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refusing to review issues that were not properly subject to a CDP hearing, regardless of whether the issues were considered at the hearing or referenced in the Notice of Determination
Summary of this case from Pennington v. U.S.Opinion
Civil Action No. 03-40097-FDS.
December 2, 2004
MEMORANDUM AND ORDER
This action involves an appeal by plaintiff Francis Harvey Sons, Inc. ("Harvey"), from an Internal Revenue Service Notice of Determination. Harvey seeks abatement of penalties imposed on it by the IRS pursuant to 26 U.S.C. §§ 6651(a)(2), 6656(a) for late payment of employment taxes.
Harvey is a construction company based in Worcester, Massachusetts. Beginning in 1993, and for the following ten and a half years, Harvey withheld taxes from its employees but failed to pay over those amounts to the IRS. Instead, Harvey used those funds to pay creditors and otherwise to finance its business. Harvey does not contest its obligation to pay the taxes, with interest. It contends only that the penalties imposed by the IRS should be abated. Harvey and the IRS also dispute which such penalties are subject to judicial review.
At an IRS collection due process hearing ("CDP Hearing") in November 2002, Harvey claimed that the penalties should be abated because the company had reasonable cause for its late employment tax payments. The IRS rejected this claim in a Notice of Determination issued on April 23, 2003. On May 15, 2003, pursuant to 26 U.S.C. § 6330(d), Harvey petitioned the Court for a de novo review of the Notice of Determination. Pending before the Court is the motion of the IRS for summary judgment on grounds that (1) the Court lacks jurisdiction over certain of the tax penalties contested by Harvey, and (2) there is not reasonable cause, as a matter of law, to abate the tax penalties over which the Court has jurisdiction.
Factual Background
Harvey is a third-generation, family-owned and operated, general construction contracting business. It is located in Worcester, Massachusetts, and employs approximately 125 people. According to Harvey, it began to suffer financial reverses in the early to mid-1990's as a result of a recession in New England that severely affected the construction business.
Harvey apparently stopped paying employment taxes to the IRS during the first quarter of 1993, and began to incur IRS penalties as a result. Thereafter, Harvey consistently failed to pay its employment taxes on schedule for more than ten years.
The record indicates that, with very few exceptions, Harvey failed to pay its employment taxes on a timely basis for quarterly tax periods from March 1993 until September 2003. With the exception of one IRS transaction transcript attributing a $6,376.98 credit to Harvey for the March 2004 tax period, the company's payment history subsequent to September 2003 is not included in the record.
Harvey blames its financial problems on the recession generally, and specifically on a construction contract dispute with Amherst College. According to Harvey, it entered into the Amherst contract on May 2, 1994. The contract provided that Harvey would receive $7.3 million in bimonthly progress payments, plus the costs of change orders and additional authorized work. The company anticipated that it would earn a profit of $313,000 under the contract.
Harvey contends that it fulfilled its contractual obligations from the inception of the project, and even performed additional work at the request of Amherst. However, in late 1994 or early 1995, Amherst refused to pay the extra charges for the additional work, and withheld approximately $2.4 million in progress payments owed to Harvey. The contract between Harvey and Amherst required the parties to resolve any dispute through mediation and arbitration, and obligated Harvey to continue to perform work should a dispute arise. As a result, Harvey was required to pay for materials and subcontractors for the Amherst project despite a $2.4 million revenue shortfall. To avoid default under the contract, Harvey elected to pay only those subcontractors and suppliers that were essential to the completion of the project. Harvey contends that it timely filed its quarterly employment tax returns until the completion of the project on May 19, 1995, but failed to pay the required taxes with those returns.
The record does not indicate the precise date on which the Amherst dispute arose.
According to Harvey, the combined effect of the recession and the Amherst dispute caused a fifty-percent decrease in its gross revenue in 1995. When Fleet Bank learned that Amherst had withheld $2.4 million in progress payments, it recalled a $1.5 million line of credit it had extended to Harvey and demanded that Harvey immediately pay the outstanding $1 million principal, which was secured by a lien on the company's assets. Harvey used operating funds, personal money of its owner, and funds borrowed from friends to pay the principal and avert foreclosure.
In addition, according to Harvey, many subcontractors who learned of Harvey's circumstances refused to work for Harvey, compelling the company to increase its workforce in order to complete outstanding projects. This, in turn, caused Harvey to incur additional employment taxes. Harvey's suppliers also demanded large retainers before extending credit and often refused credit altogether.
The arbitration of the contract dispute between Harvey and Amherst began in approximately October 1995. During the arbitration, Amherst threatened a claim against Harvey's performance bond. As a result, according to Harvey, the bond company increased Harvey's premium payments and warned that it would withhold future bonding for Harvey's projects unless Harvey settled with Amherst. Harvey reluctantly settled with Amherst on October 17, 1997, for $296,000. Thus, Harvey collected approximately $2.1 million less in revenue than it expected to receive under the contract.
Harvey contends that the foregoing circumstances forced it to give higher priority to debts to subcontractors, suppliers, employees, and creditors than to its obligation to pay employment taxes throughout the period of the Amherst dispute from late 1994 or early 1995 to October 1997. This course of action, it insists, was necessary to prevent default and bankruptcy.
The IRS contends that Harvey's description of its financial situation during and after the Amherst project "is belied by the withholding tax assessments made against Harvey . . . for the periods from 1993 through 2000. . . ." Summary Judgment Memorandum, p. 6. Those assessments, it argues, are indicative of "a company with an ever-expanding payroll — not a company struggling to rebuild in a recession." Id. Moreover, the IRS notes that Harvey's 1995 and 1997 financial statements show a net profit of $96,852 and $321,002, respectively. The IRS asserts that this contradicts the company's assertions that it could not pay its taxes on time during the Amherst dispute because it was struggling to remain in business. Id. at 8.
Harvey's economic situation improved along with the overall economy in the years following the settlement with Amherst. Nonetheless, in the aftermath of the settlement, the company continued to make untimely employment tax payments and incur IRS penalties. The company maintains that a lien placed by the IRS on its assets has prohibited it from obtaining the financing necessary to conduct business and pay its debts, and forces it to "juggl[e] funds to stay in business." Harvey Affidavit, ¶ 22.
