Associate Professor Calls IRS Ruling 'Harmful to Low-Income Taxpayers'

Dear Sirs:

I am a Clinical Associate Professor of Law at the Benjamin N. Cardozo School of Law and am also the Director of the Cardozo Tax Clinic. I also teach a course entitled "Civil Tax Controversies and Litigation" as an Adjunct Professor of Law in the Graduate Tax Program at New York University School of Law. The Cardozo Tax Clinic is an IRS-approved Student Taxpayer Clinic designed to help the poor, at no charge, in dealing with both audit and collection matters with the IRS. Some of the clients of the Cardozo Tax Clinic are constituents of Congressman Rangel's. I am writing this letter to you to express my personal concerns about a recent ruling of the Internal Revenue Service that will result in the delay of the issuance to poor people of refunds checks attributable to over-withheld income taxes, the earned income tax credit, and the refundable portion of the child tax credit. I believe the IRS is acting inconsistently as a historical matter with the nature of the Tax Court as a prepayment forum and perhaps in violation of the law. However, the quickest solution is not to wait years to litigate this matter, but to ask for corrective legislation, at least to protect the poor.

The particular IRS ruling to which I take exception is Revenue Ruling 2007-51, 2007-37 I.R.B. 573, issued last month, a copy of which I have attached to this letter. The ruling is addressed to corporate taxpayers, but does not limit itself to those taxpayers. I have confirmed today by telephone with the author of the ruling, Cynthia McGreevy, that the IRS intends to apply the ruling to individuals, as well. In a nutshell, the ruling provides that when a taxpayer is concededly due a refund from the IRS on account of an overpayment of the current year's taxes, the IRS will not refund the overpayment, but will first apply the overpayment as a credit to any IRS-asserted, but unassessed, deficiency in a prior-year's taxes that is currently being litigated in the United States Tax Court. In effect, this is a ruling that, while a Tax Court case is pending, the IRS will collect the tax in dispute in the case by withholding all refunds relating to other years, and will only issue refund checks for those other years after the disputed deficiency is fully paid through the credits so taken.

First, this ruling constitutes a reversal of practice in the United States Tax Court going back to its original founding in 1924 as the Board of Tax Appeals. The ruing both undermines the purpose of the creation of the Tax Court and cites no authority for this change to 80 years of tax practice.

Second, whether or not this ruling is correct as a legal matter, corporations and wealthy individuals can probably live with the consequences of this ruling. However, I submit that the same is not true of the poor. The ruling is especially harmful to low-income taxpayers eligible for the refundable child tax credit and the earned income tax credit. Congress enacted those credits to help working families with insufficient incomes each year to stay both employed and housed. Poor families count on their refund checks each spring to survive. What the IRS is effectively doing is saying that, even if such a poor taxpayer is fully entitled to a child tax credit and earned income tax credit refund check for the current year, because the taxpayer is fighting with the IRS about some issue on a prior-year return, the taxpayer can only get his or her current-year refunds after winning the Tax Court case. A typical Tax Court case for a poor person takes over a year to resolve, so this means the taxpayer does not see a refund check for several years -- even though, in the end, the taxpayer is held completely right by the Tax Court. In effect, this is turning the Tax Court into a post-payment forum for litigation of issues of the poor.

By way of background as to the historical issue, prior to the creation of the Tax Court's predecessor, the Board of Tax Appeals, in 1924, the procedure to contest a tax "deficiency" was to pay the entire deficiency and sue for a refund in the local U.S. district court or the U.S. Court of Claims (now the "U.S. Court of Federal Claims"). For a short summary of the history and reason for the creation of the Tax Court's predecessor, see Flora v. United States, 362 U.S. 145, 158-163 (1960). A "deficiency" is, roughly, the difference between the tax reported on a tax return and the correct tax. IRC § 6211(a). Usually, the IRS "determines" deficiencies by conducting an audit of the return and sending the taxpayer a notice of proposed deficiency, known as an Examination Report. The Examination Report is commonly called a "30-day letter", since the cover letter forwarding the Examination Report allows a taxpayer 30 days to request a conference with the IRS Appeals Office, if the taxpayer does not agree. If a taxpayer ignores an Examination Report or does not come to an agreement with Appeals, the IRS then must issue a "notice of deficiency" under IRC § 6212(a). IRC § 6213(a) prohibits the IRS from "assessing" the deficiency during the 90-day period in which the taxpayer can contest the notice of deficiency by filing a petition in the Tax Court. If the taxpayer files a petition in the Tax Court, the IRS may not "assess" the deficiency until the Tax Court case is over; Id.; and then can only assess the deficiency as "redetermined" by the Court. IRC § 6215(a).

