IRS collection hearings are one of the procedural safeguards Congress created to prevent the IRS from taking certain actions without first confirming that they have followed the law.
These safeguards are needed as the IRS works a lot of cases and the volume can result in the IRS not following the law. The IRS also has a lot of employees and, as with most organizations, employees sometimes make poor decisions. These poor decisions may even be made intentionally and to the detriment of taxpayers. It happens.
The collection due process hearing is one of these safeguards (the IRS collection appeal program is another one). The collection due process hearing itself is informal, but does not mean that it should be taken lightly. The collection due process hearing can be extremely important when the IRS does not follow the law.
This is why the Pfetzer v. Commissioner, T.C. Memo. 2021-145 is important. It addresses the question as to how far does the IRS Appeals Office have to go in conducting these informal hearings. Put another way, if IRS Appeals does not dig very deep, have they abused their discretion?
About the Collection Due Process Hearing
Congress created the collection due process hearing (“CDP hearing”) process to curb perceived abuses by the IRS in collecting back taxes.
The CDP hearing is an administrative hearing conducted by the IRS Office of Appeals. A CDP hearing can be requested by taxpayers when the IRS issues a lien notice or threatens or takes action to levy on property.
Taxpayers can raise any number of issues in these hearings. This can include challenges to the underlying tax liability (and penalties and interest). The taxpayer can also propose collection alternatives, such as payment agreements, settlement offers, and even innocent spouse relief, etc.
Importantly, if the taxpayer’s request is timely, the taxpayer can ask the U.S. Tax Court to review the appeals officer’s decision. This pre-payment judicial remedy helps ensure that the IRS does a good job at these hearings. But how good is good enough?
IRS Verification Legal & Administrative Requirements
Regardless of the issues raised, the IRS Appeals Office is required to verify that the IRS followed the law for the taxes it is seeking to collect.
Section 6330(c)(1) says that the IRS has to verify that all applicable legal and administrative requirements have been met with respect to the tax debt. This includes verifying that the tax assessment was made correctly.
The IRS makes a tax assessment by recording a tax balance on its books. It has a form that it completes for making tax assessments.
There are some procedural rules the IRS usually has to comply with before making an assessment. One such rule is that the IRS has to send the taxpayer a notice of deficiency. This puts the taxpayer on notice of the proposed liability and, in most cases, affords them the ability to petition the U.S. Tax Court.
Taxpayers who have received a notice of deficiency generally cannot challenge the underlying tax liability during the CDP hearing. So the appeals officer is supposed to verify whether the IRS mailed the notice of deficiency.
How Thorough of an Investigation?
Recall that in this case, the taxpayer did not file tax returns. The IRS prepared substitute returns for the taxpayer.
So the IRS appeals officer asked the taxpayer to provide tax returns. She would likely send the tax returns to the IRS service center for processing. If the IRS service center accepted the returns, the appeals officer would have concluded that there was no dispute as to the underlying tax. If the IRS service center did not accept the returns, they would have proffered a reason for not doing so. This can help narrow the issues that the appeals officer has to review and set the underlying tax issue up for review by the U.S. Tax Court.
Despite the appeals officer’s requests, the taxpayer did not provide any tax returns. He simply asked that the IRS verify that the tax assessments were made correctly.
The appeals officer would have then been required to conduct an investigation. The question that is addressed in this case is how far does the IRS Appeals Office have to go in verifying the tax assessment? Can they just review the IRS transcripts?
The court held that the IRS investigation has to go further than merely reviewing the IRS transcripts:
Generally, the settlement officer may rely on a Form 4340, Certificate of Assessments, Payments, and Other Specified Matters, or a transcript containing similar information… [W]hen a taxpayer alleges that the notice of deficiency was not mailed, the Appeals officer must not only consult transcripts but also examine “underlying documents”—such as the taxpayer’s return, a copy of the notice of deficiency, and a certified mailing list—to verify the proper mailing of the notice of deficiency….
The court concluded that it did not have a sufficient record before it, so it could not determine whether the tax assessments were valid. The IRS did not make its full administrative file available to the court. So the court will eventually decide the issue the taxpayer asked about. The court may have to do so without having a record as the IRS may have missed its deadline to add information to the court record.
Setting aside the nuances in this case, it’s important to note that the court imposed a pretty high standard for the IRS. It is much more than what many appeals officers do for these hearings.
This case is helpful for taxpayers as the high burden shows that the court is serious about having IRS Appeals do a diligent investigation in these hearings.
This same level of investigation should be done for each issue that has to be verified and each issue raised by the IRS.
So if the taxpayer raises the underlying liability as an issue, the IRS should conduct an investigation that goes beyond looking at transcripts, etc.
This means that the appeals officer should examine the underlying books and records supporting the tax liability, which appeals officers almost always refuse to do. IRS Appeals may have to satisfy this requirement by making a referral to an IRS revenue agent in cases like this, assuming there is time to do so.