Despite its failure to pay its employment taxes on time since 1993, Harvey has fulfilled some of its tax obligations. According to Harvey, from 1993 to September 2002, the company paid a total of approximately $6.7 million in employment taxes, interest, and penalties. The IRS contends that, as of April 19, 2004, Harvey still owes $3,027,428.97. The record indicates that Harvey has paid in full all of the liabilities it incurred prior to September 2000, and that its outstanding debt is comprised of taxes, interest, and penalties which the company failed to pay subsequent to that date.
Harvey insists that, if the penalties were abated, this amount would cover all of the taxes and interest owed by it to the IRS through September 2002.
Procedural History
On April 11, 2001, Harvey and the IRS entered into an installment agreement under which Harvey agreed to pay its past due employment taxes and penalties in the amount of $1,882,056.56. The agreement provided that Harvey would make payments of $188,000 on or before the fifteenth day of each month. Harvey honored the terms of the installment agreement from at least April through September 2001, but thereafter ceased making payments.
This figure appears to have reflected tax liabilities incurred by the company for the eight quarterly periods ending December 1993, December 1997, December 1998, March 2000, June 2000, September 2000, December 2000, and March 2001.
It is unclear from the record precisely when Harvey stopped making payments under the installment agreement, although it appears that the last payment was in September 2001. The record also does not reflect why Harvey failed to honor the agreement.
In a letter to the IRS dated September 10, 2001, Harvey's tax representative, Murray Hershman, noted that the amount to be paid under the installment agreement included penalties attributable to the late payment and late deposit of employment taxes. The letter requested that the IRS abate statutory penalties for Harvey's delinquent tax payments. The IRS rejected this letter request approximately two weeks later.
On September 25, 2001, the IRS issued Harvey a final notice of intent to levy ("Final Levy Notice") and notice of right to a hearing ("CDP Hearing Notice") (collectively "Pre-Levy Notices"). Respectively, these notices informed Harvey of the IRS's intention to levy upon its property in order to collect the company's unpaid employment taxes, interest, and penalties for the three quarterly tax periods ending September 30, 2000, December 31, 2000, and March 31, 2001, and the company's right to challenge this collection action at a CDP Hearing.
The IRS had previously made assessments against Harvey for these liabilities on February 19, 2001, May 7, 2001, and August 13, 2001, respectively.
In a letter to the IRS dated October 4, 2001, Hershman requested a CDP Hearing, and attached a Form 12153, the standard form used by taxpayers to request a hearing with the IRS Appeals Office after receipt of Pre-Levy Notices. On the form, where it requested a description of the "IRS action(s) that you do not agree with," Hershman checked "Notice of Levy/Seizure" and listed each year from 1993 to 2001 in the space provided for "Taxable Period(s)."
Hershman also attached to the letter a separate IRS Form 843, "Claim for Refund and Request for Abatement," seeking abatement of penalties for each quarterly tax period from January 1993 through March 2001. These forms did not indicate whether Harvey sought an abatement of unpaid penalties or a refund of paid penalties, nor did they specify the amount in controversy for the given tax period.
On March 27, 2002, the IRS issued Pre-Levy Notices to Harvey regarding unpaid taxes, interest, and penalties for the quarterly tax period ending on June 30, 2001. According to the IRS, Harvey has since paid in full its liabilities for that period. On April 26, 2002, the IRS issued Pre-Levy Notices to Harvey, regarding unpaid taxes, interest, and penalties for the quarterly tax period ending on September 30, 2001.
The IRS had previously made an assessment against Harvey for these liabilities on October 22, 2001.
The IRS had previously made an assessment against Harvey for these liabilities on February 11, 2002.
The IRS granted Harvey's request for a consolidated CDP Hearing on the tax liabilities specified in the three sets of Pre-Levy Notices, covering five quarterly tax periods (ending September 30, 2000, December 31, 2000, March 31, 2001, June 30, 2001, and September 30, 2001). In addition, the IRS Appeals Officer agreed to consider at the hearing Harvey's requests for refund and abatement of penalties imposed since 1993. Harvey contends that the Appeals Officer also agreed to consider its request for abatement of penalties imposed for quarterly tax periods from January 1, 2002, through September 30, 2002, although the company did not submit a Form 843 request with respect to those periods.
At the November 2002 hearing, Harvey challenged all penalties imposed since 1993, claiming that it was entitled to abatement of those penalties for reasonable cause under 26 U.S.C. §§ 6651(a)(2) and 6656(a). It did not, however, challenge the underlying tax liabilities or the interest thereon. In a Notice of Determination dated April 21, 2003, the IRS found no reasonable cause for Harvey's delinquent payments in 2000 and 2001 and allowed collection activity against Harvey to proceed. The Notice of Determination did not reference liabilities incurred by Harvey for late payments for quarterly tax periods prior to 2000 or subsequent to 2001. Harvey appealed the IRS decision to this Court pursuant to 26 U.S.C. § 6330(d).
The parties agree that the Court has jurisdiction to conduct a de novo review of the outcome of the CDP Hearing. However, they dispute which IRS penalties are subject to judicial review. Harvey contends that the Court should review penalties imposed for quarterly tax periods from 1993 through September 30, 2002, because they were all properly raised and considered at the CDP Hearing. The IRS, on the other hand, IRS maintains that only the unpaid liabilities sustained by Harvey during four quarterly tax periods in 2000 and 2001 (ending September 30, 2000; December 31, 2000; March 31, 2001; September 30, 2001) referenced in the Pre-Levy Notices and Notice of Determination are subject to judicial review.
Neither party contends that the Court is authorized in the current action to review penalties imposed on Harvey for quarterly tax periods after September 2002.
As described above, the IRS originally issued Pre-Levy Notices regarding five quarterly tax periods. However, at the summary judgment hearing, counsel for the IRS stated that Harvey paid its liabilities for the June 30, 2001, quarterly tax period prior to the issuance of the Notice of Determination. Thus, the IRS contends that the issue of penalties from that period was moot at the time of the Notice of Determination, and that the Court lacks jurisdiction to review those penalties because the IRS is no longer seeking to collect them by levy. Harvey does not appear to dispute that its liabilities for the quarterly tax period ending June 30, 2001, have been paid in full.
