Two recent opinions in Melasky v. Commissioner, Docket No. 12777-12L offer a cornucopia of issues for tax procedure watchers to digest. The Melaskys appealed a Collection Due Process (CDP) determination and ultimately lost. On its way to upholding the IRS determination, the Tax Court tackled several unresolved questions in two precedential opinions. In its preliminary opinion in Melasky (151 T.C. No. 8), the Tax Court decided the standard of review when the dispute concerns the correct application of a payment. This sets the stage for the Court’s opinion on the merits of the Melaskys’ contentions, which we’ll cover in later posts.
The facts of the case are unusual. The Melaskys hand-delivered a check for $18,000 to their local IRS office on Thursday, January 27, 2011, with direction to apply the check to their 2009 income tax liability. Unfortunately, on Monday, January 31 the IRS issued a notice of levy to the bank on which the check was drawn, which prevented the check from being honored. The IRS applied the bank levy proceeds to an earlier tax year, not 2009. Subsequently a notice of intent to levy was issued for several tax years including 2009. The Melaskys requested a CDP appeal. They argued that the proposed levy should not be sustained as to 2009 because they had no balance for that year after proper application of their payment.
Before we get to the caselaw, it’s helpful to review a little background. For both lien and levy notices, section 6330(c) sets out the matters to be considered in a CDP hearing:
(c)Matters considered at hearing. In the case of any hearing conducted under this section—
(1) Requirement of investigation. The appeals officer shall at the hearing obtain verification from the Secretary that the requirements of any applicable law or administrative procedure have been met.
(2) Issues at hearing
(A) In general. The person may raise at the hearing any relevant issue relating to the unpaid tax or the proposed levy, including—
(i) appropriate spousal defenses;
(ii) challenges to the appropriateness of collection actions; and
(iii) offers of collection alternatives, which may include the posting of a bond, the substitution of other assets, an installment agreement, or an offer-in-compromise.
(B) Underlying liability. The person may also raise at the hearing challenges to the existence or amount of the underlying tax liability for any tax period if the person did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability.
So, issues raised by the taxpayer under 6330(c)(2) fall into two separate buckets: “any relevant issue relating to the unpaid tax” under 6330(c)(2)(A); and “challenges to the existence or amount of the underlying tax liability” under 6330(c)(2)(B).
Why does it matter which bucket the taxpayer’s argument falls into? It matters for a couple of reasons, one of which is the standard of judicial review. In sections 6330 and 6320 Congress failed to specify the standard that the Tax Court should use in reviewing CDP determinations. However, the legislative history provides clear direction, which the Tax Court recognized and adopted in Goza v. Commissioner, 114 T.C. 176 (2000):
The conferees expect the appeals officer will prepare a written determination addressing the issues presented by the taxpayer and considered at the hearing. … Where the validity of the tax liability was properly at issue in the hearing, and where the determination with regard to the tax liability is part of the appeal, no levy may take place during the pendency of the appeal. The amount of the tax liability will in such cases be reviewed by the appropriate court on a de novo basis. Where the validity of the tax liability is not properly part of the appeal, the taxpayer may challenge the determination of the appeals officer for abuse of discretion.
(quoting H. Conf. Rept. 105-599, at 266 (1998)). Therefore, whether a taxpayer’s argument falls under 6330(c)(2)(A) or 6330(c)(2)(B) determines the Tax Court’s standard of review. Taxpayers prefer de novo review since there is a relatively lower hurdle for success. Of course, sometimes review of the underlying liability is not available to the taxpayer under the terms of section 6330(c)(2)(B), and in those situations a taxpayer would prefer to have their contentions reviewed for abuse of discretion than not at all.
This brings us back to the Melaskys. The proper application of the $18,000 taken from the Melaskys’ bank account is disputed, and if the taxpayers’ view prevails they will have no unpaid liability for the 2009 tax year. Does this dispute fall under 6330(c)(2)(A) – “any relevant issue relating to the unpaid tax”? Or does it fall under 6330(c)(2)(B) – a challenge to “the existence or amount of the underlying tax liability”? It cannot be both, since the statute restricts when a taxpayer may challenge the underlying liability.
A few months ago, Judge Lauber noted in Morgan v. Comm’r, T.C. Memo. 2018-98 that the Tax Court’s caselaw on this issue has been inconsistent, citing cases as far back as 2001. This is a debate that has been brewing for some time.
