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Verghese v. Commissioner (T.C. Memo. 2021-70)

On June 7, 2021, the Tax Court issued a Memorandum Opinion in the case of Verghese v. Commissioner (T.C. Memo. 2021-70). The primary issues presented in Verghese were (1) whether, under IRC § 6404(a) the petitioners are entitled to abatement on the basis of principles of fairness, and (2) whether under IRC § 6404(e) the IRS engaged in ministerial or managerial acts that constituted unreasonable delay for which the petitioners’ abatement request should be granted.

Held: Not so much.

Background

The petitioners filed joint returns for tax years 1997 and 1998, on which they claimed charitable contribution deductions from their investments in the certain partnerships. As of June 30, 2000, the IRS had commenced civil audits of the returns of all three of the petitioners’ partnerships.  The petitioners did not file a cash bond, nor does it appear that they were informed that they could do so to stop the accrual of interest against them.

A grand jury investigation into the activities of certain persons (not the petitioners) involved in the partnerships commenced while the civil audits of the partnership returns were still pending. The four co-conspirators were convicted and sentenced throughout 2007 and 2008 for crimes relating to the investigation involving the partnerships, and not until 2009 did all of the criminal proceedings ultimately conclude.

The IRS issued two notices of final partnership administrative adjustments (FPAAs) in the amounts of $2.9 million and $5.3 million.  The two partnerships filed petitions in Tax Court in 2001 and 2002, respectively, commencing TEFRA proceedings (while the criminal investigation was pending and before the issuance of the criminal indictments of the four co-conspirators).  Ultimately, the cases were consolidated, litigation was had, and the IRS filed a motion for an entry of decision.  Such decision, however, did not technically “accurately represent the stipulations of fact and the resolution of issues that the parties had previously reached.”  The partnerships alleged in a motion to strike that the IRS had intentionally made such a filing at the direction of the IRS National Office.  The IRS filed a second motion for entry of decision, and decisions were entered in April 2013.

Increase in the Petitioners’ Tax Liabilities

In May 2014, the petitioners received IRS Notices CP22E showing the following: for tax year 1997, an increase in tax of $32,389 and an increase in interest of $47,039 (for a total amount due of $79,428); and for tax year 1998, an increase in tax of $21,536 and an increase in interest of $27,844 (for a total amount due of $49,380).

Requests for Abatement of Interest

In September 2014, the petitioners filed Forms 843 (Claim for Refund and Request for Abatement), requesting interest abatement for each of the tax years 1996, 1997, and 1998. Each Form 843 indicated that the requested abatement was of interest assessed in respect of income tax and alleged that the reasons for the request were “interest was assessed as a result of IRS errors or delays” and “reasonable cause or other reason allowed under the law (other than erroneous written advice) can be shown for not assessing a penalty or addition to tax.” The petitioners attached a lengthy summary alleging that they had been the victims of a fraudulent scheme and had been solicited by criminal conspirators to make what petitioners had reasonably believed were legitimate investments. Petitioners also alleged that they were “prepared and willing to pay the total tax principal owed, however, respectfully request the interest be abated.”

The Petitioners’ Arguments (in Six Parts)

The petitioners’ submission attached to each Form 843 set forth six points of argument:

  1. The petitioners were innocent of the fraudulent scheme in which they were targeted to participate.
  2. Their belief in their innocence was reasonable because of the repeated assurances they received from their investment adviser, their accountant, and the attorney for the partnerships.
  3. The interest assessment (which had been accruing during more than a decade of Tax Court litigation) was significantly greater than the underlying tax liabilities and was therefore tantamount to a penalty, but petitioners’ conduct (unlike that of the criminal conspirators) did not warrant punishment.
  4. The TEFRA litigation involving the Heritage partnerships “began in 2000, and was not completed until 2013”, “last[ing] much longer than was reasonable”; specifically, the 5-year period from 2008, when the Heritage partnerships obtained new counsel, until the conclusion of the cases in 2013 “is very indicative of unreasonable delays” because the end result was a settlement consisting of a penalty abatement rather than a decrease in liabilities.
  5. The petitioners had an otherwise “clean” history reflecting compliance with the Federal tax laws.
  6. Denying interest abatement under such circumstances would violate “public policy [that] does not promote punishing victims of fraud,” as well as public policy in favor of considering the decline of petitioner-husband’s mental health (as was occurring at the time) “at the very least as a mitigating factor.”

Interest on Federal income tax liability

Interest on a Federal income tax underpayment arises automatically under IRC § 6601. Under IRC § 6601(a) the interest must be paid for the period from the last date prescribed for payment to the date that it is actually paid.

Important to this case, IRC § 6601(e)(1) provides that interest arising under IRC § 6601 is “treated as tax,” which is to say that it “shall be paid upon notice and demand, and shall be assessed, collected, and paid in the same manner as taxes.”  Further, any reference in the Code to any tax imposed by this title also refers to interest imposed by this section on such tax. Id.

