IRS’s referral to DOJ did not bar collection proceedings

In a case of first impression, the Second Circuit held that the IRS was not barred from referring a case to the U.S. Department of Justice (DOJ) before it rejected the taxpayers’ installment proposal, since the DOJ did not commence the collection proceedings until after the administrative appeal period had expired.

Facts: Walter and Denise Schiller, a married couple, failed to pay $91,945 in taxes, as reported on their 2007 Form 1040, U.S. Individual Income Tax Return. The couple filed the return jointly. On Nov. 3, 2008, the IRS assessed the taxpayers, jointly and severally, $122,324 in taxes, interest, and penalties for 2007.

In late 2017, the Schillers proposed to the IRS an installment agreement in which they would pay $361 per month toward their unpaid taxes (Sec. 6159). On Aug. 7, 2018, an IRS agent visited the Schillers to discuss their tax liability. A month later, the IRS determined that it would be in the government’s best interest to reject the proposed agreement.

In a letter dated Oct. 30, 2018, the IRS formally rejected the Schillers’ proposal, suggesting that they had “sufficient cash or equity in assets to fully or partially pay the balance owed.” The letter further stated that this communication would negate any conflicting letters the taxpayers received authorizing any acceptance of their proposal. The record indicated that the installment proposal “was, at least initially, marked as approved by the IRS in its online system and that [the taxpayers] had even made some payments pursuant to it in 2018.” Both parties, though, agreed that this designation by the IRS was due to a clerical mistake.

The letter also indicated that if the Schillers did not agree with the IRS’s decision to terminate the installment proposal, they could request an administrative appeal within 30 days, which they failed to do. However, by the time the Schillers received the letter, unbeknownst to them, the Service had already referred their case to the DOJ.

At the end of the 30-day period outlined in the IRS’s letter, the DOJ commenced the current action against the Schillers, seeking to reduce their 2007 unpaid federal income taxes to a civil judgment (see Sec. 6331(k)(2)(B) and Regs. Sec. 301.6331-4(a)(1)). The parties filed cross-motions for summary judgment, with the Schillers arguing that the IRS violated the statutory and regulatory provisions of Sec. 6331 and Regs. Sec. 301. 6331-4(b)(2) by referring their case to the DOJ before it formally rejected their proposed installment agreement. The IRS, on the other hand, argued that even though the referral was premature, it had still complied with the Code’s statutory requirements by commencing the civil action 31 days after formally rejecting the taxpayers’ proposed installment agreement.

Siding with the government, the district court granted the government’s motion for summary judgment and denied the Schillers’ cross-motion. Noting the absence of case law on point, the district court held that Sec. 6331 prohibits only the commencement of proceedings, not referrals while an installment agreement is pending (Schiller, No. 18-CV-6840 (E.D.N.Y. 6/1/22)). Even though the court recognized that by referring the case to the DOJ the IRS had facially violated Regs. Sec. 301.6331-4(b)(2), it declined to read the regulation as “barring a collection action exclusively because of a technical, non-prejudicial error on the part of the government” (Schiller, slip op. 11).

Issues: The government has several enforcement tools available in collecting delinquent taxes. One is to bring a civil action to collect any unpaid taxes through a judgment or settlement (Secs. 6321 and 6331(a)). A civil action may not be commenced, though, unless “two distinct acts by two distinct actors” occur: the Treasury secretary’s authorizing or sanctioning to bring a suit and the attorney general’s direction to commence the action (Sec. 7401).

The Code also imposes restrictions on the government’s use of these enforcement tools while an installment agreement is pending. Sec. 6331(k)(2) prohibits the government from levying property or rights to property with respect to unpaid tax during (1) the period that an offer for an installment agreement under Sec. 6159 is pending for payment of the unpaid tax with the IRS, (2) the 30 days following either a rejection or termination of an installment agreement, (3) the period that an installment agreement is in effect, and (4) if an appeal from the rejection or termination of an installment agreement is filed, the period that such an appeal is pending. The regulations make clear that an agreement is pending when accepted for processing and remains so until the IRS notifies the taxpayer that it has been rejected or withdrawn (Regs. Sec. 301.6331-4(a)(2)).

