23 March 2018
A letter from the Internal Revenue Service (IRS) threatening to impose substantial (some would say draconian) penalties can be a harrowing experience for any taxpayer or their advisor. A natural reaction would be to send a letter or make a phone call to the IRS requesting that the penalty be either abated or not assessed. Although this letter (as all letters from the IRS) must be taken seriously, a trap for the unwary exists in challenging those penalties prior to receiving the final notice in relation to the information return penalty. Failure to wait may cost a taxpayer the opportunity to request a Collection Due Process (CDP) hearing, generally a very effective forum, and reviewable in a court of law.
What is a CDP hearing?
A CDP hearing is generally offered by the IRS after the imposition of a tax lien or before the execution of a levy and is held with the IRS Office of Appeals (“Appeals”). If a hearing request is timely and proper, an Appeals Officer will be assigned and a hearing held.
Appeals is quasi-independent and separate from the IRS collection office that is threatening adverse action. As such, the value of presenting your case to this more neutral party cannot be overstated. Appeals will review your case from a new/fresh perspective and listen to your arguments for abatement and/or presentation of alternatives to the adverse collections activity. Although the manner in which a CDP hearing should be prepared for and conducted is beyond the scope of this article, preparation is of the utmost importance and should be much the same as preparing for a trial.
Key to the CDP process is that while the hearing is pending, and until the decision of Appeals in your case becomes final, the IRS should not take any adverse actions relating to the liability being protested. Further, if you disagree with Appeals’ decision you may file a petition to have your case heard in US Tax Court. Generally, these cases take a very long time to sort out and become final, such that adverse actions/enforced collections can begin.
CDP hearing in the context of certain international information penalties
Amongst what many consider to be International Information Penalties (IIPs), the penalty that is the most widely known and gets the most attention is the penalty for failing to file a Foreign Bank Account Report (FBAR) aka FinCen Form 114. The FBAR penalty is NOT a penalty that will be afforded the opportunity to request a CDP hearing and, as a result, many are unaware that some of the other IIPs should be afforded the opportunity to request a CDP hearing.
The hearing should be offered prior to the imposition of penalties for failure to file required returns, reporting:
- The ownership of or transactions with a foreign corporation or partnership;
- Transactions with foreign trusts;
- Foreign owned entities engaged in a US trade or business; and
- Specified foreign assets owned by a US taxpayer.
The opportunity to request a CDP hearing and obtain judicial review may be lost forever
The proposed imposition of IIPs is frequently met with panic and an urge to “make them go away” as soon as possible. Where the above IIPs (again excluding the FBAR) are involved, that impulse should be resisted until the final notice that affords the opportunity to request a CDP hearing is received. Importantly, should a penalty abatement be requested prior to that final notice, the IRS will generally take the position that because you had a prior opportunity to contest that penalty, a CDP hearing in relation to that issue is waived forever.
Knee-jerk reactions when dealing with the IRS are frequently ill-advised but especially so where that reaction can cause one’s client or oneself to be unable to take advantage of an important opportunity to be heard. If the decision is made to wait in order to take advantage of a CDP hearing, it is of critical importance to be certain that: the penalty threatened is one that will indeed qualify for review in a CDP hearing; and that the request is properly and timely filed.
Throughout this article the reader will note that I use “should” as opposed to “will” when it comes to certain IRS actions. I do this because although IRS policy states that certain penalties will be afforded the opportunity to request a CDP hearing, too frequently the IRS (perhaps) mistakenly does not follow its own guidance.