TAX COURT WEIGHS IN ON LIEN ISSUE

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1 DAN PILLA OCT TAX COURT WEIGHS IN ON LIEN ISSUE IRS Abused its Discretion in Connection with a Lien As the recession deepened over the past several years, the number of federal tax liens filed by the IRS has increased substantially. The number lien filings has increased by over 550 percent in the past eleven years, from about 168,000 in 1999 to nearly 1.1 million in Anybody with a federal tax lien filed against them knows the lien can be debilitating. A filed tax lien can lead to the termination of an open line of credit. A lien can cause a person s credit score to drop by as much as 100 points. People working in the financial industry or other "high-risk" jobs can fall under scrutiny. People requiring professional licenses may not be able to secure them. Ultimately, and ironically, the presence of the lien may actually prevent the IRS from collecting the tax. That s exactly what happened with the employment taxes owed by Alessio Azzario, Inc., a New Jersey home construction company ravaged by the recession. Alessio was behind on employment taxes for periods during 2005 and In January 2007, Alessio obtained a revolving line of credit from a local bank that gave Alessio access to up to $1 million. The line of credit was secured by Alessio s accounts receivable and certain other assets. The line of credit allowed Alessio to begin making payments on the delinquent taxes and to stay current on employment taxes going forward. But in November 2007, the IRS filed a tax lien against Alessio. Once the bank became aware of the federal tax lien, it pulled Alessio s line of credit. Without the line of credit, Alessio would not be able to stay current on its employment taxes going forward because of the fact that its own customers lagged behind on the payments due Alessio. The bank was willing to restore the line of credit, but only if the IRS would subordinate its lien to the bank s claim. That way, the bank would have the first claim to Alessio s receivables. 1

2 In response to the lien filing, Alessio submitted Form 12153, Request for Collection Due Process Hearing, to the IRS seeking: 1) subordination of the lien to the bank s claim against the receivables, and 2) an installment agreement on the delinquent taxes. Months went by before Alessio had a CDP hearing. Prior to the hearing, Alessio submitted documents to the IRS s Settlement Officer showing two different cash flow projections, one with the financing arrangement restored and the other without. Alessio also provided details on the proposed installment agreement given Alessio s current financial condition. Alessio argued that if the IRS would subordinate its lien to the bank s claim, the bank would restore the financing agreement and Alessio could be profitable going forward. Alessio was current on its employment taxes for the first two quarters of 2008, subsequent to the filing of the CDP request in late However, because the bank pulled the plug on Alessio s line of credit, the company began falling behind again, starting in the third quarter of The Settlement Officer complained that if Alessio did not get current with the employment tax deposits, they would not qualify for an installment agreement. Alessio argued that it was "severely hurt" by the inability to borrow money due to the presence of the tax lien. Alessio assured the SO that it could get and keep current going forward if the line of credit were restored. Alessio s financial projections supported the claim. The SO issued a determination letter in late It stated that Alessio did not qualify for an installment agreement because it had not remained current with employment tax deposits. The SO did not address the request to subordinate the lien. Alessio filed a Tax Court case challenging the IRS s determination as an abuse of discretion. The Tax Court ruled in Alessio s favor. The Lien Subordination The Tax Court pointed to two specific authorities in finding that the IRS abused its discretion in connection with the lien subordination request. The first is code section 6325(d)(2). This section allows the IRS to 2

3 subordinate a tax lien to another secured claim if: the Secretary believes that the amount realizable by the United States from the property to which the certificate relates, or from any other property subject to the lien, will ultimately be increased by reason of the issuance of such certificate and that the ultimate collection of the tax liability will be facilitated by such subordination * * * The second authority the Tax Court referenced is Internal Revenue Manual (IRM), section (4) (Dec. 14, 2007). There, the IRS s own guidelines instruct: The Service must exercise good judgment in weighing the risks and deciding whether to subordinate the federal tax lien. The Service s judgment is similar to the decision that an ordinarily prudent business person would make in deciding whether to subordinate his/her rights in a debtor s property in order to secure additional long run benefits. Based upon the above, the Tax Court observed that, In a collection due process hearing in which the taxpayer has requested that the Federal tax lien be subordinated, it is the task of the IRS Appeals Office to determine whether subordination will ultimately facilitate collection of the tax liability. The IRS s Settlement Officer didn t do that. Rather, he made the errant decision that the IRS could not subordinate its lien. Moreover, the SO determined that Alessio was not entitled to an installment agreement because it was not current. The Installment Agreement The IRS argued to the Tax Court that the question of whether the SO should have considered the subordination was irrelevant because even if the IRS had subordinated the lien, Alessio would still have been ineligible for the installment agreement because they were not current. Naturally, the IRS cited a legion of court decisions in CDP cases in which it was determined that a taxpayer who s not currently in compliance is ineligible for a collection alternative. 3

