like your mortgage, it works on weekends and holidays. And it keeps on working even when the IRS suspends active collection of a client’s tax liabilities, such as by putting the account in “Currently Not Collectible” status. Collection stops but interest continues, steadily increasing the amount owed. See IRM 220.127.116.11.9(15) (04-13-2021).
Third, the IRS can collect interest even before it assesses the interest. No one is really sure why.
The most comprehensive explanation I know of comes from Judge Posner in Stevens v. United States, 49 F.3d 331 (7th Cir. 1995). There, the IRS had assessed unpaid employment tax liabilities against a corporation of which Mr. Stevens was president. The IRS then served a Notice of Levy on a Trust that owned a building in which both the corporation and Mr. Stevens had equitable interests. The notice of levy listed both the assessed and unpaid employment taxes, as well as the unassessed but accrued interest and §6662(a) penalties. The IRS then applied the sale proceeds to both assessed taxes and unassessed interest and penalties. Mr. Stevens sued for a refund of the latter and the government counterclaimed for the balance due.
One of Mr. Steven’s arguments was that the IRS could not use the sale proceeds to satisfy unassessed but accrued interest and penalties. Id. at 336 (“Stevens argues that without making an assessment the IRS had no right to collect these statutory additions and therefore no right to allocate the proceeds of the sale of the building to them.”)
Judge Posner rejected that argument, but he waffles a bit on why. He gives three alternative reasons for his decision without telling us explicitly which reason controls.
Posner’s main reason seems to rely on the difference between a liability and the assessment of that liability. Posner correctly notes that assessment is just a formal act of recording a liability; it does not create tax liability, but rather just reflects liability. Yup. That's solid. We got the Supreme Court telling us that. Lewis v. Reynolds, 284 U.S. 281 (1932). Mr. Steven’s accrued interest was a liability—a debt owed to the government—and it was reflected in the Notice of Levy as part of the amounts being seized. Posner says that once the government legitimately got its hands on a payment it could use the payment to satisfy all the liabilities reflected on the Notice of Levy, including the accrued but unassessed interest liability.
Posner does not stop there, however. That might be because the first reason does not explain why the IRS can keep additional accrued interest that was not even reflected on the Notice of Levy. So Posner gives a second reason: even if an assessment was required why, hey! there was an assessment! “The assessment, which preceded the notice of levy and hence the endorsement of the check from the building's buyer, was an assessment of the unpaid taxes plus interest and penalties. The amount was not stated. Of course not. It would depend on when the taxes were paid. *** Since the statutory additions grow at a rate fixed in the statute, the taxpayer knows what he owes from day to day. Therefore no purpose would be served by requiring the IRS to make continuous assessments as a condition of collecting the additions.” Id. at 336 (citations omitted).
Posner also does not stop there! He gives yet a third reason, which would be the narrowest basis for his decision: “But even if everything that we have said so far on the issue of assessment is wrong, Stevens must lose. It is only when the government wants to proceed administratively, as by filing a tax lien, that notice and demand [of an assessed amount] are required. Their absence is irrelevant in a refund suit with counterclaim.” Id. at 337 (citations omitted).
So pick your poison. Each rationale has different scope of operation. But all three support the idea that the IRS is able collect interest without having first assessed it.
Law: Suspending Interest
If the interest monster lurking in the shadows of an audit gives taxpayers concern, they have two options to slay the beast, or at least stunt its growth. One option is to just pay the potential tax. The problem with that is if one accidentally pays all or more than what the IRS eventually decides is due, then one loses the ability to litigate in Tax Court because there will be no “deficiency” over which the Tax Court can take jurisdiction. The better option is thus usually to send money to the IRS but explicitly designate it as a “deposit” rather than a “payment.” Section 6603 gives the details, but basically says that if the taxpayer sends in a deposit that the IRS applies to the tax period under dispute, then the deposit will stop interest accruing on that amount.
There are myriad additional rules not germane to today’s post, but the key idea is that taxpayers can stop the running of interest without making an actual payment. That both preserves Tax Court access and stops interest at the same time; and §6603 even allows a deposit to earn interest if it turns into an overpayment, under certain circumstances again not relevant to today’s Lesson.
