Due Process of Law in Federal Tax Assessments

The Fifth Amendment Due Process Clause applies to tax assessments. This article explores what process is due and what process is afforded in Federal tax assessments.

What Process Is Due

Amendment V to the U.S. Constitution guarantees due process of law: “No person shall . . . be deprived of life, liberty, or property, without due process of law”.

The earliest expression of due process of law in western jurisprudence is in the Magna Carta (1215). My wife and I were at Runnymede, England on June 19, 2015 with an American Bar Association contingent for the commemoration of the 800th anniversary of the sealing of the Magna Carta. Present were Queen Elizabeth II, representing of course the Crown, Prime Minister David Cameron, representing the barons, and Archbishop of Canterbury Rowan Williams, representing the mediator of the original Magna Carta, Archbishop Stephen Langton. This event prompted me to read more about the Magna Carta.

The Magna Carta was about taxes, and it was about due process of law. All lands in England were held in the name of the king. King John had been prosecuting a war to recover ancestral lands in Normandy and Britany. To finance the war, King John had been imposing upon his tenants-in-chief, the earls and the barons, taxes and knights’ service. The barons could pay an additional tax, called a “scutage,” in lieu of posting knights for service.

The King appointed judges to adjudicate cases. The judges followed the royal court around (this is the origin of the modern term “court” of justice). When the king’s interests were at stake, the king himself was often present for trial, and the case was undoubtedly decided for the crown.¹

The barons had had enough of King John. They began raising armies in Yorkshire, and in East Anglia. They seized London, except for the Tower. King John was smart enough to realize that he would lose a war with the barons, so he parlayed with them. After negotiations, the sides met at Runnymede, on the banks of the River Thames, midway between Windsor and London, on June 19, 1215, to solemnize their treaty, the Great Charter (“Magna Carta”).

The Magna Carta was inscribed on parchment, from sheepskin, in classical Latin—perhaps a few hundred people in the entire country could have read it. The first letter of the first word of each article was enlarged and emboldened. There are no article numbers in the original Magna Carta; article (“cap.”) numbers were added by Blackstone in 1759.²

Between seven and 13 originals of the Magan Carta were sealed, and sent to bishoprics around the country for display,³ just as our Founding Fathers signed multiple originals of the Declaration of Independence, for display throughout the Thirteen Colonies. Four originals of the Magna Carta survive.⁴

King John did not sign the Magna Carta—there is no evidence he could write.⁵ King John did not even seal the Magna Carta; the sealing of charters was the task of the spigurnel, a member of the chancery staff.⁶

The Magna Carta subjected the king’s ability to impose taxes, knights’ service, and scutage to the authority of local common councils:

12. No scutage or aid is to be levied in our kingdom, save by the common counsel of our kingdom . . ..

. . .

14. And to have the common counsel of the kingdom for an aid to be assessed . . . or for a scutage to be assessed, we will cause to be summoned archbishops, bishops, abbots, earls and greater barons, individually by our letters and in addition we will cause to be summoned in general, by our sheriffs and bailiffs, all those who hold from us in chief, at a specified day, namely at a term forty days distant at least, at a specified place; and in all the letters of that summons, we will express the cause of the summons; and thus, the summons having been made, the business is to proceed on the assigned day, according to the counsel of those who are present, although not all those summoned come.

15. We will not grant henceforth to anyone that he may take an aid from his free men . . ..⁷

Magna Carta caps. 39 and 40 require due process of law:

39. No free man is to be arrested, or imprisoned, or disseised, or outlawed, or exiled, or in any way destroyed, nor will we go against him, save by the lawful judgement of his peers or by the law of the land.

40. To no one will we sell, to no one will we deny or delay, right or justice.⁸

Magna Carta cap. 52 provides that if any person is “disseised or dispossessed without lawful judgment of his peers, of lands, castles, liberties or his right, we will restore these to him immediately.”

Magna Carta cap. 55 provides that all financial penalties (“fines” and “amercements”) collected “unjustly and against the law of the land, are to be completely remitted.”

The Virginia Declaration of Rights of June 12, 1776, the foundation of our Bill of Rights, in Section 8 adopts Magna Carta cap. 39 nearly verbatim: “[T]hat no man be deprived of his liberty except by the law of the land or the judgment of his peers.” “Law of the land” means due process of law.⁹ It does not require trial by jury in all cases.¹⁰

So what is due process of law? At a minimum, it requires affording a person notice and opportunity to be heard, in a fair proceeding, before dispossessing him of any property or right.

