The Problem-Child Client: Recidivist

 

It happens: the problem-child client.

Let’s talk about one type of problem child: the recidivist.

Thomas Kelly was a securities broker in New York City. We have three tax years at play - 2013 to 2015. Thomas had not been filing his returns or paying his taxes.

On December 22, 2017, he filed 2013, reporting adjusted gross income of $1.9 million. The tax was approximately $690 grand.

A few days later (December 26, 2017) he filed 2014, reporting AGI of almost $1.5 million and tax of approximately $515 grand.

Keeping the streak going, on January 17, 2018, he filed 2015, reporting AGI of $1.2 million and tax over $400 grand.

Got it. Thomas fell out of the system and was now trying to get back in. Maybe there had been familial or medical setbacks. He was trying to correct his mistakes. Everybody likes a comeback story.

Let’s jump forward over a year and a half to September 2019. Thomas owed the IRS over $2.5 million for years 2013 through 2015.

Late file penalties. Late pay penalties. Interest on everything. Yep, it gets expensive.

The IRS issued three notices:

* Two for liens

* Another for a levy

Thomas requested a CDP (Collection Due Process) hearing. He was after three things:

* He wanted a payment plan

* He wanted withdrawal of the liens

* He wanted abatement of the penalties

Got it. So far this is standard stuff.

The hearing was scheduled for March 2020.

Then COVID happened.

The hearing was held-up until February 2021.

At the hearing …

FIRST, Thomas wanted to pay $30,000 per month.

Problem: Thomas owed enough that $30 grand would not pay his taxes in full before the statute of limitations played out.

CTG: This is a called a partial pay plan. There are requirements in the Internal Revenue Manual (IRM), and one is that the taxpayer be current on his/her other taxes. Thomas owed approximately $250 grand on his 2019 taxes.

The IRS did not want to include 2019 in his payment plan. In addition, the IRS did not see payments on his 2020 estimated taxes.

CTG: Borrow $250 grand and a bit more for those estimated taxes, Thomas. Battle, war, and all that.

It makes sense if you think about it. Thomas was asking the IRS to accept less than a dollar-on-a-dollar for past taxes. He was then asking the same deal for his current taxes. The IRS was not going to agree to this.

Thomas dug in his heels and wanted the IRS to include 2019 and 2020 in the payment plan.

The IRS of course didn’t.

Thomas complained that the IRS settlement officer abused his discretion in denying him a payment plan.

CTG: Thomas, shut up.

SECOND, Thomas wanted the liens removed.

CTG: This one is going to be tricky. The IRS is reluctant to remove a lien, especially once you get to those dollar levels.

Thomas argued that the IRS Settlement Officer abused his discretion in refusing to withdraw the liens.

CTG: Thomas … SHUT UP!

Thomas next argued that releasing the lien would facilitate his being able to pay the tax. The lien would affect his licensing, and that effect could negatively impact his earning power.

CTG: Nice segue. We now need to go from “could” to “would,” as we need to persuade skeptical parties. Is there a cite from governing body rules and regulations we can copy and paste? Can you get a letter from your employer? We need something more than our word, as that is considered self-serving.

Nope, says Thomas. My word is good enough.

CTG: You are not taking advice well, Thomas.

THIRD, Thomas wanted the penalties abated. He had two arguments.

CTG: Bring it.

The first was that he qualified for first time abatement (FTA).

CTG: OK, but that will address 2013 only. You won’t be able to use it again for the other years.

FTA is bread-and-butter. If you have been clean for the preceding 3 years, the IRS can waive the penalty. The FTA applies to a limited number of penalties, but the good news is that limited number included Thomas’s specific penalty.

Good job, Thomas.

However, the IRS pointed out that Thomas had penalties for 2012. The … tax … year … immediately … preceding 2013.

CTG: Thomas, did you even google what FTA is?

Thomas had a second argument: he had reasonable cause.

CTG: OK, Thomas, sway me.

His wife started spending money like madwoman in 2007. This caused all matters of marital and financial problems. She filed for divorce in 2015.

CTG: Thomas …

The attorney fees were crushing. He was having financial hardship …

CTG: Thomas …

… emotional problems …

CTG: Thomas …

… battling depression.

CTG: Thomas, the Court is going to want to know how your divorce proceedings – in 2015 – affected your tax responsibilities for 2013 and 2014.

