TaxProf Blog: Lesson From The Tax Court: Cannot Use CDP To Contest Trust Fund Recovery Penalty

Unpaid employment taxes are a substantial problem for both the government and taxpayers. From the government’s perspective this Treasury website tells us that “employment tax violations represented more than $91 billion of the gross Tax Gap and, after collection efforts, $79 billion of the net Tax Gap in this country.”

From the taxpayer’s perspective, dealing with payroll taxes is a real pain.  It’s all too easy to get the tax accounting and quarterly reporting misaligned with the IRS, and resolving those disputes takes time and energy.  Especially when the IRS believes taxes are not being paid, the IRS may start to look at assessing a personal liability against the owners and operators of the business under §6672, the Trust Fund Recovery Penalty (TFRP).

Today we learn that once the IRS assesses a TFRP liability against a taxpayer, that taxpayer will not be able to contest their liability during a later Collection Due Process (CDP) hearing.  In Mark P. Hafner v. Commissioner, T.C. Sum. Op. 2023-27 (Aug. 29, 2023) (Judge Weiler), the taxpayer got hit with a proposed TFRP penalty and contested it in the Office of Appeals.  He lost and the TFRP was assessed against him.  In a later CDP hearing the taxpayer again tried to contest his liability, but both the Office of Appeals and the Tax Court refused to even hear his arguments.  He was not able to use CDP to get pre-payment judicial review of his liability.  Details below the fold.

Law: §6672 TFRP Assessment Process
Section 6672 imposes a penalty on any person who is under a duty to withhold, account for, or transfer taxes owed to the federal government by another person.  These are known as “trust fund” taxes because §7501(a) says that the collected money is held in trust for the United States until it is paid over.  The persons who are under that duty are commonly called “responsible persons.”  You can find a more details in Lesson From The Tax Court: The Misunderstood Trust Fund Recovery Penalty, TaxProf Blog (Aug. 27, 2018).

Two of the most important trust fund taxes are collected by employers from their employees.  Section 3402(a) makes every employer responsible for withholding their employees’ income taxes. Section 3102(a) imposes a withholding requirement for the employees’ share of social security taxes.  Employers are supposed to remit these withheld taxes on an ongoing basis and to account for the payments and withholding once each quarter on Form 941.

If the employer fails to properly remit the trust fund taxes, then the Treasury suffers a loss, because §31(a) gives employees a credit for taxes withheld regardless of whether the money actually reaches the government’s coffers.  I teach this as the “duh” credit.  You can just hear the employee saying, “well, duh, I paid it!  My employer withheld it.  It’s not my fault my employer did not send it in.”

Section 6672 protects the government from that loss.  It provides that if any “person required to collect, truthfully account for, and pay over any tax imposed by this title…willfully fails to collect such tax, or truthfully account for and pay over such tax” then that person is “liable to a penalty equal to the total amount of the tax evaded….”  That is why the provision used to be called “the 100% penalty.”  The term “person” in the statute can include a corporate employer as well as individuals within the company who have sufficient control such that they should be held responsible for ensuring proper payment.  The short-hand term for such individuals is “responsible persons.”  Although the term has no statutory definition, Courts pretty use the definition found in IRM 8.25.1.3.1, which cites cases.

The Service has long used §6672 as a tool to collect unpaid trust fund taxes, and not as a true penalty to impose on top of a liability.  See Policy Statement 5-14, IRM 1.2.1.6.3.  Thus, for example, the IRS will cross-apply any payment of a trust fund tax against the accounts of all responsible persons who have been assessed for that tax. See IRM 5.7.7 for the various payment application rules.

Because the IRS policy is to treat the TFRP as a collection device, the IRS field employees responsible for investigating and recommending TFRP assessments are the Revenue Officers (RO), not the Revenue Agents (RA).  The RO investigation process is governed by IRM  5.7.4. 

What is important for today’s lesson is that every TFRP investigation comes with a built-in opportunity to get to the Independent Office of Appeals.  §6672(b)(3)(B).  In practice, it works like this: before assessing the TFRP the RO must get approval from the RO’s group manager, using Form 4183.  If the manager approves, then the RO will give the taxpayer Letter 1153 and Form 2751 (“Proposed Assessment of Trust Fund Recovery Penalty”) along with Pub. 1 (“The Taxpayer Bill of Rights”).

It’s Letter 1153 that gives taxpayers the opportunity to appeal.  But to do so taxpayers must send the RO a protest within 60 days of the Letter 1153.  So it’s not a robust opportunity.  The IRM tells the RO to review the protest.  If the RO still thinks the penalty appropriate, the RO’s Group Manager must then review the protest.  If the group manager then makes a second approval of the proposed 6672 assessment, the protest gets forwarded to Appeals and the RO sends the taxpayer Letter 1154 (“Notice of Protest of Trust Fund Recovery Penalty to be Forwarded to Appeals”). When Appeals gets the file it conducts a hearing, following the rules in IRM 8.25. 

