The Tax Court held that a responsible person taxpayer was not entitled to currently not collectible (CNC) status for her liability attributable to a trust fund recovery penalty and that adequate protection payments made to the IRS by her wholly owned corporation could not be applied to her liability.
Kathy Riggs was the owner of Amber Construction. Between 2003 and 2011, Amber Construction failed to pay substantial amounts of federal employment taxes. Based on her status as a responsible person for Amber Construction's unpaid employment taxes, the IRS issued a proposed assessment for a trust fund recovery penalty against Riggs in November 2011.
After Amber Construction's employment tax problems with the IRS started, Riggs began to operate her contracting business through a new wholly owned corporation, Amber Rebar. Amber Rebar foundered in short order and filed for bankruptcy on May 2012.
After establishing in court that Amber Rebar was a successor in interest to Amber Construction's tax liabilities, the IRS filed a proof of claim in the Amber Rebar bankruptcy proceeding for Amber Construction's unpaid employment taxes. Amber Rebar and the IRS then entered into an adequate protection agreement (which was converted to a Bankruptcy Court order) that required Amber Rebar to make monthly payments to the IRS. For seven months, Riggs mailed a check to the IRS on behalf of Amber Rebar. Each check indicated that it was to be applied to Riggs's liability for the trust fund recovery penalty. The IRS nonetheless applied the checks against Amber Rebar's corporate tax debts rather than Riggs's liability.
Eventually, the IRS sought to collect the trust fund penalty from Riggs as an individual and as part of its efforts filed a notice of federal tax lien against her. In response, she requested a collection due process hearing, seeking review of the IRS's efforts to collect the trust fund recovery penalty by levy.
At the hearing, Riggs argued that she was entitled to CNC status because she had no disposable income. She claimed the Bankruptcy Court determined the amount Amber Rebar could pay the IRS as adequate protection after determining the officer salary Riggs needed to pay her monthly expenses. Thus, she asserted, her salary as set and adjusted by the Bankruptcy Court left no disposable income to pay the trust fund recovery penalty.
The IRS Appeals officer in her hearing determined that Riggs was not entitled to CNC status because she had equity in several assets that could be liquidated or borrowed against to pay the trust fund recovery penalty. Riggs petitioned the Tax Court to review the Appeals officer's determination and the IRS's allocation of the adequate protection payments made by Amber Rebar. Riggs also argued that the IRS's collection actions against her were stayed by the automatic stay in place in Amber Rebar's bankruptcy case, so that the notice of determination the IRS issued to her was invalid.
The Tax Court's decision
After the Tax Court held that the automatic stay in the Amber Rebar bankruptcy case did not prevent the IRS from taking its collection actions against Riggs, giving it jurisdiction to decide the merits of the case, it held that Riggs was not entitled to CNC status because she had equity in assets that could be used to pay the trust fund recovery penalty she owed. It further held that the IRS had correctly applied the adequate protection payments made by Amber Rebar to the corporation's debts instead of Riggs's penalty.
Effect of automatic stay on Riggs: Under an automatic stay in a bankruptcy case, the IRS cannot pursue collection actions against a debtor for tax debts that arose before the commencement of the debtor's bankruptcy case. Consequently, if the IRS issues a notice of determination to a debtor while a bankruptcy stay is in place, the notice is invalid. While the bankruptcy stay generally protects only the debtor in a bankruptcy case, the Fourth Circuit, in A.H. Robins v. Piccinin, 788 F.2d 994 (4th Cir. 1986), determined that an automatic stay also protects a third party if the third party is the defendant in a case where a judgment against the third party would essentially be a judgment against the debtor (i.e., where the debtor would be required to indemnify the third-party defendant) so that the debtor is the "real party defendant." However, the court stated that this rule does not protect a third party that is independently liable.
The Tax Court found that the rule did not apply to Riggs because Amber Rebar was not the real party defendant in Riggs's case because the company would not be required to indemnify Riggs if she was forced to pay the trust fund recovery penalty. Furthermore, in Huckabee Auto Co., 783 F.2d 1546 (11th Cir. 1986), the Eleventh Circuit held that an individual's liability for a trust fund penalty is separate and distinct from an employer's payroll tax obligations. Thus, Riggs did not fall within the scope of the automatic stay in Amber Rebar's bankruptcy case, and the IRS was not prevented by the stay from pursuing collection of the trust fund penalty from Riggs. Accordingly, because the IRS's notice of determination was valid and Riggs filed a timely petition for review, the Tax Court had jurisdiction to consider the merits of the case.
Denial of CNC status: Riggs contended that the Appeals officer's refusal to grant CNC status was an abuse of discretion. First, she claimed that because she could not sell her assets or use them as collateral for loans because of the tax liens on them, her collection potential was reduced to the extent that she should be allowed CNC status. The court disagreed, finding that, per the Internal Revenue Manual and its own precedent, tax liens do not reduce the value of an asset in determining collection potential and whether a taxpayer qualifies for CNC status.
Riggs alternatively argued that despite her equity in several assets, she was entitled to CNC status because she lacked sufficient income to pay the trust fund penalty. The court rejected this argument based on Fangonilo, T.C. Memo. 2008-75, where it had held that a lack of income did not entitle a taxpayer to CNC status where the taxpayer had equity in assets that would give him sufficient funds to pay his liability, and Willis, T.C. Memo. 2003-302, where it held that a taxpayer who had the resources to pay some of his cumulative tax liability was not entitled to CNC status.
Allocation of adequate protection payments: Finally, the court addressed the allocation of Amber Rebar's adequate protection payments. Riggs contended that because Amber Rebar had directed that these payments be applied to her trust fund penalty, the IRS was obligated to do so.
The Tax Court noted that the Supreme Court has held that a Bankruptcy Court can order the IRS to apply tax payments to trust fund obligations over non-trust-fund tax liabilities if it concludes that this is necessary for the success of a bankruptcy reorganization. The Tax Court, however, found that this did not help Riggs because the Bankruptcy Court had not ordered the adequate protection payments be applied to her trust fund penalty.
The Tax Court also explained why Riggs's directions on how the checks should be applied had no effect. According to Rev. Proc. 2002-26, if a taxpayer renders partial payment to the IRS and provides specific written directions about the application of the payment, the IRS must apply the payment as directed. However, under Tax Court precedent, if the payment is not voluntarily made, the taxpayer's directions are not controlling. The court found that the adequate protection payments were made at the direction of the Bankruptcy Court for Amber Rebar's liabilities, and neither Riggs nor Amber Rebar could allocate the payments differently without the Bankruptcy Court's approval. Therefore, the payments were not voluntary, and the IRS had the authority to apply the payments as it saw fit.
Receiving CNC status can be a great boon for a taxpayer, and a practitioner representing a client who owes a tax liability should always investigate if it can be obtained. However, as this case demonstrates, it is intended for taxpayers who truly have no income or assets available to pay a liability. If a taxpayer has any assets that can be used to pay some of his or her tax debt, CNC status will likely be denied by the IRS, and the Tax Court will not overrule the IRS's decision.
Riggs, T.C. Memo. 2015-98