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Does the Failure to Timely Issue Notice and Demand Impact the Underlying Assessment Rather than the Just Liens or Levies

Posted on June 4, 2014

Notice and demand, like assessment, generally provides a mundane step in the collection process that few pay any attention. Last week the Supreme Court denied cert on the Ninth Circuit’s decision in Nakano v. Commissioner of Internal Revenue. This brings back into focus the Tax Court decision which through its silence suggested that some life may still exist in arguments that an IRS foot fault at this stage has meaningful consequences with respect to the assessment made against a taxpayer instead of just the collection actions taken thereafter. On appeal the taxpayer abandoned the argument that failure to send notice and demand rendered the assessment invalid and focused instead on arguments of ex parte and the inability of the Collection Due Process notice required by IRC 6330 to serve as the notice and demand required by IRC 6303.  The taxpayer failed but the issues in the case deserve some discussion.

Because an assessment must occur within a specific time frame, knocking out the assessment due to a default in the process of making or completing the notice and demand could eliminate the liability altogether.  The problem frequently comes to light after the time for making assessment for that tax period has expired.  So, the IRS has a strong interest in making sure that post assessment problems, such as the timely issuance of notice and demand, do not invalidate the assessment itself but only impact post assessment options available to the IRS.  Even if a delay in sending out notice and demand does not knock out the assessment, it could significantly impact the collection options available to the IRS – or not.  In this two-part post, I will discuss the role that notice and demand plays in the collection process, including its role in creating the federal tax lien and its acting as predicate to levy. In part  two, I will analyze Nakano and discuss how the cases decided in the past few decades may provide insight to some in this dusty corner of tax procedure. A look at this case and the cases decided in the past few decades may provide insight to some in this dusty corner of tax procedure.

Background of Notice and Demand Provisions

When the IRS makes an assessment, IRC 6303(a) provides that it “shall, as soon as practicable, and within 60 days after the making of an assessment of a tax pursuant to section 6203, give notice to each person liable for the unpaid tax, stating the amount and demanding payment thereof.  Such notice shall be left at the dwelling or usual place of business of such person, or shall be sent my mail to such person’s last known address.”  Subsection (b) of this section permits delay in sending the notice where the assessment occurs prior to the last date prescribed for payment, e.g., where a balance due return for individual income taxes is filed in February.  Notice and demand usually takes the form of a letter informing the taxpayer that an unpaid assessment exists and requesting that the taxpayer please pay it within 10 days.  Most taxpayers and practitioners think of it, assuming they think of it at all, as the first notice in the series of collection notices that the IRS sends before it takes serious collection action such as filing a notice of federal tax lien or initiating a levy.

While the language of IRC 6303 contains the directive “shall”, the regulations implementing the statute adopt a much more forgiving approach.  The implementing regulation generally tracks the precise language of the statute but contains an additional sentence – “However, the failure to give notice within 60 days does not invalidate the notice.”  Case law, as discussed below, has adopted the approach of the regulation and found the failure to send the notice and demand within 60 days as something that the IRS can generally cure by sending out the notice and demand after the 60-day period.  Consequences do exist for failure to send out the notice and demand letter within 60 days; however, those consequences are generally not thought to extend to invalidating the underlying assessment.  Most courts have separated notice and demand from the assessment process and made it a part of the lien process.  The Nakano case does not find the assessment invalid; however, it reaches that conclusion by finding an untraditional notice and demand letter rather than simply saying that the failure to send notice and demand does not impact assessment.

The Assessment Process

To set the scene for the discussion of the consequences of an IRS failure to send notice and demand, it helps to think about the legal and practical issues surrounding assessment.  Assessment of federal taxes serves several purposes.  It primarily serves as the mechanism for the IRS to record a liability on its books and records.  Until an assessment occurs, the IRS generally cannot take any collection action and it has no mechanism for recording the existence of a liability.  For most people, assessment of tax serves the important purpose of allowing them to obtain a refund because it is the assessment of tax coupled with the credits sitting on the account that creates the overpayment of tax generating a refund.  From 1978 to 1994, the IRS made the institutional decision to violate the automatic stay of the bankruptcy code in BC 362(a)(6) barring assessment in order to allow taxpayers in bankruptcy to obtain their refunds. Not one taxpayer ever complained about this stay violation and in 1994, Congress finally realized that by barring the IRS from making assessments in bankruptcy cases, it was keeping the IRS from recording liabilities in the only statutory method it had.

