Retirement Assets In A CDP Hearing

 

Let’s talk about a Collection Due Process (CDP) hearing, how CDPs came about and a great way to flub one.

Think of filing taxes as having two phases:

·      The assessment of tax

 For most of us, this means filing the return. It shows total tax due, from which is subtracted tax withholdings and other payments. In general, processing the return is tantamount to assessing the total tax due shown on the return. Assessment in turn begins the statute of limitations. 

·      The collection of tax 

If you are overpaid, you are normally done with the process right here. 

Go the other way and the IRS may send notice and demand for payment. If the taxpayer fails to pay, a tax lien is created automatically retroactive to the date of assessment (Sec. 6321). 

This lien is a quiet lien and does not take priority over other competing claims. The lien we fear - the publicly-recorded lien which does take priority – requires a second step. 

The lien establishes a pathway for the IRS to take property to satisfy that unpaid assessment. The IRS could, for example, bring suit to enforce the lien. More commonly, the IRS will take collection action without seeking court approval. 

That ability to take property – a bank account, a garnishment on a paycheck – is generally referred to as a power to levy.

The CDP hearing takes place here – at the point where the IRS wants to formally file its lien and/or engage its Collection division.  Code section 6330 provides for CDP hearings. Congress wanted to protect taxpayers from arbitrary or abusive IRS actions (there was history) as well as provide procedural guardrails for taxpayers.

Section 6330 requires the IRS to notify a taxpayer at least 30 days in advance of his/her right to an administrative hearing (the CDP hearing) before the IRS Office of Appeals. After the Office issues its determination, the taxpayer may then petition the Tax Court for judicial review. This review is very limited and concerns abuse of discretion by the IRS.

It may come as a surprise to a nonpractitioner, but a taxpayer is generally not allowed to dispute a tax liability at a CDP hearing. The reasoning is that the taxpayer had earlier opportunities to dispute a liability. The CDP is instead a collection hearing. To the extent review of an underlying liability is permitted, it is as a remedy against abusive collection and as protection for taxpayers who would fall through the cracks (for example, a taxpayer who was never notified that they were in Collections).

Let’s talk about a CDP case in Scanlon and Fairweather v Commissioner.

“The only issue for decision is whether the Internal Revenue Service (IRS) Office of Appeals (Appeals) abused its discretion in sustaining” collection actions against the taxpayers.

The Court’s involvement is limited: it will not reopen the matter (nerd term is “de novo”), but it will review to determine if the IRS abused its authority, perhaps by not following its own rules. This limit is intentional. CDP cases constitute approximately 15% of Tax Court cases annually, even with this limited reach.

Lawrence Scanlon was an associate professor of English at Rutgers University, and his wife (Aline Fairweather) was an attorney with Pepper Hamilton. For the years 2011 through 2013 their taxable income ranged from $345,603 to $441,185. The tax issue was their failure to pay estimated taxes against that income, resulting in a considerable tax bill.

Here is a timeline:

10/21/14      IRS sent Notice of Federal Tax Lien for 2011 and 2012.

11/27/14        Taxpayers sent Form 12153 (Request for CDP or Equivalent Hearing). Taxpayers did not challenge the underlying liabilities.

1/12/15        IRS Settlement Officer (SO) requested financial information (Form 433-A), collection alternatives, a copy of the 2013 return, and a scheduled follow-up call for 2/4/15.

1/13/15        IRS sent a second lien notice for 2013.

1/31/15        Taxpayers’ representative (Markham) sent the SO Form 433-A and proposed monthly payments of $3,000.

2/4/15          The SO tried but failed to contact Markham.

2/4/15          Later that day Markham faxed the SO saying that a follow-up was not necessary, that taxpayers had submitted financial information, and reiterated the monthly $3,000 proposal.

2/10/15        IRS sent Final Notice of Intent to Levy for 2013, which liability exceeded $117 grand.

2/20/15        Taxpayers submitted another 12153 (for a second CDP hearing). Taxpayers also resubmitted the 433-A from 1/31/15 proposing a monthly $3,000 payment.

3/16/15        The SO determined that taxpayers had enough retirement assets (one account at TIAA-CREF and a second at Vanguard, both totaling $645,538) to pay the IRS ($271,941) and scheduled a telephone conference for 7/24/15.