Law: Abating Interest
Once assessed, interest is really hard to get rid of. Only under certain narrow circumstances can taxpayers get the IRS to abate an assessment of interest on an income, estate, or gift tax liability.
Section 6404(a) is no help for most taxpayers. True, it gives the IRS a general authority to abate the assessment of “any tax” that is excessive in amount. And, true, §6601(e)(1) tells us that any reference in the Tax Code to “tax” also includes the interest imposed by §6601. So it may look like §6404(a) authorizes abatement of interest assessments that are “excessive in amount.”
Not really. Taxpayers seeking abatement of interest on income, estate, or gift tax liabilities are blocked by §6404(a). That statute says: “No claim for abatement shall be filed by a taxpayer in respect of an assessment of any tax imposed under subtitle A or B.” The Tax Court has consistently interpreted this to mean that what subsection (a) permits, subsection (b) denies for income, estate and gift taxes and since interest is to be treated as a “tax” the prohibition in (b) applies to abatement of interest as well as the underlying liability. Urbano v. Commissioner, 122 T.C. 384 (2004). Since today’s lesson involves income tax liabilities, we’ll put §6404(a) aside.
Taxpayers seeking abatement of interest on income, estate, or gift tax liabilities must use §6404(e), the subsection specifically addressing abatement of interest. Taxpayers must first try to convince the IRS to abate, using Form 843. If the IRS denies the request, taxpayers can seek judicial review. §6404(h).
Obtaining an abatement is an uphill climb. Taxpayers must prove: (1) the IRS itself caused a delay that was unreasonable; (2) the delay was in the performance of a ministerial or managerial act; (3) the taxpayer did not contribute materially to the delay; and (4) the delay occurs after the IRS first contacts the taxpayer “in writing with respect to the deficiency or the payment.” §6404(e)(1). Failing to clear any one of these hurdles will end the quest for abatement.
Each of these four requirements are difficult to meet. For example, the regulations tell us that ministerial acts are procedural or mechanical acts that do not involve the exercise of judgment or discretion. They are only those acts that occur during the processing of a taxpayer's case after all prerequisites to the act, such as conferences and review by supervisors, have taken place. Treas. Reg. 301.6404-2(b)(2). The example in the regulation of a ministerial act is the act of issuing an NOD after all the proper sign-offs have been obtained. So a delay during the review and approval process is not a ministerial act.
Even when a taxpayer proves all four requirements, the uphill climb is not done: Judge Gustafson reminds us that the Tax Court has created a further requirement: the taxpayer must link specific causes to specific periods of delay; assertions of delay “cannot be formulated as a broad request to waive all interest.” Op. at 34 (citing to a bunch of cases).
Finally, to make the uphill climb even steeper, §6404(h) says that the Tax Court will review the IRS refusal to abate under a very lenient abuse-of-discretion standard of review. That is because abatement is an act of discretion. See Mekulsia v. Commissioner, 389 F.3d 601, ___ (6th Cir. 2004) ("A taxpayer must both demonstrate the ministerial act and prove abuse of discretion in denying the abatement. ").
Thus, once the tired taxpayer has hiked into Tax Court to contest the IRS denial of an abatement request, the taxpayer must prove both that they meet the four statutory requirements above (plus the Court-created requirement). And they must also prove that the IRS was unreasonable in deciding otherwise. That is, even if the judge is convinced that he or she would have exercised discretion to abate, the taxpayer must show that no reasonable person would have refused to abate! That is what an abuse-of-discretion review standard means.
That’s one steep hill. Today we learn just how steep. It is important to know that it appears these taxpayers were, since at least 2015, capably represented by counsel, attorneys Daniel S. Heller and Gerald W. Kelly, Jr. The inability of these professional to successfully climb the hill shows just how difficult the journey really is.
Dr. and Ms. Verghese got mixed up in a tax shelter scheme in 1997 and 1998. They had invested in three partnerships all of which engaged in a fraudulent charitable donation scheme. The Vergheses had no idea. They were repeatedly assured by a bad man that the arrangement was legit. One partnership was picked up for audit in 1998. By 2000 all three partnerships were under audit. Judge Gustafson notes that the record does not show precisely when the IRS gave written notice but assumes, “for purposes of summary judgment that it occurred before the commencement of the TEFRA litigation.” Op. at 43. That is the assumption most favorable to the taxpayers because it allows them to clear one of the four §6404(e) hurdles listed above.