Historically, the IRS has only attempted to collect deficiencies that have been "assessed". IRC § 6303 allows the IRS to send a notice and demand (i.e., a collection notice) only "after the making of an assessment of tax". To prevent the IRS from assessing and collecting a deficiency while a Tax Court case is pending, IRC § 6213(a) has long contained a prohibition on assessment and collection while the Tax Court case is pending. It currently reads:

For all practical purposes, a payment made by a credit is the same as a payment made by check. See, e.g., IRC § 6513(d) ("If any overpayment of income tax is, in accordance with section 6402(b), claimed as a credit against estimated tax for the succeeding taxable year, such amount shall be considered as a payment of the income tax for the succeeding taxable year. . . ."); IRC § 6601(f) ("If any portion of a tax is satisfied by credit of an overpayment, then no interest shall be imposed under this section on the portion of the tax so satisfied for any period during which, if the credit had not been made, interest would have been allowable with respect to such overpayment."); IRC § 6611(b)(1) (where the IRS must pay interest, interest shall be allowed, "[i]n the case of a credit, from the date of the overpayment to the due date of the amount against which the credit is taken.") As the Supreme Court stated in Flora v. United States, supra at 158: "The Board of Tax Appeals was established by Congress in 1924 to permit taxpayers to secure a determination of tax liability before payment of the deficiency." (emphasis added; footnote omitted).

I am not sure that I agree with the cramped statutory reading that the IRS is giving to the prohibition on assessment and collection contained in IRC § 6213(a). But whether or not the IRS is correct as a linguistic matter, as a historical matter, the Congress clearly wrote this provision on the assumption that the IRS never attempted to collect unassessed deficiencies. Congress clearly intended that taxpayers would not have to pay any part of the deficiency while litigating in the Tax Court. I strongly suspect that, if Congress in had been aware of the new IRS intention to collect contested deficiencies from future-year refund claims while a Tax Court case was pending, Congress would have explicitly prohibited that practice as well.

I believe that the status quo was correct: Keep the Tax Court a prepayment forum. And I think that the easiest way to return to the status quo that Congress originally intended is for Congress to amend IRC § 6213(a) to make it clearer that the IRS is also precluded from taking later-year refunds away from taxpayers while a Tax Court case is pending. The prohibition should be explicitly extended to collecting unassessed deficiencies.

I understand that the Service is concerned about protecting the revenue, and that a taxpayer might dissipate the refunded money while the Tax Court case is pending. However, the IRS has plenty of authority already to make jeopardy assessments in that case while the Tax Court case is pending. I see no reason for this, in effect, blanket jeopardy assessment to all taxpayers while Tax Court cases are pending.

The IRS' solution is overkill for the problem. It adversely affects too many other taxpayers, who need their annual refunds just to survive. In writing the ruling, the IRS focused on corporations, but it made a rule logically applicable to individuals, as well. Corporations make up only a small fraction of the taxpayers filing petitions in the Tax Court. I do not have statistics on how many Tax Court cases are filed by corporations each year and how many are filed by individuals, but the Tax Court is getting between 25,000 and 30,000 petitions filed per year these days. I would be surprised if more than 1,000 of those petitions were filed by corporations. The Judges have recently been telling practitioners that more than half of the cases filed are those electing small tax case procedures under IRC § 7463, where less than $50,000 in tax is in dispute in any year -- and usually a lot less. I almost never see the name of a corporation on the small tax case calendar sheets that the Tax Court sends me in connection with upcoming New York City trial calendars. Further, a significant number of Tax Court cases not involving small tax case procedures also involve less than $50,000.

The IRS has recently been issuing many notices of deficiency to low-income taxpayers. My guess is that individual low-income taxpayers account for 10% to 20% of the Tax Court's docket. In my experience with the Cardozo Tax Clinic, the issues in low-income taxpayer deficiency cases usually revolve around (1) disallowed itemized deductions, (2) disallowed business deductions (say, for a cab driver, a painter, a mechanic), (3) unreported income (e.g., an information return showing higher tip income to a waiter or waitress), or (4) child issues (entitlement to filing status, dependency exemptions, child tax credits, child care tax credits, and the earned income tax credit). The amounts in dispute for low-income taxpayers are often only $3,000 or $4,000. But, that is the amount of the low-income taxpayer's usual refund check (because of the child tax credit and the earned income tax credit). So, unlike corporations and wealthy individual taxpayers, the poor will be forced to fully-pay their deficiencies while contesting Tax Court cases, and will bear the brunt of the IRS' new policy change. I think this a horrible policy outcome. Another professor who heads a different low-income taxpayer clinic recently called the situation created by the new IRS ruling "outrageous".

If you do not wish to amend IRC § 6213(a) to more clearly prohibit the IRS from applying refunds as credits to pending disputed Tax Court deficiencies, then I would ask that you consider amending IRC § 6402 so that, while a Tax Court case is pending, the IRS may only take refunds (1) away from corporations (not individuals) or (2) out of over-withheld taxes, and not child tax credits or earned income tax credits. Either of those solutions would help the population of low-income taxpayers who I represent. That would leave it to the corporations themselves to challenge the IRS' ruling in the Tax Court under current law.