The government establishes processes to carry out its essential functions. These processes handle a myriad of different types of cases and cases with nuanced fact patterns.
These processes allow the government to process a high volume of cases. They often do so in bulk.
The process is a like well-trodden path. The path may take life on by and for itself. The government employees who work with cases in the process sometimes view completing the process as the goal, not the overall goals for the agency or the process itself.
When this happens, one often sees disputes that show up in court in some fashion. In these court cases, the government will often continue to defend the case to basically protect the process and the court does too, even though the whole affair is divorced from the policies that underly the need for the process. The government usually wins in the cases, but loses out in the long run.
This brings us to the Lipka v. Commissioner, T.C. Memo. 2022-116 case. The Likpa case provides an opportunity to consider the IRS’s Collection Due Process Hearing (“CDP Hearing”) as a government process.
Facts & Procedural History
The taxpayers in this case owed nearly half a million dollars in Federal income taxes for the 2017 tax year. They filed their tax return but did not pay the tax that was reported on the tax return.
On July 1, 2019, at the start of the Covid-pandemic, the IRS sent the taxpayers a notice of intent to levy. The taxpayers submitted a timely Form 12153, Request for a Collection Due Process or Equivalent Hearing. On Form 12153, the taxpayers checked the boxes for “Installment Agreement“, “Offer in Compromise”, and “I Cannot Pay Balance” and checked the box marked “Other,” and in the corresponding space for the “Reason” for requesting a hearing, the taxpayers stated: “A collection alternative is necessary in furtherance of effective tax administration given Taxpayers’ unusual financial circumstances”.
Six months later, IRS Appeals scheduled a CDP Hearing. IRS Appeals noted its policy of not granting in-person hearings if the taxpayer cannot pay more recent taxes, such as estimated taxes in this case. Recall that the reason why the CDP Hearing was requested as the taxpayers asserted that they could not pay their prior year’s taxes–let alone their more recent taxes.
The taxpayers asked that their case be placed on currently not collectible status or an installment agreement be reached for an amount they can afford. The hearing ended up with an adverse determination and litigation in the U.S. Tax Court ensued.
The IRS Appeals Process for CDP Hearings
The IRS Appeals Office is tasked with reviewing whether the IRS complied with the law in assessing the correct amount of tax and followed all procedures before it levies on taxpayer assets. IRS Appeals can also consider collection alternatives if the taxpayer cannot pay and, in doing so, it can consider the financial hardship of enforcing payment options.
IRS Appeals does this by requesting financial information, which typically includes Form 433-A information. IRS Appeals did just that in this case.
The court described the interaction with IRS Appeals and the taxpayers as follows:
Mr. Lipka was under criminal indictment by the State of New Jersey, that their real estate properties were being held by the State of New Jersey, and that they had neither money nor access to their assets to pay their 2017 tax liability. They also stated that they were currently unable to secure employment because of the criminal matter. The IRS Appeals officer asked the Lipkas to submit a completed Form 433-A and additional documentation substantiating their purported inability to pay and their lack of access to their assets.
After some discussion between the parties the hearing process ended as follows:
The IRS Appeals officer accordingly redetermined the Lipkas’ gross monthly income to be $28,275 and their allowable monthly expenses to remain $17,954; thereby leaving them an approximate net monthly income of $10,321 available to satisfy their outstanding tax liability for 2017. Because of the Lipkas’ positive net monthly income, the IRS Appeals officer concluded that they were not eligible for currently not collectible (“CNC”) status and proposed an installment agreement (“IA”) with monthly payments of $10,000 over a period of 72 months. The Lipkas responded that they would not be accepting the proposed IA because they would be unable to pay it.
What IRS Appeals did not really address is the future circumstances. The taxpayers were dealing with a significant criminal case. The taxpayers had certain assets that the IRS may have been able to collect from. The IRS’s window of time to collect was probably somewhat limited. The taxpayers seem to have been asking the IRS to collect against those assets while leaving them some cash available to pay their ongoing legal fees for their criminal defense. The taxpayers were likely trying to propose a win-win for the IRS.
The Court’s Limited Review of CDP Hearings
The U.S. Tax Court reviews CDP Hearing decisions based on an abuse of discretion standard. This standard usually results in cases being sustained in the IRS’s favor.
In this case, the court considered “financial hardship” and whether IRS Appeals abused its discretion in sustaining the levy given the circumstances in this case. The court reviewed the record and noted that:
The IRS Appeals officer subsequently asked them for documentation regarding their legal expenses, but the supplemental documentation they provided did not include any legal bills. Their documentation did reveal that a portion of their deposits (originally treated by Appeals as available to pay tax) were in fact re-deposits of the same funds rather than real receipts, and that another portion had been used to pay the IRS and the State of New Jersey.