Discussion
I. Standard of ReviewThe role of summary judgment is "to pierce the pleadings and to assess the proof in order to see whether there is a genuine need for trial." Mesnick v. General Electric Co., 950 F.2d 816, 822 (1st Cir. 1991) (quoting Garside v. Osco Drug, Inc., 895 F.2d 46, 50 (1st Cir. 1990)). The burden is upon the moving party to show, based upon the pleadings, discovery and affidavits, "that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c).
Once the moving party has satisfied its burden, the burden shifts to the non-moving party to set forth specific facts showing that there is a genuine, triable issue. Celotex Corp. v. Catrett, 477 U.S. 317, 324 (1986). The Court must view the entire record in the light most hospitable to the non-moving party and indulge all reasonable inferences in that party's favor. O'Connor v. Steeves, 994 F.2d 905, 907 (1st Cir. 1993). If, after viewing the record in the non-moving party's favor, the Court determines that no genuine issue of material fact exists and the moving party is entitled to judgment as a matter of law, summary judgment is appropriate.
II. Scope of Review
The threshold issue in this matter is the scope of the Court's jurisdiction. Specifically, the Court must decide whether it has jurisdiction to review all of Harvey's tax penalties for quarterly tax periods from March 1993 to September 2002, or only those penalties incurred for the four quarterly tax periods in 2000 and 2001 referenced in the Notice of Determination. In order to decide whether a particular penalty is properly subject to judicial review, the Court must determine whether Harvey has complied with the procedural requirements of the Internal Revenue Code for challenging that penalty in the District Court.
There are two possible paths to District Court review of employment tax penalties: the taxpayer may pay the tax and file a suit for a refund, or the taxpayer may appeal from a Notice of Determination after a CDP Hearing. See 26 U.S.C. §§ 6532(a), 7422(a), 6330(d). Although these actions entail several different procedural requirements, the principal difference between the two is that the tax penalty at issue must have been paid prior to the commencement of a refund suit, whereas the tax liability necessarily remains unpaid in an appeal of a Notice of Determination. The procedural prerequisites for each type of action are set forth in greater detail below. (A) Procedures for a Refund Suit
Generally, in order to challenge employment tax penalties, the taxpayer must pay the penalty (or a divisible portion of it) and, within two years of the payment, file an administrative claim with the IRS for refund of the tax paid (and abatement of the balance of the assessment, if necessary). 26 U.S.C. § 6511(a). The taxpayer may institute a refund suit in the District Court within two years from the date of the IRS's denial of the administrative claim, or after six months from the date the claim was filed if the IRS takes no action on the claim within that time. Id. § 6532. The IRS is not permitted to grant a refund unless the taxpayer files a refund claim. Id. § 6511(a). In turn, the taxpayer must file an administrative claim with the IRS before the District Court can hear the taxpayer's refund suit. Id. § 7422(a). Because the provisions of the Code authorizing refund suits constitute a limited waiver of the sovereign immunity of the United States, strict adherence to these procedural conditions and limitations is required. See United States v. Michel, 282 U.S. 656, 658 (1931); Abadi v. United States, 767 F. Supp. 249 (M.D. Fla. 1992).
Whereas the Tax Court has jurisdiction to hear prepayment challenges to income, gift, or estate tax liabilities, there is no designated forum for prepayment challenges to employment tax liabilities, including penalties imposed for delinquent payments. See, e.g., Moore v. Commissioner of Internal Revenue, 114 T.C. 171, 175 (2000).
Prior to paying the penalty and seeking a rebate, the taxpayer can request abatement from the IRS by filing a Form 843. Id. § 6404(a); 26 C.F.R. § 301.6404-1(c).
(B) Procedures for a Collection Due Process Hearing
If the taxpayer elects not to pursue a refund, and does not otherwise pay the employment tax penalty, the IRS may attempt to collect the penalty by levying upon the taxpayer's property. 26 U.S.C. § 6331(a). Taxpayers have a right to a CDP Hearing before the date of the proposed levy. Id. § 6330.
Before the IRS may collect the unpaid tax liability by levy, it is statutorily required to send the taxpayer (1) an initial notice and demand of payment, (2) a CDP Hearing Notice, and (3) a Final Levy Notice. Id. at §§ 6303, 6330(a)(1), 6331(d). The latter two must be sent no less than thirty days before the date of the levy. Id. at §§ 6330(a)(1), 6331(d). The CDP Hearing Notice must state the amount of the unpaid tax, advise the taxpayer of its right to request a hearing, and state the levy action the IRS proposes to undertake as well as the taxpayer's rights with respect to that action. Id. at § 6330(a).
Section 6330 of the Code provides that the taxpayer may raise any relevant issue at the hearing relating to the unpaid tax or proposed levy, including appropriate spousal defenses, challenges to the appropriateness of the collection action, and collection alternatives. Id. § 6330(c)(2)(A)(i)-(iii). In addition, the taxpayer may "raise at the hearing challenges to the existence or amount of the underlying tax liability for any tax period if the person did not receive any statutory notice of deficiency for such tax liability or did not otherwise have the opportunity to dispute such tax liability." Id. § 6330(c)(2)(B) (emphasis added).
The relevant Treasury regulations shed light on what is meant by "underlying tax liability" and "any tax period" in § 6330(c)(2)(B). The regulations explain that "the taxpayer may raise challenges to the existence or amount of the tax liability specified on the CDP Notice for any tax period shown on the CDP Notice if the taxpayer did not receive a statutory notice of deficiency for that tax liability or did not otherwise have an opportunity to dispute that tax liability." 26 C.F.R. § 301.6330-1(e)(1) (emphasis added).
For the purposes of § 6330(c)(2)(B), a person has received of a "statutory notice of deficiency" if he or she received notice in time to petition the Tax Court for redetermination of the deficiency asserted in the notice of deficiency. 26 C.F.R. § 301.6330-1(e)(3), A-E2. An "opportunity to dispute" under § 6330(c)(2)(B) includes a prior opportunity for a conference with the IRS Appeals Office that was offered either before or after the assessment of the liability. Id.
The Appeals Officer presiding over the CDP Hearing also has discretion to consider "precluded issues." Id. § 301.6330-1(e)(3), A-E11. However, any decision made by the Appeals Officer with respect to precluded issues "shall not be treated as part of the Notice of Determination issued by the Appeals Officer and will not be subject to any judicial review." Id. Even if a decision concerning precluded issues is included in the Notice of Determination, "it is not reviewable by a district court . . . because the precluded issue is not properly part of the CDP [H]earing." Id.
