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Refund Suits, Divisible Taxes and Flora: When is a representative payment representative enough? Part 1

Posted on Feb. 17, 2014

Today we hear from Guest Blogger Rachael Rubenstein, and her former student, Paul Downey.  Paul is completing his Tax LLM at Southern Methodist University.  Rachael supervises the low income taxpayer clinic at St. Mary’s University School of Law in San Antonio, Texas.  She, along with clinic students, litigated a trust fund recovery case that captured much attention last fall (see our coverage of Kaplan and Jack Townsend’s blog post about the case) when the Court of Federal Claims dismissed the case for lack of jurisdiction after the clinic followed what was previously assumed to be a well-worn path to jurisdiction in such cases.  They write here about the reversal of last year’s decision and the importance of the reversal.  The case has two distinct and important aspects.  Because of that, we are breaking her post into two segments.  Today’s segment will address the IRC 6331(i) issue.  This Code provision generally prohibits the government from filing suit against a taxpayer for unpaid divisible taxes (assessed under IRC 6672) when the taxpayer first files a refund suit for recovery of any portion of the taxes paid.  The statute permits injunctive relief for taxpayers against these collection activities, but it also identifies exceptions to the prohibition against later filed suits.  Although the IRC 6331(i) dispute and result in Kaplan are not ground breaking, it is an important procedural issue we have not previously discussed.  In the second post, coming out tomorrow, Rachael will address the amount an alleged responsible officer must pay to litigate the correctness of that determination.  In addition to supervising the low income tax clinic program at St. Mary’s, Rachael has agreed to co-author the chapter on Identity Theft coming out in the next edition of Effectively Representing Your Client before the IRS.  My comments are in italics.

On January 27, 2014, in Kaplan v. United States, Judge Wheeler of the United States Court of Federal Claims made a significant jurisdictional decision in favor of a plaintiff taxpayer in a refund suit.  The issue decided was whether Mr. Kaplan’s three $100 payments towards the Trust Fund Recovery Penalties (TFRPs) assessed against him under section 6672 were sufficient amounts to confer jurisdiction on the court to determine Kaplan’s ultimate liability for the penalties.  The court ultimately accepted the three $100 payments as sufficient to establish subject matter jurisdiction but the decision did not come easy.  In August of 2013, the government filed a motion to dismiss Mr. Kaplan’s complaint, arguing that his $100 payments did not satisfy the jurisdictional requirement that he “pay the entire assessment for at least one employee per quarter.”   The government cited to Flora as authority while also acknowledging that “a number of courts have held that the full-payment rule is a divisible tax, and requires a taxpayer to pay only the amount of the penalty attributable to one employee before bringing a refund suit.” 

This attempt to deprive plaintiff of his choice of forum using Flora as authority was unusual and probably stemmed from the government’s earlier failure to get rid of Kaplan’s case in the Court of Federal Claims.  Before the government filed an answer, to Kaplan’s complaint, it moved to suspend the proceedings and simultaneously filed a separate lawsuit against Kaplan and another defendant in the Western District of Texas to reduce their TFRP assessments to judgments.  Kaplan sought an injunction against the government’s suit in Texas under section 6331(i).  For strategic reasons involving precedent, Kaplan purposefully exercised his right to file suit in the Court of Federal Claims, not the Western District of Texas.  The government was clearly not happy with plaintiff’s “forum shopping.”  Regardless, Kaplan argued that taxpayers have every right to exercise their choice of forum for refund suit litigation.  Moreover in the past few years, several trial courts, including the Court of Federal Claims, held that section 6631(i) prohibits these later filed government suits for the same taxes at issue; although no appellate circuit has yet ruled on the issue.  This venue dispute was briefed extensively and the case was temporarily stayed in both federal courts pending the outcome of Beard v. United States— a 6331(i) case that the government appealed to the Federal Circuit  after the Court of Federal Claims enjoined the government from maintaining its later filed suit.  The Federal Circuit never ruled on the 6331(i) issue because the Beard case settled after oral argument but before a decision was rendered.  In Kaplan the government ultimately conceded the issue and agreed to dismiss the case in Taxas and permit the Court of Federal Claims suit to move forward. While no longer an issue in Kaplan, section 6331(i) is likely to resurface in future cases.  I am working on a journal article with a colleague, Paul Downey, that explores the purpose of Congress’ addition of 6331(i) in the IRS Restructuring and Reform Act of 1998, and the tricky issues surrounding this powerful code provision.

[Keith comment’s]  The 6331(i) argument fascinated me because Chris Sterner and I made the suggestion that led to this provision in RRA 98.  In 1997 I was asked by the National Office to suggest changes to the Code that the IRS could offer in the collection area to benefit taxpayers.  I enlisted Chris, who also worked in the Richmond office at that time, to assist in the project because of his knowledge.  We looked for things similar to the provisions in Taxpayer Bill of Rights I and II that codified IRS practices beneficial to taxpayers.  The practice of the IRS was to hold off on collection of trust fund recovery penalty if a taxpayer sought to dispute the liability in court.  Because of that practice and the parallel between that practice and the deficiency procedures, we proposed codifying the practice of holding off in collection in trust fund recovery penalty cases along with over 20 other changes.  Several of our suggestions made it into the statue in some form.  Because I do almost no trust fund recovery penalty work in the low income taxpayer clinic, I had not followed this issue prior to reading Rachael’s submission.

