Flora Full Payment Rule and the Rough Edges (9/17/15)

In the class we discuss the rule -- called the Flora rule -- that, in order to maintain a tax refund suit, the taxpayer generally must fully pay the amount of the assessment.  See Flora v. United States, 362 U.S. 145 (1960), here.  There are some key nuances to that rule.  I discuss those nuances in the Student edition pp. 382-384 and in the practitioner edition pp.  545-549.

One of the key nuances is that, if the assessment in question is a "divisible tax," the taxpayer may pay only the divisible amount.  Flora v. United States, p. 175 n.38 (some taxes "may be divisible into a tax on each transaction or event, so that the full-payment rule would probably require no more than payment of a small amount.”)   For example, for trust fund recovery penalty ("TFRP") based on all employees for a particular quarter or quarters, because the underlying trust fund taxes are divisible, the taxpayer contesting assessment of the TFRP, need only pay for one taxpayer for one quarter.

The divisible tax rule mitigates the full bore application of Flora, and usually makes a refund remedy within the reach of a taxpayer subject to a divisible tax assessment.  The problem comes if the tax (or penalty treated as a tax for this purpose) is so large that paying the full assessment is beyond the reach of the taxpayer.

In Diversified Group Inc. v. United States, 123 Fed. Cl. 442, 2015 U.S. Claims LEXIS 1276 (2015), here [see note below at *], appeal docketed, No. 16-1014 (Fed. Cir. October 6, 2015), the promoter of an abusive shelter and his corporation involved with the promotion of the shelter was assessed a penalty under § 6707, here, for failing to register the shelter.   The penalty was over $24 million.  The promoter paid a small amount and sued for refund, hoping to fit within the divisible penalty exception to full payment.  The Court held that the penalty was not divisible, hence requiring the promoter to pay the full penalty before pursuing a refund suit.

I do not know the financial ability of the promoter or his corporation, but for most ordinary people, paying that amount would difficult, probably impossible.

So the question is when a taxpayer is financially unable to meet the Flora full payment rule and must do so for a refund suit remedy, does he have an alternative to obtain a judicial remedy?  Of course, for the types of tax that require a predicate notice of deficiency, the taxpayer can obtain a Tax Court remedy.  But sometimes the taxpayer may not have received the notice of deficiency (the last known address issue) or the type of tax or penalty does not require a notice of deficiency (§ 6707 is one).

In a case like that, the taxpayer or the person assessed a penalty may be able to get a CDP remedy that could lead to a Tax Court review of the liability.  Keith Fogg a contributor on the Procedurally Taxing Blog discusses this issue in Another Flora Decision – Bad News for Tax Shelter Promoters Highlights Possible CDP Jurisdictional Issue (Procedurally Taxing Blog 9/15/15), here.   Keith concludes:  "It appears that they can litigate the merits of this penalty using the CDP process though the path to that answer may not be as clear as one might like and the answer appears to turn on whether the taxpayer has administratively requested penalty abatement after the assessment."  Keith does a great job of discussing his reasoning and nuance, so I strongly encourage readers to read the blog.

CDP review is discussed in the text - student edition, pp. 457-463 and practitioner edition pp. 657-667.

* This blog entry was prepared on the basis of the original opinion.  The court subsequently reissued the opinion on 9/2/15.  I have changed the citation reference and the link.  Although I have not compared to see what might have changed in the reissued opinion, I don't believe anything was changed relevant to the discussion in this blog entry.

Fourth Circuit Affirmance of Summary Judgment in TFRP case (11/11/13)

In Johnson v. United States, ___ F.3d ___, 2013 U.S. App. LEXIS 22444 (4th Cir. 2013), here, the Fourth Circuit affirmed summary judgment for the Government in a trust fund recovery (also called responsible person) penalty case.  That penalty is imposed by Section 6672, here.  Johnson is a good case to illustrate the potential sweep of this penalty, which is frequently encountered by tax controversy practitioners.

I call readers attention to an excellent blog discussion of Johnson.  See Matt Lee, Fourth Circuit Affirms Responsible Officer Penalty Against Wife for Husband’s Unpaid Employment Taxes (Blank Rome Tax Controversy Watch 11/8/13), here.  I want try to recreate the blog, so to speak.  Mr. Lee's blog entry is very good and detailed.  I do offer his conclusion:

The Johnson case illustrates that personal liability may be assessed against corporate officers where a company fails to pay over employment taxes, even if the corporate officer was unaware of the failure to pay in prior periods.  Once the corporate officer learns of the tax delinquency, he or she has a duty to ensure that corporate funds are used to pay off those liabilities.  If the corporate officer fails to do so, personal liability for those taxes may be asserted. 

One interesting feature is the following from the opinion (footnote omitted):

Subsequently, the IRS assessed trust fund recovery penalties (the "100% penalty") against Mr. and Mrs. Johnson individually, pursuant to 26 U.S.C. § 6672.8 Mrs. Johnson later paid $351.00 toward her assessed penalty. 

