The standard of review refers to the standard the Court uses to decide various types of cases. The standard determines what the Court will be looking for and what evidence it will consider in examining the case. There are generally two different standards used in examining different types of cases. They are “de novo” and “abuse of discretion.”
The “De Novo” Standard
The Court reviews petitions for deficiency notices “de novo,” which means “from the beginning.” That means the judge considers the case based on the evidence presented at the trial, without reference to the administrative record.1 Naturally, either party may seek to place documents from that record into evidence, but it is not a requirement and either party may oppose the introduction of parts of the administrative record based on the “de novo” principle of a new examination of the facts.
For example, should the IRS attempt to place into evidence a letter you wrote to them during your audit that makes an argument you later learn is flawed or that you will not be making in your case, you may attempt to exclude that letter because it is not relevant to the issues in your petition. You will present new evidence to the court and not rely on what has gone before.
Abuse of Discretion
When petitioning a lien or levy action on a Notice of Determination, the standard of review is for “abuse of discretion” by the IRS appeals office that held the CDP hearing. Generally the court considers only the administrative record. In this type of case, if you didn’t raise an issue in your hearing, you won’t be able to raise it in Tax Court. If you win on the standard of “abuse of discretion” your victory will mean you go back to the same people who abused their discretion in the first place. This time they will be under instructions from the court to treat you properly.
Notices of Determination come out of Collections Due Process (CDP) hearings. These are administrative hearings to determine how you are going to pay and whether a lien or levy is justified, not whether you owe the money. If you lost a Tax Court case, for example, and are trying to negotiate how you will pay the resulting assessment, you will be granted a CDP hearing for that purpose. But since you already had a chance to dispute the liability and lost, or if you lost by default by missing the petition deadline in Tax Court, you may not dispute it again without paying it.
Your Notice of Deficiency was your opportunity to challenge the liability. If you miss that opportunity but still want to challenge the tax, you must pay it, then sue to get it back in district court. You may not challenge liability at a CDP hearing unless you have not had a previous opportunity to do so.
Prior Opportunity to Challenge Liability
If you have never had the opportunity to challenge the underlying liability for the tax the IRS is trying to collect by lien or levy, the standard of review changes. In such cases, the standard is “de novo” and new evidence may be presented that did not appear in the administrative record. A “prior opportunity” to challenge a liability is the receipt of a Notice of Deficiency. No notice, no prior opportunity.
This situation applies generally to civil penalties for filing frivolous returns. In those cases the IRS assesses penalties and starts collections without a deficiency notice.2 In that situation when you petition the Tax Court from the Notice of Determination that comes out of the CDP hearing, you can challenge the liability. Because you never received a Notice of Deficiency, you haven’t had an opportunity to contest the penalty.
Frivolous return penalties increased from $500 to $5000 in 2007. Since then the Service has been aggressively pursuing them. In these cases an unnamed revenue agent declares a return frivolous without specifying exactly what it is that makes the return frivolous. The Service assesses the penalty and takes the case directly to collections. You receive a series of collections letters, ending in a Final Notice of Lien or Levy. Your receipt of a Final Notice of Intent to Levy (Lt11 or similar) or a Final Notice of Federal Tax Lien Filing gives you 30 days to apply for a CDP hearing. When you receive an unfavorable Notice of Determination from such a hearing you have 30 days to petition the Tax Court.
Thirty day deadlines pass quickly. Pay attention to them.
If you find yourself facing such a penalty remember to contest the underlying liability at the CDP hearing. The law requires that you be given an opportunity to contest any liability. Since the Service didn’t issue a deficiency notice for the penalty, you did not have an opportunity to contest that liability. The CDP hearing is your first chance.
Be sure to include in your hearing request an assertion that proper procedures for “managerial penalty approval” were not followed. (See I.R.C. 6751(b)) Procedural arguments have the best chance of success in this type of case.
From my experience you will not prevail at a CDP hearing against a frivolous return penalty. The hearing officer will not say exactly what is frivolous about your return, but will still expect you to magically produce documentation that it is not. That, of course, is impossible. And when you do not produce the impossible documents, the CDP hearing officer will declare that the IRS has acted properly and the penalty stands. Your real chance to contest the liability will happen in Tax Court.
IRS has the Burden of Proof
The distinguishing feature of such a lien or levy action for a frivolous penalty is that, unlike most Tax Court cases, the respondent has the burden of proof under § 6703(a).3 This is an important difference. The criteria for imposing frivolous penalties are objective and specific. You’ll find them in § 6702.4 Since your opponent has the burden you need only deny having filed the frivolous return. He must establish the facts that prove your return is frivolous. You must insist that the IRS come forward with objective proof based on the information on the face of the return only. Speculation about your intent, or subjective conclusions by the Service are not proof.
1 The “administrative record” is the collection of all the correspondence, notices, assessments, records of meetings, financial records, phone calls, notes and e-mails that have anything to do with the case. It includes the IRS’ computer records and internal documents as well, which you can get through FOIA (Freedom of Information Act) requests.
2 See § 6703(b).