7/24/15        Taxpayers objected to the retirement proposal, arguing tax implications. The SO had another call. She was to return the call by end of day, but she could not reach Markham. The SO scheduled another conference call for 9/23/15.

9/23/15        Markham told the SO that taxpayers could not reach the retirement funds; the SO asked how Mrs Fairweather had managed to borrow $30,000 against her Vanguard account. The SO wanted some verification that no further borrowings or withdrawals were available from Vanguard or TIAA-CREF. She requested a response date of 9/30/15.

11/20/15      Taxpayers had not responded. The SO checked 2014 (not enough tax payments to cover the liability) and 2015 (no payments at all). She left a message for taxpayers that she was proceeding with collection action.

And … we are in Tax Court.

I could predict how this would go when I got to 7/24/15.

Through that date, the SO was behaving with restraint. The taxpayers were repeating a pattern (not paying) and the taxes due were adding up. The taxpayers however appeared to be acting in good faith, even though one had to wonder where the household income was going.  

Then we reached the two retirement accounts. Mrs Fairweather argued that one (Vanguard) was beyond her reach. We know next to nothing about the second. We do know that Markham (taxpayers’ representative) objected “because of its tax implications.” Really? If you are this deep into IRS machinery, I doubt the SO is overly concerned about your tax implications. I might, if pressed, request the SO to allow withdrawal and payment over two calendar years - to lessen some of the tax pressure.

And here is decades of tax practice speaking: you cannot - CANNOT - blow-off a response date. If there is a problem obtaining paperwork, let the IRS know as soon as possible. If life makes you unavailable that day, have someone in the office contact the IRS, preferably ahead of any scheduled call. There are … companies … out there that will use CDPs (and similar) to delay and obstruct collection activity. I know this. The IRS knows this. Do NOT give the SO reason to think you are one of those people. 

NOTE:  I have found that failure to make current estimated tax payments will generally doom a taxpayer’s request for a payment plan. I understand the issue: how can I pay this year when I cannot afford to pay the back years? Pay something toward the current year. Extend the return and continue paying on the year until you file on the last day of extension. Cut out some expenses and redirect the money. The IRS wants to see you stop digging the hole you are in.

Here is the Court:

Petitioners do not challenge the validity of their underlying Federal income tax liabilities for 2011, 2012, and 2013."

As discussed, a CDP is not the place for this anyway.

… petitioner’s underlying liabilities are not properly before the Court, and we will review Appeal’s determination for abuse of discretion…”

We do not conduct an independent review and substitute our own judgement for that of the appeals officer.”

What is the Court going to look at?

The only issue petitioners raise is whether Appeals determination to reject their proposed installment agreement and sustain the lien filings for 2011, 2012, and 2013, and the proposed levy for 2013 was an abuse of discretion.”

The first issue is the failure to make current estimated tax payments.

But …

No surprise. I have butted heads here too many times to count.

The second issue involves burning the retirement account(s).

I see that Mr Scanlon was 60 years old and Mrs Fairweather was 55. How about an economic hardship argument - only so many years to restore the monies otherwise drained from the retirement account and such?

Here you see an instance of hard procedure. There are areas in tax where “turn right” is not the same as “turn left, then left, then left.” This is one of them.

The IRS won. The IRS almost always wins a CDP case. The Court is reviewing for abuse of discretion and not for commendable application of common sense. It is a very high bar to overcome.

Our case this time was Scanlon and Fairweather v Commissioner, T.C. Memo 2018-51.

An IRS Payment Plan And Tax Evasion

 

Let’s talk today about IRS payment plans. More specifically, let’s talk about common paperwork in requesting a payment plan.

A common one is Form 433-A, and it is used by W-2 workers and self-employeds.

The IRS is trying to figure out how much you earn, own, and owe.

There are questions about whether you (or your spouse) own a business, are a beneficiary of a trust or have gifted property worth more than $10,000 over the last 10 years. Yes, they wanna know stuff.

You will have to list your bank accounts, as well as other investments, real estate and other assets.

You will have to provide an accounting of your monthly income and expenses.

There is also expanded disclosure if you are self-employed (that is, a sole proprietor).

There are other ways to own a business than as a proprietor (for example, a shareholder in a C corporation). The IRS will want to know about that, too.

