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.

New Vehicle Loan Interest Deduction

 

I have been looking at individual tax changes for 2025 returns as well as changes starting anew in 2026. We may do several posts covering the changes likely to affect the most people.

I will start with one that may affect me: the new vehicle loan interest deduction.

My car has been reliable, but it is getting old. There comes a point with older cars where regular maintenance instead changes to regular repairs. I may or may not be there yet, but I am paying attention. What I know is the next car will not be cheap.

So, what is the tax change?

First, it is a deduction, not a credit. As we have discussed before, a credit is worth more than a deduction (a credit is dollar-for-dollar, whereas a deduction is a dollar-times-the-tax-rate). We will take it, though.

Second, it is not an itemized deduction. This is important, because introducing something as an itemized deduction is as much political sleight-of-hand as a real tax break. How? Easy. Let’s say that you are married, and the sum of your taxes, mortgage interest, and contributions is $25 grand. The tax Code spots you $31,500 just for being married (this amount is called the standard deduction). Which number will you use: the actual ($25,000) or the standard ($31,500)? The standard, of course, because it is the bigger deduction. Now someone can yammer that your mortgage interest is deductible – but is it really? I would argue that it is not, because the $31,500 is available whether you have a mortgage or not. Calling it deductible does allow for political blather, though.

The vehicle loan interest deduction is taken in addition to the itemized/standard deduction. It will show up on line 13b (see below), after the standard deduction/itemized deductions on line 12e. Our married couple will be deducting $31,500 (the standard) plus the allowable new vehicle loan interest.

Third, the deduction is not limited to cars. Technically it applies to “qualified passenger vehicles,” a term that includes the usual suspects (cars, trucks, SUVs, vans, minivans) as well as motorcycles. I am not as clear on campers, although the 14,000-pound limitation might kick-in there.

Fourth, it must be a new vehicle, which the Code refers to as “original use.” Not surprisingly, there is a special rule to exclude dealership demo use.

Fifth, you must have bought the vehicle after 2024. The deduction expires (unless a future Congress extends it) after 2028. Note that I said “bought.” A lease will not work.

Sixth, the deduction is for personal use of the vehicle, and the personal use must exceed 50 percent. While this may sound strict, it is not. Deductions for business use of a vehicle might take place under other areas of the tax Code, so it is possible that you will be deducting some of the interest as a business deduction (say as a proprietor or landlord) and the personal portion under this new deduction. You decide how to chop-up and report the numbers (some business, none business), and you cannot deduct the same interest twice. The behind-the-scenes accounting might be a mess, but you have the concept. There is also a favorable rule concerning personal use: such use is decided when you buy the vehicle. Later changes in use will be disregarded.

Seventh, the deduction is available to individuals, decedent estates, (certain) disregarded entities and nongrantor trusts. An estate is not immediately intuitive (why would a deceased person buy a vehicle?), but it refers to someone passing away after buying a vehicle qualifying for the deduction. A nongrantor trust generally means a trust that files its own tax return. Personal use would be measured by the beneficiary, as a trust cannot drive a car.

Eighth, there are some housecleaning rules. For example, you cannot pay interest to yourself or – more accurately stated – to a related party. The Code wants to see a lien securing the loan on the vehicle. There are also rules on add-ons (think extended warranties), lemon law replacements, subsequent loan refinancings, and no-no rules on negative equity on trade-ins.

Ninth, final assembly must occur in the United States. You may want to check on this before buying the vehicle. I have already checked on my next likely vehicle purchase (a Lexus).

Tenth, the deduction limit is $10 grand. It doesn’t matter if you are married or single, the limit applies per return and is $10 grand. Seems to me that marrieds filing separately got a break here. File jointly and cap at $10 grand. File separately and cap at $20 grand. Such moments are rare in the tax Code.

Eleventh, if you make too much money, the Code will phase-out the deduction you could otherwise claim. Too much begins at $100 grand if you are single or $200 grand if you are married filing jointly. Hit that limit and you phase-out at 20 cents on the dollar (rounded up).

Twelfth, you must include the vehicle VIN on your tax return. Leave it out and the IRS will simply disallow the deduction and send you a bill for the additional tax.

Finally, Congress and the IRS prefer that anything which moves be reported on a Form 1099. The problem here is that the tax bill was signed midway into 2025, meaning that banks and loan companies would have to make retroactive changes for 1099s issued in 2026. In light of this, the 2026 reporting (for tax year 2025) has been relaxed a bit: you may have to go to a website to get the interest amount rather than receiving a formal 1099, for example. Do not worry, though: the normal 1099 reporting will be back in full force in 2027 (for the 2026 tax returns).

My thoughts? I would neither buy or not buy a vehicle because of this deduction, but I am happy to take the deduction if I bought and financed. The $10 grand limit seems high to me, but - to be fair - I avoid borrowing money. I suppose $10 grand might be a backdoor way to allow for two vehicle loans on the same tax return (think married filing jointly). I do know that - unless one is making beaucoup bucks - spending $10 grand on vehicle interest does not immediately appear to be sound household budgeting.

And there you have the new vehicle loan interest deduction.