Tax Court Judge Lauber recently rendered an opinion in Kanofsky v. Commissioner where he imposed the frivolous filing penalty in IRC 6673. The imposition of this penalty in a Collection Due Process (CDP) case caught my eye because the IRS has the ability to turn away frivolous CDP requests without issuing a determination letter giving the taxpayer a chance to go to Tax Court. I wondered why the IRS sent a determination letter to someone making frivolous arguments rather than issuing them a disregard letter. After reading the opinion, I think I understand how the case got to the Tax Court. Unfortunately for Mr. Kanofsky, he made his frivolous arguments in the Court case rather than before the IRS.
I say unfortunate because the IRS does not have the ability to impose a penalty for submitting a frivolous CDP request but the Tax Court does have the ability to impose a penalty for making frivolous arguments before that court. Had his CDP request risen to the level of frivolous, he would not have gotten to Tax Court and the 6673 penalty would not have entered the picture. I do not know if he can pay the underlying tax, much less the penalty he now owes, but if he had made his arguments clearer to the Appeals employee handling his case, he might have avoided the 6673 penalty. Even though Congress gave the IRS a tool to stop frivolous CDP cases from going forward to the Tax Court, his failure to respond during the administrative process caused the IRS to treat his arguments as sufficiently meritorious to earn a determination letter.
Mr. Kanofsky first went to Tax Court to contest the underlying liability at issue in the CDP case and the trial judge issued a bench opinion. The fact that the case was decided by bench opinion signals that the trial judge did not need to spend much time considering the case. Here is a link to a recent blog post on bench opinions. Mr. Kanofsky appealed his Tax Court loss to the Third Circuit and then to the Supreme Court and the Supreme Court denial of certiorari and petitioner’s subsequent petition for rehearing.
Based on the Tax Court decision, the IRS gained the right to assess unless petitioner posted a bond during the appeal of the decision. The recent Tax Court opinion states that “Petitioner did not post a bond to stay assessment and collection. See sec. 7485(a).” Therefore, the IRS assessed the liability proposed in the notice of deficiency and began sending him collection notices ending with the notice of intent to levy. This gave Mr. Kanofsky the opportunity to file a CDP request which he did. In his request he stated his basis for relief as “Still in litigation, working on reducing amounts.” This basis for relief appears reasonable on its face and especially so when he may have still had an open appeal at the time of the CDP request. The Appeals employee handling the request reached out to Mr. Kanofsky to hold a hearing but never received a response from Mr. Kanofsky. Therefore, Appeals issued a notice of determination denying the request for relief from levy and Mr. Kanofsky once again petitioned the Tax Court.
Congress added section 6330(g) to the Code in the Tax Relief and Health Care Act of 2006. This addition to CDP sought to stop the use of CDP hearings by individuals who only wanted to make frivolous arguments. If it works, section 6330(g) not only keeps the IRS from having to deal with frivolous arguments beyond the initial stages of the CDP process but also keeps the Tax Court out of the hassle of dealing with frivolous arguments because the IRS can treat frivolous submissions “as if [they] were never submitted and such portion shall not be subject to any further administrative or judicial review.” (effective for CDP hearing requests made after March 15, 2007. Tax Relief and Health Care Act of 2006 § 407(f).) Congress also created a second condition on effectiveness of the statute referencing, IRC 6702(b)(2)(A)(i) and (ii) as it created the new CDP provision making the new provision effective when the IRS published a list of frivolous positions.
The IRS has published this list, but the information on the CDP request submitted by Mr. Kanofsky was not on that list. Since it was not on the list, the Appeals employee could not treat the CDP request as frivolous and had to issue a determination letter. Of course, such a list can never capture everything and sending the notice of determination was appropriate.
If Mr. Kanofsky had put in his CDP request something on the list in the Notice, the Appeals employee would not have issued a notice of determination but rather would have issued a “disregard” letter. Someone receiving a disregard letter has no right to litigate the collection of the liability in Tax Court. The IRS and the Tax Court do not entirely see eye to eye on the effect of a disregard letter with the IRS taking the view that the Tax Court has no jurisdiction of a case petitioned following the issuance of such a letter and the Tax Court, in Thornberry v. Commissioner taking the view that it has jurisdiction to determine the merits of a non-frivolous issue. In Buczek v. Commissioner, the Court and the IRS narrowed the gap between their views a little bit but a gap still remains on the effect of a disregard letter. I think that such a letter would, however, have protected Mr. Kanofsky from the 6673 penalty if for no other reason than the Court would have known he was making frivolous arguments as it accepted the case over the objection of the IRS but neither decided case took on this issue.
The case points out that different standards and different remedies apply to frivolous behavior at different stages of a case. As with most things, misbehaving before a Court can bring serious consequences. Usually, we think of the IRS imposing the penalties but this situation also points out that sometimes the role of the IRS and the Court get reversed.