Part of tax practice is avoiding this series, if possible. For example, if you have personal tax debt of $50,000 or less, you can bypass the 433 series and request a “streamlined” payment plan. You are still entering into a contract with the IRS (you must stay current with your filings, make all payments as required, and so on), but in exchange the IRS lifts some of the paperwork requirements. Sometimes advisors recommend hybrid arrangements (taking out a second mortgage, for example), leaving the IRS debt at $50 grand or less. And sometimes you are simply into the IRS for more than $50 grand, leaving no choice but to run the 433 gauntlet. This can be a rude awakening, as the IRS uses standards for certain expense categories (for example, housing and utilities). You might google that you can request an increase from these standards. You can request; don’t expect to receive, though. Barring significant factors (think care for chronic medical conditions), it is unlikely to happen. Depending on the numbers, you might be forced to downgrade a vehicle or pull the kids from a private school. This is not a friendly loan.  

And you do not want to be … sly … when running the 433 hurdles.

Let’s look at someone who was too clever by half.

Kevin Crandell is a medical doctor. He contracted with two hospitals, one in Mississippi and another in Alabama, for $30 to $40 grand per month.

From 2006 through 2012 he did not file returns or pay taxes.

The IRS started garnishing his wages in 2010.

COMMENT: I find it remarkable that he still did not file or pay even when garnished.

The doctor racked up close to a million dollars in taxes, penalties, and interest.

Somewhere in there he formed a couple of corporations. He used one to receive monies earned as a contractor. The second appeared to serve as asset protection.

He finally hired someone (Blue Tax) to help out with tax returns and attendant debt.

Blue Tax drafted a 433. The first draft showed Crandell’s salary as $17 grand per month (I don’t know where the rest of the money went either). The doctor howled that the number was much too high and should be closer to $12 grand.

Oh, the 433 also left out bank accounts for those two corporations (which he controlled). And a $50,000 gun collection. And the $40 grand he drew from the corporations shortly after submitting a 433 stating that his salary was around $12 grand.

Doc, you have to know when to stop. Lying, and then lying about the lying is called something in tax.

Crandell was indicted for fraud.

That pattern of non-file and non-pay looked bad now. That “creative” 433 also gleamed like a badge of fraud, leaving off income, assets and so on.

Crandell argued that he relied on Blue Tax.

It is a good argument - an excellent argument, in fact - except that he did not fully disclose to Blue Tax. If you want to show reliance on an advisor, you have to … you know … actually rely on the advisor.

Crandell was convicted for tax evasion.

Our case this time was US v Crandell, 2023 PTC 178 (5^th Cir. 2023).

Having Assets And Filing An Offer In Compromise

I glanced at the case because it involved an offer in compromise, a collections hearing, a lien and currently noncollectible (CNC) status.

That is a lot going on for approximately $23 grand in tax debt.

First thing I noticed was that the taxpayer represented himself before the Tax Court. This is referred to as “pro se.” It happens quite a bit, and it usually does not work out well for the taxpayer.

I double-shudder when I think about “pro se” and going hard procedural with the IRS, such as with liens and offers in compromise.

Let’s walk through it:

(1) On November 16, 2016 the taxpayer filed an Offer in Compromise. The tax was approximately $23 grand. He offered approximately $12 grand.

COMMENT: There are several “flavors” of Offers in Compromise. This one was the traditional vanilla: inability to pay or to pay in full. Those late-night commercials are hawking this type.

(2) On May 30, 2017 the IRS sent a Notice of Federal Tax Lien Filing.

The taxpayer filed for a hearing, called a Collection Due Process (CDP) hearing. I probably would have done the same.

(3) On July 11, 2017 the IRS indicated it would not accept the Offer in Compromise, at least as submitted. 

Taxpayer appealed. Again, I probably would have done the same.

(4) On September 27, 2017 the IRS settlement officer sent taxpayer a letter that the CDP hearing was being delayed until the Offer in Compromise was resolved.

COMMENT: Left hand: right hand. Happens all the time.

(5) Wouldn’t you know that the appeal of the Offer in Compromise was assigned to the same IRS settlement officer handling the Collections hearing?

(6) The IRS scheduled a telephone hearing for December 14, 2017. The settlement officer also offered to place the taxpayer’s case in currently noncollectible (CNC) status.