The court also noted that the taxpayers “highlight that they are parties to a state law criminal matter.” This led the court to note that “taxpayers cannot rely on an unsubstantiated, unquantified claim that they would suffer economic hardship; rather, ‘taxpayers must submit complete and current financial information.'”
Given this, the court concluded that there was no abuse of discretion. The case will be closed and sent back to the IRS Collections function. This will probably take another 6-12 months for the IRS to process. This comes now after three years have passed since the time the case started. The IRS’s collection window has probably closed. By the time the IRS Revenue Officer shows up to collect, there are probably no assets left for the IRS to collect from or the taxpayers will discharge the taxes in bankruptcy. When they eventually do show up, the IRS revenue officer will likely grant the taxpayer’s request for currently not collectible status at that point. The 10-year collection statute will likely expire and the IRS will probably end up with nothing.
The IRS Ends up Losing Out
Those who consider cases like this may be perplexed by how the IRS handled this case, even though this is standard fare for CDP Hearing cases.
The process included having the IRS spend money to employ personnel to fight with the taxpayer and using court resources, resulting in the IRS not collecting anything and, in the end, the taxpayer getting the very relief that they were denied by the IRS during the fight.
In this case, the taxpayers came forward and pointed out that they have certain assets and that the IRS was competing with the state for an interest in the assets. A coordinated plan between the IRS and the state might have preserved more of the assets to satisfy the back taxes. This was likely in the taxpayers’ favor as the unpaid taxes would linger long after the criminal case was done. The taxpayers may have preferred the IRS to levy on their real estate, leaving them funds to pay for their criminal defense, and then settle the criminal restitution with the state.
The taxpayers pointed this out to the court. They argued that “IRS Appeals ‘”‘fail[ed] to explore the opportunity of multi-agency collaboration which could result in the removal of encumbrances on assets that could be sold with proceeds used to satisfy the tax debt.'” The court noted that this was raised by the taxpayers for the first time in court and not in the CDP Hearing. Those who do not handle these cases may wonder why it was the taxpayers who had the burden to raise this issue. Taxpayers in general may rightfully expect the IRS to raise this issue, not force the taxpayer to raise it, and basically penalize them if they did not do so. But this is not the nature of the CDP Hearing process as it is currently administered. The process as it is currently administered is not intended to maximize collections, even if that is what the taxpayers are requesting. That is not part of the IRS Appeals policies for how it handles cases.
IRS Appeals has a lot of discretion. They could have simply granted the taxpayer’s request for not collectible status at the start. A quick search of the taxpayers’ names on Google discloses various court documents pertaining to the criminal charges and investigation. The underlying court cases even come up. The documents all pre-date the current court hearing. The underlying records are in the public and are government records admissible as evidence in court. It does not include invoices for their legal bills, but one can surmise that a serious criminal issue such as the one leveled against the taxpayers could very easily cost more than $10,000 a month in legal fees. That does not even get to the eventual criminal restitution that seems likely. The IRS Appeals office could have used this information to put the case on non-collectible status. At least the CDP Hearing would have ended fast and the IRS could revisit its currently not collectible status in a few months.
The question is one of timing. How, at the outset of a complex criminal case, can a taxpayer prove what their income will be or what their future legal expenses and restitution will be? In this case, these fees were likely to be incurred in the next few years as the criminal case just started prior to the 2017 tax year that was at issue. The case will very likely end up with the taxpayers serving some jail time. Their livelihoods and ability to earn money will no doubt be impacted over time. And criminal restitution is likely.
This is not how the CDP Hearing “process” is set up to function. The “process” is not set up to handle cases in this fashion. IRS Appeals employees could not do this if they wanted to. These cases are not held open by IRS Appeals for very long. They generally only factor in the here and now.
The CDP Hearing process has become a central feature in our tax collection system. It buys taxpayers time to work out terms with the IRS. The process is often administered in a way that many would think is too rigid. Cases like the present case, where the taxpayer is proposing collection alternatives that someone other than a government agency would jump at, are often not accepted by the IRS. The IRS process does not provide a mechanism for the IRS to effectively work these cases.
Taxpayers’ only recourse in these cases may be to use the process for the delay aspect of it, as the government is slow in processing cases. The delay may result in the taxpayer obtaining the very remedy they sought, as in this case. While this type of tax planning may be frowned upon, it is often the byproduct of the IRS process.