On March 30, 2009, Mrs. Johnson filed suit in the United States District Court for the District of Maryland seeking a refund of the penalty she had paid, asserting that the § 6672 assessment against her was erroneous. The Government filed a counterclaim against both of the Johnsons in order to reduce its assessments to judgment, seeking to recover the balance of assessments due, including penalties, interest, and costs. Based upon transcripts of account showing the balances due as of August 22, 2011, the Government ultimately sought to recover $304,355.90 from Mrs. Johnson and $240,071.12 from Mr. Johnson.

I have previously posted on the issue of how much needs to be paid to insure that Flora's requirements are met. See  Flora v. United States, 362 U.S. 145 (1960).  Readers desiring to read the blogs on that issue can do so by clicking the subject labels below for Flora Full Payment Rule and Divisible Tax.

Thanks to the bloggers at Procedurally Taxing, here, for the lead to Mr. Lee's blog entry.  And thanks to Mr. Lee for the entry itself.

Litigating Trust Fund Recovery Penalties -- the Flora Rule, Divisible Taxes and Unfairness (10/11/13)

UPDATE, most of the discussion below is still good, but Judge Wheeler of the Court of Federal Claims issued a new opinion going the opposite way and finding jurisdiction.  I posted a blog entry on the new opinion on 1/29/14.  See Revised Opinion in TFRP Case Involving Flora Full Payment Requirement (Federal Tax Procedure Blog 1/29/14), here.

Tax procedure enthusiasts will know the venerable Flora Rule, sometimes referred to as the Flora rule, after the case of Flora v. United States, 362 U.S. 145 (1960).  The following is a cut and paste of my explanation of this rule in my Federal Tax Procedure book (footnotes omitted):

In order to file a claim for refund and then sue for refund, the taxpayer must be able to assert that he or she overpaid taxes.  The critical question has been how much the taxpayer must pay in order to assert an overpayment.  The historical answer was that the taxpayer must have fully paid the assessment (which includes penalties and interest) in order to bring a refund suit.  This is referred to as the prepayment requirement which tax practitioners sometimes refer to as the Flora rule, after the Supreme Court case, Flora v. United States, 362 U.S. 145 (1960). 

Why is a prepayment rule important?  As the Supreme Court in Flora viewed the history and fabric of the procedures Congress adopted for tax litigation, any other rule would be counterproductive to those procedures.  Congress created the Tax Court as the forum for litigating most tax controversies.  The Tax Court is a prepayment judicial forum, and is the only prepayment judicial forum we have for resolving the merits of tax liabilities (excepting of course collection suits in the district courts).  If the IRS could assert a deficiency of, say, $100,000 and the taxpayer could get a prepayment remedy simply by paying $1 against the assessment that follows, the taxpayer could effectively turn the district courts into a prepayment forum. 

Of course, this highlights one of the problems with the prepayment rule.  A taxpayer who does not have the money to pay (the $100,000 assessed amount in the above example) doesn't really have a choice.  He or she must pursue the prepayment remedy in the Tax Court.  Is that fair?  Do citizens get better choices solely because they have substantial resources?  That is a policy question, and of course the answer is yes (just as substantial resources open up better and more choices throughout the law and life). 

Many authorities and commentators felt that Flora required full payment of not only the principal amount of tax liability, but also any penalties and interest assessed by the IRS.  This, of course, makes the cost of entry to refund litigation more expensive, particularly if distant years are involved where the interest can be more than the tax or penalties.  It is not unusual in tax cases involving old years to have the interest alone, because of the passage of time, cause the total bill with interest to triple or quadruple the principal amount involved.  With this “cost” of refund litigation, many taxpayers are forced to pursue the Tax Court route if it is available to them, as it is when income tax, estate and gift tax and certain types of miscellaneous tax liabilities are in dispute. 

As you can see, one of the issues is whether it is fair to force litigation into the Tax Court simply because the taxpayer is not rich.  (OK, that is a bit of hyperbole, but makes the point.)  And, some taxes and penalties like the TFRP cannot even get to the Tax Court (except late in the process via a CDP hearing, which is a relatively recent development). Accordingly, as I note in the book, the Courts have developed the divisible tax concept to mitigate some unfairness in the Flora rule.  The divisible tax concept (again from my book with only one footnote quoted) is:

TFRP Refund Suits - How Much Must be Paid (1/18/13)

I write today on the Government's position -- pressed only once that I am aware of and not accepted or specifically rejected by any court that I am aware of -- that the Trust Fund Recovery Penalty (TFRP) (and any other divisible tax) must meet the Flora full payment rule for each assessed quarter.  For the TFRP, because of the divisible tax concept, only one employee's tax must be paid for a quarter.  But, practitioners filing a TFRP refund suit should consider the impact of the Government's argument should it continue to press it.  I have previously written on the case, but addressed the issue toward the end of that blog entry.  Ah, the Flora Full Payment Rule Raises Its Ugly Head (Federal Tax Procedure Blog 1/16/13), here.  I have decided to present the issue as a separate blog entry because TFRP refund suits are very common; if the Government is correct, the position could require dismissal of the refund suit if the minimum payments are not made for each quarter.

