For many, the New Year is a time of opportunity: the power of a new beginning and clean-slate to help us move towards our goals. I’ll admit that I am someone who makes New Year’s resolutions and several months later struggles to remember exactly what they were. In such instances I’ve missed the opportunity to change -to strike when the iron is hot. This post is all about what happens when you fail to act on an opportunity, and what “opportunity” really means… at least in the context of IRC 6330(c)(2)(B). In addressing that issue we will focus entirely on one (very important) designated order from Judge Gustafson in the case of Zhang v. C.I.R., Dkt # 4956-19L (order found here). Because I found this order so important I wanted to devote all of the post to it -Part 2, released later, will cover the remaining orders of the week.
Because of the procedural posture of the order granting an IRS summary judgment motion, it is a little difficult to parse the facts (i.e. the reality) from the “facts” (i.e. what Judge Gustafson assumes, without deciding, to be true) of the Zhang case. But the “facts” certainly paint a pretty unfair picture for the taxpayer.
Mr. Zhang runs a restaurant where, not surprisingly, customers pay with credit cards. Credit card companies love these arrangements, since they get transaction fees from the vendor. Consumers (if they don’t carry a balance) love this arrangement because they usually get points or miles. The IRS (probably) also loves this arrangement, because it makes for a paper-trail: specifically, the issuance of Form 1099-K from the credit card processors. (The only people really missing out are those that pay with cash, since the vendor usually passes on the transaction fees to the customer in the form of higher prices. Interesting take found here.)
The paper trail of the Form 1099-K is the root of the problem in this case. Mr. Zhang operates the restaurant through a C-Corporation. Generally, the income from the business (including those reflected on the Form 1099-K) should be reported on the C-Corporation’s return. And that is exactly what Mr. Zhang did: he reported the income on the business’s tax returns, rather than his personal returns. However, the issuers of the Form 1099-K appear to have listed Mr. Zhang (not the C-Corporation) as the recipient of the income… You can probably guess what happens next.
The IRS information matching system (Automated Underreporter, or AUR) prompted the IRS to take a second look at the return. Mr. Zhang never responded to any of the letters, and attests that he never received the ensuing SNOD (more on that later) so the deficiency was assessed basically through default.
The facts, at this point, are essentially that Mr. Zhang shouldn’t owe the tax the IRS assessed. Judge Gustafson goes so far as to say that the IRS “incorrectly concluded that these payments were unreported income of Mr. Zhang.”
Thank goodness Congress created Collection Due Process in the 98 RRA. Without it, not only could the IRS levy without judicial review, but Mr. Zhang wouldn’t be able to argue in Court that he doesn’t owe the tax without fully paying it first. Instead, the IRS first had to issue a “Notice of Intent to Levy” giving Mr. Zhang the right to a Collection Due Process (CDP) hearing, which Mr. Zhang dutifully (and timely) requested.
And here, reader, is where we begin to learn the meaning and value of “opportunity.” Because Mr. Zhang claims he never actually received an SNOD, he would like to use the CDP hearing to dispute the underlying tax. And, assuming that Mr. Zhang did not actually receive the SNOD, he is well within his right to raise that issue. See Kuykendall v. C.I.R., 129 T.C. No. 9 (2007).
Under IRC 6330(c)(2)(B) there appear to be two (conjunctive?) conditions a taxpayer must satisfy to have the right to argue the underlying liability. To wit, a person “may also raise at the hearing challenges to the existence or amount of the underlying tax liability for any tax period if  the person did not receive any statutory notice of deficiency for such tax liability or  did not otherwise have an opportunity to dispute such tax liability.” (I’ve added the bracketed numbers to make this track a little easier.) From what we know, Mr. Zhang did not actually receive the SNOD and didn’t “otherwise have an opportunity” at this point. Keep that second component in the back of your mind.
To the extent that a CDP hearing actually took place (being extremely informal as they are, it is sometimes difficult to pin-down their moment of consummation), IRS Appeals did not appear to consider the underlying tax issue. They also did not properly schedule a telephonic hearing with the taxpayer in the first place. Judge Gustafson goes so far as to say, based on the (assumed) facts, IRS Appeals “abused its discretion in the handling of Mr. Zhang’s” CDP hearing.
