Lesson From The Tax Court: The CDP Butterfly

It’s hard to catch a butterfly.  I have fond childhood memories of chasing them (and lightening bugs, too).  And when you do catch them you must handle them carefully because they are delicate.

Collection Due Process (CDP) hearings are like butterflies: taxpayers must act quickly to catch the first opportunity before it flits away and dies; and, even when caught, CDP hearings require careful handling.  Alhaji B. Benson v. Commissioner, T.C. Memo. 2021-78 (June 29, 2021) (Judge Urda), teaches us how even though taxpayers actually can get two CDP hearings, missing the first CDP opportunity forecloses challenging the underlying tax liability in the second opportunity.  Monique D. Long v. Commissioner, T.C. Memo. 2021-81 (June 30, 2021) (Judge Lauber), teaches us how it is all too easy to bungle a CDP hearing.

As usual, details below the fold.

Law:  Two CDP Hearings
I think it helpful to review once again the difference between the IRS’s two main collection tools: the federal tax lien and the tax levy.  That is because taxpayers get potentially two CDP hearings, one regarding the lien and one regarding the levy.  Don’t be ashamed if you don’t know the difference.  It took me two years in IRS Chief Counsel before I learned.  It will take you, however, only the time to read the next few paragraphs.  And if you already know this stuff, skip on down!

I will start with the levy tool because that is where you find the main rules on CDP hearings.

Levies.  A levy is an action, a taking, a seizure.  Section 6331 permits the IRS to summarily seize all “property or rights to property” belonging to the taxpayer once the IRS properly assessed and given proper notices to the taxpayer.  It also permits seizure of any property to which the federal tax lien is attached, even if that property is no longer the taxpayer’s property. Treas. Reg. § 301.6331-1(a)(1).  Section 6334 then exempts from levy a long list of particular types of property, including in some instances, the taxpayer’s principal residence.  See e.g. §6334(a)(13).  As a practical matter, most levies are done by the Automated Collection System (ACS), although the IRS Data Books report only the total number of levies.  During FY2020—half of which was affected by COVID—the number of levies dropped by half, from about 800,000 levies in FY2019 to about 400,000 levies in FY2020.  See 2020 IRS Data Book, Table 25.

Scope and Limits of Levy CDP Hearing.  In the 1998 IRS Restructuring and Reform Act (RRA98), 112 Stat. 685, Congress created the CDP hearing procedures.  Before the IRS can use its levy power for the first time, §6330(a) requires it to send the taxpayer a Notice of its intent to levy and to give the taxpayer the right to ask for a CDP hearing regarding whether levy action is appropriate.

Taxpayers must act speedy-quick to get a CDP hearing.  The right to a CDP hearing last no longer than the average life of butterflies: a month.  It is actually shorter.  The statute says the taxpayer has 30 days from the date of the notice to request the CDP hearing.  But that is not really 30 days because even if the IRS mails the CDP notice out on the same day, it may be a few days before the taxpayer receives the notice.  So it’s really more like four weeks.

If the taxpayer misses the CDP butterfly, but still requests a hearing within one year of the notice, the IRS will give the taxpayer what it calls an “equivalent” hearing.  Treas. Reg. 301.6330-1(i). The difference is that while taxpayers can seek Tax Court review of an adverse CDP hearing result, they may not obtain judicial review of an equivalent hearing.  This leads skeptical practitioners to doubt whether the equivalent hearing is, truly, equivalent.

Section 6330(c) describes the scope and limits of the Levy CDP hearing.  During the hearing the IRS Independent Office of Appeals (“Appeals”) must perform three tasks: (1) review the file to ensure that all administrative i’s and t’s have been dotted and crossed; (2) address any issues appropriately raised by the taxpayer; and (3) balance “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.” §6330(c)(3)(C).

One important limitation on the scope of a CDP hearing is the ability to taxpayers to raise certain issues.  While taxpayers can raise any issue relevant to the collection of the assessed tax liability, they are restricted in contesting the underlying liability itself.  As a practical matter, as we saw in this lesson, the purpose of CDP is to stop the collection train to give taxpayers a chance to work out a repayment plan.  But taxpayers often want to attack the underlying assessment.  Nope.  A taxpayer can challenge the underlying liability only 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).

This language enabling taxpayers to raise liability issues is both generous and restrictive.  It is generous in that it permits a taxpayer who can show they did not receive the NOD to later contest the liability in an appropriate CDP hearing...if they catch the butterfly.  This “actual receipt” rule differs from the mailing rule for NODs.  Mailing an NOD to the taxpayer’s last known address is sufficient to permit the IRS to assess, even if the taxpayer does not respond.  The theoretical shot at pre-payment judicial review is good enough.  It is different with CDP.  The Tax Court has emphasized that a “prior opportunity to dispute” means more than a theoretical opportunity. See e.g. Kuykendall v. Commissioner, 129 T.C. 77, 80 (2007)(taxpayer who showed they actually received the NOD 12 days before the end of the 90 day period did not have a “prior opportunity to dispute” within the meaning of §6330(c)(2)(B).  The Tax Court has taken a similar position with respect to any other qualifying “opportunity.”  See also 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.”).  Further, the Tax Court has read this language expansively to permit taxpayers to later contest self-reported but unpaid tax liabilities See Montgomery v. Commissioner, 122 T.C. 1, 36 (2004).

