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Imposition of an Extra 50% Penalty for Failing to Honor Levy – Is the Levy Form Inadequately Descriptive

Posted on Mar. 12, 2014

Both the Internal Revenue Code and the Internal Revenue Service deal harshly with parties who receive a levy from the IRS and fail to pay over the amounts required by the levy when funds exists with which to satisfy the levy.  The situation only gets worse when the person in receipt of the levy pays the funds instead to the taxpayers.  The situation gets worse still when the taxpayer stands convicted of evasion of payment – a rarely invoked crime covered by IRC 7201.

In United States v. 911 Management LLC, No. 3:10-cv-01367-BR, 2014 WL 28996, at *1 (D. Or. Jan. 2, 2014), the IRS sought to impose the 50% penalty under IRC 6332(d)(2) on Daniel Dent as a result of his failure to honor the levy.  Prior to the decision in this case, the court had previously determined that Mr. Dent owed $129,205.48 (plus interest and statutory accruals from December 31, 2011) due to his failure to honor the levy.  Here, the court decided whether he owed an additional 50%, $64, 602.74, resulting from that failure.  The court decided not to impose the penalty because it found his defense of confusion stemming from language on the levy form sufficient to hold off imposition of this penalty.  I want to examine the language of the form and how the defense to the penalty differs in result from the defense to the imposition of the personal liability for the failure to honor the levy.  These cases frequently present tough factual situations because the imposition of personal liability already creates a heavy, penalty like remedy and the IRS bears a heavy burden as a practical matter to get the penalty on top of the underlying amount.

Mr. Dent essentially made two arguments in seeking to avoid the imposition of the penalty:  1) “the language of the levies was ambiguous, confusing, and contained contradictory instructions” creating a dispute over the legal effectiveness of the levies and 2) reliance on the advice of the business’ attorney creating reasonable cause.  I will examine each one in turn.

The case commenced when the United States sued Mr. Dent and his employer 911 Management for allegedly violating IRC 6332(d)(2).  The government asserted that Mr. Dent failed to comply with the IRS’s Notice of Levy to collect the liabilities of employees Thomas and Kathy Weathers, who had failed to pay their income taxes for the tax years of 1996 and 1998 through 2006.  The government sought judgment against Mr. Dent and 911 Management for both the unpaid income tax as well as a 50% penalty for failing to comply with the levies without reasonable cause under IRC 6332(d)(2).

As the only manager of 911 Management, Mr. Dent had sole discretion to make payments on the company’s behalf, and incurred an obligation to allocate 35% of profits to Ms. Weathers.  As of 2006, 911 Management had a “fixed and determinable” obligation to pay Ms. Weathers $5,000 per month, a figure that was increased to $5,700 per month in 2006.  Additionally, in 2007, 911 Management executed two license agreements by which it would operate and receive income from two hotels leased by the Weathers in exchange for paying the Weathers 3% of the hotels’ gross monthly proceeds in the form of a license fee.  In February 2008, the IRS served a Notice of Levy on Mr. Dent and 911 Management to collect on Mr. and Ms. Weathers’ outstanding federal income tax liabilities and notified Mr. Dent that these levies would attach to both the monthly $5,700 paid to Ms. Weathers as well as the 3% license fee.

Mr. Dent consulted with 911 Management’s attorney and a business advisor for the Weathers and 911 Management, who informed him that he had provided the IRS with a $10,000,000 bond that fulfilled all of the Weathers’ outstanding tax liabilities.  However, 911 Management’s attorney, Marc Sellers, advised Mr. Dent that he was unaware of such a bond and gave Mr. Dent no legal opinion that implied that the levies could be satisfied in this manner.  Despite this ambiguity, Mr. Dent contacted the IRS, writing that it was his understanding that all of the Weathers’ financial obligations had been satisfied and that 911 Management did not pay wages or salary to the Weathers.  In response, the IRS informed Mr. Dent that the levies attached to all monies paid by 911 Management to the Weathers and that unless 911 Management received a Form 668-D Release of Levy, all monies distributed to the Weathers were attached and must be given to the IRS.  Despite this response and the IRS’s subsequent final demands, Mr. Dent continued to fulfill the $5,700 monthly obligation to Ms. Weathers until 2010, aware that he could potentially become personally liable for any property not surrendered and face a 50% penalty.

While the court concluded that Mr. Dent’s reliance on the purported $10,000,000 bond to satisfy the Weathers’ outstanding obligations was not a reasonable reliance, it went on to find that the ambiguous language in the levy notices created uncertainty about the kinds of funds to which the levies attached.  The court agreed with the Magistrate court’s opinion that the instructions created the impression that the levies attached only to funds owed at the time of the levies and not to ongoing payments such as the monthly $5,700 obligation paid to Ms. Weathers.  This was sufficient for the court to determine that it was objectively reasonable for Mr. Dent to rely on Mr. Seller’s advice and notify the IRS that 911 Management did not pay wages to the Weathers, despite the IRS’s response to the contrary.  The court thus found in favor of Mr. Dent and chose not to impose IRC’s 6332(d)(2)’s 50% penalty.

What does the Form 668-W say?  This issue comes up with frequency.  The form must state the covered items as clearly as possible to avoid confusion on a regular basis.  The form itself divides the effect of the levy into two parts by stating: “This levy requires you to turn over to us (1) the taxpayer’s wages and salary that have been earned but not paid, as well as wages and salary earned in the future until this levy is released; and (2) this taxpayer’s other income that you have now or for which you are obligated.”  The form then refers the recipient to the instructions for further guidance on what to do with the levy – particularly with respect to notification of the taxpayer to allow the taxpayer to claim certain exemptions.