The Appeals Officer must issue a Notice of Determination with respect to challenges raised by the taxpayer at the CDP Hearing. The taxpayer then has thirty days to appeal this Notice of Determination to the Tax Court or the District Court, depending upon which court has jurisdiction over the tax liabilities at issue. 26 U.S.C. § 6330(d). Decisions of the Appeals Officer regarding employment tax liabilities must be appealed to the District Court. See id. §§ 6212(a), 6213(a); Moore, 114 T.C. at 175. The District Court's power of review under 26 U.S.C. § 6330(d) extends to all issues properly raised at the CDP Hearing. 26 C.F.R. 6330-1(f)(2), Q-F5 A-F5; Konkel v. Commissioner of Internal Revenue, 2000 WL 1819417, *3-*4 (M.D. Fla. 2000). (C) Whether Harvey Can Challenge Tax Liabilities Not Referenced in Pre-Levy Notices in the Current Action
The parties to this action agree that Harvey properly challenged the late payment penalties it incurred during the four quarterly tax periods in 2000 and 2001 at the CDP Hearing. Those penalties were properly contested because they were "tax liabilit[ies] specified on the CDP Notice for . . . tax periods[s] shown on the CDP Notice," 26 C.F.R. § 301.6330-1(e)(1), that Harvey never had a prior opportunity to dispute. Id.; 26 U.S.C. § 6330(c)(2)(B). The parties also agree that the District Court should conduct a de novo review of the Appeals Officer's determination that the tax penalties were not subject to abatement for reasonable cause.
In light of the Code procedures outlined above, the Court concludes that the withholding tax penalties assessed to Harvey, which were not referenced in the Pre-Levy Notices, cannot be reviewed in the instant action because they have been paid in full. The fact that these penalties have been paid requires denial of judicial review on two grounds: (1) Harvey's only recourse is to attempt to recover them through a refund action, rather than an abatement claim; and (2) Section 6330 of the IRC precluded the company from challenging them at its November 2002 CDP Hearing, and therefore they are not properly before the Court on appeal. These grounds are explained in greater detail below.
1. Harvey Must Bring a Refund Suit to Contest Paid Penalties in the District Court
The Code sets forth a specific process for obtaining a refund of tax liabilities that have already been paid. It is through the refund procedure alone that the government has agreed to waive its sovereign immunity to permit the taxpayer to sue for a rebate of paid penalties. Accordingly, the District Court cannot permit the taxpayer to challenge paid penalties in conjunction with an appeal from Notice of Determination without completely undermining the Code's mandatory procedures.
Harvey's tax liabilities for the years in question, other than those specified on the Pre-Levy Notices, have been paid in full. That fact is made clear from the IRS transcripts of the company's tax transactions for the relevant time periods. Thus, the company's only option is to prosecute a refund action to recover those penalties.
The issue of whether a particular refund claim is timely at this point will depend upon when Harvey paid the penalty it seeks to recoup. The Court takes no position on whether or to what extent Harvey has fulfilled the procedural prerequisites for a refund suit.
In an attempt to avoid this conclusion, Harvey contends that it has not actually paid its withholding tax penalties from March 1993 through June 2000 and December 2001 through September 2002. IRS records suggest otherwise, the company insists, because the IRS has improperly applied the payments it earmarked for underlying taxes and interest to its previous unpaid tax penalties. See Harvey Affidavit, ¶ 22.
The IRS denies this and has submitted excerpts from the Internal Revenue Manual and its Procedural Regulations setting forth the IRS's policy to apply designated payments as directed by the taxpayer and payments unaccompanied by specific directions from the taxpayer in the manner that will best serve the IRS's interests. The IRS maintains that it consistently complied with this policy in its application of Harvey's payments.
Harvey has submitted no contrary evidence. It has not, for example, offered copies of letters to the IRS accompanying its payments that direct the IRS to apply its payments in some different manner. The company's argument that the IRS improperly applied its payments, without more, is insufficient to create a material factual dispute. Because the uncontroverted evidence indicates that Harvey paid tax penalties for the relevant periods, Harvey can only challenge those penalties through a refund suit, not through the present action.
2. 26 U.S.C. § 6330 Did Not Authorize Harvey to Challenge Penalties Not Shown on Pre-Levy Notices at the CDP Hearing
The provisions of 26 U.S.C. § 6330, which govern the conduct of IRS collection activity and CDP Hearings, likewise do not permit Harvey to challenge penalties not set forth in the Notice of Determination. Section 6330 affords the taxpayer a hearing on unpaid tax liabilities that the IRS intends to collect through levy. It does not permit a taxpayer to challenge paid taxes that the IRS has no need or intention to collect through levy at a CDP Hearing.
Harvey rejects this conclusion, citing the portion of 26 U.S.C. § 6330(c)(2)(B) that states that a taxpayer may challenge "the underlying tax liability for any tax period" at a CDP Hearing. This language, the company contends, authorized it to contest any of its tax liabilities at the November 2002 CDP Hearing, and in turn, allows the Court to review any penalty considered at the hearing.
The most glaring problem with the company's broad reading of § 6330(c)(2)(B) is that it would allow taxpayers to ignore the refund process and recover paid taxes without any waiver of the government's sovereign immunity. The Court cannot impute a meaning to § 6330(c)(2)(B) that would put it in direct conflict with the statutory provisions regarding refunds.
Assuming arguendo that the Court could turn a blind eye to this inconsistency, § 6330 would still preclude the taxpayer from challenging liabilities not referenced in Pre-Levy Notices at a CDP Hearing. The language of § 6330(c)(2)(B) stating that a taxpayer can challenge tax liabilities "for any tax period" must be read in light of the other provisions of § 6330 and the corresponding Treasury regulations.
Section 6330(c)(2)(A) provides that, at a CDP Hearing, a taxpayer may raise issues relating to the unpaid tax or proposed levy, such as spousal defenses, the appropriateness of the collection action, and collection alternatives. This provision is immediately followed by § 6330(c)(2)(B), which affords the taxpayer an opportunity to raise challenges to the unpaid tax liability itself, in addition to issues relating to the liability.
