Tax Court Preserves Taxpayer Protections against Arbitrary and Capricious Appeals Rulings

us_tax_courtIn Buczek v. Commissioner, 143 T.C. 16 (2014), the Tax Court granted the IRS’s motion to dismiss for lack of jurisdiction under IRC § 6330(g) where the taxpayers offered only frivolous arguments as the basis for a Collection Due Process (“CDP”) hearing.  Of note, however, is the Court’s refusal to overturn the Tax Court’s decision in Thornberry v. Commissioner, 136 T.C. 356 (2011), which also involved a IRC § 6330(g) determination.

In November 2013, the IRS sent the taxpayers a final notice of intent to levy to collect unpaid Federal income tax and interest assessed for 2009.  The taxpayers timely filed Form 12153, Request for a Collection Due Process or Equivalent Hearing, in response.  The taxpayers did not check any boxes on the Form 12153 but wrote “common law hearing” on the form where they could state another grounds for requesting a CDP hearing.  The taxpayers submitted seven additional pages with the Form 12153, including a copy of the notice of intent to levy stamped with common tax protestor arguments, “Pursuant to UCC 3-501”, “Refused from the cause”, “Consent not given”, and “Permission DENIED”.

The IRS sent the taxpayers a letter in January 2014 requesting that the taxpayers amend their CDP hearing request to provide a legitimate reason for the hearing or to withdraw the request.  The taxpayers did not timely respond to this letter.  In March 2014, the IRS sent the taxpayers a letter informing the taxpayer that the IRS was disregarding the taxpayers’ CDP request under the authority of IRC § 6330(g).

The taxpayers attached the notice of disregard letter to their Tax Court petition in response to a notice of deficiency for a different tax year.  The Court dismissed the case for lack of jurisdiction and ordered the notice of disregard letter be filed as an imperfect petition for the taxpayers’ 2009 tax liability.  The taxpayers filed an amended petition in May 2014 pursuant to an order by the Court.  The taxpayers’ petition and subsequent pleadings complained about the conduct of an IRS agent, not the appeals officer that sent the notice of disregard letter, and did not raise any “justiciable issue with regard to the Appeals Office’s disregard of his hearing request or its determination to proceed with the collection of his unpaid income tax liability for 2009.”

In June 2014, the IRS filed a motion to dismiss for lack of jurisdiction asserting that the Court does not have jurisdiction when a disregard letter is issued under IRC § 6330(g).  The motion to dismiss was contrary to the Court’s decision in Thornberrywhich held that while IRC § 6330(g) denies further administrative or judicial review of the portions of a CDP request that the Appeals office deem frivolous, the statute does not deny judicial review of that determination.

Judge Dawson, writing for the court, denied the IRS’s request to overturn Thornberry, distinguishing this case on its facts.  Unlike the taxpayers in Thornberry, who presented four valid grounds for a CDP hearing under IRC § 6330(c)(2), here the taxpayers’ CDP request did not make any assertions that would raise a legitimate issue under IRC § 6330(c)(2).  The taxpayers did not challenge the appropriateness of the collection action, request collection alternatives, or properly contest the underlying tax liability.  Also, unlike Thornberry, where the taxpayers’ CDP request and petition properly raised issues under IRC § 6330(c)(2)(A) and (B), here the taxpayers did not raise any valid issues that could be considered in a CDP hearing.

Judge Dawson granted the IRS’s motion to dismiss for lack of jurisdiction based upon his determination the the taxpayers did not make a proper request for a CDP hearing and thus the CDP request was properly treated as if it was not submitted.  However, Judge Dawson clearly states that the Court’s review of IRS determinations under IRC § 6330(g) are important in protecting taxpayers from determinations that are “arbitrary and capricious” and did not overturn Thornberry.

Read the full opinion here: Buczek v. Commissioner, 143 T.C. No. 16 (2014)

Amended Returns Don’t Help Taxpayer Minimize §6707A Penalties

us_tax_courtIn Yari v. Commissioner, 143 T.C. No. 7, the Tax Court upheld a $100,000 statutory maximum, penalty under IRC § 6707A(b)(2)(A) assessed against the taxpayer for failing to report a listed transaction.  The case presents an issue of first impression on the proper calculation of a penalty under IRC § 6707A(b).

The taxpayer participated in a listed Roth IRA transaction from 2002 to 2007.  The transaction involved the taxpayer forming a disregarded entity, Topaz Global Holdings, LLC, and a Nevada corporation, Faryar, Inc., which elected to be treated as an S-Corporation for federal income tax purposes.  The taxpayer opened a Roth IRA account in 2002 with an initial contribution of $3,000.  The Roth IRA acquired all of Faryar, Inc.’s stock for $3,000 and became the sole shareholder of the corporation.

