Collection Due Process and Bankruptcy
Analyzing Cases and the Internal Revenue Code

By Adam M. Scarpati

E-mail Story Print Story

Background

Bankruptcy practice in the United States has its origins in the Constitution, Article 1, Section 8. Bankruptcy is designed to promote the effective rehabilitation of a bankrupt debtor and, when necessary, provide for the equitable distribution of the debtor’s assets. The most common way for taxpayers to discharge outstanding tax liabilities and get a fresh start is to file under Chapter 13. Chapter 13 provides the taxpayer the opportunity to submit a plan to the court and pay tax debts off over time. The timeframe for debt repayment usually lasts three years but can be extended up to five years under certain circumstances.

As provided for in 11 USC section 362(a), a petition filed with the Bankruptcy Court operates as an “automatic stay” from the taxpayer’s creditors, including the IRS. A bankruptcy petition bars the commencement or continuation of a judicial or administrative hearing that could have been commenced prior to the filing of the petition arising from an IRS audit, the issuance of a tax deficiency, or the demand for tax returns. The automatic stay on collection activities ensures that one particular creditor does not gain an unfair advantage over the other creditors.

IRC section 6330, enacted as part of the IRS Restructuring and Reform Act of 1998, provides taxpayers with due process prior to the exercise of a tax levy. Congress believed that taxpayers should be entitled to protections against the IRS that they would normally have with other creditors. Moreover, Congress intended that the IRS and the taxpayer would engage in a meaningful hearing on an administrative level, with adequate notice of collection, to increase fairness to taxpayers. Congress also provided that a taxpayer who was dissatisfied with the administrative proceeding could appeal to the U.S. Tax Court, or to a U.S. District Court if the tax is outside of the Tax Court’s jurisdiction, under IRC section 6330(d)(1). These hearings have become known as Collection Due Process (CDP) hearings. Under IRC section 6330(c)(2), in the course of the proceedings taxpayers can raise only certain issues with respect to collection activities:

• Appropriate spousal defenses;
• Challenges to the appropriateness of the collection action;
• Offers of collection alternatives, such as installment agreements and offers-in-compromise (OIC); and
• The opportunity to dispute the underlying tax liability, provided the taxpayer had not had the occasion to do so.

The Cases

In Prevo v. Comm’r (123 TC No. 21, 12/14/04), the IRS issued to the taxpayer a Notice of Intent to Levy, as required by IRC section 6330(a)(1), for an outstanding tax liability owed on a number of years. The taxpayer timely requested a CDP hearing with an IRS appeals officer. During the administrative hearing, the taxpayer raised one of the four issues that can be introduced at a CDP hearing: The taxpayer offered a collection alternative by suggesting an installment agreement. The appeals officer rejected the installment agreement on the basis that the taxpayer was not current on the respective tax liability and that an installment agreement or an OIC was unreasonable. The appeals officer determined the levy was appropriate and issued the taxpayer a notice of determination as required by IRC section 6330(c)(3). In contemplation of the notice, the taxpayer filed a petition for bankruptcy under Chapter 13. Simultaneously, however, the taxpayer also filed a petition for judicial review by the U.S. Tax Court. The court held that it lacked jurisdiction for judicial review because the notice of determination violated the automatic stay protection provided by the Chapter 13 filing. The court went on to further note that under IRC section 6330, the filing of a bankruptcy petition did not toll the time for filing a petition with the Tax Court. IRC section 6330(d)(1) affords that the taxpayer must file a petition with the appropriate court, in this case the Tax Court, within 30 days of the notice of determination. The court pointed out that IRC section 6330 did not contain a provision similar to one in IRC section 6213. Under IRC section 6213(a), a taxpayer has 90 days to file a petition for redetermination of a deficiency with the U.S. Tax Court after the notice of deficiency is mailed. This is more commonly referred to as the “90-day” letter. IRC section 6213(f) provides coordination with the bankruptcy court by suspending the 90-day requirement to file a Tax Court petition pending a simultaneous petition with the U.S. Bankruptcy Court until 60 days after the discharge/dismissal of the bankruptcy petition.

In Catherine Beverly v. Comm’r (TC Memo 2005-41), the IRS issued the taxpayer a Notice of Intent to Levy for unpaid taxes. Prior to the issuance of the notice, the taxpayer filed for bankruptcy under Chapter 13. Upon receiving the notice, the taxpayer concurrently requested a CDP hearing. The appeals officer, having no knowledge of the bankruptcy proceeding and its dismissal, issued the taxpayer a notice of determination. The court determined that it had jurisdiction to review the notice of determination. The court found for the taxpayer and set out three main points in its decision:

• When an appeals agent issues a Notice of Intent to Levy subsequent to a bankruptcy petition, the issuance of the notice constitutes an abuse of discretion, because the issuance of a notice of determination is deemed a commencement of a collection activity in violation of the automatic stay. Abuse of discretion is a defense that a taxpayer may raise during administrative or judicial review. This defense satisfies IRC 6330(c)(2) as a challenge to the appropriateness of the collection action.
• The notice of determination issued following a dismissal/discharge by the bankruptcy court is valid and invokes the court jurisdiction.
• Even though the taxpayer failed to inform the appeals officer of the pending bankruptcy petition, that in and of itself was not sufficient to supersede the automatic stay.

