Court Allows Foreclosure of Delinquent Taxpayer’s Home and Business Property for Employment Tax Liability

The U.S. District Court for the District of New Mexico recently held that the government is entitled to foreclose federal tax liens against a delinquent taxpayer’s home and business property, even though the taxpayer’s wife may be a joint owner. In United States v. Fields, Samuel Fields, the sole proprietor of a dry cleaner business, owed $211,855.80 in employment and unemployment taxes from 1993 to 2009. The IRS had made assessments against Fields starting in 1995. In 2005, for no consideration, Fields executed deeds to his two real properties – his home residence and business property – located in New Mexico, stating that he and his wife were joint owners. The U.S. Department of Justice sought partial summary judgment against Fields personally and to foreclose its federal tax liens against his home and business property.

The key issue was whether the federal tax liens were superior to the wife’s interests in the properties. Under Internal Revenue Code Sections 6321 and 6322, if a person fails to pay federal taxes owed, on the day the taxes are assessed a statutory tax lien arises and attaches to all property rights owned by the person. Further, the tax liens will also defeat a third party’s interest in the property unless that third party is a certain secured interest holder, a judgment lien creditor, or a purchaser. While priority of federal tax liens is determined by federal law, property interests are determined under state law – New Mexico law, in this case.

The court held that the tax liens arising from assessments made before Fields executed the deeds encumber and are superior to the property interests of both Fields and his wife. But the tax liens arising from assessments made after Fields executed the deeds, as a matter of law, only encumber and are superior to Fields’ interests in half of the value of each property. Although the United States may ultimately be entitled to the full value of each property if the deeds were a fraudulent transfer under New Mexico law, this issue may involve a factual determination as to Fields’ intent, and so the United States did not include it in its motion for partial summary judgment. Thus, the court permitted the foreclosure, as Section 7403(c) allows district courts to order the sale of property subject to a federal tax lien regardless of homestead exemptions or other ownership interests.

This case is part of the U.S. Department of Justice’s commitment to cracking down on employment tax violations.

11th Circuit Decision Highlights the Disparity Between Regular IRS Appeals and Collection Appeals

Although IRS Appeals personnel handle both traditional cases and collection due process (CDP) hearings, the two proceedings have vast practical differences for taxpayers. First, regular Appeals cases are conducted by Appeals Officers, who are well-versed in the law and legal authorities, whereas CDP hearings are conducted by Settlement Officers, who typically are former collection personnel that often lack the technical background of Appeals Officers. Although this difference is not critical in a case focusing solely on establishing a payment plan, it can be a significant issue if the case involves a dispute over substantive legal questions relating to the underlying tax dispute.

A recent opinion from the U.S. Court of Appeals for the Eleventh Circuit highlights the distinction between the two proceedings in a case of first impression in that circuit. In its opinion, the panel reversed the Tax Court on the issue of whether a preassessment hearing is required when a taxpayer timely protests a case involving trust fund recovery penalties but is subsequently afforded a CDP hearing. In Romano-Murphy v. Commissioner, the 11th Circuit reviewed the statute and regulations governing trust fund taxes, other applicable regulations, and the Internal Revenue Manual, and concluded that taxpayers who properly request preassessment hearings must be granted such hearings. This holding highlights the disparate opportunities available to a taxpayer in a traditional IRS Appeals hearing as compared to a CDP hearing.

Although the critical issue in Romano-Murphy is procedural in nature, the issue arose in the context of trust fund taxes. When an employer withholds federal income tax, Social Security tax, and Medicare tax on that income (known as “trust fund taxes”) but fails to deposit the withheld taxes, the Commissioner has several alternatives to collect those taxes. Section 6672(a) makes the responsible officers or employees personally liable for a penalty equal to the amount of the delinquent taxes, allowing the Commissioner to seek the tax from the individuals responsible for the collection and payment of withholding taxes on behalf of the organization, so long as the individuals willfully failed to properly pay.

The taxpayer in Romano-Murphy, Chief Operating Officer of a healthcare staffing company, was assessed nearly $350,000 in trust fund recovery penalties for her company’s failure to remit withheld taxes. The taxpayer timely and properly protested the assessment, providing all required information and identifying disputed issues, but the IRS failed to send her protest to IRS Appeals (no explanation for this failure was offered in the court’s opinion). Subsequently, the IRS served the taxpayer with a notice of intent to levy to collect the trust fund taxes, as well as a notice of federal tax lien filing. In response, the taxpayer challenged the levy and the lien in a request for a CDP hearing. At the CDP hearing, the Settlement Officer considered the taxpayer’s challenges and upheld the assessment in full. The taxpayer then challenged the CDP determination, including the legitimacy of the assessment in the Tax Court. In its decision, the Tax Court addressed the underlying liability and found the taxpayer liable for the taxes and essentially dismissed the taxpayer’s argument that she was entitled to a preassessment hearing before IRS Appeals before the assessment itself could be made.

The taxpayer’s sole argument in its appeal to the 11th Circuit was that the IRS denied her a preassessment hearing, which therefore invalidates the assessment. The IRS asserted that the absence of an explicit statutory requirement negated the need for a preassessment hearing, but the 11th Circuit panel looked to other statutory references, the regulations, the Internal Revenue Manual, and other relevant authorities to conclude that a regular IRS Appeals conference is indeed required on a preassessment basis when timely requested by the taxpayer. The court rejected the IRS’s argument that it may “simply ignore, disregard, or discard a taxpayer’s timely protest . . . if it so chooses” without establishing any rational criterion for doing so. The court went on to point out that were the IRS’s position correct, “the IRS could arbitrarily decide to shred one of every three . . . protests that arrive in the mail, or throw out all such protests received on Fridays, without any consequences whatsoever.”

In the alternative, and perhaps more importantly, the IRS argued harmless error on the grounds that the taxpayer’s challenges to the underlying tax were considered and rejected, just in the setting of a CDP hearing. Essentially, the IRS equated the opportunity afforded the taxpayer to present her case at the CDP hearing to the opportunity that she would have received at a preassessment Appeals hearing. The taxpayer argued that the denial of a preassessment conference prejudiced her because, for example, interest began accruing from the date of the assessment, the delay in hearing her claim kept her from being able to access for 18 months information that was only maintained on the IRS’s system, and the lien placed on her property harmed her credit. The court refused to rule on the issue of actual harm to the taxpayer but acknowledged that arguments exist on both sides. On one hand, it stated that the taxpayer was “not completely denied a right to be heard,” and thus her due process rights were not violated. But, the court also acknowledged the importance of enforcing procedures required by law that an agency failed to follow. The court vacated the judgment but remanded the case to the Tax Court to address whether the taxpayer was harmed by the error.

Although the 11th Circuit did not expressly address the vast differences between a taxpayer presenting its case in a preassessment Appeals hearing versus a CDP hearing, the differences in the qualifications between Appeals Officers and Settlement Officers cast a troubling shadow over the case due to the existence of substantive tax issues that require a higher degree of training, knowledge, and experience. As a result, whether a taxpayer presents its case at a preassessment Appeals hearing or a CDP hearing can significantly affect the outcome.

The court’s remand to the Tax Court will require the Tax Court to determine whether the IRS’s denial of a preassessment Appeals hearing that was ultimately held in a CDP hearing before a Settlement Officer years later caused sufficient harm to the taxpayer to warrant the invalidation of the assessment. If the taxpayer prevails, it appears that the statute of limitations may bar a reassessment by the IRS.