Taxpayer Properly Barred from Challenging Penalty in CDP Hearing

(Parker Tax Publishing May 2017)

The Seventh Circuit, in a case of first impression, held that a taxpayer could not challenge its liability for a reporting penalty in a collection due process (CDP) hearing after having unsuccessfully challenged the penalty in an administrative hearing before the IRS Office of Appeals. Because the taxpayer did not raise his issue in the CDP hearing, it could not be considered on appeal by the Tax Court, and the taxpayer's only recourse was to pay the penalty in full and sue for a refund. Our Country Home Enterprises, Inc. v. Comm'r, 2017 PTC 214 (7th Cir. 2017).

Our Country Home Enterprises, Inc. participated in an employee benefit plan from 2003 through 2007. Only one employee, Thomas Blake, was enrolled in the plan. The company took deductions for its payments into the plan, but Blake did not report income from the plan on his return. The IRS determined that Our Country Home's participation in the plan was a listed transaction. According to the IRS, Our Country Home should have filed a Form 8886, Reportable Transaction Disclosure Statement. The maximum penalty of $200,000 was imposed for Our Country Home's failure to report its participation in the plan.

Before the penalty was assessed, Our Country Home was offered an administrative hearing before the IRS Office of Appeals. In that hearing, Our Country Home challenged its liability for the penalty, arguing that the IRS incorrectly computed the penalty amount and improperly classified its participation in the plan as a listed transaction. After holding a conference with Our Country Home's counsel, an IRS appeals officer sustained the penalty in full.

The IRS assessed the penalty against Our Country Home in February 2013. A month later, the IRS issued a final notice of intent to levy under Code Sec. 6330 and informed Our Country Home of its right to a collection due process (CDP) hearing. Our Country Home requested a CDP hearing in June 2013 to contest again its liability for the penalty. An appeals officer determined that Appeals had already considered a liability challenge to the penalty and that Our Country Home was therefore precluded under Code Sec. 6330(c)(2)(B) from challenging it again. Our Country Home's challenge was dismissed and the levy against it was sustained.

Our Country Home petitioned the Tax Court to review the Appeals Office decision. The Tax Court granted the IRS's motion for summary judgment, holding that Our Country Home had a prior opportunity to dispute its liability in its conference with the Appeals Office. Our Country Home then appealed the Tax Court's decision. The issue was important to Our Country Home because, had it been able to challenge the penalty in the CDP hearing, the outcome of that hearing would be appealable to the Tax Court under Code Sec. 6330(d)(1), giving Our Country Home judicial review before having to pay the penalty. Our Country Home's only other option was to pay the penalty in full and sue for a refund.

The Court of Appeals affirmed the Tax Court. It held that Code Secs. 6330(c)(2)(B) and 6330(c)(4)(A) precluded Our Country Home's challenge of the penalty in the CDP hearing after having raised the issue in its initial conference with Appeals.

Under Code Sec. 6330(c)(2)(B), a taxpayer can raise any issue in a CDP hearing as long as the taxpayer either (1) did not receive a notice of deficiency for the liability, or (2) did not otherwise have an opportunity to dispute the liability. The reporting penalty imposed on Our Country Home was not subject to a notice of deficiency, so the issue was whether Our Country Home's challenge before the Appeals Office was a prior opportunity to dispute the liability. Our Country Home argued that a prior opportunity means a prior judicial opportunity. The IRS's reading of the statute was that a prior opportunity means any opportunity, whether judicial or administrative.

The Seventh Circuit sided with the IRS and found that under Reg. Sec. 301.6630-1(e)(3), an opportunity to dispute the underlying liability includes a prior opportunity for a conference with the Appeals Office that was offered either before or after the assessment of the liability. The court reviewed the regulation under the deferential standard provided in Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984). It determined that Code Sec. 6330(c)(2)(B) is ambiguous and that the IRS's interpretation of it in the regulation was reasonable.

