In Keller Tank Services II, Inc. v. Commissioner, No. 16-9001 (Feb 21, 2017) the 10th Circuit upheld the Tax Court’s determination of “prior opportunity to dispute a liability.” The Tax Court, in turn, upheld the IRS determination of this phrase in the Collection Due Process (CDP) regulations. The 10th Circuit went through a Chevron analysis of the statute and the regulation in making its decision to uphold the regulation. We have discussed this issue previously here, here, here and here. The last link discusses in detail that Keller Tank is the first of three recent circuit court arguments by Lavar Taylor challenging the regulation.
The result here is disappointing for those of us hoping that the CDP process can provide a pre-payment forum for tax liabilities, usually a penalty, that do not have the benefit of the deficiency process and are not divisible. For these liabilities, the decision in Keller Tank places the taxpayer in the unenviable position of having an Appeals Officer as the only person standing between them and a sometimes crushing liability for which they will never have the opportunity to litigate because paying several million dollars to satisfy the liability and the Flora rule is not a possibility.
The IRS asserted a penalty under 6707A against Keller Tank for engaging in and failing to report a listed transaction. This case does not reach the merits of the penalty assessment and finds that the taxpayer cannot contest the merits in the CDP case. The 10th Circuit correctly points out that the taxpayer still has an opportunity to contest the merits through a refund suit. It does not mention that in many cases that opportunity is illusory because of the amount of money the taxpayer would have to pay in order to satisfy the Flora rule. The amount of the penalty in Keller Tank is not so high that it presents a practical inability to pay; however, I have no idea if the amount, though not astronomically high, still exceeds the taxpayer’s ability to pay.
Section 6330(c)(2) describes the matters that can be heard at a CDP hearing. Subparagraph (B) under that section provides that
“The 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.”
Treas. Reg. 301.6320-1(e)(3) addresses matters considered at a CDP hearing. The regulation is primarily in Q&A format. Q-E2 asks the question:
“When is a taxpayer entitled to challenge the existence or amount of the tax liability specified in the CDP notice?”
A-E2 answers that question in a long paragraph that includes the following statement:
“An opportunity to dispute the underlying liability includes a prior opportunity for a conference with Appeals that was offered either before or after the assessment of the liability. An opportunity for a conference with Appeals prior to the assessment of a tax subject to deficiency procedures is not a prior opportunity for this purpose.”
The language of the regulation stating that the conference with Appeals satisfies the requirement of section 6330(c)(2)(B) formed the basis for the appeal. The taxpayer argues that this language conflicts with the intent of the statute. The IRS refused to allow the taxpayer to argue the merits of the penalty in the CDP hearing because it had a prior opportunity to address the merits of the penalty during the assessment phase although that opportunity did not include the ability to contest the assessment of the penalty in a pre-assessment judicial forum. According to the IRS, that opportunity arose after the IRS issued a 30-day letter because the taxpayer submitted a written protest challenging the grounds for issuing the penalty and participated in a telephone conference, which resulted in Appeals sustaining the penalty. The Tax Court agreed with the determination CDP by Appeals on this point which was the only point raised by the petitioner in the CDP request. On appeal to the 10th Circuit, Keller Tank argued that the refusal to allow it the opportunity to raise the merits of the penalty assessment in the CDP process violated the goal of the statute and that the regulation impermissibly frustrated that goal.
The regulation creates a clear distinction between taxes governed by the deficiency procedures and those that are not. A taxpayer with a liability covered by the deficiency procedures can have a pre-assessment conference with Appeals at which Appeals sustains the liability proposed by the Examination Division. If the taxpayer does not receive the notice of deficiency, the taxpayer can raise the merits of the underlying liability in the Tax Court in the context of a CDP hearing because of the failure of the opportunity to go to Tax Court prior to the assessment due to the non-receipt of the notice of deficiency. In this situation, the IRS must have mailed the notice of deficiency to the taxpayer’s correct address or the taxpayer could set aside the assessment. Yet, Congress recognized that sometimes taxpayers did not receive the notice of deficiency and sought to give them an opportunity to have their day in court because of the non-receipt of the notice.
