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Our Country Home Enterprises, Inc. v. Commissioner of Internal Revenue

United States Court of Appeals, Seventh Circuit

May 3, 2017

Our Country Home Enterprises, Inc., Petitioner-Appellant,
Commissioner of Internal Revenue, Respondent-Appellee.

          Argued November 9, 2016

         Appeal from the United States Tax Court. No. 7688-14 L - Lewis R. Carluzzo, Special Trial Judge.

          Before Bauer and Kanne, Circuit Judges, and Feinerman, District Judge. [*]


         This case presents an issue of first impression in our circuit-one that requires us to delve into the abstruse world of federal-tax procedure. In this appeal, we address whether Our Country Home Enterprises, Inc. may challenge its liability for a tax penalty in a Collection Due Process ("CDP") hearing after having unsuccessfully challenged its liability for that penalty in an administrative hearing before the IRS Office of Appeals. The tax court determined that the earlier liability challenge precluded the later one. Our Country Home appealed. We affirm.

         I. Background

         This appeal concerns the matters a taxpayer can raise in a CDP hearing. For the reader's benefit, we provide a brief overview of what CDP hearings are, why they exist, and how they fit within the enigmatic mishmash that is the Internal Revenue Code. We then address the issues before us.

         A. Overview of the CDP Process

         Congress has given the Secretary of Treasury the power "to determine, assess, and collect federal taxes." Gyorgy v. Comm'r, 779 F.3d 466, 472 (7th Cir. 2015) (citing I.R.C. §§ 6201(a), 6301). The Secretary, in turn, has delegated that power to the Commissioner of Internal Revenue, who has further delegated that power to local IRS officials. Hughes v. United States, 953 F.2d 531, 536 (9th Cir. 1992). IRS officials review taxpayers' tax returns. BASR P'ship v. United States, 795 F.3d 1338, 1339 (Fed. Cir. 2015). In these returns, taxpayers must report the income they earn each year. Lain v. Comm'r, 103 T.C.M. (CCH) 1546, *2 (2012).

         If a taxpayer understates his income and additional tax is due, the IRS may propose a deficiency. Michael I. Saltzman & Leslie Book, IRS Prac. & Proc. ¶ 10.03 (2016). A deficiency "is the amount of tax imposed less any amount that may have been reported by the taxpayer on his return." Laing v. United States, 423 U.S. 161, 173 (1976) (citing I.R.C. § 6211(a)). A deficiency does not have the force of a judgment; rather, it constitutes the IRS's provisional determination of how much additional tax a taxpayer owes. IRS Prac. & Proc. ¶ 10.01 [1]. Before the IRS can collect a deficiency, it must issue a notice to the taxpayer. Murray v. Comm'r, 24 F.3d 901, 903 (7th Cir. 1994). This notice gives the taxpayer the right to challenge the deficiency in tax court. Id.

         "The Tax Court is an Article I court created by Congress with limited jurisdiction to rule on deficiencies assessed by the government on taxpayers." Crawford v. Comm'r, 266 F.3d 1120, 1121-22 (9th Cir. 2001). Congress created the tax court as an avenue for prepayment judicial review of tax deficiencies. Flora v. United States, 362 U.S. 145, 158 (1960). Without this forum, the only way a taxpayer could challenge a deficiency judicially would be to pay the tax and sue for a refund in federal court. Bartman v. Comm'r, 446 F.3d 785, 787 (8th Cir. 2006); I.R.C. § 7422(a). In some cases, however, a deficiency might be so costly that a taxpayer cannot pay it. Under these circumstances, the taxpayer would not be able to initiate a refund suit, and the IRS would be insulated from judicial review. Flora, 362 U.S. at 158-59. To alleviate this problem, Congress enacted §§ 6212 and 6213. These sections prohibit the IRS from assessing a deficiency in income, estate, gift, and certain excise taxes until the IRS issues a notice of deficiency, giving the taxpayer access to tax court. Murray, 24 F.3d at 903.

         A taxpayer has 90 days (or 150 days if he lives outside the United States) to petition for review in tax court. I.R.C. § 6213(a). So long as the taxpayer makes a timely petition, the court can review the deficiency and decide whether to modify or reject it. IRS Prac. & Proc. ¶ 10.01 [1].

         If the taxpayer does not timely file a petition, the IRS can assess the deficiency. Id. at ¶ 10.01 [2] [b]. An assessment is the formal recording of a taxpayer's tax liability. See I.R.C. § 6203. "The assessment is given the force of a judgment/' authorizing the IRS to collect the tax. Bull v. United States, 295 U.S. 247, 260 (1935); see Matter of Carlson, 580 F.2d 1365, 1368 (10th Cir. 1978).