In other words, the Court essentially says that based on the assumed facts this was a pretty poor hearing, and a pretty poor opportunity to argue your underlying tax. I’d argue based on the facts assumed by the Court that it wasn’t really a CDP hearing at all -and why I’d argue that will make a lot more sense by the end of this post.
But for now, it is critical to note that the underlying tax argument (indeed, no argument) was not raised with the Tax Court after this CDP “hearing.” The IRS issued a Notice of Determination upholding the levy, and Mr. Zhang did not respond.
Failing to exercise your right to judicial review when the IRS abuses its discretion is a textbook “missed opportunity.” And it is a costly one in this case.
It isn’t clear whether the IRS ever followed through on the levy, but they did later issue a Notice of Federal Tax Lien (NFTL) for the same tax year. And with an NFTL comes essentially the same CDP hearing rights, albeit under IRC 6320.
Mr. Zhang again timely requests a CDP hearing, and again raises the underlying tax issue. And if it was an abuse of discretion not to consider it before surely it is now, right?
Now it doesn’t even matter if Mr. Zhang “actually received” the SNOD because of the second clause in IRC 6330(c)(2)(B): you can’t argue if you “otherwise have an opportunity to dispute such liability.” And that “opportunity to dispute” was precisely the first CDP hearing… So IRS Appeals again doesn’t entertain the argument about the underlying liability, but this time on the grounds that he already had an opportunity to do so.
This time, however, Mr. Zhang isn’t taking “can’t argue underlying tax liability” for an answer. He petitions the tax court. If only he had done so with the first hearing…
Judge Gustafson feels for Mr. Zhang (“If the facts assumed here are correct, then Mr. Zhang’s situation is very sympathetic,”) but this is not a court of equity and being sympathetic isn’t enough. Mr. Zhang should have petitioned the court after the first hearing where the IRS presumably abused its discretion by not entertaining his argument about the underlying liability. That was his prior opportunity: when you raise the issue, you better follow through. Now, hoping to return to it, he is barred by the language of IRC 6330(c)(2)(B): what was once an abuse of discretion in the first hearing under the first clause of that provision has now morphed into Appeals correctly applying the law.
Summary judgment to the IRS.
There is a lot going on here, such that I cannot help playing arm-chair lawyer. My biggest qualm is with the quality of the “opportunity” Mr. Zhang received. I think the Court and the Treasury Regulations have really stacked the deck against taxpayers in a way that Congress and even the statute as written do not require.
If Mr. Zhang were to argue that the first hearing never really took place (as I suggested), since there was no phone call (it isn’t clear what else happened) might that be a way out? It would be an uphill battle for sure. The Treasury Regulations go so far as to say that simply receiving the CDP Levy notice is enough to preclude arguing the underlying tax at a later CDP lien hearing… whether you act on it or not. See Treas. Reg. 301.6320-1(e)(3), A-E7. The Tax Court appears to take no issue with that Treasury Regulation definition of prior “opportunity” (see, e.g. Nichols v. C.I.R., T.C. Memo. 2007-5). So maybe no dice on that argument… or maybe it has some life in a different iteration (that I will conclude this post with).
Let’s consider just how bad or ethereal an “opportunity” to dispute the tax can be for it to still be an opportunity. In this case, the assumed facts are that the taxpayer raised the issue, was told by the IRS that they couldn’t raise the issue, and then when they tried to raise it again were told they already had the “opportunity” to do so. Note that IRC 6330(c)(4) specifically lists out what issues are “precluded” from being raised: those that were “raised and considered under a previous hearing” (emphasis added) is the first one listed. To me, the underlying liability was certainly raised, but just as certainly not considered. I’ll talk more about why I think that matters from an administrative law perspective, but I’d note that this designated order did not rely on IRC 6330(c)(4) to reach its conclusion: the underlying liability was “precluded” from being reviewed under IRC 6330(c)(2).
Intentionally or otherwise, the case law and treasury regulations have turned “prior opportunity” into a landmine-strewn DMZ for taxpayers: the moment you step foot towards the Office of Appeals, you better tread lightly. We have already seen that if you raise the underlying liability with Appeals, even though you have no route to Court at that time, you may be barred from raising the liability at a later CDP hearing under the “prior opportunity” rationale. See Keith’s post here for an excellent review (Note that we’re still waiting on Tax Court to rule on the proposed opinion, which was assigned to Judge Goeke on 11/13/2019.)
