When a taxpayer owes a tax debt to the IRS, the IRS routinely initiates administrative collection actions against the taxpayer to collect the debt. In most cases this means the issuance of a notice of federal tax lien, or worse, a proposed levy.
However, since 1998, the Internal Revenue Code has provided significant procedural rights to taxpayers with respect to proposed levies. Specifically, under I.R.C. § 6330, the IRS is precluded from levying until it has “notified such person in writing of their right to a . . . [Collection Due Process] hearing.” Once the CDP notice is issued, the taxpayer has 30 days to timely respond, and if the taxpayer does so, the levy action is stayed until the taxpayer has completed the CDP process. Significantly, this stay of levy action can last from the time the CDP notice is issued until the United States Tax Court’s decision becomes final, if the taxpayer contests the IRS’ CDP hearing determinations.
But, many taxpayers seemingly get lost in the maze after the CDP hearing process begins. This is understandable. Generally, they will receive correspondence from the IRS Independent Office of Appeals (Appeals) acknowledging receipt of the CDP hearing request. In most cases, the letter or a follow-up letter will request certain information from the taxpayer in addition to informing the taxpayer of the potential for collection alternatives, such as an installment agreement or an offer-in-compromise. However, the procedural rights afforded to a taxpayer, which generally flow through the course of those proceedings, are often found littered throughout the Internal Revenue Code and the various provisions in the IRS’ handbook referred to as the Internal Revenue Manual (IRM). The former National Taxpayer Advocate has succinctly summed up what many taxpayers are up against as they battle the IRS’ proposed levy during the CDP hearing:
While the Internal Revenue Code contains significant rights, protections, and expectations of taxpayers, these provisions are scattered throughout the Code and the IRM. They are not easily accessible to taxpayers, nor are they written in language that is readily understandable by many taxpayers.
This state of affairs is particularly unfortunate with respect to CDP hearings, which are designed to provide taxpayers with a quasi-independent forum to potentially resolve their tax debts without resort to levy action. Moreover, as many published Tax Court decisions show, CDP hearings do, on more than infrequent occasions, go awry. See, e.g., Loveland v. Comm’r, 151 T.C. 78 (2018) (IRS abused its discretion in failing to fully consider the taxpayer’s arguments); Judge v. Comm’r, T.C. Memo. 2009-135 (IRS abused its discretion in not providing the taxpayer with a reasonable extension of time to submit information); Vinatieri v. Comm’r, 133 T.C. 392 (2009) (IRS abused its discretion in proceeding with levy action although levy would cause economic hardship); Alessio Azzari, Inc. v. Comm’r, 136 T.C. 178 (2011) (IRS abused its discretion in not interpreting applicable law correctly).
A recent Tax Court decision, Kirkley v. Comm’r, T.C. Memo. 2020-57 illustrates all of these points. In addition, it further demonstrates the advantage some taxpayers have with the help of experienced tax counsel to provide advice throughout the CDP hearing process.
Kirkley v. Comm’r
In Kirkley, the taxpayers (husband and wife) were jointly liable for federal income tax, penalties, and interest of approximately $4.2 million. Because of the large tax debts, the IRS issued the taxpayers a proposed levy and CDP notice. Based on the facts in the opinion, the taxpayers were represented throughout the CDP hearing by a tax professional.
In response to the CDP notice, the taxpayers’ counsel properly submitted a timely Form 12153, Request for a Collection Due Process or Equivalent Hearing. As discussed above, the filing of the Form 12153 stayed the IRS’ proposed levy action until the taxpayers were afforded, at a minimum, a CDP hearing. In the Form 12153, the taxpayers’ counsel raised the collection alternative of an installment agreement. In addition, the taxpayers’ counsel also communicated to the IRS that the taxpayers were being proactive and working with a financial institution to borrow against the equity of their principal residence, which loan proceeds would be used to pay down the tax debts.
As the CDP hearing progressed, the taxpayers’ counsel proposed an installment agreement of $50,000. Because the payments under the installment agreement would not full pay the outstanding tax, penalties, and interest, the proposed installment agreement is referred to as a “partial payment installment agreement.” These types of installment agreements are specifically permitted under I.R.C. § 6159(a), as amended by the Americans Jobs Creation Act of 2004.
The opinion does not address this particular issue, but generally the IRS will accept a partial payment installment agreement if the proposed payments represent the excess of the taxpayer’s available income over the taxpayers’ necessary and allowable expenses, but the taxpayer will not full pay the tax debt within the statute of limitations for collection. Often times, disputes arise between the IRS and the taxpayer with respect to what constitutes a necessary and allowable expense, but that was not the issue here.
To permit the IRS an opportunity to independently determine the payments a taxpayer can make under a partial payment installment agreement, the taxpayer is required to submit financial information to the IRS, which includes bank statements and a collection information statement. The taxpayers’ counsel in Kirkley provided the necessary financial information to the SO, including a copy of a bank denial letter to show the taxpayers were unsuccessful in their efforts to obtain an equity loan. Again, the opinion does not address this issue, but it is common for banks to deny equity loans if the IRS has filed a notice of federal tax lien against the taxpayer, which was the case here.
