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April 6, 2019

Using the CDP Hearing to Challenge Tax Penalties

Tax Penalties

Houston Tax Attorney

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There are times when it is important to pick the right method of approaching a problem with the IRS. The VICA Technologies v. Commissioner, T.C. Summary Opinion 2019-7, case provides an example of contesting penalties in an IRS collection due process hearing.

Facts & Procedural History

The taxpayer was assessed a Sec. 6698(a) penalty for filing its partnership tax return late. The taxpayer filed one month late.

The taxpayer filed a penalty abatement request. The taxpayer argued that the tax returns were filed late due to it accountant and financial situation that did not allow it to fully pay its accountant and the taxpayer’s own lack of knowledge of taxes at the time.

Instead of appealing the denial of the penalty abatement request, the taxpayer submitted a timely collection due process hearing request. This post considers the court case that appealed the decision reached in the IRS’s collection due process hearing.

About Collection Due Process Hearings

Those of us who are older recall the Congressional hearings in the mid-1990s that covered IRS collection abuses. The hearings made the national headlines for several weeks. The effort culminated in the Restructuring and Reform Act of 1998 (or RRA98).

One of the things included in RRA98 was the new process to have collection due process hearings. These hearings are to provide an opportunity for an administrative hearing before the IRS collection actions go forward. The IRS Office of Appeals was tasked with handling these hearings. This even affords a hearing if the IRS files a lien notice.

Issues Considered in Collection Due Process Hearings

Taxpayers can generally use the collection due process hearing to:

  • Challenge the appropriateness of collection actions;
  • Request collection alternatives (such as an installment agreement, offer in compromise, or currently not collectible status);
  • Request innocent spouse relief;
  • Challenge the existence or amount of the underlying tax liability if no prior opportunity to dispute the liability was afforded to the taxpayer; and
  • Challenge any other relevant issue relating to the unpaid tax, the notice of tax lien, or the proposed levy.

The last item often results in disputes–as taxpayers and the IRS often disagree as to whether a prior opportunity to contest a liability has been afforded to the taxpayer.

Collection Due Process Hearing

The IRS Office of Appeals assigns a settlement officer to handle collection due process hearings. Settlement officers are usually former IRS revenue officers who were tasked with collecting taxes from taxpayers.

If the collection due process hearing is timely filed, the settlement officer is required to:

  • Verify that the requirements of applicable law or administrative procedure have been met;
  • Consider any relevant issues the taxpayer raises; and
  • Consider whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that any collection action be no more intrusive than necessary.

The hearing itself is informal and, in most cases, handled by phone. The process ends with the issuance of a written letter stating the decision of the IRS settlement officer.

Appealing a CDP Hearing Decision

Collection due process hearings are appealable to the U.S. Tax Court. The standard of review is one of abuse of discretion. This standard construes most facts in the settlement officer’s favor.

If the court finds that the settlement officer did not follow the law in handling the hearing, the court will typically remand the case back to the settlement officer with some instruction as to how to remedy the deficiency.

While not common, in other cases, if the type of deficiency permits it, the court will render a decision and enter an order directing the outcome without sending the case back to the settlement officer.

Appealing a Penalty in a CDP Hearing

This brings us to the case in this post. The IRS revenue officer (at the collection level) had issued the taxpayer a Letter 2413(P) denying the taxpayer’s penalty abatement request. The taxpayer did not respond to the letter timely. Instead, it filed a timely CDP hearing request.

The settlement officer refused to consider the penalty abatement request as it determined that the taxpayer had a prior opportunity to dispute the penalty. The taxpayer did not do so as it did not respond to the original Letter 2413(P).

In court, the taxpayer argued that the Letter 2413(P) was not sufficient opportunity to contest the penalty. This may be the case, as the letter has not been updated since 1991–long before the collection due process hearing or other collection rules in RRA98 were put into place.

The court did not have to get to this issue as the settlement officer actually heard and rejected the taxpayer’s penalty abatement arguments. Looking at the facts and the penalty abatement rules, the taxpayer’s position seems plausible.

Had the arguments been raised in a normal appeal filed in response to the Letter 2413(P), the outcome may have been different. The reason why is that the case would have been considered by an appeals officer, not a settlement officer. The other reason is that the “abuse of discretion” standard applicable to collection due process hearings is not a high hurdle for the IRS to overcome.

The taxpayer’s argument that he relied on his accountant for a tax filing has not been accepted by the IRS or courts. The law is well established there. But whether the taxpayer’s financial circumstances prevented him from paying an accountant when combined with the taxpayer’s own lack of knowledge of business taxes may have risen to the level of reasonable cause for abating the penalty.

By raising the issue in an appeal via a collection due process hearing, it does not appear that the taxpayer had a fair determination of this aspect of the penalty itself. This case shows how important it is to pick the right forum for appealing a penalty abatement request.

While not mentioned in the case, presumably the IRS had sent a prior notice to the taxpayer when it assessed or recorded the penalty for the taxpayer. This would also pose a problem for most penalty abatement requests that taxpayers may challenge in collection due process hearings.

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