Two other connected provisions of the Code, when combined, bar the government from collection proceedings when an installment agreement is still pending, the court stated, Secs. 6331(i)(4)(A) and (k)(2)–(3). The regulations go even further by combining the statutory authority of Sec. 6331 to “delay even referrals” if an installment agreement is still pending, the court stated. Regs. Sec. 6331-4(b)(2) states that “the IRS will not refer a case to the [DOJ] for the commencement of a proceeding in court, against a person named in an installment agreement or proposed installment agreement, if levy to collect the liability is prohibited” by Regs. Sec. 6331-4(a)(1).

This dispute presented a question of first impression for the Second Circuit, centering on the impact of the IRS’s referral to the DOJ prior to the formal rejection of the Schillers’ proposed installment agreement.

The Schillers claimed that the “premature referral” was unlawful, barring DOJ from enforcement action. They argued that since Sec. 6331(i)(4)(A) “refers to a discrete act by the Secretary” that the proceeding contemplated in the statutory language “begins immediately upon the Secretary’s referral of the assessment to the the DOJ.” The government contended that the enforcement action was valid since the IRS commenced collection proceedings after the 30 days to appeal had expired.

The Second Circuit held that there was a clear distinction between a referral and the beginning of a collection proceeding. It further stated that the Code is silent on when a case can be referred to the DOJ. Therefore, regulations that limit the IRS’s referral power “cannot read into the statute something that is not there” (citing Koshland v. Helvering, 298 U.S. 441 (1936)). Also, this conclusion is not altered by the fact that “authorization from the Treasury Secretary is a prerequisite to commencing an in-court proceeding” (Sec. 7401). The court noted that an additional step beyond referral is required to begin collection proceedings, which is that the attorney general “must direct” the commencement of an action. If referral by the Treasury secretary were combined with the attorney general’s enforcement power, “two distinct acts,” as seen in Sec. 7401, would be collapsed into one.

This conclusion that the statute contemplates formal litigation when referring to a proceeding is further reinforced, the court stated, by the use in the statutory provisions of “the term ‘proceeding’ in conjunction with language such as ‘commence’ and ‘final order or judgment.’ ” The repetition of “proceeding” in Sec. 6331(i) (4)(a) “suggests that an equivalent meaning was intended” (see Prus v. Holder, 660 F.3d 144 (2d Cir. 2011)). According to Rule 3 of the Federal Rules of Civil Procedure, “A civil action is commenced by filing a complaint with the court,” which, in this case, the DOJ timely filed.

Next, the Schillers claimed that the IRS’s violation of the regulations barred the government from collecting against them. The Second Circuit acknowledged that even though the IRS’s failure to follow its own regulations or procedures can require its action to be invalidated, it went on to say that it would only be invalidated if it violated their “fundamental rights derived from the Constitution or a federal statute” (Waldron v. Immigration and Naturalization Service, 17 F.3d 511 (2d Cir. 1993)). According to the court, since the Schillers had not advanced any theory of prejudice of their rights or established any harm from the premature referral — and were not even aware of the IRS’s referral to the DOJ when it rejected their installment proposal — they suffered no harm to their fundamental rights.

Holding: Affirming the district court’s opinion, the Second Circuit held that the IRS’s referral to the DOJ before it rejected the Schillers’ proposed installment agreement did not bar the government from commencing collection proceedings against them. The government’s breach of Regs. Sec. 301.6331-4(b)(2), as the district court had determined, was nothing more than “a technical, non-prejudicial error on the part of the government.”

■ Schiller, No. 22-1566 (2d Cir. 8/30/23)

— Thomas Godwin, CPA, CGMA, Ph.D., and John McKinley, CPA, CGMA, J.D., LL.M., are both professors of the practice in accounting and taxation in the SC Johnson College of Business at Cornell University. To comment on this column, contact Paul Bonner, the JofA’s tax editor