Tax Brakes: Taxpayer Bill of Rights 2 Shifts the Burden From Taxpayers to the IRS on a Variety of Procedural Matters
First Published in the Los Angeles Lawyer
On July 30, 1996, President Clinton signed the Taxpayer Bill of Rights 2, which, in the manner of Hollywood action movies, is now sometimes known as "T2."1 The name "T2" suggests that, like Arnold Schwarzenegger in Terminator 2, the new law will deliver a knockout blow to the opposition in this case, the Internal Revenue Service. While this scenario is unlikely, T2 does contain some significant changes that will enhance the rights of taxpayers. In many instances, however, it does little more than codify changes the IRS has already made, albeit under the threat of congressional action.
In perhaps the most far-reaching provision of T2, Congress has expanded the authority of the IRS to abate interest and it has given the U.S. Tax Court jurisdiction to determine whether the IRS has abused its discretion when failing to abate interest assessed against a taxpayer.2 Under prior law, the IRS only had the authority to abate interest on a deficiency that was attributable to an IRS failure to perform a "ministerial act" in a timely manner, or to an IRS error in performing a ministerial act.3
The IRS previously had defined "ministerial acts" very narrowly.4 As a result, it refused to abate interest even under circumstances where there had been lengthy delays in the audit process caused by inefficient staffing decisions. If, for example, during the middle of an audit a revenue agent was sent to a training course, and the agent's work was not reassigned, neither the decision to send the agent to the training course, nor the decision not to reassign the agent's cases, was a ministerial act allowing the abatement of interest.5
T2 provides that the IRS may abate interest brought about by unreasonable errors or delay in both ministerial acts and "managerial acts"6 a term that is not defined. However, according to the legislative history, managerial acts are intended to include significant delays caused by the loss of records by the IRS, extended illnesses, IRS personnel transfers, extended personnel training, or extended absence.7 The new provision is effective with respect to interest accruing on deficiencies or payments for taxable years beginning after July 30, 1996.8
In the past, the courts consistently held that there was no judicial authority to review a decision by the IRS not to abate interest.9 T2 now vests jurisdiction in the U.S. Tax Court to review such IRS decisions,10 but the review is limited to determining whether an IRS failure to abate interest was an abuse of discretion.11 In turn, the Tax Court's decision is reviewable by the appropriate circuit court of appeal.12 In order to obtain judicial review, a taxpayer must file an action with the Tax Court within 180 days of the mailing of a notice by the IRS of its final determination not to abate interest.13
The flaw in this remedy is that no rule, decision, or statute appears to legally prevent the IRS from demanding payment of the interest while the taxpayer's case is pending before the Tax Court. Also, not all taxpayers are entitled to Tax Court review. A taxpayer seeking a review of its interest-abatement denial must meet the same requirements of net worth and size that are imposed in the awarding of attorneys' fees.14 Thus, at the time a Tax Court action is filed, an individual taxpayer must have a net worth of $2 million or less.15 A corporation or partnership is limited to a net worth of $7 million or less, with 500 or fewer employees.16
Other forms of help are on the way for taxpayers. T2 offers more notice requirements and has expanded the availability of attorneys' fee awards against the IRS in several areas.
The IRS already enjoyed the authority to provide an installment-payment plan to a taxpayer unable to pay liabilities in full.17 Once the taxpayer and IRS enter into an installment-payment agreement, it remains in effect for its term, unless certain specified events occur.18 These include a change in the taxpayer's financial condition, a failure to make any payment when due, or the incurring of additional tax liability during the term of the agreement.19 Under prior law, if the reason for termination was a change in the taxpayer's financial condition, the IRS was required to notify the taxpayer of its decision to terminate the agreement 30 days in advance.20 T2 expands this provision to require notice for all terminations unless the reason was an IRS determination that the collection of tax was in jeopardy.21 More important, T2 requires the IRS to establish an administrative process for the review of decisions to terminate installment agreements.22
A taxpayer who prevails in litigation against the IRS is not necessarily entitled to attorneys' fees, but under prior law, in addition to meeting other requirements, the taxpayer had the burden of proving that the position of the United States was not "substantially justified."23 Until now, attorneys' fee awards have been the exception rather than the rule. According to one study, total awards under Internal Revenue Code Section 7430 have averaged $220,000 annually, and only $6,300 per award.24 Under T2, the burden now falls to the IRS to prove that its position was substantially justified.25 It is not clear whether the switch in the burden of proof will have any effect on the number of cases in which attorneys' fees will be granted.