This authorization is conditioned on the taxpayer's not having had a prior opportunity to dispute the liabilities shown on the notices. Id.
The regulations promulgated under § 6330 indicate that the phrase "any tax period" in § 6330(c)(2)(B) was not meant to function as an open-ended invitation to raise complaints at a CDP Hearing. Rather, § 6330(c)(2)(B) allows the taxpayer to contest "the existence or amount of the tax liability specified on the CDP notice for any tax period shown on the CDP notice." 26 C.F.R. § 301.6330-1(e)(1) (emphasis added).
In other words, § 6330(c)(2) authorizes the taxpayer to challenge the unpaid tax liabilities shown on the Pre-Levy Notices, as well as issues relating to those liabilities. It does not, as Harvey argues, give taxpayers license to contest any tax liability at a CDP Hearing. The Hearing is not a forum to recoup paid taxes, or for that matter, to challenge any tax liability other than those that the IRS has given notice of its intent to collect through levy. The IRS's notification of its intention to collect unpaid liabilities triggers the taxpayer's right to a hearing. The scope of the hearing is, in turn, limited to the content of the Pre-Levy Notices, as is the scope of the District Court's review.
Morever, it is irrelevant, for the purposes of judicial review, that the IRS Appeals Officer agreed to consider Harvey's challenges to tax penalties that were not properly the subject of the CDP Hearing. The Appeals Officer, in his or her sole discretion, is entitled to consider issues precluded under § 6330. The District Court is, however, prohibited from reviewing such issues, regardless of whether they were considered at the hearing or referenced in the Notice of Determination.
In summary, Harvey was not authorized under § 6330 to challenge tax penalties incurred from March 1993 through June 2000 and December 2001 through September 2002 at the CDP Hearing, because these penalties were paid and were not referenced in Pre-Levy Notices. The Appeals Officer's decision to entertain Harvey's arguments regarding these liabilities was entirely within his discretion and does not serve to expand the District Court's jurisdiction on appeal. The Court will therefore confine its review to the question of whether there is reasonable cause to abate penalties incurred during the quarterly tax periods ending on September 30, 2000; December 31, 2000; March 31, 2001; and September 30, 2001.
The Court notes that, even if § 6330 permitted Harvey to challenge liabilities not referenced in Pre-Levy Notices (which it did not), it appears from the record that Harvey had a prior opportunity to dispute many those liabilities. IRS records show that, in many of the tax periods in which Harvey incurred penalties for delinquent employment tax payments, the company was issued Notices of Intent to Levy. Under § 6330, a notification of the taxpayer's right to a CDP Hearing must be issued, along with a Notice of Intent to Levy, at least thirty days prior to the collection date. The evidence suggests, therefore, that Harvey had a prior opportunity to dispute many of the tax penalties not shown on the Pre-Levy Notices and collection due process notice, and, as a result, was precluded from challenging those penalties at the CDP Hearing under § 6330(c)(2)(B).
III. Reasonable Cause
The Court must conduct a de novo review of the IRS's determination that Harvey lacked reasonable cause for its failure to timely pay its employment taxes during the four quarterly tax periods at issue. In this endeavor, the Court must first decide whether a taxpayer's financial distress can ever constitute reasonable cause for delinquent payment of employment taxes. If it decides this question in the affirmative, it must then proceed to determine whether Harvey's financial circumstances gave it reasonable cause for its untimely employment tax payments. The determination of whether financial problems can create reasonable cause presents an issue of law, whereas the inquiry into whether Harvey's financial problems gave it reasonable cause presents an issue of fact. See East Wind Industries, Inc. v. United States, 196 F.3d 499, 504 (3d Cir. 1999).
(A) Whether Financial Difficulties Can Create Reasonable Cause as a Matter of Law
In resolving the legal issue, the Court must first consult the language of the Code and implementing Treasury regulations. The Code requires employers to withhold FICA and income taxes from their employees' salaries and to hold these taxes — often called "trust fund taxes" — in trust for the United States. 26 U.S.C. §§ 3101, 3102(a)-(b), 3111, 3402, 3403, 7501; see East Wind, 196 F.3d at 505. The employer must transfer these withheld taxes to a government depository according to the payment schedule prescribed by the Treasury regulations. Id. § 6302; 26 C.F.R. § 31.6302(c)-1. In addition, employers are required to pay a FICA tax with respect to each of their employees. 26 U.S.C. § 3111(a). When an employer files its quarterly tax return, it must make full payment of all FICA taxes owed for that quarter. Id. § 6151; 26 C.F.R. § 31.6151-1(a).
The Code imposes mandatory penalties on taxpayers who fail to deposit or pay employment taxes by the statutorily-prescribed deadline, unless the taxpayer can demonstrate that its failure to comply with the regulations was due to "reasonable cause and not due to willful neglect." 26 U.S.C. §§ 6651(a)(2), 6656(a). In construing the penalties provisions of the Code, the Supreme Court has observed that taxpayers seeking waiver of penalties for failure to deposit bear the " heavy burden of proving both (1) that the failure did not result from `willful neglect,' and (2) that the failure was due to reasonable cause." United States v. Boyle, 469 U.S. 241, 245 (1985) (emphasis added).
In Boyle, the Supreme Court defined "willful neglect" as "conscious, intentional failure or reckless indifference." Id. The taxpayer's behavior must be particularly egregious to warrant a finding of willful neglect. For example, in East Wind, the court held that the taxpayers had not willfully neglected to pay their employment taxes on time, despite the fact that they participated in the bribery scheme that led to their financial predicament. 196 F.3d at 508. It reasoned that, although the taxpayers "were not entirely innocent, their financial viability and cash flow was entirely dependent on the corrupt employees" of their business partner. Id. If a court can decide an abatement claim based on a finding of reasonable cause, or lack thereof, it need not reach the issue of willful neglect. See, e.g., Fran, 164 F.3d at 819.
Boyle addressed penalties for failure to file a return under § 6651(a)(1), not failure to deposit taxes under §§ 6651(a)(2) and 6656 (the provisions implicated in this action). Nonetheless, because the standard for exemption from penalties is identical in all three provisions, the definition of "willfulness" likewise should be identical. See Fran Corp. v. United States, 164 F.3d 814, 815 (2d Cir. 1999).