The IRS finished the TEFRA audits in 2002, issued appropriate notices, and the partnerships contested the proposed adjustments in Tax Court. The civil litigation paused, however, in 2005 while criminal charges were being sought against the bad man and his accomplices. By 2009 the criminal matter was finalized: the bad man was convicted and sentenced. The civil trial resumed, concluding in April 2013 when the Tax Court entered a stipulated decision under Tax Court Rule 248, reflecting an agreement between the parties on the proper outcome of the case.
In 2014 the IRS sent the Vergheses Notice CP22E, which told them to pay up not only the tax they now owed for 1997 and 1998, but also the accumulated interest, which was much more than the tax. They did not. Instead, the Vergheses filed a Form 843, requesting abatement of the interest that had accumulated, thus triggering almost 7 years of conflict and stress, during which Dr. Verghese passed away.
Part of the reason it took almost 7 years to resolve the Vergheses’ claim for abatement is that they had to make two trips to Tax Court. While one part of the IRS was processing the Form 843, another part of the IRS was attempting to collect the assessed taxes, interest, and penalties.
In 2015 the IRS sent the Vergheses a CDP notice and they timely requested a CDP hearing. During this first CDP hearing they repeated their request for interest abatement. Actually, that was pretty much all they wanted. Their attorney repeatedly said that was their only issue. During that first CDP hearing, however, the Settlement Officer decided that she could not consider their interest abatement issue.
The Vergheses petitioned the Tax Court claiming that the SO’s refusal to consider their interest abatement was an abuse of discretion. The IRS Chief Counsel’s office agreed, and so in June 2016 the Tax Court remanded the matter back to Appeals. The Vergheses then got a second CDP hearing with a second Settlement Officer. This second SO did consider the interest abatement....and ion 2017 exercised the discretion given by §6404 to deny all requests for abatement.
Thus did the matter came back to the Tax Court in July 2017, after which the IRS filed a summary judgment motion in April 2018, two months before the scheduled trial. The Vergheses countered with a Motion to Compel discovery, claiming that they would surely be able to show how and why periods of delay were the fault of the IRS if only they had more information from the IRS.
By the time the matter was ready for decision, the taxpayers had grouped their abatement requests into three time periods: (1) The entire period from commencement of the combined TEFRA audits in 2000 to the entry of Tax Court judgment in April 2013; (2) The period of criminal prosecution from 2005 To 2009; and (3) The period of the partnership tax litigation from February 2009 to its conclusion in April 2013. They did not appear to seek abatement of interest for any part of the 7 years during which they were seeking abatement of interest. Perhaps they had stopped the further accumulation of interest by paying the underlying liability.
Lesson: Almost No Delay Qualifies for Interest Abatement
Each time period teaches the same lesson.
- The entire period.
Judge Gustafson first rejects the taxpayers’ Hail Mary effort to get interest abated for the entire time period from audit to assessment, 2000 to 2013. The taxpayers made two loser arguments.
First, they tried to avoid even climbing the steep hill of §6404(e) by claiming they were entitled to interest abatement under §6404(a). Nope. As I explain above, it’s black-letter law that §6404(a) does not apply to abatement requests for interest on income tax liabilities (nor estate and gift tax).
Second, the taxpayers swore that the IRS never told them about the deposit rules, neither when it first notified them about the partnership audits nor at any time after that. That failure created a delay caused by an unreasonable ministerial or managerial act (or, more precisely, failure to act) of the IRS. Judge Gustafson patiently points out that the IRS has published public guidance since 1984 on how to use the deposit option. Therefore, since the information was public, “petitioners’ failure to make a deposit to halt interest accrual cannot be attributed to delay or failure of the IRS to advise them personally of this information.” Op. at 44.
- The criminal prosecution period from 2005 to 2009.
The taxpayers argued that the IRS decision to suspend the TEFRA Tax Court litigation pending the outcome of the related criminal investigation and later prosecution. Judge Gustafson points out that such a decision is not a “ministerial or managerial” act as defined in Treas. Reg. 301.6404-2(b)(2), but is instead an act of judgment. He refers readers to Taylor v. Commissioner, 113 T.C. 206 (1999) for a good explanation of why the IRS’s policy is to stop civil proceedings until related criminal proceedings are concluded.