In contrast a taxpayer with a liability not governed by the deficiency procedures offered an opportunity to meet with Appeals prior to or after the assessment of the liability, receives no opportunity to have their day in court through the CDP process even though they previously had no opportunity to go to court to contest the merits of the liability. For these taxpayers, the right to contest the liability through the refund procedure remains their only path to court. The regulation acknowledges that taxpayers whose taxes are assessed through the deficiency process are not limited to only using the refund procedure while forcing the refund procedure on those taxpayers whose liabilities did not related to a tax assessed through the deficiency process. The 10th Circuit and the Tax Court find that regulation reaches a logical result in interpreting an unclear statute despite the distinction it draws between the types of taxes.
To sustain the Tax Court decision, the 10th Circuit engaged in a Chevron analysis of the regulation. It first looked at the language of the statute to determine if the language of the statute spoke to the precise question at issue and determined that it did not. The 10th Circuit agreed with the Tax Court that the “otherwise have an opportunity to dispute” language in the statute was ambiguous and was not defined in the 1998 legislation creating the language or elsewhere in the Internal Revenue Code. That determination allowed the Court to move on to step 2 of the Chevron analysis which looks at the interpretation of the statute by the regulation in question in order to decide if that interpretation is based on a permissible construction of the statute. The 10th Circuit again agreed with the Tax Court that a reasonable interpretation of “opportunity to dispute” includes “a prior opportunity for a conference with Appeals that was offered either before or after the assessment of the liability.” A factor influencing both the Tax Court and the 10th Circuit is the failure of Congress to simply say that a taxpayer who has not had a prior opportunity for judicial review will receive on in the CDP process. No doubt, this is a strong basis in support of the decision.
The 10th Circuit opinion has a paragraph that attempts to support its determination using logic I cannot follow. It suggests that accepting the taxpayer’s argument would promote similarly situated taxpayers to skip the conference with Appeals and wait until collection begins so they can go directly to court. Few taxpayers would want to pass up an opportunity to resolve their problem at the lowest level in the cheapest way simply so they could argue a case before a court. Taxpayer’s argument in favor of an opportunity to go to court does not minimize the importance of Appeals and does not undercut the importance of the informal conference. To the extent the 10th Circuit relied on this logic to reach its conclusion, I think its based its decision on flawed reasoning.
After reaching its conclusion, the 10th Circuit doubled back to address arguments presented by the taxpayer. Keller Tank argued that the regulation impermissibly limits the jurisdiction of the Tax Court through a regulation because the regulation limits the matters the Tax Court may hear. The 10th Circuit finds that the regulation does not diminish the Tax Court’s jurisdiction but only limits what may be heard in the administrative process before the IRS in a CDP proceeding. Because the limitation is on the administrative process and not on the Tax Court, even though the Tax Court is limited to addressing matters that may be raised in the administrative hearing, the 10th Circuit finds that the regulation does not directly limit the Tax Court’s jurisdiction. Not only is this logic unsatisfactory but the opinion goes on to throw in an additional paragraph here noting that taxpayers have the ability to bring a refund suit without discussing the realities of this ability.
Next, the 10th Circuit addresses taxpayer’s argument that the regulation contains internal inconsistencies. Keller Tank first argued that the regulation “is inconsistent because it precludes liability challenges at a CDP hearing even when the taxpayer failed to exercise its opportunity to dispute liability at the Appeals Office and was therefore not actually heard.” Because the statute on speaks to “opportunity” and not to an opportunity the taxpayer exercises, the 10th Circuit finds that the regulation is consistent with the statute and it promotes the statutory purpose of encouraging taxpayers to meet with Appeals. Keller Tank next argued the regulation was inconsistent “because it precludes liability challenges at a CDP hearing for some, but not all, prior administrative opportunities.” Keller Tank’s argument here goes to the discrepancy between taxes arises under the deficiency process and those outside that process. The 10th Circuit simply finds that the distinctions are not “unreasonable or arbitrary or that it is inconsistent to treat different administrative proceedings differently.”
One down and two to go
Arguments occurred within a short time in three circuits. Taxpayers have lost the first but have two more opportunities. If the arguments do not succeed, perhaps the judicial interpretations of the language in the statute will persuade Congress to fix the inconsistency between deficiency and non-deficiency process taxes and allow all taxpayer to have a day in court before they must pay. Congress seemed to want that result in 1998 when it passed the CDP provisions. If the courts cannot be persuaded that Congressional language allows that result, it is time to push for legislative change. Because many, though certainly not all, of the people assessed penalties through the non-deficiency process are people with whom few legislators will be excited to assist, getting a legislative change may prove difficult.