Furthermore, there is a rebuttable presumption that, if the IRS did not follow its "applicable published guidance," its position was not substantially justified.26 Applicable published guidance includes regulations, revenue rulings, revenue procedures, information releases, notices, and announcements.27 Private letter rulings, technical advice memoranda, and determination letters may also trigger the rebuttable presumption but only if they are issued to the taxpayer.28
An IRS position is not substantially justified if it is unreasonable.29 The Tax Court sometimes has quoted the legislative history of Section 7430 in defining the factors that are important in determining whether an IRS position is substantially justified.30 According to the report issued by the House of Representatives:
The committee intends that the determination by the court on this issue is to be made on the basis of the facts and legal precedents relating to the case as revealed in the record. Other factors the committee believes might be taken into account in making this determination include: (1) whether the government used the costs and expenses of litigation against its position to extract concessions from the taxpayer that were not justified under the circumstances of the case; (2) whether the government pursued the litigation against the taxpayer for purposes of harassment or embarrassment, or out of political motivation; and (3) such other factors as the court finds relevant.31
Thus it appears the IRS would be required to prove that the government did not use the expense of litigation to extract concessions from the taxpayer, and that it did not pursue litigation against the taxpayer for purposes of harassment or other improper purpose. Testimony from an IRS attorney presumably could meet this burden of proof.
Generally, the courts consider the basis for the legal position of the IRS as well as the manner in which the position was maintained.32 The courts will look to whether the IRS had a reasonable basis in both law and fact,33 and this determination is based on all facts and circumstances.34 The IRS now will have the burden of going forward and producing evidence to support its decision to litigate. If it fails to do so, the taxpayer will receive an award of attorneys' fees.35 Cases conceded by the IRS prior to trial might create a necessity for a minitrial in which the IRS would be forced to show what evidence it relied upon to maintain its position. Nevertheless, it will probably be the rare case where the evidence is so evenly balanced that the court will make its decision based on the burden of proof.
T2 was designed not only to enhance the availability of attorneys' fee awards but to increase the hourly rate for the awards. Previously the statutory limit was $75 per hour, adjusted upward for cost-of-living increases.36 T2 increased the hourly cap to $110 per hour, adjusted upward for cost-of-living increases after 1996.37 The increased cap is applicable to cases filed after July 30, 1996.38
The new provision, however, may not actually increase the hourly cap now in existence. The Tax Court has held that the $75 statutory cap is to be adjusted upward for cost-of-living increases from October 1981.39 However, several circuit courts of appeal, including the Ninth Circuit, have ruled that cost-of-living increases are available only from January 1, 1986.40 The Tax Court has used both the national and local consumer price indexes to measure cost-of-living adjustments.41
If T2 had not been enacted, the statutory cap as of July 1996, using October 1981 as a starting point, would have been $126.07 per hour.42 Using January 1986 as a reference point, fees would have been limited to $97.55 per hour.43 Depending, therefore, on which circuit the taxpayer resides in, T2 could actually decrease the statutory cap. It will, however, introduce more certainty as to how to calculate future cost-of-living adjustments.
In order to qualify for attorneys' fees, the taxpayer must exhaust the administrative remedies available within the IRS.44 At one point the IRS had taken the position in its regulations that if the taxpayer was not given a conference with the IRS Appeals Division because the taxpayer refused to extend the statute of limitations on assessment, then the taxpayer would be deemed to have failed to exhaust all administrative remedies. That regulation was struck down by the Tax Court as invalid.45 The IRS subsequently amended its regulation, in effect conceding the issue.46 T2 codifies this result.47
T2 provides that an exempt organization can now recover attorneys' fees in connection with an action for a declaratory judgment to determine its exempt status. Prior to T2, an exempt organization could recover attorneys' fees only in connection with the revocation of its exempt status.48
T2 modifies the "trust fund recovery penalty," which generally provides that "responsible persons" (usually, but not always, officers of a corporation) who willfully fail to pay corporate, employment, or other trust fund taxes are personally liable for those taxes.49 Before T2, the IRS could bill a taxpayer for this penalty without any prior notice. In practice, the IRS usually issued a preliminary notice informing the taxpayer of the intention of the IRS to assess the penalty, and allowing the taxpayer 60 days to request an administrative review with the IRS Appeals Division.
