Taxpayers famously focus on trying to get their “day in court” against the evil IRS. The Independent Office of Appeals (Appeals) is no court. It is not surprising, then, that taxpayers’ myopia often leads them down the dangerously wrong path of ignoring their opportunity to go to Appeals. Today’s lesson teaches us one reason that is a mistake.
In Mahammad A. Kazmi v. Commissioner, T.C. Memo. 2022-13 (Mar. 1, 2022) (Judge Paris), the IRS was seeking to collect a §6672 Trust Fund Recovery Penalty (TFRP) assessed against the taxpayer. In a Collection Due Process (CDP) hearing, Mr. Kazmi attempted to explain why the assessment was improper against him. He relied on the rule that a taxpayer can challenge a liability in a CDP hearing if the taxpayer had not had a prior opportunity to do so. While Mr. Kazmi had been given the opportunity to take an administrative appeal during the prior §6672 assessment process, he said that should not count because it did not give him a day in court. While that argument might have traction in other situations, it failed in this one. Details below the fold.
Taxpayers can always get judicial review of the accuracy of the tax assessed against them, but cannot always get pre-payment judicial review.
That is, taxpayers always have the (theoretical) option to fully pay the taxes the IRS says they owe. Then they can file an administrative claim for refund and then file a suit for refund if the administrative claim is not successful. The practical problem, of course, comes when an assessed liability is simply far greater than what the taxpayer can pay. In that situation, there is no practical opportunity for judicial review of the assessed liability. Still, the Supreme Court has seemingly blessed the constitutionality of that process. Phillips v. Commissioner, 283 U.S. 589 (1931); Flora v. United States, 362 U.S. 145 (1960). And lower courts repeatedly reject carving out a “hardship exception” for taxpayers who cannot, actually, fully pay the tax. See Curry v. United States, 774 F.2d 852 (7th Cir. 1985)(collecting cases).
For income, estate, and gift tax liabilities, taxpayers have been able to get pre-payment review since 1924, under the deficiency procedures in §6211 et seq. In fact, the Phillips and Flora decisions both involve income tax liabilities. The availability of pre-payment judicial review appears important in their due process analysis, as it does in the cases refusing to create a hardship exception.
For other types of taxes, however, Congress has not created a consistent route to pre-payment judicial review. Notably, the §6672 TFRP procedures have never given taxpayers a route to pre-payment judicial review. It’s all pay-first-litigate-later. But that is typically no big deal because a taxpayer can start a refund proceeding without paying the entire assessed liability. Instead, the taxpayer just has to pay the assessed liability for one employee for one quarter (yes, you would pick the lowest paid employee!) and then can start the refund process. See, e.g. Davis v. United States, 961 F.2d 867, 870 (9th Cir. 1992) (taxpayer paid $100 of a $69,000 assessment to get the refund ball rolling).
In contrast to judicial review, the opportunity for pre-payment administrative review has been around since the creation of the IRS in 1862. In 1927 the opportunity was formalized by the creation of a specialized administrative appeals function, located within the Commissioner’s Office, and staffed by experience Revenue Agents. That was the forerunner of the current Independent Office of Appeals. Most of the opportunities for administrative review were created by administrative action.
In 1998, Appeals became a creature of statute. §7803(e). And its portfolio expanded from reviewing disputes about liability to reviewing disputes about collection via Collection Due Process (CDP) hearings. §6330. For details see Lesson From The Tax Court: Appeals Is Still Part Of The IRS, Really! TaxProf Blog (Aug. 19, 2019).
In 1998, Congress also added statutory opportunities to go to Appeals. For example, it modified §6672(b) to create a pre-payment administrative review process for the TFRP. Under that process the IRS must now give the taxpayer a notice that it is planning to assess a TFRP and then give the taxpayer 60 days to take an administrative appeal. §6672(b)(2), (3).
While both its name and portfolio changed over time, Appeals’ mission has remained constant: to settle tax controversies and prevent the need to litigate them in court. See Publication 4227 (Rev. 1-2020). Whether the controversy is about a potential tax liability or about collection of that liability, Appeals is able to evaluate the work of the relevant IRS function (Exam or Collection) and consider the hazards of litigation in coming to a decision about either the taxpayer’s liability or the IRS’s ability to move forward with collection.