From 2002 to 2007, Faryar, Inc. reported management fees from related entity Topaz Global Holdings, LLC and interest income of $1,221,778.  Because Faryar, Inc. was an S-Corporation with a Roth IRA as the sole shareholder, the income was not taxed at either the corporate level or the shareholder level.  The structure allowed the taxpayer to exceed Roth IRA contribution limits and decrease the income he otherwise would have reported because Topaz Global deducted the management fee paid to Faryar, Inc.

In IRS Notice 2004-8, the IRS designated these Roth IRA transactions as “abusive.”  The taxpayer filed a federal income tax return for 2004 in on October 17, 2005.  This return did not disclose the taxpayer’s participation in the Roth IRA transaction.  The IRS audited the taxpayer’s returns for 2002 through 2007 and issued notices of deficiency for each year.  The IRS determined that the taxpayer should have included $482,912 from the management fee transaction as income in the 2004 tax year.  After computational adjustments, this increased the taxpayer’s tax liability by $135,215.  The IRS issued notices of deficiency and the taxpayer when to the Tax Court.

During the course of the audit, the taxpayer amended his 2004 tax return to correct reported Schedule K-1 information.  The amended return also included $482,912 from the management fee transaction as income. The taxpayer then filed a second amended return claiming a net operating loss carryback from 2008, and again reporting the $482,912 management fee as income.

The taxpayer and the IRS settled the deficiency cases and entered into a closing agreement in 2011.  The closing agreement required the taxpayer to include certain amounts in his income for each of the tax years, including $482,912 for the 2004 tax year.  The Court entered stipulated decisions in the deficiency cases that reflected the closing agreement.

In September 2008, the IRS issued a IRC § 6707A penalty of $100,000 for the 2004 tax year because the taxpayer failed to disclose his participation in a listed transaction.  The IRS issued a Notice of Intent to Levy in February 2009 and the taxpayer timely requested a Collection Due Process (CDP) hearing.  Prior to the hearing, Congress amended IRC § 6707A as part of the Small Business Jobs Act (SBJA) to change the method of calculating the penalty.  The change was effective retroactively for penalties assessed after December 31, 2006.  The new statute designated a penalty of 75% of the decrease in tax shown on the return as a result of the listed transaction and set minimum and maximum penalties of $5,000 and $100,000, respectively, for individuals under IRC § 6707A(b).

The IRS suspended the CDP hearing to reconsider the calculation of the penalty and determined that the penalty did not need to be modified under the new statute.   The taxpayer took the position that the amended returns should be used to calculate the decrease in tax, and thus the penalty should be the statutory minimum of $5,000 under IRC § 6707A(b)(2)(B).  The revenue agent disagreed and used the original return to calculate the penalty, resulting in a maximum $100,000 liability under IRC § 6707A(b)(2)(A).  At the taxpayer’s request, the settlement officer issued a notice of determination sustaining the collection action.  The taxpayer challenged the calculation of the penalty and petitioned the Tax Court.

Despite stipulations to the Tax Court’s jurisdiction over this matter, the Court determined its jurisdiction over the matter and distinguished this case from Smith v. Commissioner, 133 T.C. 424 (2009).  In Smith, the Court found it lacked jurisdiction to redetermine an IRC § 6707A penalty because the penalty did not fit the statutory definition of deficiency and because the IRS could assess and collect the penalty without issuing a statutory notice of deficiency.  However, the Tax Court held that the Court does have jurisdiction to redetermine a liability challenge asserted by a taxpayer in a Collection Due Process hearing pursuant to IRC § 6330(d)(1).  Notably, the Tax Court reviewed the CDP determination de novo because the underlying tax liability was properly at issue.  Sego v. Commissioner, 114 T.C. 604, 610 (2000).

The taxpayer stipulated that he participated in a listed transaction and that he failed to properly disclose his participation.  The taxpayer argued that the amended returns should be used to calculate the decrease in tax, and thus the penalty should be the statutory minimum of $5,000, rather than the $100,000 maximum assessed by the IRS.  He based his argument on the plain language of the statute, the statutory scheme, and legislative history.

The Court held that “the statute is clear and unambiguous: The penalty is calculated with reference to the ‘tax shown on the return’. IRC § 6707A(b).”  In its analysis of legislative intent, the Tax Court found that Congress intended to penalize the failure to disclose participation in a listed transaction, not the tax savings produced by the transaction.  The Court also noted that Congress could have referenced “a” return in the statute, rather than “the” return, if it intended for the IRS to use amended returns in calculating the penalty under IRC § 6707A.  Thus, the Court upheld the maximum penalty of $100,000 assessed against the taxpayer.

The Tax Court did leave the door open for taxpayers who file an amended return prior to the due date of the original return.

Read the full opinion here: Yari v. Commissioner, 143 T.C. No. 7.