I present the issue by cutting and pasting my revised discussion in my Federal Tax Procedure book and now offer the following excerpts that she the background for the issue and the Government's argument (most footnotes omitted):

The TFRP is generally litigated in refund suits in either the district court or Court of Federal Claims.  There is no “ticket to the Tax Court” (notice of deficiency) in TFRP cases. Denial of access to the Tax Court -- which is a prepayment forum for litigating liability -- can have a harsh effect.  The Flora rule requires in tax refund suits that the tax must be fully paid before the taxpayer may file a refund suit.  It is not unusual for trust fund penalties to be quite large and thus prohibitive if the Flora rule were to apply full bore.  Fortunately, the due process issues – and certainly general fairness issues – that might otherwise inhere in the full bore application of the Flora rule are avoided by two procedural techniques -- one statutory and the other non-statutory -- that permit the putative responsible person to litigate the liability without payment of the entire amount.

Ah, the Flora Full Payment Rule Raises Its Ugly Head (1/16/13)

In Roseman v. United States, 2013 U.S. Claims LEXIS 2 (2013), here, a nonpublished opinion and order, the Court of Federal Claims (Judge Allegra) dismissed the taxpayer's trust fund recovery refund suit for failure to meet the prepayment requirement for refund suits.  This just applies the so-called Flora rule (see Flora v. United States, 362 U.S. 145, 150 (1960)) that a refund suit requires full payment, a rule that is mitigated in so-called divisible tax cases to require only the payment for one such divisible tax.  I explain this below, but first address the Rosenman opinion.

The body of the opinion is short, but a good reminder for practitioners and their clients:

Jurisdiction in this tax refund suit lies, if at all, under 28 U.S.C. § 1491(a)(1). n2 As a general rule, before bringing a refund suit, a taxpayer must, inter alia, pay his or her full tax liability. See Shore v. United States, 9 F.3d 1524, 1526 (Fed. Cir. 1993) (citing Flora v. United States, 362 U.S. 145, 150 (1960)); see also Ledford v. United States, 297 F.3d 1378, 1382 (Fed. Cir. 2002). This rule, however, does not apply to so-called divisible taxes, including the penalty under section 6672. Rather, "a taxpayer assessed under section 6672  need only pay the divisible amount of the penalty assessment attributable to a single individual's withholding before instituting a refund action." Boynton v. United States, 566 F.2d 50, 52 (9th Cir. 1977); see also Steele v. United States, 280 F.2d 89, 90-91 (8th Cir. 1960). n3 Courts have held that this requirement is satisfied where a plaintiff pays the penalty attributable to one employee's wages for one quarter. See, e.g., Ruth v. United States, 823 F.2d 1091, 1092 (7th Cir. 1987); USLIFE Title Ins. Co. of Dall. v. Harbison, 784 F.2d 1238, 1243 n.6 (5th Cir. 1986); Boynton, 566 F.2d at 52; Suhadolnik v. United States, 2011 WL 2173683, at *5 (C.D. Ill. June 2, 2011); Todd v. United States, 2009 WL 3152863, at *3-4 (S.D. Ga. Sept. 29, 2009); Lighthall v. Comm'r of Internal Revenue, 1990 WL 53127, at *2 (N.D. Ill. Apr. 12, 1990), aff'd, 948 F.2d 1292 (7th Cir. 1991). n4
   n2 It is worth repeating that jurisdiction for refund suits in this court is not provided by 28 U.S.C. § 1346. See Hinck v. United States, 64 Fed. C1. 71, 74-76 (2005), aff'd, 446 F.3d 1307 (Fed. Cir. 2006), aff'd, 550 U.S. 501 (2007).
   n3 "This relaxed requirement is based on the theory that section 6672 assessments represent  a cumulation of separable assessments for each employee from whom taxes were withheld." Boynton, 566 F.2d at 52.
   n4 Defendant argues that payment must be made for one employee for each of the periods involved. Given the facts presented, this court need not address this argument. 

Plaintiff's payment of $25 per quarter satisfies neither the Flora "full payment" rule nor the Boynton exception for divisible taxes. As confirmed by the tax records filed in this case, the penalties in question were imposed based on a finding that plaintiff was an employee of his corporation. The amount of employment tax owed with respect to plaintiff for any of the quarters at issue far exceeds the $25 payment amount. Accordingly, the jurisdictional prerequisite for bringing this refund action has not been satisfied. 

Based on the foregoing, the court GRANTS defendant's motion to dismiss under RCFC 12(b)(1). The Clerk is hereby ordered to dismiss the complaint.