Effective for proposed assessments made after June 30, 1996,50 T2 gives taxpayers a statutory right to 60 days' notice of the IRS intention to assess the penalty.51 The 60-day notice must be mailed to the taxpayer's last known address.52 An IRS error in sending the notice to the correct last known address could invalidate the notice and effectively prohibit the IRS from assessing the penalty.53 Although the drafters apparently intended that taxpayers be given the right to an administrative review of the penalty, the statute does not explicitly grant one.54 The IRS, however, will no doubt continue its long-established practice of administrative review.
In cases involving the trust fund recovery penalty, the existence of several responsible persons is not uncommon. Each responsible person is jointly and severally liable for the full liability, although partial payment of the penalty by one person will reduce the amount owed by the other responsible persons.55 Therefore, responsible persons have a strong interest in knowing what efforts the IRS is making to collect the penalty from other responsible persons, and how successful the effort has been. Previously the IRS was not permitted to disclose this information.56 Upon request, the IRS now will be required to provide specific information to a responsible person, including the name of any other person determined by the IRS to be a responsible person, whether the IRS has attempted to collect the penalty, the general nature of such collection activities, and the amount collected.57
Although the IRS only collects the trust fund recovery penalty once, it makes no attempt to allocate the penalty among responsible officers. The IRS may at times collect from the easiest target, letting other responsible officers escape unscathed. Magnifying this potential inequity, it has been consistently held that there is no federal right of contribution, enabling one responsible officer to recover a proportionate share of the penalty from the other responsible persons.58 The laws of some states also prohibit contribution among individuals found to be responsible persons.59
To remedy this inequity, T2 creates a new federal right of contribution among responsible officers.60 However, any claim for recovery may not be joined with an action brought by the IRS for collection of the penalty, or with an action in which the IRS files a counterclaim or third-party complaint for the collection of the penalty.61 Accordingly, if an allocation cannot be agreed upon among the responsible persons in a lawsuit with the IRS, the issue of contribution must be decided in a separate judicial proceeding. The new right of contribution extends to trust fund recovery penalties assessed after July 30, 1996.62
T2 exempts certain volunteer board members of tax-exempt organizations for liability for the trust fund recovery penalty. Volunteers who qualify share the characteristics that they 1) were unpaid board members; 2) served in an honorary capacity; 3) did not participate in the day-to-day management or financial operations of the organization; and 4) did not have actual knowledge of the organization's failure to remit the trust fund taxes.63
The disclosure requirements for trust fund recovery penalty cases now apply to cases involving jointly filed income tax returns. If there is a tax deficiency applicable to a joint income tax return filed by a husband and wife, and the spouses are no longer married or no longer reside in the same household, the IRS must disclose, upon request, whether it has attempted to collect the deficiency from the other spouse, the general nature of the collection activities, and the amount (if any) collected.64
T2 clears the decks on other matters, including the elimination of at least one infamous trap for the unwary. The IRC provides numerous deadlines for the payment of taxes and the filing of tax returns and myriad other documents. A document that is timely mailed is deemed to have been timely filed.65 This rule is not applied, however, where the document has been delivered by means of a private delivery service such as Federal Express.66 Thus a document could be deemed late even though it was timely mailed and its arrival at the designated location occurred prior to the time it would have arrived had it been mailed through the U.S. Postal Service. T2 authorizes the U.S. Treasury Secretary to extend the "timely mailed, timely filed" rule to private companies that are "designated delivery services."67 A delivery service may achieve designated status only if it meets certain criteria, including that its deliveries are "at least as timely and reliable on a regular basis as the United States mail."68
Under prior law, once the IRS filed a notice of federal tax lien as a public record, it could not withdraw that lien unless it was filed "erroneously," or until it had been paid, bonded, or rendered unenforceable.69 T2 permits, but does not require, the IRS to withdraw the notice of lien if it determines that:
- The filing of the notice was premature or not in accordance with IRS administrative procedures.
- The taxpayer has entered into an installment-payment agreement.
- The withdrawal of the notice will facilitate the collection of the tax.