Whereas the definition of "willful neglect" is fairly well-settled, there is a good deal of controversy surrounding the definition of "reasonable cause" in §§ 6651 and 6656 of the Code. The Treasury regulations provide some insight into the meaning of reasonable cause. They state, in pertinent part, as follows:
If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to a reasonable cause. A failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship (as described in § 1.6161-1(b) of this chapter) if he paid on the due date.26 C.F.R. § 301.6651-1(c)(1). The phrase "undue hardship" is defined as
. . . [M]ore than an inconvenience to the taxpayer. It must appear that substantial financial loss, for example, loss due to the sale of property at a sacrifice price, will result to the taxpayer from making payment on the due date of the amount with respect to which the extension is desired. If a market exists, the sale of property at the current market price is not ordinarily considered as resulting from an undue hardship.26 C.F.R. § 1.6161-1(b) (emphasis added).
The regulations instruct those assessing whether the taxpayer "exercised ordinary business care and prudence" to consider
. . . [A]ll the facts and circumstances of the taxpayer's financial situation, including the amount and nature of the taxpayer's expenditures in light of the income (or other amounts) he could, at the time of such expenditures, reasonably expect to receive prior to the date prescribed for the payment of the tax. Thus, for example, a taxpayer who incurs lavish or extravagant living expenses in an amount such that the remainder of his assets and anticipated income will be insufficient to pay his tax, has not exercised ordinary business care and prudence in providing for the payment of his tax liability. Further, a taxpayer who invests funds in speculative or illiquid assets has not exercised ordinary business care and prudence in providing for the payment of his tax liability, unless, at the time of the investment, the remainder of the taxpayer's assets and estimated income will be sufficient to pay his tax or it can be reasonably foreseen that the speculative or illiquid investment made by the taxpayer can be utilized (by sale or as security for a loan) to realize sufficient funds to satisfy the tax liability. A taxpayer will be considered to have exercised ordinary business care and prudence if he made reasonable efforts to conserve sufficient assets in marketable form to satisfy his tax liability and nevertheless was unable to pay all or a portion of the tax when it became due.26 C.F.R. § 301.6651-1(c)(1) (emphasis added).
Finally, the regulations dictate that
In determining if the taxpayer exercised ordinary business care and prudence in providing for the payment of his tax liability, consideration will be given to the nature of the tax which the taxpayer has failed to pay. Thus, for example, facts and circumstances which, because of the taxpayer's efforts to conserve assets in marketable form, may constitute reasonable cause for nonpayment of income taxes may not constitute reasonable cause for failure to pay over taxes described in section 7501 [trust fund taxes] that are collected or withheld from any other person.26 C.F.R. § 301.6651-1(c)(2).
The parties dispute whether financial distress can constitute reasonable cause under the foregoing regulations. The IRS contends that financial difficulties are never reasonable cause for late payment of employment taxes under the Treasury regulations, whereas Harvey contends that the regulations require the Court to account for a taxpayer's financial circumstances in determining whether to waive penalties for reasonable cause. The parties' dispute tracks a disagreement among the Circuits over the issue.
The Sixth Circuit was the first to confront the question in Brewery, Inc. v. United States, 33 F.3d 589 (6th Cir. 1994). The court in Brewery espoused the current minority view that abatement of penalties is per se inappropriate when the taxpayer's reason for delinquency is financial difficulty. Id. at 592. In reaching this conclusion, it cited 26 C.F.R. § 301.6651-1(c)(2), which suggests that a taxpayer's failure to pay its own income taxes may be easier to justify under the reasonable cause standard than the taxpayer's failure to deposit employment taxes. See Id.; 26 C.F.R. § 301.6651-1(c)(2). The court interpreted this regulation to mean that "facts and circumstances required to establish reasonable cause must be particularly compelling" where trust fund taxes have not been seasonably deposited. 33 F.3d at 592. In light of this heightened standard, the court concluded that "financial difficulties can never constitute reasonable cause to excuse the penalties for nonpayment of withholding taxes by an employer." Id. Further, it stipulated that "`[i]t is no excuse that . . . the money was paid to suppliers and for wages in order to keep the corporation operating as a going concern — the government cannot be made an unwilling partner in a floundering business.'" Id. at 593 (quoting Collins v. United States, 848 F.2d 740 (6th Cir. 1988)).
Every Circuit to address the issue since Brewery has rejected the bright line rule followed by the Sixth Circuit in favor of a case-by-case assessment of reasonable cause that takes account of the taxpayer's financial situation. See Fran, 164 F.3d at 818; East Wind, 196 F.3d at 506, 508; Van Camp v. United States, 251 F.3d 862, 868 (9th Cir. 2001). In Fran, the Second Circuit held that the Brewery Court's categorical approach to financial circumstances "finds no support in either the penalty provisions of the [IRC] or in the longstanding Treasury Regulations drafted to implement those provisions." 164 F.3d at 818.
The Fran court departed from Brewery out of a belief that the categorical approach would defeat the purpose of the reasonable cause exception and the relevant Treasury regulations. Id.; East Wind, 196 F.3d at 507. The court reasoned that the Code's penalty provisions do not differentiate between employment taxes and other taxes in promulgating the reasonable cause standard. Indeed, § 6656, which specifically addresses the failure to deposit employment taxes, contains a reasonable cause standard. Fran, 196 F.3d at 818. Moreover, the court pointed out that the Treasury regulations direct those assessing reasonable cause to consider "all the facts and circumstances of the taxpayer's financial situation," and to determine whether the taxpayer would suffer "undue hardship," i.e. substantial financial loss, from the timely payment of taxes. Id. at 818. Thus, it concluded, courts are obligated to conduct a factual assessment of the taxpayer's financial situation to determine whether it has exercised ordinary business care and prudence in juggling IRS obligations and competing financial commitments. Id. at 819.
The court also noted that the reasonable cause/willful neglect standard has been part of the penalty provisions of the tax code since 1916. It suggested that the survival of these provisions in their original form evinces continuing congressional ratification of a uniform reasonable cause standard, applicable to employment and non-employment tax payments alike. Id. at 818. Moreover, the court pointed out that the Treasury Regulations mandating that courts account for the taxpayer's financial situation and financial loss in assessing reasonable cause have remained unchanged since 1973. Id. Because the regulations are "long continued without substantial change [and] appl[y] to unamended or substantially reenacted statutes," the court observed, they "are deemed to have received congressional approval and have the effect of law." Id. (quoting Cottage Savings Ass'n. v. Commissioner, 449 U.S. 554, 561 (1991)).