But the language is also restrictive, showing the delicacy of the CDP opportunity given.  First, the “prior opportunity” does not have to be one involving judicial review.  It can be any administrative opportunity.  Mason, supra.  Second, the CDP butterfly is delicate: taxpayers must be sure to actually raise their liability and give Appeals relevant evidence or some basis for reviewing their liability.  Mere assertions are not sufficient.  It is up to the taxpayer to give Appeals the information necessary for it to decide the taxpayer’s issue, whether that is a proposed collection alternative or a challenge to the underlying liability. 

Liens.  A lien is a formal assertion of a creditor's claim to property of a debtor.  The federal tax lien arises as a matter of law once the IRS makes a proper assessment, sends the taxpayer a proper notice and demand to the taxpayer’s last known address, and the taxpayer then fails to pay. §6321, §6322.  One the lien arises, it attaches immediately to “all property and rights to property” belonging to the taxpayer.  §6321.  That is, it becomes an enforceable claim against all such property.  If there are other claims on the property, other liens, federal law uses a “first in time, first in right” rule to determine the order of payoff.  United States v. City of New Britain, 347 U.S. 81 (1953). Once it arises, the federal tax lien relates back to the assessment date and so the assessment date becomes the relevant date for determining priority. §6322.

Unlike the levy, a tax lien is a passive collection tool.  It just sits there and looks cute.  The IRS does not have to do anything because the lien must be accounted for when the property is sold.However, when the lien arises, it is not public. Congress did not think it fair for the secret tax lien to take priority against four types of competing creditors (the “four horsemen”):  a purchaser, a holder of a perfected judgment lien, a holder of a perfected security interest, or a holder of a perfected mechanic’s lien. §6323. To defeat the four horsemen, the IRS must take action to make the federal tax lien public.  The IRS does that by filing a Notice of Federal Tax Lien (NFTL) in the place designated by each state.  Id.  Once the NFTL is filed, the tax lien take priority over any competing creditor, even as to any property the taxpayer later acquires. United States v. McDermott, 507 U.S. 447 (1993).

As with levies, most NFTL filings are done via computer.  The IRS maintains a Centralized Lien Operation, described in IRM 5.19.12.  According to the 2020 IRS Data Book, the IRS filed just over 291,000 NFTL's in FY2020, again down from 543,000 in FY2019.

Scope and Limits of NFTL CDP Hearings.  After the IRS files the first NFTL for a given tax period, it has five business days to send out the CDP notice to the taxpayer, telling the taxpayer what has happened.  That is a departure from the original proposal in 1998 which would have required the IRS to give the lien CDP notice 30 days before filing the NFTL.  Seriously!  That was the proposal. You can read about it in the RRA98 Conference Committee Report, H.Rep. 105-599 at 365.

Thus, the CDP notice for the NFTL has the same butterfly life as the levy CDP notice: less than 30 days.  And if the taxpayer’s request comes after the butterfly has died but within one year after the CDP notice, the IRS will give the taxpayer an equivalent hearing.

The scope of the NFTL CDP hearing is a same as a levy CDP hearing.  §6320(c).  It also has similar limitations.  First, the collection action at issue in a NFTL CDP hearing is not the existence of the federal tax lien.  Taxpayers cannot use the CDP hearing to get rid of the tax lien.  The question in this CDP hearing is whether the filing of the NFTL was appropriate.  That’s why I call it the NFTL CDP hearing.

Combined CDP Hearings: One Plus One Equals One. In the CDP statutes, Congress gave several indications that it wanted the IRS to combine hearings when possible.  Thus, §6320(b)(4) provides that “[t]o the extent practicable, a hearing under this section shall be held in conjunction with a hearing under section 6330.”  The RRA98 Conference Committee Report says “The conferees anticipate that the IRS will combine Notice of Intent to Levy and Notice of Lien hearings whenever possible. If multiple hearings are held, it is expected that, to the extent practicable, the same appellate officer will hear the taxpayer with regard to both lien and levy issues. If the taxpayer requests a hearing following receipt of a Notice of Lien or Notice of Intent to Levy and, prior to the date of the hearing, receives the other notice, the scheduled hearing will serve for both purposes and the taxpayer is obligated to raise all relevant issues at such hearing.” H.Rep. 105-599 at 367.

The IRS regulations track the statute and Committee Report.  They provide that, whenever possible, “a CDP hearing with respect to one tax period shown on a CDP Notice will be combined with any and all other CDP hearings which the taxpayer has requested.”  Treas. Reg. 301.6330-1(d), Treas. Reg. 301.6320-1(d).