A lesson used to be “wait to take the first step.” That is, instead of submitting audit reconsideration and going to Appeals, wait until the CDP hearing. This is obviously a poor use of judicial and administrative resources, but one that I feel practitioners have to keep in mind given the IRS (and Court’s) interpretation of the Treasury Regulations. With Zhang v. C.I.R. one can fairly add “once you’ve taken that first step, you better run with it all the way to Tax Court.” It wasn’t that he failed to insist on his administrative rights when given the chance (e.g. ignoring the first notice of intent to levy, which somehow “precludes” raising the issue later), but that he didn’t insist on his judicial rights to enforce the opportunity he was denied. When Mr. Zhang paused after his first step he stranded himself in no-man’s-land.
Finally, this case brings up interesting Taxpayer Bill of Rights and -of course- potential administrative law questions. I submit to you the following thought experiment: Assuming the Tax Court gets it right (i.e. the first CDP hearing was an opportunity to dispute the tax), might it nonetheless be an abuse of discretion for the IRS Appeals officer to fail to consider the underlying liability?
Consider the Treasury Regulations first, which provide in relevant part that “In the Appeals officer’s sole discretion, [they] may consider the existence or amount of the underlying tax liability, or such other precluded issues, at the same time as the CDP hearing.” Treas. Reg. 301.6320-1(e)(3), A-E11. However, the Treasury Regulation goes on to clarify “Any determination, however, made by the Appeals officer with respect to such a precluded issue shall not be treated as part of the Notice of Determination issued by the Appeals officer and will not be subject to any judicial review.” Id. In other words, Appeals can be nice and review the underlying liability when it is otherwise precluded, but their decision to do so (or not do so) can never, ever, be questioned. I take issue both with the Regulation’s definition of the underlying liability as “precluded” in those circumstances, and its attempt to limit the Tax Court’s review (one may say, the Tax Court’s jurisdiction).
First, query whether a regulation can limit the jurisdiction of the Tax Court to review a discretionary act, especially where Congress has specifically granted that Court jurisdiction. That, to me, is the admin law question. As a matter of judicial deference to such a regulation, Carl has written here. You might retort: “it isn’t a really a “discretionary” act that the regulation is forbidding review of: Congress precluded review of the underlying liability in those instances.” I think that is dead-wrong, and a huge problem that the Tax Court and Treasury Regulations have created on their own.
I read IRC 6330(c)(2) as a list of the issues a taxpayer has the right to raise. If the taxpayer’s situation doesn’t meet the requirements therein, they don’t have the right to raise the issue, but that isn’t to say it can’t be raised altogether (i.e. that it is precluded), only that it is discretionary. This reading, I believe, is bolstered by the fact that just two paragraphs down (6330)(c)(4)) Congress does, in fact, list out what issues cannot be raised under the helpful heading “Certain issues precluded.” Unless the underlying tax was already litigated, or “raised and considered” in a prior CDP hearing (again, emphasis added) it is not a precluded issue. And if it isn’t a precluded issue, and the IRS has the discretion to consider the issue, then I find it odd that the Court is precluded from reviewing that exercise of discretion solely because the agency has essentially shielded itself from review through the issuance of a regulation. I rarely invoke the Constitution in my tax practice, but that seems like a separation of powers issue to me.
Now, let’s talk TBOR. Imagine, as is nearly the case here, an IRS Appeals officer says, “I know you probably don’t owe the tax, but you missed your chance to argue it so we’re going to uphold the lien/levy. The Regulations provide that it is in my sole discretion whether to look at the underlying tax or not, and I’ve decided not to because I don’t have to.” Could TBOR provide a statutory basis for saying this is an abuse of discretion? After all, doesn’t TBOR ensure that the IRS employees should act in accord with the right to “pay no more than the correct amount of tax” (IRC 7803(a)(3)(C))? What is the point of that “right” if not to keep the IRS from collecting more tax than is due based on technicalities?
Again, it is possible that all of the “facts” here make this case seem a lot worse than the reality. But that is the beauty of the posture of this case, and how it illuminates the legal issues that I, for one, would love to see worked out in a precedential case.