On June 27, 2019, the Office of Chief Counsel, IRS published Notice CC-2019-004 to update a notice it issued eight years ago shortly after the IRS was given permission by Congress to make assessments based on restitution orders. We have written about assessments based on restitution orders before here, here and here. The idea to allow the IRS to make assessments based on these orders improved the process for handling the civil side of criminal cases. Before the change in the law, the IRS had to go through the entire deficiency process before it could begin the collection process. Many taxpayers who go through the criminal process already have a significantly diminished ability to satisfy any subsequent assessment of the tax relating to the crime. For those taxpayers who did have the post criminal process ability to pay the tax, the sometimes multiyear process needed by the IRS to achieve an assessment further winnowed the group with an ability to pay.
So, in general, the innovation of restitution-based assessments greatly improved the process; however, these assessments have limitations and almost 10 years after these types of assessments were approved, the limitations are still being refined. This notice addresses limitations on restitution-based assessments when it comes to interest and penalties. Keep in mind that although Congress granted the IRS the ability to make an assessment of tax after the imposition of a restitution order it did not prevent the IRS from continuing to use its traditional bases for making an assessment and those traditional bases could fill the gaps left by restitution based assessments in those situations in which pursuing the additional steps to assessment would make good sense.
In its original notice regarding restitution based assessments, Notice CC-2011-018, the IRS took the position that underpayment interest under IRC 6601 would accrue on the restitution assessment. In Klein v. Commissioner, 149 T.C. No. 15 (2017), blogged here, the Tax Court disagreed. The new notice states:
Consistent with Klein, if a taxpayer challenges in litigation the accrual of interest on an amount of restitution assessed under section 6201(a)(4)(A), the interest should be abated.
Does this mean that taxpayers who do not challenge the imposition of this interest in litigation must still pay it? Is this an example of Sludge where the IRS knows that it shouldn’t do something but refuses to establish the administrative process for fixing the problem, forcing taxpayers and the courts to do that work for them? I do not understand why the IRS would only eliminate the accrual of this interest in litigation and not just do it or at least do it upon an administrative request by the taxpayer. Perhaps readers will comment on why the IRS has adopted this position which will only benefit taxpayers who bring an action against the IRS in court.
In the following sentence the IRS limits the situations in which it will abate the accrued interest to those situations in which the restitution order does not include interest. I do not know the percentage of restitution orders that mention interest. Obviously, this is something that the IRS would want to work with the U.S. Attorneys around the country to insure is included in restitution orders. Usually, taxpayers would have a very limited ability to keep this language out of the restitution order. So, I see it as a matter of educating the prosecutors to make sure the language appears in the restitution order. If prosecutors become sufficiently educated on the subject, the IRS may have a means of circumventing the adverse decision in Klein or at least setting up for additional litigation over whether 6201(a)(4)(A) allows the assessment of accrued interest.
The new notice does refer back to the original notice on the issue of interest accruing under 18 USC 3612(f) and continues to take the position that even though the United States can seek interest on the restitution ordered amount the IRS cannot assess interest under that provision. The Department of Justice could, however, go after the person to obtain this interest.
The Notice next turns to the failure to pay penalty. For taxpayers assessed in the traditional IRS ways, the making of the assessment will trigger the penalty which runs at .5% per month up to a total of no more than 25% if the assessed amount remains unpaid for 50 months. In Klein the Tax Court also held that the IRS lacks authority to assess and collect this penalty based on a restitution assessment. The penalty applies to the failure to pay the tax required to be shown on a return; however, the restitution assessment is not an assessment of tax. So, the Notice provides that “the failure to pay penalty does not apply to an amount of restitution assessed under section 6201(a)(4)(A).”
Again, the Notice provides that if the restitution order makes this penalty a component of the restitution order “the taxpayer is liable for the failure to pay penalty included in the order.” The Notice notes that these situations will be rare.
Without data regarding how much the IRS collects on restitution orders, it’s hard to say how much the limitation on the collection of interest and penalties based on restitution orders impacts the overall collection of tax liabilities. Because my experience trying to collect from people who have gone through the criminal tax process suggests that collection from these individuals often results in low yields, I think that the limitation on the ability of the IRS to collect certain interest and penalties based on the restitution order does not negatively impact the Service in any significant way. For those individuals for whom it identifies a continued ability to pay it can go through the traditional means of making an assessment while pursuing collection of the tax it has assessed as a result of the restitution order.
The new notice brings the guidance of the Service into line with the decision of the Tax Court. The Tax Court’s decision makes sense. For those individuals assessed between 2010 and the timing of this notice, I expect that it will be difficult to get the Service to abate the interest and penalties it now acknowledges it should not have made. Some of these individuals may be entitled to a refund. Others will want the assessments abated in order to reduce the amount the IRS collects from them. Some will be so judgment proof that this may not matter.