IRS Levy While Tax Litigation is Pending

If you owe back taxes and are litigating the case with the IRS, what happens if you come into money? The IRS has broad levy powers. Can the IRS get the money even though the taxes are being disputed in court?

The answer can vary based on whether the underlying tax liability is being disputed or whether the IRS’s efforts to collect the tax are being disputed. If the tax liability is being disputed, the answer is usually “no.” If the collection is being disputed, the answer is usually “yes.” This is an oversimplification.

The United States v. Midtling, Case No. 20-cv-0903 (WMW/DTS) (D. Minn. 2022) provides an example of the latter situation. It involves litigation over the IRS’s ability to collect and proceeds of a house that was sold while the litigation was pending. But in the collection case, the taxpayer was also disputing whether he was still liable for the taxes.

Facts & Procedural History

The taxpayer owed back taxes for 2008, 2009, 2011, 2015, 2016, and 2018. The IRS brought suit to collect the taxes.

In his Answer in the suit, the taxpayer admits that he is liable for the taxes for 2011-2018. He raised the affirmative defense as to the statute of limitations for the 2008-2011 taxes. This defense is premised on the IRS’s 10-year collection statute having expired for these earlier years. The IRS apparently contends that the defense is not available as the taxpayer had previously voluntarily extended the statute (the IRS noted that the taxpayer filed an offer in compromise that extended the statute).

Before the court could consider the case, the taxpayer sold his home. The title company likely paid the proceeds to the IRS as the IRS had a lien notice on file in the county records. The IRS applied the sales proceeds to the tax balances for the 2008-2011 tax years. Since the 2008-2011 tax years were paid, the IRS filed into the court case to dismiss the 2008-2011 tax years. The IRS also filed for summary judgment on the later years as the taxpayer agreed that those years were owed.

In his reply, the taxpayer’s position is that the proceeds cannot be paid to 2008-2011 as the collection statute expired for those years. He also noted that the proceeds would fullpay the 2015-2018 tax years, leaving no issues in controversy in this case.

The Court Skipped the Affirmative Defense

The court had to decide whether the affirmative defense as to the statute of limitations was valid for the 2008-2011. If it was, the IRS was not entitled to reduce its lien to judgment for those years.

The court did not address this issue. The court skipped it by not taking the issues up in chronological order.

The court jumped to the application (or misapplication, if the taxpayer was correct) of the sales proceeds first. By skipping the first issue in the case, the court concluded that the taxpayer had not yet exhausted its administrative remedies. The court reasoned that one has to first exhaust administrative remedies and then file suit for wrongful levy. Only then can the court consider whether the application of the sales proceeds was proper.

This does not seem correct procedurally. The court case should not have been decided on summary judgment as there is a question of fact as to the affirmative defense. A motion for summary judgment based on a later-in-time issue was premature. To effectuate this, the taxpayer may have needed to file its own summary judgment or, as noted by the court, withdrew its admission as to liability for the earlier years.

This case was brought to the court only by the IRS’s motion for summary judgment and it wasn’t predicated on the affirmative defense. This effectively allowed the IRS to sidestep the taxpayer’s affirmative defense.

The Wrongful Levy Suit

The taxpayer does have other remedies, as noted by the court. This includes a refund and/or wrongful levy suit. The taxpayer can raise the same affirmative defense for the earlier years. The case may even be before the very same court and maybe the very same judge. Court cases are not fast. This could take a year or more just to get back before the court. The taxpayer made this very argument, “citing judicial economy and cost minimization as justifications.”

The court did not agree with the judicial economy arguments. Even though it skipped over the affirmative defense, the court concluded that the law is clear and that the taxpayer has to pursue a wrongful levy suit first. An appeals court might not agree with the trial court. The problem for the taxpayer is that appealing the trial court’s ruling could take longer and cost more than simply re-filing as a wrongful levy case in the same court as the trial court suggested.

The Takeaway

It is not clear whether the taxpayer was working with the IRS or just sold the house without consulting the IRS. It might have been possible to work out an arrangement whereby the funds were paid into the registry of the court pending the outcome of this case. That could have saved both the taxpayer and the government time and money in deciding this case.

While it may seem that the IRS won this case, that isn’t necessarily true. Winning a delay is not really a victory given that the government. The government has limited resources. It also has nearly an unlimited number of disputes it could be working on. The IRS will have to dedicate personnel to continue to work on this case instead of other cases. This means that there is probably another taxpayer who owes back taxes who will get away with not paying anything.