Analysis

The key issues with respect to these cases are whether the taxpayer is entitled to both a CDP hearing and a bankruptcy hearing simultaneously, and, if so, whether bankruptcy proceedings are coordinated with CDP hearings as they are with other tax-related proceedings. The basis of the court’s jurisdiction appears predicated upon when the notice of determination is issued. The court found that it had jurisdiction for CDP review when the notice was issued and the automatic stay was lifted. Rule 13(e) of Tax Court Practice and Procedure provides that “with respect to the filing of a petition or the continuation of proceedings in this Court after the filing of a bankruptcy petition see 11 USC 362(a)(8) and IRC Sec. 6213(f).” Under 11 USC 368(a)(8), the filing of a bankruptcy petition not only operates as a stay against the taxpayers creditors but also bars the commencement or continuation of proceeding in the Tax Court.

The Tax Court does not have jurisdiction to determine whether there has been a dismissal/discharge, but it does have jurisdiction to determine whether the automatic stay is in effect, per Moody v. Comm’r (95 TC 655). In cases arising for CDP judicial review, the court has held that two factors must be present:

• There must be a timely filed petition with the court.
• There must be a valid notice of determination (Offiler v. Commissioner, 114 TC 492, 498).

In Meyer v. Comm’r (115 TC 417), the court sought to lay the foundation to determine what constitutes a valid notice of determination under IRC section 6330(c)(3). The taxpayer in Meyer sought a CDP hearing, and the appeals officer never conducted one. The appeals officer did, however, issue a notice of determination. The taxpayer timely filed a petition for judicial review by the Tax Court. The court found that it lacked jurisdiction to hear the case because the appeals officer did not properly conduct the administrative hearing, hence the notice of determination was rendered invalid.

In Lundsford v. Comm’r (117 TC 159), however, the court overruled itself and provided the precedent to which it would have jurisdiction. In this case, the court held that it cannot “look behind” the notice to determine its validity and whether the taxpayer was afforded an appropriate hearing, but that by virtue of its being sent, the notice of determination was facially valid. Congress, when enacting IRC section 6330, sought to mend relations between taxpayers and the IRS by providing an opportunity for both sides to reach an agreement before the taxpayer’s property was annexed. Congress had anticipated that taxpayers would be able to deal with the IRS like any other creditor. The Treasury Department subsequently issued regulations that undermined these Congressional intentions. Treasury Regulations section 301.6330-1 Q&A D-6 provides that under CDP hearings, the formal hearings required under the Administrative Procedures Act, 5 USC 551, do not apply. This was cited by the court as the rationale for its decision. However, Treasury Regulations section 301.6330-1 Q&A D-7 affords that a taxpayer who requests a formal hearing must be offered the opportunity for a face-to-face hearing at the Appeals office closest to the taxpayer’s residence. By allowing an ambiguous definition of what constitutes a “hearing,” the court hinders a taxpayer’s efforts to effectively deal with the IRS at the administrative level.

Contradictory Rulings, Interesting Analogies

Under the Prevo and subsequent Beverly decisions, it appears that a taxpayer is not entitled to both a CDP hearing and a bankruptcy proceeding simultaneously. Accordingly, bankruptcy proceedings are not coordinated with CDP judicial review as would be the case with other tax-related hearings. Moreover, under the Prevo ruling, if the automatic stay is not terminated prior to the expiration of the timely filed requirement, the taxpayer forfeits the right to judicial review in favor of a bankruptcy proceeding. In determining that the notice of determination controls its jurisdiction, the court validated the majority opinion in Lundsford where the minority opinion should have prevailed. The minority opinion in Lundsford was that it was proper to look behind the notice of determination. Where there is no hearing, there could be no notice of determination, and therefore the court does not have jurisdiction. This is in keeping with Congress’ intent to provide the taxpayer with an independent review of the administrative proceedings conducted by the IRS. Under the minority opinion, the issuance of the notice of determination, whether issued during or after a bankruptcy proceeding, would be void. The issuance of the notice of determination would not have effect until 60 days after discharge/dismissal from bankruptcy, thereby allowing the taxpayer a choice of forums.

It is noteworthy, however, that in Offiler, the court compared a notice of determination to a 90-day letter with respect to its jurisdiction. If the analogy were to prevail, the notice of determination would fall under the influence of IRC section 6213(f). In another recent case that supports this minority opinion, Smith v. Comm’r (124 TC 36), the court held that the issuance of the Notice of Intent to Levy violates the automatic stay provision and is void. Because the notice is void, under IRC section 6330 there can be no hearing and no notice of determination. Therefore, taxpayers would seem to be able to file a bankruptcy petition first and, if unsuccessful, request a CDP hearing.

As the Supreme Court stated in Bull v. U.S. (55 S. Ct. 695): “But these reversals of the normal process of collecting a claim cannot obscure the fact that after all what is being accomplished is the recovery of a just debt owed the sovereign. If that which the sovereign retains was unjustly taken in violation of its own statute, the withholding is wrongful. Restitution is owed the taxpayer. Nevertheless, the taxpayer may be without remedy” (emphasis added).