Carl Smith explores a recent 11th Circuit refund case and discusses some of the nooks and crannies of the Flora full payment rule, such as the intersection of the lapsing of the statute of limitations on collection and the refund claim statute of limitations. Les
In Lawrence v United States, a per curiam Eleventh Circuit recently dismissed a taxpayer’s second amended compliant and wouldn’t let him try a third amendment. His original complaint was a scattershot, kitchen sink affair lasting 101 pages. His first amended complaint was worse — 128 pages. After the district court then ordered him to file a second amended complaint of no longer than 20 pages, he filed one consisting of 26 pages, but attaching scads of exhibits. Although he again offered to amend his complaint a third time, as this point, the district court dismissed the complaint for lack of jurisdiction. In addition to the complaint’s being an incomprehensible mess, the court noted that there were no detailed allegations of or evidence that he had actually filed administrative refund claims for any of the years involved (as required by section 7422(a)), and for some years, there was also evidence that he had not fully paid the balances due shown on IRS transcripts. Flora v. United States, 362 U.S. 145 (1960) (opinion on rehearing) — cited by the court — certainly interpreted the jurisdictional statute of 28 U.S.C. § 1346(a)(1) to require full payment before a district court tax refund suit is brought. But this case presents a couple significant issues, neither of which are answered: Can one ever meet the Flora full-payment requirement after the section 6502 statute of limitation on collection has lapsed and the balance was written off? And was the court looking at the right amount that Mr. Lawrence had been required to pay before Flora was satisfied — i.e., did he need to pay the tax, penalty, and interest, or only the tax?
Turning to the first question, imagine that an income tax module for one year shows a balance due, despite some payments having been made. Then, imagine that the year is so old that the collection period under section 6502 expires, and the IRS writes off the balance with a credit entry to zero out the account. Would it be possible for a taxpayer at some much later date to send a check to the IRS for the balance that was written off and direct the check in payment of the year for which the IRS no longer maintains a module? And what should the payment amount be to meet the Flora rule, since, no doubt, when the IRS wrote off the balance, some time had passed since the IRS had posted additional late-payment penalties and interest to the account, so an account write-off might be far less that the amount of tax, interest, and penalties that would have been due had the IRS first assessed the accrued items before placing a credit entry to zero out the account? Third, what about the additional interest that in theory might have accrued on the written off balance? The IRS is not authorized to assess interest after the collection period has expired. Sec. 6601(g) (“Interest prescribed under this section on any tax may be assessed and collected at any time during the period within which the tax to which such interest relates may be collected.”) Fourth, what of the provision at section 6401(a) that reads, “The term ‘overpayment’ includes that part of the amount of the payment of any internal revenue tax which is assessed or collected after the expiration of the period of limitations properly applicable thereto”?
Take this example:
For her 2003 year income taxes, the taxpayer timely filed an income tax return on April 15, 2004 showing a balance due of $10,000, which was immediately assessed. Over the years, the taxpayer sends another $8,000 to the IRS — with the last $1,000 being paid on April 1, 2014. The account on that date shows about $4,000 still due — consisting of $1,000 of tax and the rest interest and late-payment penalties that were last assessed in 2006. On April 15, 2014, the IRS writes off the $4,000 balance without first posting (i.e., assessing) the accrued interest and penalties. Had it posted the additional interest and penalties through April 14, 2014, the balance would have been $7,000. Imagine that on June 1, 2015, the taxpayer decides to fully pay off the tax and file a refund claim based on her erroneous inclusion in income of what she now contends was a non-taxable return of capital. Let’s say she pays the $4,000 amount that the IRS actually placed as a credit in her account to zero it out, and she files an administrative refund claim for $5,000 — consisting of the $4,000 she just paid, which is treated as an overpayment under 6401(a), and the $1,000 payment made on April 1, 2014, less than two years before the claim was filed under the rule of 6511(a). Is there anything to stop this? Should she have also been required to pay the additional $3,000 of interest and penalties that accrued but were not posted before the write-off? Should she pay any more, since she is getting an interest-free loan from the IRS after April 15, 2014, since the IRS at that point cannot by law imposed any more interest?