While administrative review may be useful, taxpayers still want their "day in court." Sometimes taxpayer can get pre-payment judicial review of Appeals decisions. But often they cannot.
As to liability controversies, when taxpayers go to Appeals after the examination is completed but before the IRS issues a formal Notice of Deficiency (NOD), it is Appeals who will issue the NOD if it cannot settle the case. The taxpayer can then take the NOD ticket to the Tax Court. In contrast, when taxpayer go to Appeals under what the IRS calls its Early Referral Program, there is no judicial review. The Early Referral Program allows Appeals to review one particular issue in controversy without waiting for the entire examination to be completed. But if the taxpayer does not like Appeals’ decision, there is no judicial review until after the examination is complete. See also Rev. Proc. 99-28.
As to collection controversies, taxpayers who timely request a CDP hearing and are unable to resolve the dispute in Appeals will receive another type of NOD: a Notice of Determination. That, too, is a ticket to the Tax Court where they can get judicial review. §6330(d). In contrast, taxpayers who miss what I call the CDP Butterfly may still get what is called an “Equivalent Hearing” before Appeals. But there is no judicial review for that decision. Treas. Reg. 301.6330-1(i).
Sometimes Appeals makes a decision about both liability and collection in the same proceeding. That can happen in CDP hearings. While CDP hearings are ostensibly just collection disputes, taxpayers can object to the underlying liability being collected, but if and 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). Where the underlying tax liability is properly at issue, the Tax Court uses a de novo standard of review, just as it does when reviewing a Notice of Deficiency. But it reviews all other issues under an abuse of discretion standard, which means it just looks at whether the Appeals decision was reasonable. See Goza v. Commissioner, 114 T.C. 176, 181–82 (2000).
The Tax Court has been generous in some ways in allowing taxpayers to contest liabilities in CDP hearings. First, the Court permits a taxpayer to attack a liability in the CDP hearing if they did not receive the NOD. 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. Phillips, supra. It is different with CDP. The Tax Court has emphasized that a “prior opportunity to dispute” means more than a theoretical opportunity. Thus, if the taxpayer can show that they did not actually receive the relevant prior notice, they get to argue about their liability in the CDP hearing. See Lesson From The Tax Court: When Non-Receipt Of An IRS Notice Matters TaxProf Blog (Oct. 1, 2018). Second, the Tax Court has read this language expansively to permit taxpayers to later contest even liabilities they self-reported, but left unpaid. See Montgomery v. Commissioner, 122 T.C. 1, 36 (2004).
However, the Tax Court also interprets the “otherwise have an opportunity” language in §6630(c)(2)(B) restrictively to deny taxpayers the ability to contest an underlying liability. It has done so by relying on Treas. Reg. 301.6330–1(e)(3), Q & A–E2, which says, in relevant part: “An opportunity to dispute a liability includes a prior opportunity for a conference with Appeals that was offered either before or after the assessment of the liability.” The regulation does not distinguish between Appeals conferences that are or are not subject to judicial review.
Application of that regulation is today’s lesson. Let’s take a look.
Mr. Kazmi was a part-time hourly bookkeeper for a company that did not pay over trust fund taxes for two quarters in 2014. An IRS Revenue Officer (RO) conducted a TFRP investigation of Mr. Kazmi and concluded that Mr. Kazmi should be held liable for the penalty.
In December 2015, the IRS sent Mr. Kazmi a Letter 1153 telling him it was going to assess a TFRP against him. That triggered his 60-day period to take an administrative appeal. He did not. The IRS then assessed a $10,200 TFRP and started the collection process. It filed a Notice of Federal Tax Lien (NFTL) and, per §6320, sent Mr. Kazmi a notice of that action, giving him 30 days to request a CDP hearing. He did. At the CDP hearing his only argument on why the NFTL should not have been filed was that he was not liable for the assessed TFRP. He seems to have some good facts to support that argument. Judge Paris notes that he was an hourly part-time employee, that he had no ownership interest in the company, was not an officer of the company, had no power to sign checks or authorize payments on behalf of the company. Op. at 2. His sad story was that he was just a little part-time fish unfairly caught in the TFRP net.
