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Disputing the Underlying Liability in CDP Following a Substitute For Return (SFR) by CORY STIGILE

In Dennis M. Powers v. Comm’r, TC Memo 2015-210, the Tax Court Granted the government’s motion for summary judgement against a pro se Taxpayer who petitioned the Tax Court to dispute the underlying liability set forth on a substitute return prepared by the IRS.  While the Taxpayer left the IRS and subsequent Court little choice by failing to timely submit evidence during the Collection Due Process (CDP) proceedings, the posture of the case raises interesting questions about disputing the underlying liabilities in CDP  proceedings under different circumstances.

The Taxpayer in Powers failed to file timely tax returns for two prior years.  Using third party information, the IRS prepared a substitute for return for both of these periods reflecting taxes owed under IRC § 6020(b).  IRC § 6020(b) is effectively a collection device to facilitate the assessment and collection of tax.  Despite its authority to prepare such returns, the IRS is still subject to the deficiency procedures and must issue a Notice of Deficiency before assessing and collecting the tax.  In the instant case, the IRS followed these procedures and the Taxpayer failed to file a Petition in the Tax Court within 90 days.  Instead, the Taxpayer defaulted on the Notice of Deficiency and the IRS started enforced collection activity by issuing a Notice of Intent to Levy, and then a Notice of Federal Tax Lien.  The Taxpayer filed a CDP Appeal (Form 12153) to dispute the collection action, and ultimately raised the issue of disputing the underlying liability.

Section 6330(c)(2)(B) permits a taxpayer to challenge the existence or amount of the underlying liability only if the taxpayer did not receive a notice of deficiency or otherwise have a prior opportunity to contest that liability. While a taxpayer’s dispute of the underlying liability when properly raised in CDP is revised de novo, other disputes regarding the IRS’s determinations in a CDP appeal are reviewed for abuse of discretion.  In such instances, abuse of discretion exists when a determination is arbitrary, capricious, or without sound basis in fact or law. See Murphy v. Commissioner, 125 T.C. 301, 320 (2005), aff’d, 469 F.3d 27 (1st Cir. 2006).

While not apparently raised or addressed in Powers, when the IRS prepares a substitute for return, it sends a notice to the taxpayer that permits the taxpayer agree to the liability (with or without payment), file a delinquent return, request an appeals conference, pay the balance due and file a refund claim, or simply do nothing.  IRM 5.18.1; CCA 200518001.  If the taxpayer does nothing, then the Service will issue a statutory notice of deficiency, and ultimately assess the tax if the taxpayer does nothing after 90 days, as was the case here.

The Settlement Officer requested again during the CDP proceedings for the taxpayer to submit tax returns, but the taxpayer again did not do it, or at least did not properly document that he did it as part of the administrative record in the CDP proceedings. As such, there was not a record for the Settlement Officer of the Court to review.  Moreover, for purposes of the CDP proceedings under IRC § 6330(c)(2)(B), the pro se Taxpayer arguably had a meaningful opportunity to “dispute the underlying liability,” but he just did not do it when he declined to file a Petition following the issuance of the 90 day letter.

While the pro se Taxpayer failed to properly make any delinquent (and supposedly corrected) tax returns a part of the administrative record, the substitute for return process presents a trap for the unwary in the options it presents for “fixing” the substitute for return. Often times, as the substitute for return process is automated, the optimized standard or itemized deductions, dependents, or exemptions, are not reflected in the asserted tax liability.  It is tempting to, as the initial letter offers, prepare a return or provide information in repose to the initial 30 day letter, instead of filing a Petition with the Tax Court after the 90 day letter is issued.  This approach would be less costly, and the Taxpayer may well do it and save both herself and the government a lot of money.[i]  The downside though is that the Taxpayer just lost the ability for the adjudication of any disputes with respect to the liability in a deficiency proceeding before a Judge (i.e. the first non-IRS person to review the taxpayer’s arguments).

In an alternative posture where the taxpayer either submitted a return following the initial SFR notice to a subsequently assigned Revenue Officer, or during a CDP proceeding, the IRS may well disagree with some or all of the disputed issues in a well documented administrative record. The taxpayer may attempt to dispute that issue in the CDP proceeding as part of his dispute of the underlying liability or the appropriateness of the collection action.  The ability of the taxpayer to separately raise the appropriateness of the collection action in such instances in a CDP hearing under IRC §6330(c)(2)(A)(ii) arguably permits this, even if a notice of deficiency was previously issued[ii].  A Court may refuse to consider a dispute to the underlying liability since a Notice of Deficiency may have been issued[iii].  In such instances though, even if a de novo review is not permitted, the established existence of an available deduction may permit the Settlement Officer and subsequent Court to determine that the discretion existed to allow such a deduction, or that the refusal to permit such a deduction was an abuse of discretion or an inappropriate collection action when the established facts and law would require it.

If the IRS’s letters and notices with respect to substitute for returns allow a pro se taxpayer to wander down procedural path that omits a Court’s review through the deficiency procedures[iv], the IRS should still be subject to Court review if it engages in in appropriate collections actions while reviewing that information during the collection and CDP appeal process.

CORY STIGILE – For more information please contact Cory Stigile – cs@taxlitigator.com  Mr. Stigile is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a CPA licensed in California, the past-President of the Los Angeles Chapter of CalCPA and a Certified Specialist in Taxation Law by The State Bar of California, Board of Legal Specialization. Mr. Stigile specializes in tax controversies as well as tax, business, and international tax. His representation includes Federal and state civil and criminal tax controversy matters and tax litigation, including sensitive tax-related examinations and investigations for individuals, business enterprises, partnerships, limited liability companies, and corporations. His practice also includes complex civil tax examinations. Additional information is available at www.taxlitigator.com

[i] This is similar to the often presented decision for the taxpayer of choosing between a Collection Appeals Process Appeal, versus a CDP Appeal, when the Revenue Officer is considering a lien or levy.  Again, the CAP appeal presents an alluring low cost and probably quicker opportunity to have an independent IRS person review the issue, but it comes at the cost of potentially losing your right to dispute the underlying liability with a de novo standard of review in the Tax Court.


[ii] The statutory right to raise the issue of the appropriate of the collection action is distinct and separate from the right to raise the issue of disputing the underlying liability, which is restricted when a prior notice of deficiency was issued, or there was no other meaningful opportunity to dispute the underlying liability.  IRC §6330(c)(2)(B).

[iii] Note that differences may exist between a disputed liability in a CDP Hearing, versus liabilities that were the subject of a prior Notice of Deficiency or appeals hearing.  In such instances where there was no meaningful opportunity to dispute the underlying liability on a particular issue, for instance if new equitable remedies may be available, the underlying liability may still be disputed.  See Revah v. Comm’r, 584 Fed. Appx. 813 (9th Cir. 2014).


[iv] See CCA 200518001.

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