Our Country Home's argument was based on the language in the regulation, which permits a taxpayer to challenge a liability in a CDP hearing "if the taxpayer did not receive a statutory notice of deficiency for such liability or did not otherwise have an opportunity to dispute such liability." According to Our Country Home, this implied that if a notice of deficiency entitles a taxpayer to judicial review before paying the penalty, then "opportunity to dispute" must also refer to an opportunity for prepayment judicial review. The court rejected this argument. It noted that nothing suggests the phrases "notice of deficiency" and "opportunity to dispute" are linked in a way that indicates they share a common quality. The court reasoned that, just because a notice of deficiency can be reviewed by a court before payment did not mean that other opportunities to dispute a liability must also be reviewable in the same way.

Next, the Court of Appeals determined that Reg. Sec. 301.6330-1(e)(3), which defines "opportunity to dispute" to include prior conferences with the Appeals Office and to exclude conferences prior to the IRS's assessment of a tax subject to deficiency procedures, is a reasonable interpretation of the statute. The regulation does not, in the court's view, conflict with the statute. The court said that other provisions in the statute, including Code Sec. 6330(c)(4)(A), lend support to the IRS's interpretation; Code Sec. 6330(c)(4)(A) precludes a taxpayer from raising an issue at a CDP hearing if the issue was raised and considered at a previous administrative or judicial proceeding. Our Country Home had not, in the court's view, explained why Congress considered an administrative proceeding an adequate forum for purposes of Code Sec. 6330(c)(4)(A) but not for Code Sec. 6330(c)(2)(B). To the contrary, it was more likely in the court's view that Congress, by creating an independent appeals function within the IRS, considered an administrative proceeding to be an appropriate way to resolve most prepayment tax challenges.

The court was not persuaded by Our Country Home's argument that the regulation is unreasonable because it tries to limit the Tax Court's jurisdiction. It found that the regulation does not address jurisdiction, it only specifies the issues that can be raised in a CDP hearing. According to the court, the regulation was reasonable because it preserved Our Country Home's right to file a refund suit in court after paying the tax, so Our Country Home at all times had a judicial forum to challenge the liability.

The court considered the IRS's alternative argument that Our Country Home was precluded under Code Sec. 6330(c)(4)(A) from challenging its liability at the CDP hearing. That provision says that if an issue was raised and considered at a previous administrative or judicial proceeding and the taxpayer participated meaningfully in that proceeding, the taxpayer cannot raise that issue again in a CDP hearing. Our Country Home argued that the word "issue" in Code Sec. 6330(c)(4)(A) does not include a liability challenge, so that statute did not apply. It said that because Code Sec. 6330(c)(2)(B) explicitly deals with liability, "issue" as used in Code Sec. 6330(c)(4)(A) does not include liability. The court disagreed and found that the word "issue" encompasses liability challenges in Code Sec. 6330(c)(2)(B) and Code Sec. 6330(c)(3)(B), so it should have the same meaning in Code Sec. 6330(c)(4)(A).

Our Country Home next argued that reading Code Sec. 6330(c)(4)(A) to include liability challenges was inconsistent with Reg. Sec. 301.6330-1(e)(3), which says that a conference with the Appeals Office before the assessment of a tax subject to deficiency procedures is not a prior opportunity. The court saw some merit to Our Country Home's argument. It noted that on the one hand, the regulation assures the taxpayer that a preassessment administrative hearing before the Appeals Office would not preclude a future liability challenge in a CDP hearing. On the other hand, a taxpayer who did challenge a liability in a hearing before Appeals would then be prohibited under Code Sec. 6330(c)(4)((A) from raising the issue in a later CDP hearing. In resolving this apparent inconsistency, the noted a planning opportunity for the savvy taxpayer.

Planning Tip: According to the court, a taxpayer given an opportunity to challenge its liability before the Appeals Office could decline that invitation in order to preserve the ability to raise the challenge later in a CDP hearing. Having challenged the liability in the CDP hearing, the taxpayer could then appeal that decision to the Tax Court and thus have access to a prepayment judicial review of the liability, which would not be available if the issue was not considered in the CDP hearing.

The court ultimately held that under the plain language of Code Sec. 6330(c)(4)(A), Our Country Home raised the issue of its liability in a prior hearing before the Appeals Office and participated meaningfully in that hearing, so it could therefore not contest its liability again in its CDP hearing.

For a discussion of collection due process hearings, see Parker Tax ¶260,540.20.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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