- The withdrawal would be in the best interests of the taxpayer and the United States.70
A taxpayer may be entitled to bring an action for damages in U.S. district court whenever an IRS employee intentionally or recklessly disregards any provision of the IRC or the Treasury Regulations in connection with the collection of a tax. No damages may be awarded for actions that are merely negligent or careless. Under prior law, damages were limited to the lesser of $100,000 or the actual, direct economic damages sustained as a proximate result of the reckless or intentional actions of the IRS employee, plus the costs of the action.71 T2 increases the cap to $1 million.72
Previously no damages could be awarded in a wrongful collection action unless a taxpayer had exhausted all administrative remedies within the IRS.73 Effective for proceedings beginning after July 30, 1996, this requirement has been repealed.74 However, the court will have the discretion to reduce the damages awarded if the taxpayer did not exhaust his or her administrative remedies.75
T2 also should speed up the processing of offers in compromise by the IRS. Through the offer process, the IRS has the authority to settle a tax debt for less than the full amount owed if there is doubt as to the collectibility of the tax or whether the taxpayer is liable.76 Previously, if the amount of tax being compromised was $500 or more, a legal opinion from the IRS Office of Chief Counsel was required.77 This approval process often added weeks or months to an already lengthy procedure. Effective July 30, 1996,78 if the amount being compromised does not exceed $50,000, review by the chief counsel will not be required.79
T2 adds a number of additional provisions to the tax code. These include:
- Limitations on the IRS's authority to issue retroactive regulations.80
- The establishment of the position of Taxpayer Advocate within the IRS to replace and strengthen the position of the IRS Ombudsman.81
- An extension of the interest-free period provided to taxpayers for payment of the tax liability reflected in an IRS notice from 10 calendar days to 10 business days, or 21 calendar days if the tax liability is $100,000 or less.82
- Allowing taxpayers who file separate returns to subsequently switch to a single joint return without full payment of the tax liability.83
- Permitting, but not requiring, the IRS to return levied-upon property to the taxpayer in a variety of situations where it would be equitable to do so.84
- Creating a private right of action against a third party by a taxpayer who is injured because of a fraudulent information return, such as a Form 1099, filed with the IRS.85
Ultimately, whether the provisions of T2 will be effective will depend on how the IRS chooses to implement them and whether the IRS fairly embraces the spirit of the new law. In signing the legislation, President Clinton stated, "We're trying to inject more common sense and fairness into the process .With the Taxpayer Bill of Rights, we say to America's taxpayers you have rights and we will shield them."86 Unfortunately, President Clinton probably has a somewhat different perspective than the average tax collector.
Nevertheless, a number of the provisions of T2 create important new procedural rights for taxpayers. Given the difficulty that taxpayers regularly have in vindicating their positions with the IRS, every little bit helps.
|1.||Pub. L. No. 104-168.|
|2.||Internal Revenue Code of 1986 (I.R.C.) §6404(g).|
|3.||H.R. Rep. No. 506, 104th Cong., 2d Sess. (1996) (hereinafter House Rep.), 96 TNT 65-15, ¶28.|
|4.||See Treas. Reg. §301.6404-2T(b)(1).|
|5.||Treas. Reg. §301.6404-2T(b)(2), Example 4.|
|7.||House Rep., 96 TNT 65-15 ¶30.|
|8.||Pub. L. No. 104-168, §301(c).|
|9.||See, e.g., Argabright v. United States, 35 F. 3d 472, 474 (9th Cir. 1994).|
|10.||I.R.C. §6404(g)(1) (effective for requests for abatement made after July 30, 1996). Pub. L. No. 104-168, §302(b).|
|15.||See I.R.C. §7430(c)(4)(A)(iii) (referencing 28 U.S.C. §2412(d)(2)(B)).|
|19.||See I.R.C. §6159(b).|
|20.||I.R.C. §6159(b)(3)(B) (in effect prior to amendment by T2, Pub. L. No. 104-168).|
|22.||I.R.C. §6159(c) (effective Jan. 1, 1997). Pub. L. No. 104-168, §202(a).|