Tax Court: Yes, Thomas, please tell us.

Here are a few trenchant comments by the Court:

He successfully conducted his securities business during 2013 – 2015, earning more than $1 million annually …”

… he has a history of tax noncompliance, dating as far back as 2009.”

His allegations of financial hardship at the relevant times thus seem questionable.”

CTG: We are losing them here, Thomas.

Tax Court:

In any event, financial hardship ‘generally does not affect a person’s ability to file.’”

CTG: Going…

Tax Court:

At the time of the CDP hearing petitioner’s outstanding liabilities for 2013 - 2015 exceeded $2.5 million. Those liabilities arose from his repeated failure to file returns and pay tax, despite earning between $1 million and $2 million annually. During the hearing he refused to pay even his (comparatively modest) estimated tax liability for 2020.

CTG: Gone.

Yes, the IRS sours with a recidivist. I have seen the IRS dig in when they see someone failing to file, never paying estimates, extending with no payment, repetitively filing returns with significant balances due. This is not a matter of knowing how to navigate the IRS. One can navigate like Magellan and not get there.

Thomas could have - I believe - gotten a partial pay. Perhaps he needed to borrow to pay 2019 and 2020, but: so what? He had the earning power, and borrowing would have facilitated the (much more significant) $2.5 million at play for 2013 through 2015.

He had a shot at releasing the liens if he could show (likely) injury to his earning power. He had to show some cause, though, otherwise everyone would make this argument and the IRS would never be able to lien.   

He was hosed on penalty abatement, however. Recidivist.

He certainly did not need to fling charges of abusing discretion. The Settlement Officer was just following IRM guidelines, which Thomas (or his tax advisor) could have double-checked at any time.   

Our case this time was Thomas E Kelly v Commissioner, T.C. Memo 2022-73.

The IRS Caught Dumping A Collection Case

Let’s look at a taxpayer win on an issue not known for taxpayer wins.

Thomas Hamilton was an attorney and Edith Hamilton was a chaplain. They filed a 2016 tax return showing tax due of almost $72 thousand. They however did not pay the tax in full.

The IRS assessed.

The IRS then issued a Notice of Federal Tax Lien (NFTL) to secure its assessment.

This presented a procedural option: the Hamiltons could request a Collection Due Process (CDP) hearing. If they could work-out a payment agreement perhaps they might avoid the lien. Liens can be embarrassing.

They requested a CDP hearing.  

The IRS Settlement Officer (SO) asked for a lot of information, including:

(1)  Proof of 2018 estimated tax payments

(2)  Their 2017 personal tax return

(3)  Six months of bank statements

(4)  Three months of pay stubs

(5)  Proof of various expenses for the preceding three months

The SO also wanted the law practice to catch-up on its (mostly payroll-related) tax returns from 2015 through 2017.

The SO did stagger some of the due dates for the above: some were due on October 17, others were due October 24. The hearing itself was November 15, 2018.

The Hamiltons did not provide any documents by October 24.

Oh oh.

They did write a letter on October 31, explaining that their (now) previous bookkeeper failed to keep many documents, a fact which came to light as they were trying to comply with the SO’s request. They hired a CPA, who was helping reconstruct records as well as representing them during the CDP hearing. Finally, they had reordered online bank statements and would forward the requested documentation as soon as possible. They reiterated their desire for a payment plan.

Let me retract the “oh oh” comment, although they should have responded – in some manner - by the October 17 date.

Why? To discourage the SO from thinking that they were stalling.  

Between November 2 and November 15, the Hamiltons sent five faxes totaling hundreds of pages. They sent bank statements, copies of bills and some (but not all) of the payroll tax returns for the law practice.

The day before the hearing they also faxed personal and business financial information (Forms 433-A and 433-B) as well as a copy of their 2017 individual tax return and its electronic acceptance by the IRS.

The SO had spent no time on the case from October 1 to the date of the hearing, when she spent an hour preparing beforehand.

At the hearing the SO pressed on the following:

·      They had not filed their 2017 individual tax return.

·      They had not provided proof of their expenses.

·      They were not making 2018 estimated tax payments.

·      They had not filed payroll returns for the law practice.   

The CPA chimed in:

·      They had filed their 2017 tax return and provided proof of electronic acceptance by the IRS.

·      They had provided bank statements and documentation for the vast majority of their expenses.