Appeals is the end of the line for pre-assessment review.  If Appeals decides to approve the proposed assessment, the taxpayer has no further recourse pre-assessment.  Section 6672 does not provide for any Tax Court or other judicial review of an Appeals decision to make the assessment.  And once assessment is made, the IRS starts the collection process as explained in IRM 5.19.14 (“Trust Fund Recovery Penalty”).

So is there any way to get pre-payment review on the merits of the TFRP determination?  Well, that takes us to the CDP background.

Law: Collection Due Process For TFRP Assessments
To collect assessed taxes, the IRS has some pretty awesome collection powers that it implements mostly through an automated system called, appropriately enough the Automated Collection System (ACS).  Those powers include the power to file a Notice of Federal Tax Lien (NFTL), which helps the IRS beat out competing creditors, and the power to seize (“levy”) any of the taxpayer’s property it can find, including amounts that others are obligated to pay the taxpayer, such as wages, financial accounts, and social security payments.

Before the IRS cranks up the ACS collection machine, however, §6320 and §6330 require it to tell the taxpayer that bad stuff is about to go down, and give the taxpayer an opportunity for a hearing before the Office of Appeals.  This is called the Collection Due Process (CDP) hearing.

Informally, a CDP hearing provides an array of benefits to taxpayers, as I explained in Lesson From The Tax Court: No Second Bite In CDP For Rejected OIC, TaxProf Blog (Mar. 1, 2021).

Formally, however, §6330 lists the benefits given a taxpayer by a CDP hearing.  One of those is that a taxpayer may raise “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 an opportunity to dispute such tax liability.”  §6330(c)(2)(B).

Challenging an underlying liability in a CDP case is difficult.  See Lesson From The Tax Court: The Eye Of The CDP Needle, TaxProf Blog (May 4, 2020).  The main reason is because the relevant regulation interprets the term “otherwise have an opportunity” to include:  “a prior opportunity for a conference with Appeals that was offered either before or after the assessment of the liability.” Treas. Reg. 301.6330–1(e)(3), Q & A–E2 (emphasis supplied).  It makes no difference whether the taxpayer actually took advantage of the “offer.” See e.g. Chadwick v. Commissioner, 154 T.C. 84 (2020) (“Because he had an opportunity to dispute his TFRP liabilities upon receipt of these letters but declined to do so, he was not entitled to challenge his underlying tax liabilities at the CDP hearing and may not advance such a challenge in this Court.”).

Thus, for most liabilities, about the only way a taxpayer can obtain post-assessment-but-pre-collection judicial review of the liability is if they show they did not actually receive the document that gives them the relevant “opportunity.”  They never got the offer.  Thus, for example, if the taxpayer can show they did not actually receive an NOD, they can argue about the assessed deficiency in the CDP hearing, regardless of the reason for not receiving an NOD.  See Montgomery v. Commissioner, 122 T.C. 1, 36 (2004) (taxpayer permitted to dispute their self-reported liability in CDP hearing because they never received an NOD, even though they were not entitled to an NOD because there was no deficiency asserted by the IRS).

The same holds true for §6672 notices.  If the taxpayer shows they did not actually receive the Letter 1153, then they can contest that liability in a CDP hearing.  Mason v. Commissioner, 132 T.C. 301, 318 (2009) (“a section 6672(b)(1) notice that was not received, but not deliberately refused, by a taxpayer does not constitute an opportunity to dispute that taxpayer’s liability.”)  See generally Lesson From The Tax Court: When Non-Receipt Of An IRS Notice Matters TaxProf Blog (Oct. 1, 2018).

But if a taxpayer does receive the Letter 1153, they cannot wait until the CDP process to contest their TFRP liability.  That’s what we learn today.  Let’s take a look.

Facts and Lesson: You Cannot Challenge Merits of TFRP in CDP Hearing
Mr. Hafner was a manager and equal owner of a Florida LLC called Cinco Investments which owned and operated a restaurant called “Mango’s on the Bayou.”  The restaurant apparently started struggling in 2014.  At least its food service inspection records show a seeming increase in violations during 2014 according to the local newspaper’s restaurant inspections website.  And its social media reviews started tanking in 2015, as this short YouTube comment explains:

While the restaurant did not close until some time in 3rd quarter 2015 (per the YouTube comment), it was apparently having troubles meeting its payroll tax obligations starting in 2014.  Judge Weiler explains that “In 2014 Revenue Officer (RO) Lisa Henderson was assigned to the collection of the outstanding employment tax liabilities of Cinco.”  Op. at 2.