Depositing to Forestall Interest

A taxpayer whose liability is in dispute, and who therefore may (or may not) be incurring a mounting interest obligation while the dispute is pending, has the option of making a deposit. Under IRC § 6603 (effective since October 2004), a taxpayer may make a cash deposit before assessment toward “any tax imposed (under subtitle A or B or chapter 41, 42, 43, or 44), which has not been assessed at the time of the deposit. To the extent that such deposit is used by the IRS to pay tax, for purposes of IRC § 6601, the tax shall be treated as paid when the deposit is made. IRC § 6603(a), (b).

Before the enactment of IRC § 6603, the IRS had prescribed administratively an equivalent method for taxpayers to make and designate remittances to the IRS as “deposits in the nature of a cash bond” which were “made merely to stop the running of interest” and not “in satisfaction of a tax liability.” Rev. Proc. 84-58, § 1, § 2.03, superseded by Rev. Proc. 2005-18, § 9. Petitioners did not ever make such a deposit. Viewing the facts in the light most favorable to petitioners (as the IRS had filed a motion for summary judgment), the Tax Court assumes that the IRS did not specifically advise petitioners that they could suspend the running of interest by making a deposit.

Interest Abatement in General

Congress authorized the IRS to abate interest for reasons specified in IRC § 6404, and the IRS’s decisions whether to abate interest are subject to abuse-of-discretion review by the Tax Court. See IRC § 6404(h)(1); Woodral v. Commissioner, 112 T.C. 19, 23 (1999); Foote v. Commissioner, T.C. Memo. 2015-187, at *15-*16, aff’d, 700 F. App’x 760 (9th Cir. 2017). With the exception of this limited power of review over abatement, the Tax Court generally lacks jurisdiction over issues concerning interest. Urbano v. Commissioner, 122 T.C. 384, 390 (2004); see also Med James, Inc. v. Commissioner, 121 T.C. 147, 151 (2003).

Interest Abatement under IRC § 6404(a)—When Assessment is “Excessive in Amount”

IRC § 6404(a)(1) empowers the IRS to abate the unpaid portion of the assessment of any tax or any liability in respect thereof that is “excessive in amount.” However, IRC § 6404(b) precludes abatement under IRC § 6404(a)(1) of interest on income tax. Urbano, 122 T.C. at 395. Thus, what IRC § 6404(a) giveth, IRC § 6404(b) taketh away. Adams v. Commissioner, T.C. Memo. 2019-99, at *8-*9, aff’d, 811 F. App’x 276 (5th Cir. 2020). This is so because IRC § 6404(b) provides that a taxpayer may not file a claim for abatement “in respect of any assessment of any tax imposed under subtitle A or B.”

Interest Abatement under IRC § 6404(e)—When There Has Been a “Ministerial” Error or Delay

IRC § 6404(e)(1)(A) authorizes the IRS to abate an assessment of interest on any deficiency attributable to “any unreasonable error or delay by an officer or employee of the IRS in performing a ministerial or managerial act.” The term “ministerial act” means a procedural or mechanical act that does not involve the exercise of judgment or discretion, and that occurs during the processing of a taxpayer’s case after all prerequisites to the act, such as conferences and review by supervisors, have taken place. Treas. Reg. § 301.6404-2(b)(2). A “managerial act,” on the other hand, is an administrative act that occurs during the processing of a taxpayer’s case involving the temporary or permanent loss of records or the exercise of judgment or discretion relating to management of personnel. Treas. Reg. § 301.6404-2(b)(1). A decision concerning the proper application of Federal tax law is neither a managerial nor a ministerial act. Treas. Reg. § 301.6404-2(b).

The flush text of IRC § 6404(e)(1) adds two caveats:

First, an error or delay is taken into account only after the IRS has contacted the taxpayer in writing with respect to the deficiency or the payment. IRC § 6404(e)(1) (flush language). For purposes of evaluating this requirement with respect to partnership items that are subject to litigation in a TEFRA proceeding, the relevant date occurs when the IRS first contacts the taxpayers in writing regarding the examination of the partnership. See Larkin v. Commissioner, T.C. Memo. 2010-73, *3.

Second, an error or delay is considered “only if” no significant aspect of the error or delay is attributable to the taxpayer involved. IRC § 6404(e)(1)(B). The Tax Court has construed this “attributable to the taxpayer” exclusion to mean that no abatement is warranted where, notwithstanding a mistake by the IRS, no earlier payment of the tax would have been made. See Braun v. Commissioner, T.C. Memo. 2005-221, *5. This is so because interest accruing merely because a taxpayer fails to pay the assessed tax is not subject to abatement under IRC § 6404(e).” Id.

In addition to these requirements, a request for abatement under IRC § 6404(e) cannot be formulated as a broad request to waive all interest; rather, the taxpayer must identify a mistake by the IRS and must also link the mistake to a specific period of delay as to which interest should be abated. See Hancock v. Commissioner, T.C. Memo. 2012-31, *4 (citing Hill v. Commissioner, T.C. Memo. 2009-39, Guerrero v. Commissioner, T.C. Memo. 2006-201; Braun, T.C. Memo. 2005-221). The requisite correlation between an error or delay attributable to the IRS and a specific period of time is, for the most part, missing where a taxpayer requests that all interest with respect to the deficiencies be abated. Braun, T.C. Memo. 2005-221 at *5 (citing Donovan v. Commissioner, T.C. Memo. 2000-220).