·      They would be current with their 2018 estimated taxes as soon as the following month.

·      They had file some of the payroll returns the SO was considering unfiled.

The SO said she would recommend filing the NFTL.

Mr Hamilton requested additional time to provide the missing information.

The SO said: no chance.

The IRS sustained the filing of the NFTL for 2016 and also rejected their request for an installment agreement.

Sheesshh. That CDP hearing blew up.

And so we get to Tax Court.

Let’s set up the issue:

·      There was a proposed lien

·      To which taxpayers requested a CDP hearing

·      And got turned down for not complying with the SO’s documentation requests

You can take one of these to Tax Court, but it is very tough to win. In short, you must show that the IRS was capricious and abused its discretion. 

The Court went through the file:

1. The Hamiltons sent an 11-page fax on November 9. The fax included one of the payroll tax returns the SO considered missing.

    The SO had included the fax cover sheet in her record.

    But not the other 10 pages.

    One wonders how accurate the SO’s records were.

    Human error, one supposes.

2. They had filed their 2017 individual tax return and had faxed the SO a copy. They had also informed her of this filing at the hearing.

    But the SO had included the non-filing as a reason for her bounce.

    Odd.

3. Between November 2 and the November 15 hearing date, they had sent at least five faxes, totaling hundreds of pages of financial documentation

    But the SO said they had not provided documentation.

    Here is the Court:

The failure of the administrative record to capture some documents makes us question the completeness of the administrative record that the settlement officer considered and that we are reviewing.

    And here the case turned.

    The third strike.

The Court pointed out that the Hamiltons made efforts to keep the SO apprised – of the bookkeeper debacle, of the request for copies of documents and bank statements. They asked the SO to apprise them of any questions or issues while they could still react.

Then the Court emphasized that the SO had not even looked at the file until the day of the hearing.

The hearing where she nonetheless chastised the Hamiltons for not having provided all the paperwork.

Here is the Court:

She did not take them up on that offer; her doing so would have allowed the Hamiltons to address any issues before the November 15, 2018 hearing.”

The Court continued:

… the settlement officer made up her mind after a cursory one-hour review of the Hamiltons’ materials and failed to give proper consideration to the issues they raised …”

The cumulative effect of the settlement officer’s conduct in this case was to deprive the Hamiltons of fair consideration of their issues and concerns. The Hamilton’s conduct was by no means perfect, but it reflected consistent cooperation and good-faith effort throughout the CDP process.”

The SO’s decision was found arbitrary and lacking sound basis in fact or law.

The case was returned to IRS Appeals for another hearing.

The SO had gotten the case off her desk.

But she had not done her job.

And there you have a rare taxpayer win in the CDP arena.

Our case this time was Hamilton v Commissioner, T.C. Memo 2022-21.

The Collection Due Process Hearing

A client recently faxed me a Notice of Intent to Levy. His tax case is relatively simple, as we are not debating the amount of tax. Rather, he is in a position where he cannot pay-off his tax due. This requires a payment plan, which can blow up if the taxpayer misses a payment. He is self-employed with erratic income, so he is at ongoing risk of blowing up his payment plan. He unfortunately believes – or has believed – that we can reactivate a payment plan whenever he feels like missing a payment, but I believe we impressed upon him that this is not the case. The IRS becomes weary, and frankly so do we.

I thought this a good time to talk about the Collection Due Process hearing.

Once you receive a Notice of Federal Tax Lien (NFTL) or Intent to Levy, you have 30 days to request a CDP hearing. If so, the levy action will be suspended for the duration of the hearing. IRS Appeals conducts the hearing. The taxpayer can appeal a CDP hearing, if so inclined.

What happens if you miss the 30 days? Not all is lost. You can request an Equivalent Hearing as long as you file within one year of the NFTL or levy notice. The difference is that you cannot appeal an Equivalent Hearing.

You have to file a form (Form 12153) and state a reason for the hearing. In our case, we will request a collection alternative, such as an installment agreement. Our client does not qualify for an offer in compromise, which is another valid reason. Other reasons include requests to release or subordinate a lien, request for innocent spouse and a dispute over the amount of unpaid taxes. An important reason in today’s economy is financial hardship, which can include heavy medical bills, unemployment, and taxpayer’s reliance on social security or unemployment benefits.

An unfortunate note is that – even if the IRS accepts the collection alternative – interest and penalties will continue to accrue.