Collection Due Process case favors IRS

In a case involving a request to abate penalties, the Tax Court partially granted the IRS’s motion for summary judgment, allowing the remaining issues to go to trial to determine whether a taxpayer’s failure to timely file returns and pay taxes owed was due to reasonable cause.

Facts: Thomas E. Kelly was a securities broker residing in New York City who made $1 million to $2 million annually during 2013–2015. However, he did not file timely returns for those years reporting this income.

He filed a delinquent return for 2013 on Dec. 22, 2017, reporting an adjusted gross income of $1,919,000 and tax of $689,923. He did not include payment for the full amount owed with his return.

On Dec. 26, 2017, he filed a delinquent return for 2014, reporting tax of $514,875, and on Jan. 17, 2018, he filed a delinquent return for 2015, reporting tax of $403,096. He made no payments toward his tax liability for either year. For each of the years at issue, the IRS imposed penalties under Secs. 6651(a)(1) and (2) for failure to file and pay tax timely and/or Sec. 6654 for failure to pay estimated tax, plus interest.

The IRS issued a levy notice on Sept. 4, 2019, in an effort to collect the liabilities, which by then exceeded $2.5 million. One week later, the IRS issued a notice informing Kelly that it had filed two notices of federal tax lien (NFTLs).

Kelly timely requested a Collection Due Process hearing for the levy notice and the NFTL filings. During the hearing, he asked for an installment agreement, withdrawal of the NFTLs, and abatement of the penalty additions to tax for all three years, either under the IRS’s first-time abatement policy or for reasonable cause.

The IRS rejected all these requests and issued Kelly a notice of determination sustaining the collection actions. He timely petitioned the Tax Court to review the determination, and in Tax Court, the IRS moved for summary judgment.

Issues: The Tax Court reviewed the three issues Kelly raised in his CDP hearing to determine whether the IRS’s determination was an abuse of discretion. Abuse of discretion exists when a determination is arbitrary, capricious, or without sound basis in fact or law.

To qualify for a first-time abatement of penalties, a taxpayer must have had no penalties for the preceding three years. Kelly’s history of noncompliance disqualified him from receiving a first-time abatement, the settlement officer (SO) ruled, and the Tax Court agreed. The IRS had also assessed the same penalties for 2012, immediately before the first year at issue, the court noted.

Kelly had also argued he had reasonable cause for his failure to file and pay his taxes on time. He claimed his wife’s spending habits contributed to financial problems beginning in 2007. She filed for divorce in 2015, which he said caused “financial hardship, emotional problems, and depression.” The SO rejected this abatement request, citing the petitioner’s history of noncompliance and consistently high income over the previous several years. The court stated Kelly faced an “uphill battle” in proving reasonable cause, but because a reasonable-cause defense “usually entails question of fact ill-suited to summary adjudication,” the court could not decide the issue on summary judgment.

Similarly, Kelly was not qualified for a partial payment installment agreement (PPIA) due to his current unpaid tax liabilities. The court noted that Sec. 6159 gives the IRS discretion to enter into an installment agreement if it determines that the agreement will facilitate full or partial collection of a taxpayer’s unpaid liability. Under IRS guidelines, the taxpayer must be in compliance with current requirements with respect to filing, withholding, and estimated tax payments. The court noted that the record showed Kelly had not paid his full tax liability for 2019 or estimated taxes for 2020, so the IRS did not act arbitrarily or capriciously in rejecting the PPIA.

Kelly also requested the NFTL filings be withdrawn, arguing the tax lien would adversely affect his employment prospects as a securities broker, causing “significant hardship” and hindering his ability to pay his taxes. Consequently, he argued, withdrawal was warranted because it would facilitate the collection of tax. The court called Kelly’s claim of loss of future income “entirely speculative” and noted that although he submitted evidence that the NFTL filings had caused him to lose his securities registration in two states, he did not submit evidence they would meaningfully affect his ability to pay his tax debts. Under Kelly’s circumstances, the court found the IRS did not abuse its discretion in refusing to withdraw the NFTLs.

Holding: The court held that the IRS did not abuse its discretion in denying Kelly’s request for a first-time abatement, an installment agreement, and an NFTL withdrawal, and it granted the IRS’s motion for summary judgment on those issues. However, it denied the IRS’s motion for summary judgment on whether Kelly was entitled to penalty relief based on reasonable cause.

■ Kelly, T.C. Memo. 2022-73

— Hannah Pitstick is a writer with the Association of International Certified Professional Accountants.