         Some taxes are not considered deficiencies under the Internal Revenue Code. For instance, penalties for failing to file a tax return or for outright failing to pay taxes due are not deficiencies. See I.R.C. § 6651(a)(1)-(2); Internal Revenue Manual at Nor are reporting penalties imposed for failing to report participation in various tax-shelter transactions. See I.R.C. § 6707A; Smith v. Comm'r, 133 T.C. 424, 428-29 (2009). For these nondeficiency taxes-which are not subject to deficiency procedures like prepayment judicial review in tax court-the IRS can make an immediate assessment. See Smith, 133 T.C. at 428-29; Internal Revenue Manual at;

         Within 60 days of an assessment, the IRS must notify the taxpayer of the amount due and demand payment. I.R.C. § 6303(a). If the taxpayer fails to pay what is due on time, the IRS can file a notice of federal tax lien, which places a lien on all of the taxpayer's property. I.R.C. § 6321. The IRS then can collect delinquent taxes through either judicial or administrative means. For instance, the IRS can file a civil action in federal district court to foreclose on a tax lien. I.R.C. § 7403. Alternatively, the IRS can take administrative action by levying on a taxpayer's property. I.R.C. § 6331. To collect through an administrative levy, the IRS must give the taxpayer 30 days' prior notice. I.R.C. § 6331(d)(1)-(2).

          Before 1998, "the IRS could reach a delinquent taxpayer's assets by lien or levy without providing any sort of pre-attachment process." Dalton v. Comm'r, 682 F.3d 149, 154 (1st Cir. 2012). Moreover, IRS officers could take these actions without any judicial oversight. See James K. Wilkens and Thomas A. Matthews, A Survey of Federal Tax Collection Procedure: Rights and Remedies of Taxpayers and Internal Revenue Service, 3 Alaska L. Rev. 269, 269-70 (1986). Congress determined that the IRS had gone too far in its collection activities. So Congress enacted the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, 112 Stat. 685, designed to provide taxpayers with additional procedural safeguards to oppose IRS collection efforts. Kindred v. Comm'r, 454 F.3d 688, 695 (7th Cir. 2006). Specifically, Congress enacted §§ 6320 and 6330, which grant a taxpayer the right to a CDP hearing after the IRS issues a notice of federal tax lien (§ 6320) or before the IRS levies on the taxpayer's property (§ 6330).

         Officers in the IRS Office of Appeals conduct these CDP hearings. Gyorgy, 779 F.3d at 472; I.R.C. § 6320(b)(1). The Appeals Office is an independent bureau of the IRS charged with impartially resolving disputes between the government and taxpayers. See Gyorgy, 779 F.3d at 472. Although the appeals officer reviewing the case represents the IRS, he must have had no prior involvement with the taxpayer regarding the tax at issue. Tucker v. Comm'r, 676 F.3d 1129, 1131 (D.C. Cir. 2012). The officer also must verify that the IRS has satisfied all legal and administrative requirements with respect to the tax. I.R.C. § 6330(c)(1).

         At the hearing, a taxpayer may raise "any relevant issue relating to the unpaid tax or the proposed levy, " including collection alternatives and challenges to the proposed collection action. I.R.C. § 6330(c)(2)(A). He may not, however, raise an issue if "the issue was raised and considered at a ... previous administrative or judicial proceeding" and he "participated meaningfully" in that proceeding. I.R.C. § 6330(c)(4)(A).

         Moreover, a taxpayer may contest his liability for the tax, but only if he "did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability." I.R.C. § 6330(c)(2)(B). The Treasury Regulations note that "[a]n 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." Treas. Reg. § 301.6330-l(e)(3) Q&A-E2. The regulations further note, however, that "[a]n opportunity for a conference with [the] Appeals [Office] prior to the assessment of a tax subject to deficiency procedures is not a prior opportunity for this purpose." Id.

         Although CDP hearings provide taxpayers with additional procedural safeguards, calling the proceeding a "hearing" is somewhat misleading in that "there is no obligation to conduct a face-to-face hearing, no formal discovery, no requirement for either testimony or cross-examination, and no transcript." Dalton, 682 F.3d at 155. Moreover, a taxpayer has no right to subpoena documents or witnesses. Konkel v. Comm'r, No. 6:99-CV-1026-ORL-31C, 2000 WL 1819417, at *4 (M.D. Fla. Nov. 6, 2000). And a CDP hearing need not include every party in interest. Dalton, 682 F.3d at 155. Indeed, far from constituting a formal hearing, a CDP hearing provides a taxpayer with nothing more than an opportunity for an informal oral or written conversation with the IRS before he must pay a tax. Id.