In well over 90%, probably closer to 99% of cases, the IRS makes an assessment because the taxpayer files a tax return and consents to assessment.  In the other cases, assessment results from the taxpayer signing a consent to assessment during audit, the math error process, a default of a notice of deficiency or a partial or complete loss in Tax Court.  No matter how it occurs, the IRS will search the specific account period and tax type for which the assessment occurs to determine if credits (payments) exist on that account.  If credits exist, the IRS will satisfy the assessment with the credits and refund to the taxpayer any excess of credits (assuming the offset provisions are not triggered by an outstanding federal tax or other qualifying debt.)  If credits do not exist, the IRS will (should) send out a notice and demand letter within 60 days of the assessment for the difference between the amount of the credits on the account and the amount of the assessment.  Most taxpayers have withholding credits or estimated tax payments on their account or they remit the known balance with their return, and they never see a notice and demand letter.

In the small minority of cases in which the credits on the account do not equal the amount of the assessment, the IRS issues the notice and demand letter.  The IRS knows of the need for this letter before it makes the assessment based on the process it has developed.  It almost always makes assessment on Mondays and it almost always sends out the notice and demand letter on the Saturday before the Monday (postdating the letter to Monday) in order for the taxpayer to have as much notice as possible in order to pay the balance within 10 days after notice and demand and avoid the federal tax lien.  See relevant portions of the Internal Revenue Manual here.  As with all systems, sometimes it fails and notice and demand does not go out within 60 days of the assessment or, and this is not the issue in Nakano, the notice and demand letter does not go to the taxpayer’s last known address.

Consequences of Failing to Send Notice and Demand Letter

The Supreme Court, 11th Circuit, and 6th Circuit previously addressed what happens when the IRS fails to send out notice and demand.  The cases generally hold that the failure to send the notice and demand does not invalidate the underlying assessment but rather prevents the federal tax lien from coming into existence and prevents the IRS from taking administrative collection action.  More specifically, the 5th Circuit held that the government’s failure to notify under § 6303(a) cuts off government’s administrative [lien and levy] and non-judicial remedies. Additionally, a Maryland District Court, and the 10th Circuit have held that the Commissioners must comply with the notice and demand requirements before exercising non-judicial collection powers.

Courts have agreed with the regulation and allowed the IRS to issue the notice and demand letter late and begin administrative collection action/notice of tax lien filing thereafter.  The consequence to the IRS of not sending the notice and demand letter is not to destroy its right to tax administrative collection action but merely to postpone it.  Courts have also found that different types of IRS correspondence other than the narrowly tailored notice and demand letter of IRC 6303 can meet the statutory requirement.

The focus on the federal tax lien rather than assessment exists because the assessment provisions of IRC sections 6201, 6202 and 6203 do not mention notice and demand.  Section 6201 provides the general authority for assessment, by asserting “The Secretary is authorized and required to make the inquiries, determinations, and assessments of all taxes… imposed by this title ….”.  In sections 6202 and 6203 Congress granted broad authority to the IRS to establish the mode and time of assessment and the method of assessment, respectively.  Like the statutory provisions, the regulations under these sections do not mention notice and demand.  I believe they do not because notice and demand is a post-assessment process not linked to the validity of the assessment itself.  The regulations under IRC 6203 were written in 1954 and last amended over 30 years ago.  They set up a procedure for assessment officers in service centers who sign summary records as the method of making assessments.

The Role of Notice and Demand in Creating the Federal Tax Lien

In contrast to the assessment process, which does not mention notice and demand, the federal tax lien provisions in IRC 6321 and 6322 peg their existence to the failure of the taxpayer to pay the tax after the IRS makes its demand.  I.R.C. 6321 states “If any person liable to pay any tax neglects or refuses to pay the same after demand… the amount shall be a lien….”  Once neglect or refusal to pay occurs after the making of notice and demand, the federal tax arises and, pursuant to IRC 6322 arises (or relates back to) the date of assessment.  Without notice and demand, the federal tax lien cannot arise.  If the federal tax lien does not arise, the IRS has an assessment but no means for securing the assessment, protecting the priority of its position in the assets of the taxpayer or moving forward with administrative collection.

Notice and Demand as a Predicate to Levy

Similarly, the notice and demand provisions play a pivotal role in the other main collection tool of the IRS – the levy.  IRC 6331(a) makes notice and demand a predicate to levy – “If any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary to collect such tax by levy….”  IRC 6330 places an additional requirement restricting levy “unless the Secretary has notified such person in writing of their right to a hearing under this section before such levy is made.”

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