4 The Tax Court curtly rejected the IRS s argument. In doing so, the court state: [I]n the other previous cases in which we have upheld the Commissioner s rejection of collection alternatives because the taxpayers had failed to satisfy current tax obligations, the Commissioner had done nothing to contribute to the taxpayers failures to remain current with their tax liabilities. In contrast, respondent s abuse of discretion contributed to petitioner s failure to make timely tax deposits. Said another way, it was the IRS s fault that Alessio fell behind on its tax deposits for periods beginning in late It was the IRS s lien that caused the bank to pull the plug on Alessio s line of credit. Moreover, the IRS s Settlement Officer failed to apply the law properly (or rather, at all) in considering whether to subordinate the IRS s lien to the bank s claim. If the IRS had done its job, Alessio would not have fallen further behind. Making its point even clearer, the Tax Court observed: We do not accept [the IRS s] argument that [the Settlement Officer s] decision regarding subordination of the tax lien is irrelevant. Indeed, accepting [the IRS s] contention would be tantamount to granting [the IRS] the power to abuse its discretion at will as long as petitioner eventually misses a deposit on its employment taxes. In situations similar to the instant case, where [taxpayer s] business is in a dire position largely due to industry conditions beyond its control, the Commissioner s decision not to subordinate a [tax lien] could exacerbate taxpayers cash flow problems and make it difficult, if not impossible, for taxpayers to remain current with their tax deposits while continuing to run their businesses. The Commissioner could hold off issuing a notice of determination indefinitely until the taxpayer missed a deposit, and the Commissioner could then refuse to grant an installment agreement on the basis of the taxpayer s failure to remain current with its tax deposits. Because the taxpayer would have already fallen behind on current tax liabilities, we would be unable to meaningfully review the Commissioner s decision not to subordinate the [tax lien]. We find such a scenario unacceptable. 4

5 The IRS insisted here, as it does in all CDP cases, that the taxpayer must be current with tax payments to allow an installment agreement. The Court agreed that the IRS may not authorize an installment agreement until a taxpayer is current with its tax deposits. But the Court went on to say: However, nothing in the Code, the regulations, the IRM, or our decisions requires that the Commissioner deny the taxpayer s request for an installment agreement simply because it is not, at that moment, current with its Federal tax deposits. The Commissioner could, instead, wait until the taxpayer is current and then enter into the installment agreement. Even when an installment agreement is in place and the taxpayer fails to remain current with its tax liabilities, the Commissioner is not required to terminate the agreement; rather, he has the discretion to do so. Rev. Reg. sec (c)(2); emphasis added. What exactly does this mean? Very simply, the IRS should work with taxpayers so that the agency can enter into installment agreements when the circumstances justify. Just because a taxpayer is not current "at that moment" does not mean he cannot get current in the near future if the IRS would cooperate. For more details on getting and staying current, see my Tax Amnesty Package. I believe the Tax Court is saying to the IRS, "get the boot off the neck so taxpayers can get current, then enter into an installment agreement or other collection alternative." Taxpayers must be given an "opportunity to become current" before the IRS just brushes the case out the door, saying "relief denied". Proving the Case I have stated many times over the years that you must think like a prosecutor when it comes to CDP cases. The taxpayer has the burden of proof in CDP cases. The IRS has no burden when it comes to collection alternatives. That is, the IRS doesn t have to prove you re not entitled to lien or levy relief. Rather, you must prove that you are entitled to such relief. The IRS s settlement officers generally do nothing more than "play goalie" in connection with your case, finding reasons to kick away your proposals rather than 5

6 finding reasons to accept them. We can learn from what Alessio did to prove its case. Consider the following: 1. Alessio presented two different cash flow projections to the SO. The first showed what will happen if the lien was not subordinated, and the second showed what will happen if the lien was subordinated. From these projections, Alessio argued that the subordination of the lien would "facilitate collection of the tax". 2. Alessio presented data to show that they could remain current going forward. Specifically, they showed that: a) they cut payroll substantially by laying off employees, b) they implemented specific cost-cutting strategies in other areas, and c) they moved their business into areas other than the depressed new home construction market. 3. Allesio provided documentation from the bank showing that: a) the bank terminated the line of credit due only to the presence of the federal tax lien, and b) the bank would indeed reinstate the lending arrangement if the lien were subordinated. 4. Allesio provided a specific plan to show how the current taxes were to be paid going forward. And, finally 5. Allesio provided a specific installment agreement plan with all supporting financial information to pay the delinquent taxes. Finally and notably, Alessio made proposals to the settlement officer in writing. This is important because there s no formal record made of a CDP hearing. It s not as if there s a court reporter available to make a transcript of all discussions. Without some kind of written record of your arguments, it s hard to prove to the Tax Court exactly that you presented to the SO to support your case. I believe this is the first Tax Court decision to bust the IRS for failing to properly apply the law and good judgment in a lien case. This is an important development given the current state of the economy. As I have stated in the this newsletter several times over the past couple of years, the IRS talks a good game when it comes to lien relief but has failed repeatedly to put its money where its mouth is. 6

7 In the April 2011 issue of my newsletter, Pilla Talks Taxes, I talked about even more "changes" to lien policy that the IRS announced early this year. But will the agency follow its own rules? They didn t do so in Alessio, and unless you force the issue, you can t expect them to so in your own case. That s why you need ammunition to fight back with, such as what you get here. I will be addressing lien in great detail in the 2011 Taxpayers Defense Conference. For the full text of the decision, see Alessio Azzari, Inc. v. Commissioner, 136 T.C. No. 9, (United States Tax Court, 2011). 7