Analysis by Tax Court

The Tax Court has previously held that Appeals cannot abuse its discretion where it declines to authorize abatement of interest that the statute itself does not authorize. See Woodral, 112 T.C. at 21-25 (holding that IRC § 6404(e) does not authorize abatement for interest on employment taxes and that “a person with no discretion simply cannot abuse it”). Accordingly, the Tax Court turned to the merits of the parties’ arguments regarding whether IRC § 6404(a) authorized the IRS to abate interest assessed on income tax.

IRC § 6601(e)(1) provides, in part, that any reference in the Code to any “tax” imposed by the Code “shall be deemed also to refer to interest imposed by this section on such tax.” IRC § 6601(e)(1). Applying this principle, the Tax Court has held that the prohibition of IRC § 6404(b), that no claim for abatement shall be filed by a taxpayer in respect of any assessment of any tax imposed under subtitle A or B, means that Congress did not authorize abatement for any tax imposed under subtitle A or B or for any interest imposed on that tax. Urbano, 122 T.C. at 395; see also Goettee v. Commissioner, 192 F. App’x 212, 217 (4th Cir. 2006), aff’g 124 T.C. 286 (2005).

The Tax Court found the petitioners’ arguments regarding the text of the regulations that implement IRC § 6404 “similarly unavailing,” in part because the regulations repeat the provision of IRC § 6601(e) to the effect that interest is treated as tax. See Treas. Reg. § 301.6601-1(f)(1). Not surprisingly, the regulations follow the statute in construing “tax” to include interest on that tax. If “tax” is “deemed also to refer to interest imposed on such tax,” then a bar on the abatement of “income tax” and an allowance of abatement that excepts “income tax” necessarily bars and excepts the “interest imposed” on income tax.  Well, that clears it up, then.  But just for giggles, let’s keep going. Appeals cannot abuse its discretion by declining to do something as to which Congress did not confer discretion, and IRC § 6404(a) does not give the IRS discretion to abate interest on income tax. Accordingly, the Tax Court granted the IRS’s motion for summary judgment as it related to any abatement of interest under IRC § 6404(a).

The absence of a “personal invitation to make a deposit” does not give rise to an abuse of discretion when Appeals determined that IRC § 6404(e) did not provide for interest abatement under such circumstances.  Further, broad allegations regarding a lack of timeliness and accuracy are generally insufficient to identify an error or delay arising from a ministerial or managerial act of the IRS. Bartelma v. Commissioner, T.C. Memo. 2005-64, *3. With respect to pending litigation, it is well established that the mere passage of time in the litigation phase of a tax dispute does not establish error or delay under IRC § 6404(e). Lee v. Commissioner, 113 T.C. 145, 150 (1999).

The Holdings

Delay during civil litigation that is the result of the IRS’s strategy to first dispose of criminal proceedings necessarily requires the “exercise of judgment” and, therefore, cannot constitute a ministerial act. Id. at 150-151; see also Taylor v. Commissioner, 113 T.C. 206, 211-212 (1999) (explaining the reasons for the IRS’s longstanding policy “to defer civil assessment and collection until the completion of criminal proceedings”) (quoting Badaracco v. Commissioner, 693 F.2d 298, 302 (3d Cir. 1982), rev’g T.C. Memo. 1981 404, aff’d, 464 U.S. 386 (1984)), aff’d, 9 F. App’x 700 (9th Cir. 2001); Dadian v. Commissioner, T.C. Memo. 2004-121, *4 (holding that denial of interest abatement was not abuse of discretion with respect to period of delay caused by a related criminal investigation of tax shelter promoter). Nor does that exercise of judgment constitute a “managerial act” as contemplated by the statute. See Adams, T.C. Memo. 2019-99 at *11, n.6; see also Treas. Reg. § 301.6404-2(b)(1).  Therefore, the Tax Court held that the IRS was entitled to summary judgment under IRC § 6404(e) for the period from the commencement of the TEFRA litigation until the conclusion of the criminal proceedings in 2009, as well as the period from the end of the criminal proceedings until August 2012.

The Tax Court threw the petitioners a bit of a bone, albeit a tiny, gnawed off portion, when it refused to grant the IRS’s motion for summary judgment as to the five-month period between the date of the first stipulation in Tax Court and the entry of the IRS’s corrected entry of decision (after withdrawing the first, erroneous one).  The Tax Court previously held that the IRS’s nearly five-year delay in the counter-signing of a settlement agreement during the pendency of partnership litigation constituted an unreasonable delay due to a ministerial act of the IRS, see Mathia v. Commissioner, T.C. Memo. 2009-120, *15-*17, aff’d, 669 F.3d 1080 (10th Cir. 2012); and the Tax Court could not say whether the shorter delay in this case had the same defect.

(T.C. Memo. 2021-70) Verghese v. Commissioner

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