IRS Refunds in Collection Due Process Cases

Published Categorized as IRS Debts, Tax Procedure
IRS collection due process refund, Houston Tax Attorney

The refrain from the Rolling Stones song, Satisfaction, says “I can’t get no satisfaction.” That is a common refrain when it comes to the IRS and owing back taxes.

Congress has provided a myriad of rules and remedies for taxpayers when it comes to taxes. If the taxpayer is lucky enough to have a remedy, the next question is whether the remedy actually provides the desired relief. Sometimes there are remedies that provide, well, inadequate relief.

The McLain v. Commissioner, No. 20-1074 (4th Cir. 2022), is an example. The taxpayer had a remedy (i.e., a collection hearing), but according to the court, the remedy stopped short of providing the relief sought (a tax refund).

One way to view the question is whether the IRS’s act to hold a refund owed to a taxpayer is an illegal collection action. The IRS collected the funds, but is the holding the funds is illegal if it is evident that the taxpayer is entitled to the refund? Can the court just find that there is no tax due or can it go further and order the IRS to issue the refund that is owed?

Facts & Procedural History

This is a case involving a small business. It appears that the business was a sole proprietorship. The tax return reported a loss for the 2008 tax year.

The IRS conducted an audit of the tax return for the 2008 tax year, presumably. In doing so, it issued a Notice of Deficiency to the taxpayer.

The notice proposed to disallow nearly all of the business’ expenses. This suggests that the taxpayer may not have even been aware that the IRS was conducting an audit. The IRS will frequently deny all tax deductions and close audits if a taxpayer does not respond. This leaves the taxpayer on the hook for tax based on the reported income, but the income is not reduced by any tax deductions.

The IRS agreed that the taxpayer did not receive the notice. The IRS then filed a tax lien notice for the resulting tax. The taxpayer filed a collection due process hearing request to challenge the underlying tax liability.

During the collection due process hearing the taxpayer provided sufficient information to show that the business loss was correct. Thus, there was no tax due. The IRS agreed that there was no tax due. The IRS then abated the tax assessment, but did not issue a refund.

The taxpayer alerted the U.S. Tax Court that he was entitled to a refund and contended that the court should enter an order that the refund was due.

The tax court and then the appeals court had to consider whether it had the authority to enter an order obligating the IRS to pay a refund.

Judicial Review of Collection Due Process Hearings

The U.S. Tax Court is a court of limited jurisdiction. This means that it can only hear certain types of cases. The collection due process hearing at issue in this case is an example. The U.S. Tax Court is authorized to hear these types of cases.

The statute that confers jurisdiction says that the taxpayer can raise “challenges to the existence or amount of the underlying tax liability” during this process. The taxpayer did just that in this case.

Once the taxpayer challenges the liability, he can ask the tax court to review the IRS’s determination.

Refund Claims in a CDP Hearing Case

This case addresses whether the court can consider a refund in a challenge to a Notice of Determination in CDP hearing case.

Presumably the IRS considered the refund as it considered whether the tax liability was owed during the CDP hearing. The IRS reviewed the records and concluded that there was no tax due as part of the hearing. This would also suggest that a refund was due.

The tax court and then appeals court concluded that the tax court cannot consider a refund in a collection due process hearing:

The phrase “underlying tax liability” does not provide the Tax Court jurisdiction over independent overpayment claims when the collection action no longer exists.

This means that the tax court can only say that there is no liability with the result that the IRS’s cannot continue collections.

The taxpayer will have to request the IRS issue the refund separately. This may be in the form of an administrative request or a formal claim for refund. If the IRS does not voluntarily pay the refund, the taxpayer will have to sue the IRS in district court or the court of claims.

The Takeaway

Collection due process hearings can provide an avenue for halting IRS collections and even correcting a tax deficiency. This case shows that this remedy may be inadequate when the taxpayer is wanting a refund when there is no tax deficiency. The CDP hearing can clear the tax deficiency, but it probably will not force the IRS to issue a refund in excess of the deficiency.

Waiting for the IRS or tax court to make a decision in the CDP hearing may result in the refund period expiring. The time for filing a refund might not be open by the time the CDP hearing is concluded. The CDP hearing holds open the collection statute, but not necessarily the assessment statute. Thus, taxpayers may want to file a refund claim with the IRS in addition to the CDP hearing if they are seeking a refund. This placeholder refund claim may help avoid questions about whether the refund can be issued at that point.

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