COMMENT: I have used CNC status over the years, especially during and after the Great Recession of 2008. The IRS realizes that there is no money to collect, so it places the case on hold, generally for a year or so. Their normal collections machinery is paused.

Mind you, the IRS is not writing-off the debt. They are allowing a break in collection activity, hoping your situation improves.

(7) Not waiting until the hearing, taxpayer on December 1 sent the settlement officer a letter addressing the rejection of his offer in compromise.

COMMENT. He should include additional or expanded financial information, as his offer was based on inability to pay. The common-sense response to rejection of an offer based on inability to pay is to expand on why one is unable to pay.

Having taken the stage, taxpayer also alleged that the IRS engaged in criminal activity.

COMMENT: Stop that. You are not winning with that behavior.

The settlement officer rescheduled the hearing for January 9th.

(8)  On December 12 taxpayer sent the settlement officer another letter lamenting the rejection of his offer in compromise.

COMMENT: Once again: no additional or expanded financial information. This action was fruitless and ill-advised.

(9) We finally get to the hearing. The settlement officer reviewed the offer in compromise. She sees debt of approximately $23 grand and assets of approximately $110 grand. Receiving no additional or expanded financial information from the taxpayer, the officer decided that rejection of the offer was appropriate.

(10) After the hearing taxpayer sent a letter to the settlement officer, complaining about the IRS Fresh Start Program and including correspondence the taxpayer previously exchanged with the Taxpayer Advocate Service.

Taxpayer was focused on the lien and highlighted a TAS letter including the statement “the IRS has determined that the lien should be withdrawn.”

He wanted the lien withdrawn.

The settlement officer, to her credit, looked into this. It did not change the outcome, but she did try.

The immediate takeaway is the someone with $100-plus grand in assets is probably not going to be able to offer-down $23 grand in tax debt, irrespective of having low income. While true as a generalization, there are several specific considerations.

(1)  Given his focus on removing an IRS lien, I presume that taxpayer’s house comprised most if not all of taxpayer’s assets. I can see not wanting to refinance when one has limited income. In truth, one probably could not refinance, as no traditional mortgage provider would originate the loan.

a.     And there is how I would respond to the request for additional financial information: by providing rejection letters from a couple of mortgage companies.

(2)  Let’s say that the house is not the lion’s share of the assets. Perhaps it is something else, like a retirement account.

a.     If a retirement account, I would argue economic hardship.

                                                                         i.      That is, taxpayer needs that asset and the income therefrom in order to meet reasonable basic living expenses. The loss of said asset would be an economic hardship.

                                                                      ii.      It is already stipulated that the taxpayer is low income. How hard of an argument is this?

(3)  In general, I am unmoved by the IRS filing a lien.

a.     I may be moved if disclosure of said lien would adversely affect one’s career or public status (a mayor or judge, for example), but those instances are few and far between.

b.     Distinguish a lien from a levy.

                                                                         i.      A lien just secures the government’s interest. A lien on my house cannot be collected until I sell the house.

                                                                      ii.      A levy is a different matter. The IRS going into your bank account is an example of a levy.

(4)  Let’s circle back to the presumption that taxpayer’s residence represented the majority of his assets, hence his focus on removing the lien. The IRS just bounced his offer. What happens next?

a.     Folks, the IRS cannot (barring exceptional circumstances) take one’s primary residence.

b.     Yep, he will get periodic and annoying IRS correspondence, but …

c.     … so what? There is little bite left in that dog.

d.     And after 10 years (without the IRS taking the matter to Court to obtain judgement), the statute of limitations will kick-in.

You can see the downside to a pro se, especially when dealing with IRS procedure. There is a lot going on here, and I suspect that – with professional advice – taxpayer could have gotten the offer. I doubt he would have gotten the lien released, though. He saved a few grand in professional fees in order to completely strike out with the IRS.

The case for the home gamers is Banks, TC Memo 2019-166.

Someone Fought Back Against Ohio – And Won

I admit it will be a challenge to make this topic interesting.

Let’s give it a shot.

Imagine that you are an owner of a business. The business is a LLC, meaning that it “passes-through” its income to its owners, who in turn take their share of the business income, include it with their own income, and pay tax on the agglomeration.

You own 79.29% of the business. It has headquarters in Perrysville, Ohio, owns plants in Texas and California, and does business in all states.