The language on the Form 668-W itself leaves some uncertainty about non-wage future payments but the words “for which you are obligated” should put concern in a recipient of the levy that it seeks more than just the non-wage funds in the hands of the party receiving the levy.  Enough uncertainty about non-wage funds should send the recipient to the attached instructions. 

The instructions first deal with wages and salary and make clear that wages and salary include “fees, commissions, and bonuses.”  This sentence clarifies an area of some confusion but apparently did not address the situation of the payment due from 911 Management to the taxpayer in the eyes of the court.  The court failed to specifically address the existence of fees even though the levy recipient paid out $79,571.71 in license fees after receipt of the levy.  These payments would appear to fit squarely within the language of the instructions.  It is hard to understand how the instructions could have been much clearer on this point.  They describe wages and salary as including “fees.”   Here a portion of the future payment was itself designated as a license fee.  This would seem to have been sufficient direction as to this portion of the monthly payments.  The court simply did not address this issue.  There appears little the IRS could do on this issue to make the form clearer. 

That leaves the fixed monthly payments and the issue of whether those payments fit within the term “fees, commissions and bonuses.”  The description of the basis for these payments in the opinion calls them a “fixed and determinable” obligation.  I cannot tell if this obligation was in the nature of a fee, commission or bonus.  It does not appear to be a fee or a bonus.  Nothing in the description makes me think it is a commission.  That puts it into a catchall provision the IRS tries to describe at the very end of the instructions.

If the payments each month were not wages and salary, the instructions do get more difficult to follow if the IRS expects future payments.  The last sentences of this section of the instructions provide:  “For income other than wages and salary and benefit and retirement income as described above, the levy is effective only for funds you owe the taxpayer now.  We may issue another levy if necessary.  However, the levy attached to all obligations you owe the taxpayer at the time you receive it, even though you plan to make the payment at a later time.”  These sentences seek to have the levy recipient pay the IRS funds for which it is currently obligated to the taxpayer even if the levy recipient did not plan to currently pay the taxpayer.  It describes a circumstances well settled in case law.  This language would capture deferred compensation or some obligation rooted in compensation but not currently payable.  The language would not seem applicable to a note even though a note has these same characteristics since a note is not wages and this levy sent in this case was sent on a wage levy form.  It is unclear to me if the payments due the taxpayer in this case fit within this provision since the description of the payments in the opinion did not provide sufficient detail.

The catchall provision could perhaps provide more clarity but it is difficult to describe every possible circumstance in a levy form.  Perhaps the IRS could review this language to more clearly describe what the levy intends to reach.  Given that the levy recipient spoke with the revenue officer here who specifically stated that the levy did reach these payments, it is hard to believe that the form itself was the major issue.

Moving on from the form itself, the levy recipient also asserted reliance on counsel as a basis for reasonable cause in not complying with the levy as a basis for not applying the penalty even though it was not a basis for avoiding personal obligation.  The regulations under IRC 6332(d)(2) state that reasonable cause exists where there is a bona fide dispute over: 1) “the amount of property to be surrendered” or 2) “the legal effectiveness of the levy.”  301.6332-1(b)(2).  See United States v. Donahue Indus. Inc., 905 F.2d 1325, 1331 (9th Cir. 1990).

Reliance on counsel can form the basis for penalty relief.  In other contexts the reliance on counsel occurs in a vacuum which is to say that the taxpayer is filing a return and taking a position without input from the IRS.  Here, counsel for the levy recipient gave advice that the levy notice did not seem to apply to these payments but the revenue officer also gave clear instructions that it did.  A more refined version of the question in this case includes reliance of counsel in the face of clear instructions from the IRS.  Certainly, the IRS can make mistakes.  Where clear individualized instructions come from the IRS does the situation require more digging by the taxpayer before continuing to rely on the advice of counsel that the IRS has stated is incorrect?

The court mentions that advice was sought from a second attorney who also expressed concerns with the position of the IRS.  The court does not talk about the expertise of either attorney.  I think the existence of the second attorney here makes a difference.  I think that the taxpayer should have been required to make some showing that one of the attorneys had some expertise with respect to levies.  That may have occurred and not made it into the opinion.  I find myself wanting a stronger showing of the basis for reliance where the payments went on for a long period of time, the attorney for the business might have been swayed by the taxpayer’s involvement in the business and clear, individualized instructions had come contradicting the attorney’s opinion.  Two wage levy cases provide some instruction on this issue.  In a 1950s case, Hoye v. United States, 172 F. Supp. 532 (S.D. Cal. 1959), the court declined to impose the penalty on the comptroller of Los Angeles because he raised reasonable concerns and paid the money into the registry of the court.  In United States v. Leonard, Inc., 1994 WL 511247 (D. Mass. 1994), the court did impose the penalty where the levy recipient received specific instructions from an IRS attorney to comply with the levy.

The penalty is harsh since it sits on top of the personal obligation for the full amount of the unpaid tax.  In relying on the lack of clarity in the form, the court seems to miss the clear instructions regarding fees as salary.  In finding reasonable cause for reliance on advice of counsel, I find myself wanting more analysis in light of the individualized and contradictory instructions from the IRS.  I am unconvinced that the levy form must be changed but perhaps that will help a future levy recipient making fixed payments.

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