It is worth noting that there was no dispute between the parties to the Melasky case over the standard of review. Both parties agreed that for the 2009 liability, the Court’s review should be de novo because “the Melaskys argue that they had no 2009 tax liability.” (Slip op. at 5) This opinion is a good reminder that the Court is not bound by the parties’ views of the law.
So, the Court considers the question despite nobody asking, and answers it here in a precedential opinion. In his opinion, Judge Holmes cites his earlier case of Kovacevich v. Commissioner, T.C. Memo. 2009-160. It is worth reviewing Kovacevich for a more thorough understanding of Judge Homes’s reasoning.
Mr. Kovacevich argued that the IRS had not properly applied five payments he’d made by check. In order to parse section 6330 and figure out which category of argument this fit into, the Court first needed to define the term “tax liability.” Judge Holmes looks to the IRC and finds that “[a] tax liability is the tax imposed by the Code on a particular taxpayer for a particular tax year. Sec. 26(b)(1).” With that definition in mind,
challenges to the proper crediting of checks that a taxpayer sends to the IRS are not ‘challenges to the underlying liability,’ because they don’t raise questions of the amount of tax imposed by the Code for a particular tax year. They raise, instead, questions of whether that liability remains unpaid.
Kovacevich, slip op at 14. In the Kovacevich litigation and in a 2014 Chief Counsel Notice, the IRS agrees, and further argues that this conclusion finds support in the structure of section 6330(c). See Notice CC-2014-002 (May 5, 2014).
Judge Holmes has not changed his mind since deciding Kovacevich and he reiterates his earlier reasoning and conclusion in Melasky. Despite the agreement of the IRS and the taxpayer, the Melaskys will receive abuse of discretion review for all tax years, including 2009.
Judge Holmes’s analysis in Kovacevich and Melasky is consistent with the IRS’s views set out in Notice CC-2014-002, except for one point: whether overpayment credits are different from payments such that they fall into a different 6330(c)(2) bucket.
Melasky did not involve overpayment credits, so the opinion naturally does not analyze the issue. However, Judge Holmes does take pains to distinguish it. The main puzzle for me in both the Kovacevich and Melasky opinions is Judge Holmes’ deferential treatment of Landry v. Commissioner, 116 T.C. 60 (2001). Both opinions distinguish Landry. Landry involved a taxpayer who elected to apply his tax refunds to his estimated tax for the following year. Things did not go smoothly for Mr. Landry and he ended up in CDP arguing about his entitlement to some of these credits. The Landry opinion takes just one sentence plus a cite to Goza to conclude that a dispute regarding the amount unpaid after application of overpayment credits places “the validity of the underlying tax liability” at issue. Slip. Op. at 5. There is no analysis of the issue or recognition that some might argue otherwise. It is quite a contrast to the detailed parsing and analysis of the Kovacevich opinion.
In an income tax case, if the underlying liability is the “tax imposed under subtitle A” of the Code, it is not obvious to me that disputes about overpayment credits are disputes regarding the underlying liability. Under section 6513(d), overpayment credits applied from a prior year return “shall be considered as a payment of the income tax for the succeeding taxable year…” (emphasis added). In contrast, the Code uses different language to describe refundable credits (which are also listed as “payments” on Form 1040, alongside estimated taxes). For example, section 32 begins, “In the case of an eligible individual, there shall be allowed as a credit against the tax imposed by this subtitle for the taxable year…”
The Landry opinion seems to me inconsistent with the reasoning in Kovacevich, and it is plainly inconsistent with the Chief Counsel’s position. Notice CC-2014-002 argues that, “payments and overpayment credits and their proper application have no effect on how much tax is imposed by the Code.” No distinction is made between payments and overpayment credits. This approach seems right to me under the analytical framework used by both the IRS and Judge Holmes. However, I welcome comments on this. There may be Tax Court opinions addressing this issue in depth which I did not find.
If overpayment credit disputes under section 6513 are subject to de novo review but also the limitations of 6330(c)(2)(B), you could have situations where a taxpayer ends up in very different places depending on whether they elected to have their refund credited to next year’s taxes or whether they got the cash and then paid estimated taxes with it. This does not seem ideal from a taxpayer fairness point of view, since nearly identical taxpayers will get different levels of judicial review. It reminds me of an earlier post, where the distinction between an overpayment credit and a refund made all the difference.
For now, the Tax Court has decided that payment disputes are not “challenges to the existence or amount of the underlying liability,” but are instead “a relevant issue relating to the unpaid tax.” The law is clearer than it was, although many disputes remain to be litigated.