The Fran court also dismissed the Brewery court's reliance on 29 C.F.R. § 301.6651-1(c)(2) to support a per se rule precluding a finding of reasonable cause for delinquent employment tax payments due to financial difficulties. "That provision," the court remarked, "simply requires that we consider, among other factors in our analysis of the taxpayer's care and prudence, `the nature of the tax which the taxpayer has failed to pay,' and provides an illustrative example. . . ." 164 F.3d at 819. Thus, although courts must account for the type of tax at issue in a request for abatement of penalties, the fact that the challenge is to penalties for late payment of trust fund taxes does not bar a finding of reasonable cause after consideration of all factors identified in the regulations. Id. "[T]o hold otherwise," the court opined, "would effectively read out of the statute the `reasonable cause' exception to mandatory penalties in many employment tax cases." Id.; see Van Camp, 251 F.3d 862, 867-868 (rejecting Brewery and adopting the reasoning and holding of Fran in a refund action); East Wind, 196 F.3d at 508 (endorsing the Fran approach because "it gives meaning to sections 6651 and 6656 and the regulations interpreting them [whereas] Brewery forecloses consideration of the facts and circumstances of the taxpayers' financial situation in contravention of the clear language of Treas. Reg. § 301.6651-1(c)(1)").
The Court concludes that the approach adopted in Fran, which has since become the majority rule, is the correct one. A case-by-case approach, which takes account of all the facts and circumstances of the taxpayer's financial situation, best comports with the language of the Code and the regulations.
(B) Whether Harvey's Financial Situation Gave It Reasonable Cause for Late Employment Tax Payments
The Court must now determine whether Harvey can meet the "heavy burden" of showing that its financial circumstances gave it reasonable cause for failing to make timely payments during the four quarterly tax periods in 2000 and 2001. See, e.g., East Wind, 196 F.3d at 508. If the evidence establishes that Harvey exercised ordinary business care and prudence or that the company would have suffered undue hardship from paying its employment taxes on schedule, then reasonable cause existed for its failure to pay the taxes, and abatement of penalties is warranted. See Id.
In determining whether a finding of reasonable cause can be grounded on the facts of the present case, it is useful to review how other courts have treated abatement requests. In Fran, the plaintiff taxpayer, an electrical contracting company, failed to pay one-half of its employment taxes on schedule for five quarters between April 1993 and June 1994. 164 F.3d at 815. During this period, the company lacked sufficient assets to pay all of its creditors due to the withholding of payments owed to it under two major contracts. Id. The company eventually managed to obtain a bank loan to pay its taxes, and by October 1995, paid the entire balance of taxes, interest, and penalties it owed from April 1993 to June 1994. Id. In early 1997, the company filed a claim in the District Court for a refund of the penalties, arguing that it had reasonable cause under 26 U.S.C. §§ 6651(a)(2) and 6656(a) for late payment of employment taxes from April 1993 to June 1994. Id.
The court held that the company failed to exercise ordinary business care and prudence in its financial dealings and thus failed to show reasonable cause for its late employment tax payments. 264 F.3d at 819. It based this conclusion, principally, on the taxpayer's "failure to provide any evidence to show that it placed its obligations to the IRS before those to any and all creditors not directly related to the two projects that defaulted." Id. at 820. Because the taxpayer could not show that it subverted its tax obligations only to those expenditures which kept it in business, the court denied the company's request for abatement. Id.
The court specifically cited the taxpayer's decision to pay (1) $3,500 per month in rent to the taxpayer's president, despite an outstanding loan of $148,636.89 made by the company to the president; (2) automobile leases and repair costs; and (3) costs associated with golf and hockey outings and two dinner dances, as indicative of the company's imprudent management of funds from 1993-1994. Id. at 819-820. The court agreed with the lower court's characterization of certain of these expenses as "lavish or extravagant" under 26 C.F.R. 301.6651-1(c)(1), because the preservation of the business did not depend upon them. Id. at 820.
In contrast to Fran, the rather unique facts of East Wind created what the court described as "that rare situation . . . where the Taxpayers should be relieved of the penalty for failing to pay and deposit employment taxes when due." 196 F.3d at 513. The case involved two corporate taxpayers, who, prior to 1982, dealt exclusively with agencies of the United States Defense Department and participated in a bribery scheme with employees of those defense agencies. Id. at 509, 513. However, when the taxpayers decided to stop participating in the scheme, the defense agencies retaliated by refusing to give the taxpayers new contracts and withholding payments owed to the taxpayers for work performed and goods delivered under existing contracts. Id. at 502. These retaliatory actions caused the taxpayers to fall behind in their employment tax payments from 1982-1988. Id. During this period, the taxpayers took several actions against the defense agencies, including filing a lawsuit against them, contacting the Defense Department's legal staff, and cooperating with an FBI investigation of the bribery scheme. Id. at 502-503. In 1991, the taxpayers received a settlement from the defense agencies, out of which they paid all of their outstanding employment taxes, interest, and penalties from 1982-1988. Id. at 503. They subsequently sought a refund of the penalties pursuant to 26 U.S.C. §§ 6651(a)(2) and 6656(a) on the grounds that their financial difficulties gave them reasonable cause for late withholding tax payments during that time frame. Id.
The court held that the taxpayers had reasonable cause for delinquent employment tax deposits, in part because timely payments would have caused the taxpayers undue hardship from financial loss. 196 F.3d at 509. The court pointed out that officers of the taxpayer corporations incurred substantial personal debt, in the form of loans and mortgages, in order to stay in business during their delinquency. Id. at 509.