         Despite these procedural shortcomings, one of the better aspects of the CDP process is the opportunity for prepayment judicial review in tax court following the administrative hearing in the Appeals Office. Under § 6330(d)(1), a taxpayer who disagrees with the Appeals Office's decision can appeal that decision to the tax court. See Gyorgy, 779 F.3d at 472. And when the issue involves liability for the penalty, the tax court reviews the Appeals Office's determination de novo. Id. That said, the tax court's review is limited to the issues raised in the CDP hearing. Goza v. Comm'r, 114 T.C. 176, 182-83 (2000). This means that, because a taxpayer cannot raise liability challenges precluded by § 6330(c)(2)(B) and issues precluded by § 6330(c)(4)(A) in a CDP hearing, the taxpayer cannot present them to the tax court in its review of the Appeals Office's decision. Keller Tank Sews. II, Inc. v. Comm'r, No. 16-9001, 2017 WL 1424973, at *7 (10th Cir. Apr. 20, 2017).

         Moreover, the tax court usually affirms the Appeals Office's decisions. See IRS Prac. & Proc. ¶ 14B.09[2] (noting that there is a "high rate of sustention of the Appeals employee's determination when the case is heard in Tax Court"). So a taxpayer's best chance for success lies with the appeals officer conducting the CDP hearing, not with the tax court. Id.

         With this background in hand, we turn to the issues before us.

         B. Issues Presented

         From 2003 through 2007, Our Country Home participated in an employee-benefit plan called the Sterling Plan. Thomas Blake was the only Our Country Home employee enrolled in this plan. Although the company took deductions on its tax returns for its payments into the plan, Blake claimed no income from the plan on his returns.

         The IRS proposed a § 6707A reporting penalty for Our Country Home's failure to report its participation in this plan on its 2007 tax returns. The IRS also proposed deficiency penalties against Our Country Home, claiming that the company's deductions for its payments into the plan were improper; these penalties included a § 6662(a) penalty (which is assessed when a taxpayer makes a substantial understatement and acts with negligence or disregard of the rules or regulations) and a § 6662A penalty (which is assessed when a taxpayer makes an understatement related to a reportable transaction that was disclosed inadequately). Two contemporaneous proceedings followed, one concerning the reporting penalty and the other concerning the deficiency penalties. This appeal concerns the reporting-penalty proceeding and Our Country Home's attempts to challenge its liability for the § 6707A penalty.

         Taxpayers incur § 6707A penalties by failing to report participation in certain abusive tax-shelter transactions. Smith, 133 T.C. at 427. Because these are reporting penalties, they do not depend on a tax deficiency; indeed, the IRS will impose these penalties even in cases involving an overpayment of tax. Id. at 429.

         Section 6707A covers two different kinds of transactions: "reportable" transactions, which are those "having a potential for tax avoidance or evasion"; and "listed" transactions, which are reportable transactions that are the same as or substantially similar to those that the Secretary of Treasury has specifically identified as tax-avoidance transactions. I.R.C. § 6707A(c)(1)-(2). The IRS determined that participation in the Sterling Plan constituted a listed transaction because it is substantially similar to one of the listed transactions that the Secretary delineated in Notice 2007-83, 2007-1 C.B. 960. Thus, according to the IRS, Our Country Home should have filed a Form 8886 with its tax returns, disclosing its participation in the plan. Treas. Reg. § 1.6011-4(d). Because Our Country Home did not file this form, the IRS imposed a $200, 000 penalty-the statutory maximum for listed transactions. I.R.C. § 6707A(b)(2)(A).

         The IRS offered Our Country Home an opportunity for a preassessment administrative hearing before the Appeals Office. See Internal Revenue Manual at Our Country Home accepted the invitation and challenged its liability for the penalty, arguing that the IRS erred in computing the penalty amount and improperly classified participation in the Sterling Plan as a listed transaction. An appeals officer reviewed the relevant documents and discussed the issues with a technical specialist. On July 26, 2012, she held a conference with Our Country Home's counsel. Thereafter, she issued a memorandum explaining that the IRS correctly computed the penalty and properly treated participation in the Sterling Plan as a listed transaction under Notice 2007-83. She thus sustained the penalty in full and closed the case.

         On February 18, 2013, the IRS assessed the penalty. A month later, the IRS issued a final notice of intent to levy under § 6330 and informed ...

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