Commonly, after receipt of the financial information, the SO will forward that information to an IRS Revenue Officer (RO) for review. In this case, the RO reviewed the taxpayers’ financial information and concluded that the taxpayers’ disposable monthly income was only $3,349 per month. The apparent discrepancy between the taxpayers’ proposed monthly payments of $50,000 and the RO’s $3,349 disposable monthly income determination related to the taxpayers’ recent payoff of another installment agreement they had set up with a State for unpaid income taxes.
After reviewing the RO’s determinations, the SO sent the taxpayers a letter indicating that if the taxpayers were unable to obtain an equity loan they were “expected to sell all assets, with the exception of two vehicles, and provide evidence that these assets had been placed up for sale.” The letter also suggested that the taxpayers’ sale of assets should include their principal residence and certain real property owned and utilized by their S corporation business.
More negotiations ensued. Thereafter, the SO sent the taxpayers another letter and various forms. The accompanying letter indicated that the taxpayers had only 14 days to execute the forms and return them to the SO. The Forms included a Form 433-D, Installment Agreement, and a Form 12257, Summary Notice of Determination, Waiver of Right of Levy Action, and Waiver of Periods of Limitation in Section 6330(e)(1). The Form 433-D, which had been prepared by the SO, stated that the taxpayers would agree to pay a lump sum of $1,019,660 from the sale of their assets within 6 months in addition to $50,000 per month starting 2 months after the Form 433-D was executed. Significantly, the Form 12257 provides a waiver of certain significant rights, if executed. These include:
- An acknowledgement by the taxpayer that the Appeals determination as described in the Form 12257 is “appropriate and correct and resolves the issues . . . raised in the . . . [CDP] hearing.”
- An acknowledgement that there is no need for judicial review of Appeals’ determinations or the continuation of any prohibitions of levies;
- A waiver of rights to judicial review with the U.S. Tax Court;
- A waiver of the 30-day prohibition on levies, which is generally provided to permit the taxpayer sufficient time to petition the U.S. Tax Court for review.
In the correspondence to the taxpayers, the SO indicated that if the forms were executed within 14 days she would recommend to her manager that the installment agreement be accepted.
The taxpayers’ counsel responded within the 14 day deadline. In the response, the taxpayers’ counsel provided the SO with an executed Form 433-D. But, the taxpayers’ counsel’s accompanying letter informed the SO that the taxpayers, under the guidance of their counsel, refused to execute the Form 12257 because they did not want to waive their appeals rights.
Discussions continued; however, the SO eventually sent an additional letter to the taxpayers that indicated the IRS could not accept the proposed instalment agreement because: (1) the Internal Revenue Manual (IRM) does not permit the IRS to enter into an installment agreement until the taxpayers have liquidated their assets and paid the proceeds to the IRS; (2) the taxpayers could pay only $3,438 per month; and (3) the taxpayers had “significant equity in assets that must first be liquidated.” Accordingly, the SO determined that no collection alternative was available to the taxpayers and that the proposed levy action should be sustained. A Notice of Determination to this effect was issued to the taxpayers, and the taxpayers timely petitioned the Tax Court for review of the IRS’ determinations.
On these facts, the Tax Court found in favor of the taxpayers. Specifically, the Tax Court concluded that the IRS had abused its discretion in analyzing the applicable IRM provisions related to partial payment installment agreements. On the issue of required liquidation of the taxpayers’ assets, the Tax Court reviewed the applicable IRM provisions and determined that such guidance did not require taxpayers to liquidate their assets in all instances. Moreover, the Tax Court found that the IRS had failed to determine whether certain assets – including the taxpayers’ personal residence and the S corporation’s real estate – were necessary for the production of income or the health and welfare of the taxpayer’s family, which would generally exclude the assets from collection. Thus, the Tax Court remanded the taxpayers’ case back to Appeals for a supplemental hearing.
The Tax Court’s decision is a big win for the taxpayers. Although they could have appealed an adverse decision by the Court, any such appeals would generally be the last opportunity for judicial review of the IRS’ determinations. Without judicial review, the stay of levy on approximately $4.2 million of tax debts would have been initiated again unless the taxpayers offered an alternative collection alternative outside the CDP hearing context. In this latter case, the taxpayers would not be afforded judicial review and would be at the mercy of the IRS’ administrative decisions.
In this case, tax counsel wisely chose to advise his clients not to sign the Form 12257 waiver without additional assurances from the SO. If the taxpayers had signed the Form 12257, the taxpayers would not have had judicial review of the SO or SO’s manager’s determinations. Moreover, tax counsel was able to further advocate on behalf of his clients in the Tax Court by correctly pointing out to the Court the SO’s erroneous interpretation of the IRM provisions, which constituted an abuse of discretion warranting remand back to Appeals.
Need assistance litigating in the U.S. Tax Court? Freeman Law’s tax attorneys are experienced litigators with trial-tested litigation skills and in-depth substantive tax knowledge, having collectively litigated hundreds of cases before the U.S. Tax Court. Our tax controversy lawyers have extensive experience in Tax Court matters involving partnership audits and litigation under both the TEFRA and BBA regimes, international tax penalties, foreign trusts, valuation, reasonable compensation disputes, unreported income, fraud penalties, other tax penalties, and many other matters. We draw on our experience and wealth of tax knowledge to advise and guide clients through the entire tax controversy process, building the right strategy to resolve tax controversies from day one. Schedule a consultation or call (214) 984-3000 to discuss your Tax Court concerns or questions.