The complete language of the statute can be reached through the link above.  The critical language of the statute for this discussion is in IRC 6331(4)(A) which provides that “No proceeding in court for the collection of any unpaid tax to which paragraph (1) applies shall be begun by the Secretary during the pendency of a proceeding under such paragraph.”  The goal of IRC 6331(i) was to keep the IRS from collecting while the TFRP case moved forward.  Taxpayers challenging this assessment have the possibility of winning their case and eliminating the need for collection action.  Collection action while the litigation ensues could significantly damage the taxpayer in a way that the subsequent return of the funds would not set straight.  The Kaplan case, like others before it, involved an indirect attempt to pursue collection.  The IRS did not seek to collect money from him but rather brought a suit to reduce the assessment to judgment.  The question presented is whether such a suit violates the language of the statute – which it clearly seems to do – and the purpose of the statute – which it does not so clearly do.  The IRS argued that the suit did not seek to actually collect anything and, therefore, should not be enjoined. 

The IRC 6331(i) issue arises here, in part, because of the rules of the Court of Federal Claims that do not allow the IRS to bring third parties into the litigation.  In district court cases involving the trust fund recovery penalty, the IRS counterclaims against the taxpayer bring the suit for any unpaid balance on the penalty and brings third party complaints against all of the other individuals or entities assessed the penalty for the same period(s).  Since the IRS could not bring third party complaints in the Court of Federal Claims, it sought to bring the litigation against all responsible parties in the district court in the Western District of Texas.  In such a suit the IRS could join all potentially responsible persons in the same case and sit back and watch them point fingers at each other.  In the Court of Federal Claims the case would just be the IRS against one of the potentially responsible persons.  Other reasons for choosing the Court of Federal Claims over the local district court may also have existed for Rachael’s taxpayer and other reasons have motivated the Government to try this same forum shopping technique in courts other than the Court of Federal Claims.  The benefits sufficiently concerned the Department of Justice that it went and filed affirmative litigation in the Western District of Texas seeking to effectively move the litigation of this issue from Washington, D.C. to Texas.

In the Beard case the Court of Federal Claims addressed the same tactic involving the same district.  The proposed responsible officer in Beard filed suit in the Court of Federal Claims on August 25, 2010.  After answering the case on December 27, 2010, and filing a counterclaim for the unpaid balance, the Government filed a suit to reduce the assessment to judgment in the Western District of Texas on January 11, 2011.  The Department of Justice filed a motion to suspend the Court of Claims case pending the outcome of the proceeding in Texas and the Beards opposed the motion seeking an injunction against the Texas litigation pursuant to IRC 6331(i)(4)(A)&(B).  The Court of Federal Claims enjoined the Texas litigation after carefully analyzing the language of the statute.  An effort to seek an interlocutory appeal of this issue failed.  101 Fed. Cl. 100 (Sept. 7, 2011), aff’d, 451 Fed. Appx. 920 (Nov. 3, 2011).

The result in Beard was duplicated in Kaplan.  Several other cases deciding this issue are captured in language from Thomas v. United States, 2012 WL 10235746 (W.D. Wis. 2012):

“More recently, however, courts routinely have denied motions to stay and enjoined later-filed collection actions pursuant to 26 U.S.C. § 6331(i). See, e.g., Beard v. United States, 99 Fed. Cl. 147 (Fed.Cl.2011) (providing extensive discussion of the statutory language and legislative history in finding that the government’s later-filed action to determine TFRP liability was a “collection action” under 26 U.S.C. § 6331(i) and enjoining the government’s action); Nickell v. United States, No. 4:08CV319, 2009 WL 2031915 (E.D.Tex. Apr. 2, 2009); Conway v. United States, No. 4:04CV201, 2009 WL 2031856 (E.D.Tex. Mar. 26, 2009); Rineer v. United States, 79 Fed. Cl. 765 (Fed.Cl.2007); Swinford v. United States, No. 5:05CV–234–R, 2007 WL 496376 (W.D.Ky. Feb. 9, 2007), vacated on other grounds, 2008 WL 4682273 (W.D.Ky. Jun. 20, 2008); cf. Kennedy v. United States, 95 Fed. Cl. 197, 206–07 (Fed.Cl.2010) (declining to enjoin collection action as to one tax period where that action covered seventeen tax periods and was already underway).”

While the 6331(i) decision in Kaplan is not novel and it was conceded by the Government, it is an important issue to follow if the IRS continues the practice of seeking to move venue in trust fund litigation by seeking to bring suits to reduce the liability to judgment in a venue viewed by it as more favorable than the forum choice made by the taxpayer. If the concession here means the IRS has dropped the effort to seek an alternate forum in cases of this type, it is also important to know that the issue will no longer exist.  Stay tuned for Rachael and Paul’s article on this subject.

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