Contesting Liability -- CDP, Audit Reconsideration and OICs for Doubt as to Liability (10/19/13)

Last week in my Tax Procedure Class, we covered Collections generally.  Subsets of collections that were covered were (i) audit reconsideration, (ii) offers in compromise and (iii) Collection Due Process (CDP) hearings.  Today, I write on a Tax Court order in Seifert v. Commissioner (T.C. No. 24735-12) Order dated 10/18/13, here, that in a short order covers key concepts for these three topics.

The taxpayers were assessed taxes in amounts that they claimed they did not owe.  Essentially, the IRS based its assessment on Form 1099 information of gross sales without reducing the gain for basis.   The taxpayers failed to contest the amounts after receiving a notice of deficiency.  So, the assessment on the allegedly excessive amounts was made.  When the IRS tried to collect, the taxpayers invoked the CDP procedures.  The Court rejected the taxpayers attempt to contest the merits of the amounts as follows:

Mr. Seifert asserts that "the sole subject" of this case is his contention that he does not actually owe the tax that the IRS is attempting to collect from him for 2007. That is, he challenges the asserted liability. We observe that it is a very plausible challenge, since gain on a sale must take into account the seller's cost. 

When Mr. Seifert received the notice of deficiency, he had an opportunity to challenge that liability in Tax Court. He could have presented evidence of his cost basis in the securities and, depending on his proof, could have seen his liability reduced or eliminated. But he did not do so. Consequently, the IRS's determination went unchallenged, and the IRS therefore had the right and the responsibility to assess and collect the tax it had determined. When the IRS undertook to collect the tax, then Mr. Seifert attempted for the first time to challenge that liability -- in the CDP hearing. 

However, under section 6330(c)(2)(B), Mr. Seifert may raise a challenge to the underlying liability as part of the CDP hearing only if he "did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability." But Mr. Seifert does not dispute that he did receive a notice of deficiency with respect to his 2007 liability. As a result, he is not permitted in the agency-level CDP hearing (nor in this judicial review of it) to challenge that liability.

But, as the IRS conceded and the Tax Court specifically observed, all is not lost to these taxpayers to achieve a fair result.  The Tax Court specifically said (emphasis supplied by JAT)

ORDERED that the Commissioner's motion for summary judgment is granted. However, Mr. Seifert is strongly encouraged to consider accepting the invitation of the Commissioner (made at pages 2-7 of his reply filed September 30, 2013) either to request audit reconsideration or to submit an Offer in Compromise based on Doubt as to Liability, outside of the CDP context.

These are important points for practitioners to consider in getting cost-effective results for their clients.

The following will provide more introduction -- somewhat summary only -- of the key points discussed above.

1.  In the CDP hearing, the issues that may be considered are (excerpts from my Federal Tax Procedure book, footnotes omitted):

(2) The taxpayer may raise any appropriate defense, including spousal defenses, the propriety of IRS collection measures and alternatives to collection measures (posting bond, substitution of collateral, etc.).  This is broad ground where the taxpayer or taxpayer's advocates skills in the art of persuasion (requiring a knowledge of tax law and procedures) may be effective.  Virtually everything is on the table.  The Appeals Office Employee (Appeals Officer or Settlement Officer) will not, however, consider any issue previously disposed of in a CDP hearing or in a prior administrative or judicial proceeding in which the taxpayer could have contested liability and participated meaningfully.  As to the underlying liability, the taxpayer can only contest if he “did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability.”  The notice of deficiency, of course, gives the taxpayer the right to contest the underlying liability in the Tax Court and thus is fatal to a review of the underlying tax liability in a CDP hearing.  The taxpayer will also be considered to have had a previous opportunity to contest if he or she waives the right to a notice of deficiency on Form 870 or Form 4549.  Other forms of administrative review of the underlying tax liability (e.g., pursuing an appeals remedy for a § 6672 penalty even if there is no prepayment court remedy) will prevent the contest of the underlying tax liability in the CDP hearing.  What about taxes that the taxpayer reports on the original or an amended return?  Self-reported tax is assessed without issuing a notice of deficiency.  If the self-assessed tax is not paid with the return, the IRS will institute collection procedures.  May the taxpayer contest the merits of the self-reported tax liability in a CDP proceeding?  The Tax Court recently held that the taxpayer may.  Finally, the mere opportunity to pay tax and sue for refund in a refund forum appears, by itself, not to be an available remedy so as to defeat review of the underlying tax liability in the CDP proceeding.

Section 6330(c)(2)(B), referred to in the order excerpt, is here.

2. For more on audit reconsideration, See IRM Part 4. Examining Process, Chapter 13. Audit Reconsideration, the beginning parts of which are here.  Also, web searches can find reasonable discussions of the procedure.  My brief explanation of the process in my Federal Tax Procedure book is:

Audit Reconsideration. 

The IRS has an audit reconsideration process for reconsidering the merits of tax deficiency assessments.  Generally, the taxpayer must have filed a return, including a delinquent return in response to a substitute for return.  The IRS can consider information that was not previously considered during the original examination. 

The IRS is not statutorily required to have this audit reconsideration process.  You will recall that we discussed above the fact that, although the IRS is not required to consider claims in abatement in taxes subject to the deficiency procedure, it always has the discretionary authority to abate if the assessment exceeds the correct liability.  The general denial of a claim for abatement for these taxes is designed to channel taxpayers into participation in the audit and appeals process and Tax Court litigation, with refund litigation as the only alternative.  Nevertheless, the IRS has this audit reconsideration process based on its discretionary authority in order to provide relief to taxpayers who may have fallen through the cracks on the normal process.

3.  For more on OIC's doubt as to liability see 4.18.2  Doubt as to Liability Offers, here.  My brief explanation from my Federal Tax Procedure Book is:

c. Doubt as to Liability. 

OICs may also be made for doubt as to liability.  Usually, if the taxpayer has a good defense as to his or her liability, the taxpayer will have had an opportunity to present that defense before the IRS makes the assessment.  We covered above the system whereby, through the requirement for a notice of deficiency, the taxpayer may contest liability in the Tax Court.  The taxpayer also could have contested liability in a refund or even in a collection suit.  Once the liability is judicially contested, the IRS will not consider offers in compromise based upon doubt as to liability.  

Administratively, also, the taxpayer will have had some procedural avenues, including invoking Appeals Office consideration or audit reconsideration, to contest liability.  Nevertheless, there are many taxpayers who have not had effective judicial reviews of their liabilities for the assessed taxes.  They may not owe the taxes.  Those taxpayers can use OICs to contest their liability for the underlying taxes.   

Sometimes the taxpayer will make an OIC based upon a combination of doubt as to collectibility and doubt as to liability.  The IRS will process the OIC first on doubt as to collectibility, because if the offer is acceptable on that basis, the issue of liability is moot.