The business has made a couple of bucks. It has allowed you a life of leisure. You fly-in for occasional Board meetings in northern Ohio, but you otherwise hire people to run the business for you. You have golf elsewhere to attend to.

You sold the business. More specifically, you sold the stock in the business. Your gain was over $27 million.

Then you received a notice from Ohio. They congratulated you on your good fortune and … oh, by the way … would you send them approximately $675,000?

Here is a key fact: you do not live in Ohio. You are not a resident. You fly in and fly out for the meetings.

Why does Ohio think it should receive a vig?

Because the business did business in Ohio. Some of its sales, its payroll and its assets were in Ohio.

Cannot argue with that.

Except “the business” did not sell anything. It still has its sales, its payroll and its assets. What you sold were your shares in the business, which is not the same as the business itself.

Seems to you that Ohio should test at your level and not at the business level: are you an Ohio resident? Are you not? Is there yet another way that Ohio can get to you personally?

You bet, said Ohio. Try this remarkable stretch of the English language on for size:

ORC 5747.212 (B) A taxpayer, directly or indirectly, owning at any time during the three-year period ending on the last day of the taxpayer's taxable year at least twenty per cent of the equity voting rights of a section 5747.212 entity shall apportion any income, including gain or loss, realized from each sale, exchange, or other disposition of a debt or equity interest in that entity as prescribed in this section. For such purposes, in lieu of using the method prescribed by sections 5747.20 and5747.21 of the Revised Code, the investor shall apportion the income using the average of the section 5747.212 entity's apportionment fractions otherwise applicable under section 5733.05, 5733.056, or 5747.21 of the Revised Code for the current and two preceding taxable years. If the section 5747.212 entity was not in business for one or more of those years, each year that the entity was not in business shall be excluded in determining the average.

Ohio is saying that it will substitute the business apportionment factors (sales, payroll and property) for yours. It will do this for the immediately preceding three years, take the average and drag you down with it.

Begone with thy spurious nonresidency, ye festering cur!

To be fair, I get it. If the business itself had sold the assets, there is no question that Ohio would have gotten its share. Why then is it a different result if one sells shares in the business rather than the underlying assets themselves? That is just smoke and mirrors, form over substance, putting jelly on bread before the peanut butter.

Well, for one reason: because form matters all over the place in the tax Code. Try claiming a $1,000 charitable deduction without getting a “magic letter” from the charity; or deducting auto expenses without keeping a mileage log; or claiming a child as a dependent when you paid everything for the child – but the divorce agreement says your spouse gets the deduction this year. Yeah, try arguing smoke and mirrors, form and substance and see how far it gets you.

But it’s not fair ….

Which can join the list of everything that is not fair: it’s not fair that Firefly was cancelled after one season; it’s not fair that there aren’t microwave fireplaces; it’s not fair that we cannot wear capes at work.

Take a number.

Our protagonist had a couple of nickels ($27 million worth, if I recall) to protest. He paid a portion of the tax and immediately filed a refund claim for the same amount. 

The Ohio tax commissioner denied the claim.

COMMENT: No one could have seen that coming.

The taxpayer appealed to the Ohio Board of Tax Appeals, which ruled in favor of the Tax Commissioner.

The taxpayer then appealed to the Ohio Supreme Court.

He presented a Due Process argument under the U.S. Constitution.

And the Ohio Supreme Court decided that Ohio had violated Due Process by conflating our protagonist with a company he owned shares in. One was a human being. The other was a piece of paper filed in Columbus.

The taxpayer won.

But the Court backed-off immediately, making the following points:

(1)  The decision applied only to this specific taxpayer; one was not to extrapolate the Court’s decision;

(2)  The Court night have decided differently if the taxpayer had enough activity in his own name to find a “unitary relationship” with the business being sold; and

(3)  The statute could still be valid if applied to another taxpayer with different facts.

Points (1) and (3) can apply to just about any tax case.

Point (2) is interesting. The phrase “unitary relationship” simply means that our protagonist did not do enough in Ohio to take-on the tax aroma of the company itself. Make him an officer and I suspect you have a different answer. Heck, I suspect that one Board meeting a year would save him but five would doom him. Who knows until a Court tells us?

With that you see tax law in the making.

By the way, if this is you – or someone you know – you may want to check-out the case for yourself: Corrigan v Testa. Someone may have a few tax dollars coming back.

Testa, not Tesla