Frankly, this leaves me scratching my head. If any reader can point me to case authority on this, I’d like to hear. I never ran across it before in my practice. Since there is no mention in the Lawrence Circuit court opinion that the taxpayer there made any payments after the section 6502 statute expired, nothing in Lawrence answers these questions. Indeed, all the Lawrence opinions says of the facts of payment is, “Despite Lawrence’s allegations that he fully paid the assessed amounts for every disputed tax year, the documents attached to the second amended complaint and the motion to dismiss show that, for every year other than the tax years 1980, 1991, and 1992, Lawrence had an unpaid balance that was written off by the IRS as uncollectible”.
This sentence from Lawrence triggered another issue to my thinking: Why did the court refer to “balance due”? We tax lawyers know that the balance due on an IRS transcript consists of assessed taxes, interest, and penalties. I think the court should have examined whether Mr. Lawrence had paid the full tax, even if he did not pay the full interest and penalties. This brings up an issue that I find few tax controversy lawyers are aware of: In Flora, in the same footnote 37 at 362 U.S. 171 that notes that it may be appropriate to treat excise taxes as divisible — a hallmark of 6672 litigation since Flora — there is another sentence that reads that “the statute lends itself to a construction which would permit suit for the tax after full payment thereof without payment of the interest”. Thus, if Mr. Lawrence had paid the tax in any year, but not any of the interest and penalties, perhaps he might have gotten some recovery if he had filed administrative claims and sought tax payments made in the prior two years.
Lower courts tend not to discuss this tax-only sentence from Flora, but I have used it to advantage in my practice. For example, I once filed a refund suit in the EDNY after the IRS had snatched a 2002 EITC refund and applied it to a 1998 liability that the taxpayer thought improperly denied her dependency exemptions. The snatched amount fully paid the 1998 tax deficiency (which the taxpayer had failed to contest, since she had moved and never got the notice of deficiency) — but hardly any of the interest and penalties. She was presently unemployed and in currently not collectible status, so my low-income client was in no position to pay all the accrued interest and penalties totaling over $2,000 before bringing a suit with respect to 1998.
I had a discussion with the DOJ attorney before he filed either a motion to dismiss or an answer to my complaint, and he agreed that the payment of the tax alone in her case was jurisdictionally sufficient under Flora and a Federal Circuit case, Shore v. United States, 9 F.3d 1524, 1527-1528 (Fed. Cir. 1993), which relied on the Flora footnote. In Shore, the Federal Circuit held that payment of the tax alone was sufficient, so long as the taxpayer was not making any argument specific to interest (such as it being wrongly computed) or penalties (reasonable cause). The court wrote that “only if the taxpayers assert a claim over assessed interest or penalties on ground not fully determined by the claim for recovery of the principal must they prepay such interest and penalties as well as the assessed tax principal.” Id. I find this a very peculiar ruling, but won’t look a gift horse in the mouth. Although technically, it is the courts who on their own determine their jurisdiction — not parties like the IRS or DOJ — the IRS has announced that it follows the Shore rule, though the government reserves the right to continue to pursue collection of the unpaid balance either by way of levy or counterclaim in the suit. 1996 FSA LEXIS 476 (Mar. 15, 1996). In my case, the DOJ conceded the suit shortly after I filed it, and neither the judge nor magistrate were made aware of or expressed themselves independently on the Flora issue. That was a good thing, since I was unable to find any other Circuit opinion that discussed the Shore rule, but the Second Circuit — before Shore — had held that Flora requires the full payment of all tax, penalties, and interest. In Magnone v. United States, 902 F.2d 192 (2d Cir. 1990), the Second Circuit wrote that “the full payment rule requires as a prerequisite for federal court jurisdiction over a tax refund suit, that the taxpayer make full payment of the assessment, including penalties and interest”. Id., at 193. If Magnone had been raised by the district court, I was prepared to take the issue to the Second Circuit. Although I could not distinguish the devastating Magnone language, I could distinguish the context. In Magnone, the taxpayers had already paid all the tax. They then paid part of the interest. In their suit, they did not challenge the tax assessed, but challenged whether interest suspension had been properly done under section 6601(c) and whether it was right that they be charged old section 6621(c) tax motivated interest. Since these are challenges “not fully determined by the claim for recovery of the principal”, the ultimate ruling in Magnone is consistent with Shore, though on different reasoning.
Has anyone else had a Flora case like mine where they paid all the tax, but not the interest and penalties? I keep waiting to hear of a ruling from another Circuit. Doubtless it will be an unusual ruling because the DOJ won’t itself raise the issue. But, you can’t stop a court from sua sponte raising a jurisdictional issue.
Anyway, it is amazing how many little and not so little issues were possibly presented in the Lawrence case that the court apparently knew little about.