Moreover, in contrast to the company in Fran, the taxpayers paid only the work force and creditors necessary to avert bankruptcy, and even decided to forego rent payments. Had the taxpayers "paid their employment taxes when due," the court concluded, "they would have had insufficient funds to pay the reduced work force and essential creditors to enable them to remain a going concern." Id.; see also Van Camp, 251 F.3d at 868 (reversing the district court's adoption of Brewery and instructing the court on remand to consider the fact the financial difficulties facing the taxpayer "created a great financial strain . . . to the extent there was some question whether the corporation would survive"); In Re Pool Varga, 60 B.R. 722, 728 (E.D. Mich. 1986) (reasonable cause demonstrated where the evidence showed that the taxpayer would have had to terminate its business and liquidate in order to pay the taxes); Glenwal-Schmidt v. United States, 1978 U.S. Dist. Lexis 16635, *5 (D.D.C. 1978) (finding reasonable cause where contractor elected to pay only those subcontractors and suppliers necessary to avoid default on its contract). There are significant limitations on the extent to which general principles can be distilled from a small sample of cases that are necessarily fact-bound. Nonetheless, courts have clearly been more sympathetic where the taxpayer faced a real choice between making payments to the IRS and going out of business, and (1) the duration of the financial crisis was relatively limited in time; (2) the occurrence of one or more specific contingencies (such as payment of a contractual obligation) was expected to alleviate the crisis; (3) the taxpayer was prioritizing creditors and marshaling personal and other resources in order to avoid going out of business; and (4) the taxpayer was not unfairly enriching itself (or its owners) or unfairly favoring other creditors ahead of the IRS.
Here, Harvey has failed to meet its "heavy burden" of demonstrating reasonable cause for the abatement of penalties. Boyle, 496 U.S. at 245. While it is apparent that the company faced a genuine financial crisis, that crisis was not a one-time event of short duration. The Amherst contract dispute was settled in 1997, long before the periods at issue here; Harvey was neither enmeshed in a contract dispute, nor denied funds owed to it by another business entity, during 2000 and 2001. Compare East Wind, 196 F.3d at 509-510; Glenwal-Schmidt, 1978 U.S. Dist. Lexis at *5.
Because the Court can resolve the IRS's present motion based on Harvey's failure to show reasonable cause for the liabilities at issue, it need not reach the question of whether Harvey engaged in willful neglect. See Fran, 164 F.3d at 819.
The company contends that it continues to feel the negative financial affects of the Amherst dispute to the present day. However, allowing a past contract dispute to serve as the basis for excusing penalties incurred by the taxpayer long after the resolution of that dispute would substantially undermine the "reasonable cause" exception. There must be temporal proximity between the taxpayer's untimely payments and the pendency of the contract dispute. See Fran, 164 F.3d at 815; Glenwal-Schmidt, 1978 U.S. Dist. Lexis at *5; East Wind, 196 F.3d at 502. After the passage of time, the company may no longer be said to be suffering from an acute condition (a short-term financial crisis) but a chronic one (a long-term inability to meet its obligations except by unauthorized borrowing from the Treasury).
The company claimed in its September 10, 2001, letter to the IRS that "[O]ne of the consequences of Amherst withholding monies due [Harvey] under the contract has been [Harvey's] struggle, over the last five years, to remain in business." Hershman Affidavit, Exhibit 2. More recently, the company stated that it "has been fighting the tide since the Amherst disaster." Harvey Affidavit, ¶ 21.
Moreover, Harvey has not established that it was incapable of paying the IRS on schedule during 2000-2001 or that doing so would have put the company out of business. Compare East Wind, 196 F.3d at 509; In Re Pool Varga, 60 B.R. at 727, Van Kamp, 251 F.3d. at 868. To the contrary, the company admits that it became profitable again in the years following the Amherst dispute, and insisted, at the summary judgment hearing, that it is not a failing business. See Harvey Affidavit, ¶¶ 20, 22. The company has not introduced proof as to which creditors it paid, and which it ignored, in order to avert default or bankruptcy during 2000-2001. See Fran, 164 F.3d at 819-820; compare East Wind, 196 F.3d at 509. There is no indication that the company's owners used personal funds in order to keep the business afloat during 2000-2001. Compare East Wind, 196 F.3d at 509. While there is no evidence that Harvey made frivolous or extravagant expenditures during 2000-2001, the mere absence of such evidence in no way obviates the company's burden to put forth affirmative evidence that financial distress gave it reasonable cause to make late payments. See Boyle, 496 U.S. at 245.
The fact that company officers expended personal funds to avert bankruptcy in the mid-1990's, during the Amherst dispute, is not indicative of undue financial hardship in 2000 and 2001.
It also bears noting that Harvey's request for exemption from penalties arises from the IRS's attempt to collect the company's unpaid debts, rather than from a refund suit brought subsequent to full payment of the tax liabilities at issue. Compare, e.g., East Wind, 196 F.3d at 500-501; Fran, 164 F.3d at 815. Harvey's failure to fulfill its tax obligations, even after its finances improved and the Amherst dispute settled, militates against a finding that the company exercised reasonable business care and prudence from 2000-2001. Moreover, here, unlike in East Wind and Glenwal-Schmidt, the government bears no responsibility for the taxpayer's financial distress. See East Wind, 196 F.3d at 512-513; Glenwal-Schmidt, 1978 U.S. Dist. at *9.
The Court is cognizant of Harvey's claim that it received demonstrably less in its settlement with Amherst than it had expected to receive under the contract. However, the settlement shortfall is offset by Harvey's admissions that it became profitable after the dispute was resolved and that the economic atmosphere became more conducive to the contracting business in the late 1990's.
At best, Harvey can demonstrate that "times were tough" in 2000 and 2001. See In Re Pool Varga, 60 B.R. at 727. However, this explanation, without more, is not sufficient to demonstrate reasonable cause for abatement of withholding tax penalties. Acceptance of Harvey's explanation would substantially lower the bar to abatement of employment tax penalties, in contravention of the directive in the Treasury regulations to apply heightened scrutiny to late payment of trust fund taxes. See 26 C.F.R. 301.6651-1(c)(1). In short, this is not an example of "that rare situation," East Wind, 196 F.3d at 513, where a taxpayer's financial difficulties justifies a waiver of employment tax penalties. Accordingly, the Court will grant the IRS's motion for summary judgment on Harvey's complaint appealing from the Notice of Determination dated April 23, 2003, and otherwise seeking an abatement of penalties incurred for quarterly tax periods ending on September 30, 2000; December 31, 2000; March 31, 2000; and September 30, 2001.
Order
For the foregoing reasons, the motion of the Internal Revenue Service for summary judgment in its favor is GRANTED.
So Ordered.