The Settlement Officer (SO) in Appeals did not want to hear Mr. Kazmi’s sad story. Since Mr. Kazmi raised no other issues, the SO issued a Notice of Determination and Mr. Kazmi petitioned the Tax Court for review.
Lesson: Take the Administrative Appeal
Judge Paris explains that Mr. Kazmi’s prior opportunity to have Appeals review the proposed TFRP precluded him from contesting the liability in a CDP hearing. The fact that he would not be able to get pre-payment judicial review did not disable that opportunity from being a prior “opportunity” for CDP purposes. It was still a meaningful opportunity. She relies on, adopts, and re-states the reasoning of Judge Gustafson in Bishay v. Commissioner, T.C. Memo. 2015-105, as follows:
“The lack of opportunity for judicial review after the Letter 1153 proceeding does not severely prejudice the taxpayer because, as we have previously noted, the section 6672 penalty is divisible, so that a taxpayer may litigate the penalty after having paid an amount corresponding to the tax withheld from a single employee. Thus, the taxpayer whose liability is upheld in the Letter 1153 proceeding can make a small “token” payment towards the section 6672 penalty, file a refund claim with the IRS, and, if the refund claim is denied, file a refund suit in the Federal District Court or the Court of Federal Claims.” (internal quotes and citations omitted).
Judge Paris appears sympathetic to Mr. Kazmi. First, she notes that “[a]t this time, the Court declines to overturn its previous holdings that a properly mailed and received Letter 1153 constitutes a prior opportunity.” Op. at 11 (emphasis supplied). Second, she then very generously re-characterizes his contention that he was not a responsible person as claim that the SO acted arbitrarily in performing their duty to “obtain verification from the Secretary that the requirements of any applicable law or administrative procedure have been met.” §6330(c)(1). She then notes that the abuse-of-discretion standard meant she could not substitute her own judgment for the SO’s. “A difference of reasonable minds does not rise to the level of arbitrariness required for finding an abuse of discretion.” Op. at 12.
Comment: An Additional Rationale? Despite Judge Paris’ qualification “at this time,” the Tax Court seems to have firmly adopted the CDP regulation’s position that all administrative appeals constitute prior opportunities to contest a liability whether or not there is any judicial review of the Appeals decision. It does so seemingly on the singular rationale Judge Paris re-states: the taxpayer is not “severely prejudiced.” This seems very similar to the rationale the Supreme Court used in Philips and Flora. In those cases, taxpayers were not severely prejudiced because Congress had provided for pre-payment review. In this case, the lack of pre-payment liability review does not severely prejudice the taxpayer because it requires only a “token” payment to (eventually) get judicial review of the IRS’s liability determination.
I would offer an additional rationale for the rule that a purely administrative review opportunity precludes a taxpayer from disputing liability in a CDP case. It’s not just that the taxpayer is not “severely prejudiced.” It’s that a purely administrative review is still a constitutionally meaningful opportunity. That is true even if the "hearing" a taxpayer receives lacks the adversarial structure of a court hearing. I blogged about that last week ("What Constitutes a CDP Hearing"). The casually cynical notion that Appeals can only do its job under the prospect of immediate judicial review is, I think, erroneous. My thesis is that the availability of judicial review does not significantly affect either Appeals' workload or outcomes. That is, it was my experience when on the inside that the ROs and SOs in Appeals take their mission to heart; they do not simply rubber-stamp decisions from other IRS functions when there is no judicial review. Instead they attempt to give the same qualify of review regardless of whether the taxpayer can obtain judicial review. Of course, neither my anecdotal experience nor anyone else's really proves much. The thesis could be tested more rigorously if one compared CDP hearing outcomes with Equivalent hearing outcomes. That kind of study, however, would require access to non-public data. If TIGTA or TAS has conducted such a study, I've missed it and would appreciate a link. Absent such a study we have only anecdotes. Still, I would be interested to hear from readers whether and to what extent Appeals does a demonstrably better job in CDP hearings or a demonstrably worse job in Equivalent hearings.
Bryan Camp is the George H. Mahon Professor 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.