- The partnership tax litigation from after February 2009 to its conclusion in April 2013.
Tax Court litigation takes time. While four years is longer than average, it is certainly not per se unreasonable. In this particular TEFRA litigation, for example, there were apparently problems with a series of Tax Matters Persons being appointed and removed. Judge Gustafson walks us through the various points of the litigation and concludes that the record shows conclusively (remember this is a summary judgment motion) that the taxpayers could not make the appropriate showings during this time period, with one potential 5-month exception. That was between (1) August 7, 2012, the date the parties submitted stipulated facts and issues to the court (which would constitute the basis for a stipulated decision to be entered under Tax Court Rule 248), and (2) January 3, 2013, the date the IRS filed a proper motion for entry of decision in January 2013. The IRS had filed a first motion in October but that motion contained an error caught by partnership attorneys. So the IRS had to re-do the motion and Judge Gustafson said that the Vergheses were entitled to “further discovery related to potential delay in entry of the stipulated decisions in the....partnership cases.”
Comment: A Little Help Up The Hill?
It is not clear why Judge Gustafson thought the entire period between the date the parties submitted their stipulation of facts and issues to the Court (August 7, 2012) and the date the IRS submitted the corrected motion for entry of decision (January 2, 2013) could be subject to §6404(e) abatement. When the parties submitted their stipulations on August 7, 2012, the Court ordered the IRS to submit the appropriate motion for entry of decision by October 9, 2012. The IRS obeyed the Court’s deadline. It is impossible to see how this period could be a delay that qualifies for interest abatement. Meeting a court-ordered deadline would not appear to constitute “delay” at all, much less the "unreasonable" delay required by the statute.
However, when the IRS submitted the inaccurate motion on October 9th, the time it took to fix that error might qualify for interest abatement. Here is where the taxpayers may get a little help up the hill from prior Tax Court cases.
The taxpayers can win here if they can show that the act of taking stipulations of facts and issues and translating them into a motion for entry of judgment is a ministerial act, an act where there is no exercise of judgment or discretion. If the IRS’s act of submitting an inaccurate decision document resulted from unreasonable ministerial or managerial acts, then the period of delay caused by that (the period between the submission and correction) could qualify for interest abatement.
The example Judge Gustafson gives is Mathia v. Commissioner, T.C. Memo. 2009-120. There the IRS apparently received a fully prepared “decision document” from the taxpayers. The only remaining act to be done before the document could be filed with the Tax Court was for IRS counsel to countersign it. That's it. Just sign the sucker. But the IRS attorney did not countersign the document. Five years later, the same attorney sent the exact same decision document to the taxpayer attorney for signature, got it back, and promptly countersigned and filed it.
In Mathia, Judge Marvel gave taxpayers a hand up the hill. She noted that the record was unclear on the reason for the delay and held that against the IRS, explaining that once the taxpayer had identified the ministerial act, it was up to the IRS to explain the delay. That was because the IRS was in possession of the information relevant to ascertaining the cause of the delay. Putting the burden on the taxpayer would incentivize the IRS to hide information or not keep accurate records. Whatever you may think about that rationale, the result is that if the taxpayer can show a delay resulted from performance of a ministerial act, they do not have to then prove why the delay occurred.
As applied here, it seems incumbent on the IRS to explain why its employee messed up the first decision document. If it turns out that the IRS attorney made an unreasonable ministerial error in preparing the first decision document in the partnership case, then the Vergheses would be entitled to interest abatement, but only, I think, from October 9 to January 2. That would be the time period attributable to the mistake. Even if the IRS had acted quickly to fix the error, the delay is still due to the error. But if preparation of the decision document involved discretion and judgment, or if the error in the first submitted motion was a reasonable error, then the Vergheses would not be able to meet all the requirements in §6404(e) for abatement of interest attributable to that period.
As always, I welcome reader comments and observations.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He does not work nights and Sundays. He invites readers to return to TaxProf Blog each Monday for a new Lesson From The Tax Court.