The idea here is that the IRS need not duplicate the efforts to review the appropriateness of proceeding to levy or file an NFTL.  This idea is one reason that the Tax Court will refuse to consider issues in a second CDP when the taxpayer failed to appeal a prior CDP hearing on the same tax and period.  See Lesson From The Tax Court: One Plus One Equals One, TaxProf Blog (March 30, 2020).

Lesson 1: Catch The First CDP Butterfly
Benson v. Commissioner.  Mr. Benson did not file tax returns for 2008 and 2009.  So the IRS proposed to do it for him.  It prepared Substitutes for Returns (SFRs) and sent him NODs in July 2011 (for the 2008 year) and November 2011 (for the 2009 year).  Mr. Benson did not seek review in Tax Court.

Time passed.  In October 2016 the IRS sent Mr. Benson a CDP Notice of Intent to Levy to collect both the 2008 and 2009 liabilities.  He did not seek a levy CDP hearing within the 30 days from the date of the levy CDP Notice.  In fact he made no response at all. More time passed.  In October 2018 the IRS filed an NFTL and sent Mr. Benson a second CDP.  This time, he timely responded and requested a NFTL CDP hearing.  Finally.  He also asked for a hearing on the levy CDP but that butterfly was long dead.  He was too late for even an equivalent hearing.

Mr. Benson’s basic reason for wanting the IRS to stop collection action was that he had indeed filed returns for 2008 and 2009 and did not owe the taxes reflected on the SFRs.  That is, he wanted to contest the merits of his tax liability.

Judge Urda did not allow Mr. Benson to contest the merits.  First, Mr. Benson had a prior opportunity to dispute the tax liabilities through the deficiency process.  Mr. Benson did not even allege that he had not actually received the NODS.  Second, even if Mr. Benson had not received the NODs, he had received the October 2016 levy CDP notice.  “This notice provided him an an opportunity to request a CDP hearing with respect to tax years 2008 and 2009, the years at issue in this case.”  Op. at 8.

Bottom line: By failing to catch the first CDP butterfly Mr. Benson lost his ability to challenge the merits of the assessments being collected.

Lesson 2: Handle The CDP Butterfly With Care
Long v. Commissioner. Ms. Long timely filed her 2015 and 2016 returns.  The IRS selected them for audit and sent her an NOD proposing a $2,000 deficiency.  The NOD was returned by the Post Office as undelivered.  Judge Lauber assumes for purposes of the case that she did not actually receive the NOD.  So she had no prior opportunity to contest the merits of the assessment.

In December 2018, the IRS filed an NFTL and sent Ms. Long an NFTL CDP Notice for both years.  She timely requested a CDP hearing and in her request expressed confusion about the merits of the assessment, asserting that the IRS had improperly overlooked a dependent.  The opinion is unclear on whether she was contesting the merits of both years or only one year.  But she waffled by also asserting that she intended to pay the assessed liabilities in full.  Well, the SO hopped right on that!  The SO sent Ms. Long Form 12257.  As this law firm webpage nicely explains, that’s a form by which taxpayer basically concedes all issues and waives any right to petition Tax Court.

I am betting most of us would have advised Ms. Long to DON’T SIGN THE WAIVER!

She signed the waiver.

However, the SO did not wait to receive the signed Form 12257 but instead closed out the case and issued a Notice of Determination.  Ms. Long timely petitioned the Tax Court again raising her contention that the IRS got her tax liability wrong because it failed to count her son as a dependent.  This time, the opinion is clear that she was indeed contesting the merits of her 2015 assessment but “did not dispute her underlying tax liability for 2016.” Op. at 6.

Judge Lauber did not allow Ms. Benson to contest the merits.  It was his opinion that Ms. Long had improperly handled her CDP hearing by not persisting.  He writes: “petitioner stated that she did not know why she had outstanding tax liabilities, and she repeated that question at the start of the conference call.  But after the SO explained the background and summarized the notices of deficiency, petitioner withdrew any challenge to her underlying liabilities. *** At no time did petitioner submit any evidence to the SO regarding her entitlement to a dependence exemption (or any other issue relevant to her 2015 tax liability).”  Therefore, concluded Judge Lauber, “petitioner’s underlying liability is not properly before us as to either year in issue....”

Bottom line: By failing to properly present or preserve her assertion regarding the merits of her liabilities, Ms. Long killed her ability to obtain Tax Court review of the assessment.  Even when taxpayers catch the CDP butterfly, they need to handle it with care.

Coda:  This year my wife decided to turn our backyard into a pollinator haven. I did not object—it freed me from mowing the back yard!  And how we have butterflies (yes, butterflies are pollinators).  At my age, however, I chase them only with my eyes. 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return to TaxProf Blog each Monday for another Lesson From The Tax Court.