|23.||House Rep., 96 TNT 65-15 ¶92; I.R.C. §7430(c)(4)(A) (in effect prior to amendment by T2, Pub. L. No. 104-168).|
|24.||See ABA Tax Section's testimony at House Ways & Means Oversight Panel Hearing on Taxpayer Bill of Rights II Legislation, 95 TNT 59-70 (1995).|
|29.||Sher v. Commissioner, 89 T.C. 79, 84 (1987), aff'd, 861 F. 2d 131 (5th Cir. 1988).|
|30.||See, e.g., Coastal Petroleum Refiners, Inc. v. Commissioner, 94 T.C. 685 (1990).|
|31.||H.R. Rep. No. 404, 97th Cong., 1st Sess. 12 (1981).|
|32.||Wasie v. Commissioner, 86 T.C. 962, 969 (1986).|
|33.||Estate of Wall v. Commissioner, 102 T.C. 391, 393 (1994).|
|34.||Don Casey Co. v. Commissioner, 87 T.C. 847, 858 (1986).|
|35.||See House Rep., 96 TNT 65-15 ¶92.|
|36.||I.R.C. §7430(c)(1)(B)(iii) (in effect prior to amendment by T2, Pub. L. No. 104-168).|
|38.||Pub. L. No. 104-168, §702(b).|
|39.||Bayer v. Commissioner, 98 T.C. 19 (1992).|
|40.||See, e.g., Huffman v. Commissioner, 978 F. 2d 1139 (9th Cir. 1992); Heasley v. Commissioner, 967 F. 2d 116 (5th Cir. 1992); Cassuto v. Commissioner, 936 F. 2d 736 (2d Cir. 1991), reversing on this issue, 93 T.C. 256 (1989).|
|41.||Compare Cassuto v. Commissioner, 93 T.C. 256 (1989) (Department of Labor Consumer Price Index for All Urban Consumers-CPI-U used) with Huffman v. Commissioner, T.C. Memo 1991-144 (CPI for greater Los Angeles area used).|
|42.||The Bureau of Labor Statistics Consumer Price Index-All Urban Consumers was 279.3, 328.4, and 469.5 for Oct. 1981, Jan. 1986, and July 1996, respectively. The corresponding percentage increases are 68 percent and 30 percent.|
|45.||Minahan v. Commissioner, 88 T.C. 492 (1987).|
|46.||See Treas. Reg. §301.7430-1 (as amended by T.D. 8543) (June 6, 1994).|
|47.||See Pub. L. No. 104-168, §703.|
|48.||I.R.C. §7430(b)(3) (in effect prior to the amendment to T2, Pub. L. No. 104-168).|
|50.||Pub. L. No. 104-168, §901(a).|
|53.||I.R.C. §6672(b). The notice provisions incorporate the mailing requirements of I.R.C. §6212(b). Failure to comply with those provisions, in the absence of actual timely notice, prevents the assessment of income tax deficiencies. See, e.g., Mulvania v. Commissioner, 81 T.C. 65, 67 (1983), aff'd, 769 F. 2d 1376 (9th Cir. 1985).|
|54.||See I.R.C. §6672(b).|
|55.||See Verdung v. United States, 84-1 U.S.T.C. ¶9324 (N.D. Ill. 1984).|
|56.||See House Rep., 96 TNT 65-15 ¶118.|
|57.||See I.R.C. §6103(e)(9).|
|58.||See, e.g., Continental Ill. Nat'l Bank v. United States, 822 F. 2d 905 (9th Cir. 1985).|
|59.||See, e.g., Conley v. United States, 773 F. Supp. 1175 (S.D. Ind. 1991).|
|62.||Pub. L. No. 104-168, §903(b).|
|64.||See I.R.C. §6103(e)(8).|
|66.||Correia v. Commissioner, 58 F. 3d 468 (1995).|
|69.||See House Rep., 96 TNT 65-15 ¶65.|
|71.||I.R.C. §7433(b) (in effect prior to amendment by T2, Pub. L. No. 104-168).|
|72.||I.R.C. §7433(b) (effective for actions taken by the IRS after July 30, 1996). Pub. L. No. 104-168, §801(b).|
|73.||I.R.C. §7433(d) (in effect prior to amendment by T2, Pub. L. No. 104-168).|
|74.||Pub. L. No. 104-168, §802(b).|
|77.||Id. (in effect prior to amendment by T2, Pub. L. No. 104-168).|
|78.||Pub. L. No. 104-168, §503.|
|80.||I.R.C. §7805(b) (effective for regulations that relate to statutory provisions enacted on or after July 30, 1996). Pub. L. No. 104-168, §1101(b).|
|82.||I.R.C. §6601(e)(3) (effective for notice and demand given after Dec. 31, 1996). Pub. L. No. 104-168, §303(c). See House Rep., 96 TNT 65-15 ¶38.|
|83.||Pub. L. No. 104-168, §402 (effective for taxable years beginning after July 30, 1996).|
|86.||President Clinton's remarks at White House Signing Ceremony of Pub. L. No. 104-168, The Taxpayer Bill of Rights 2, Tax Management Weekly Report, Aug. 4, 1996, at 1159.|
*Dennis Brager, Esq., is a State Bar Certified Tax Specialist in Los Angeles. A former IRS senior trial attorney, Mr. Brager now devotes his efforts exclusively to helping clients resolve their tax problems with the IRS and California State tax agencies. Services include negotiating Tax Debts, Tax Fraud Representation, Tax Litigation, Tax Audit and Appeals Representation, Tax Preparer Penalty Mitigation, Payroll Tax Audits, and California Sales Tax Problems. He may be reached at 800.380.TAX LITIGATOR.