RO Henderson completed her investigation in July 2015 and sent Mr. Hafner a Letter 1153.  She proposed to assess the TFRP against him for Cinco’s unpaid payroll taxes for last three quarters of 2014 and the first quarter of 2015.Mr. Hafner protested the proposed assessment, receiving a conference with Appeals in February 2016.  That went nowhere.  Appeals upheld the proposed assessment.

Eventually, in 2019, the IRS sent Mr. Hafner a levy CDP notice.  Alert readers will see that this was not a lien CDP notice.  Remember, in theory taxpayers can get two CDP hearings, one when the IRS wants to start seizing property and one when the IRS files a Notice of Federal Tax Lien.  But that’s pretty rare in practice.  See Lesson From The Tax Court: One Plus One Equals One, TaxProf Blog (Mar. 30, 2020).  Here, for example, it appears that Mr. Hafner may have missed his opportunity for a lien CDP hearing because it seems the IRS had already filed a Notice of Federal Tax Lien.  See Op. at 4, footnote 4.

Mr. Hafner timely requested a CDP hearing and once again argued to Appeals that he was not liable for the TFRP.  This time, Appeals did not even consider his arguments on the merits of the assessment, because he not only had a prior opportunity to dispute it as part of the §6672 assessment process, he had actually taken advantage of the opportunity given.

Mr. Hafner timely petitioned the Tax Court.  He was still focused on wanting to re-argue the merits of his liability.

Judge Weiler explains that because Mr. Hafner had the opportunity to dispute the merits of the TFRP liability as part of the §6672 TFRP Assessment Process, he was not allowed to raise that issue either in the CPD hearing or during the Tax Court review.  “Since petitioner has previously disputed the underlying liabilities now at issue, he was not entitled to challenge the underlying TFRP liabilities at the CDP hearing and is precluded by section 6330(c)(2)(B) from now contesting them in this Court.”

Bottom Line: Don’t ignore your opportunity to go to Appeals during the §6672 TFRP assessment process.  You won’t get another shot at it in CDP.  Notice that in this case Mr. Hafner happened to have actually utilized his prior opportunity.  But that does not matter; just receiving the opportunity is enough to foreclose later argument.  Chadwick, supra.

Coda: Don’t Give Up!  Two Other Paths to Judicial Review
Generally speaking, to get judicial review of what the taxpayer believes is an erroneous tax assessment, the taxpayer must fully pay the assessed liability.  Flora v. United States, 362 U.S. 145 (1960).  For TFRP penalty assessments, however, there are two potential workarounds.

First, the Courts have long interpreted a TFRP assessment to be divisible.  See Steele v. United States, 280 F.2d 89 (8th Cir. 1960).  So meeting the Flora full pay rule is generally not onerous for TFRP assessments.  The taxpayer just pays the amount of trust fund taxes due for one employee for one pay period, and then requests a refund and, when that is denied, files a refund suit.  For a lovely explanation of all of this, and much more about representing clients with §6672 problems, see Chapter 16 of “Effectively Representing Your Client Before the IRS” (8th ed 2022).  Highly recommended.

Second, bankruptcy courts are an often overlooked path for pre-payment judicial review of any tax liability.  Yes, you have to file bankruptcy.  But once you do, 11 U.S.C. §505(a)(1) provides that “the court may determine the amount or legality of any tax, any fine or penalty relating to a tax, or any addition to tax, whether or not previously assessed, whether or not paid, and whether or not contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.” (emphases added).

There are complications here, however, that I should at least mention.  First, watch out for §505(a)(2) which says that the bankruptcy court cannot review the tax “if such amount or legality was contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction before the commencement of the case under this title;”  (emphasis added).  In today’s case, for example, Mr. Hafner got Appeals to review the TFRP.  I do not know whether that means Mr. Hafner would be precluded from contesting the liability again in bankruptcy.  But note that restriction is not as harsh as the CDP regulation prohibiting reivew if there was simply an opportunity for review.

A second complication is that there must be a bankruptcy purpose for a §505 determination.  That means a debtor cannot just hop into a no-asset Chapter 7 to get a §505 review.  See In re Johnston, 484 B.R. 698, 709 (Bankr. S.D. Ohio 2012) (declining to do a TFRP review because it would not serve a bankruptcy purpose, such as getting a speedy determination of the legality or amount of tax claims, which if left to other proceedings, would delay the administration of the bankruptcy estate, or providing an opportunity for the trustee, on behalf of creditors, to contest the legality and amount of a tax claim when the debtor is unable or unwilling to do so and a dissipation of estate assets might otherwise occur). 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return each Monday (or Tuesday if Monday is a federal holiday) to TaxProf Blog for another Lesson From The Tax Court.

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