What Process Is Afforded

Penalties Imposed Without Deficiency Procedures

The IRS assesses most penalties without deficiency procedures. For these penalties, liability is strict: if the taxpayer committed the proscribed act or omission, the penalty lies, without resort to a mental element.

IRC § 6651(a) provides in part:

In case of failure–

1. to file any return required under authority of subchapter A of chapter 61 . . . on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;

(2)  to pay the amount shown as tax on any return specified in paragraph (1) on or before the date prescribed for payment of such tax (determined with regard to any extension of time for payment), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount shown as tax on such return 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate; or

(3)  to pay any amount in respect of any tax required to be shown on a return specified in paragraph (1) which is not so shown . . . within 21 calendar days from the date of notice and demand therefor (10 business days if the amount for which such notice and demand is made equals or exceeds $100,000), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount of tax stated in such notice and demand 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate.¹¹

The notice requirement in § 6651(a)(1) or (2) is implicit: the penalty applies unless the taxpayer makes an adequate showing that the failure to timely file a tax return or pay tax reported thereon was due to reasonable cause and not willful neglect. To make such a showing, the taxpayer must have been informed of the penalty.

The notice requirement in § 6651(a)(3) is explicit: the penalty applies if the taxpayer fails to pay the amount of tax required to be reported on a tax return which is not so reported within 21 days after notice and demand therefor (10 business days if the amount for which such notice and demand is made equals or exceeds $100,000), unless it is shown that such failure is due to reasonable cause and not due to willful neglect.

Many Federal tax penalties have a reasonable cause exception. The IRS will consider a taxpayer’s reasonable cause arguments. A taxpayer should also be sure to argue that the IRS failed to secure written, supervisory approval of the penalty required by IRC § 6751(b)—more on this later.

If the IRS sustains a penalty over the taxpayer’s arguments, the taxpayer may seek IRS Appeals Office review of the penalty. Appeals office review often bears fruit for the taxpayer.

Penalty relief may also be available by way of collection due process appeal, as explained below.

Penalties Assessed with Deficiency Procedures

Congress passed the deficiency procedures of IRC §§ 6211-6216 to provide due process of law in Federal tax assessments. The term “tax” for this purpose includes penalties.¹²

Penalties for which the IRS allows deficiency procedures include those under IRC §§ 6662(b)(1) (negligence), 6662(b)(2) (substantial understatement of income tax), 6662(b)(3) (substantial valuation misstatement), 6662(b)(5) (substantial valuation misstatement), and 6663 (civil fraud). These penalties involve an element of mental culpability. IRC § 6664(c) provides a reasonable cause exception for penalties imposed under for penalties imposed under § 6663, and for most penalties imposed under § 6662.

In proposing a tax deficiency, the IRS will refer the case to IRS Appeals to attempt settlement, unless there is insufficient time for this on the assessment statute of limitations.

If IRS Appeals is unable to resolve a case, or the IRS does not refer the case to Appeals, and the IRS determines a tax deficiency, the IRS will, under IRC § 6212(a), send a notice of the deficiency to the taxpayer.¹³ Within 90 days (150 days if addressed to a person outside of the United States) after the IRS mails a notice of deficiency to a taxpayer, the taxpayer may petition the U.S. Tax Court for review of the deficiency.¹⁴ If the Tax Court sustains the deficiency, the taxpayer may appeal to the U.S. Court of Appeals. If the taxpayer fails to timely petition the Tax Court, or if the taxpayer petitions the Tax Court and the deficiency is sustained, the assessment is made, i.e., is posted to the taxpayer’s account. Once an assessment is made, and remains unpaid, a lien in favor of the United States arises against all of the taxpayer’s property, real or personal.¹⁵ The Federal tax lien continues until the assessment is satisfied or becomes unenforceable by operation of law.¹⁶ The collection statute of limitations is 10 years.¹⁷ The IRS records notice of the Federal tax lien in the local register of deeds’ office, to prevent later purchasers, holders of a security interest, mechanic’s lienors, or judgment lien creditors from having priority over the Federal tax lien.¹⁸ The IRS endeavors to collect a Federal tax lien by levy (seizure) of the taxpayer’s property.¹⁹

Once the IRS issues a notice of intent to levy with respect to an assessment, the taxpayer may seek IRC § 6330 collection due process (“CDP”) review of the assessment. A taxpayer may seek CDP review by filing Form 12153, Request for Collection Due Process or Equivalent Hearing, with the IRS. If, within 30 days after IRS makes the assessment, the taxpayer requests CDP review of the assessment, the taxpayer may have a CDP hearing on the assessment before the IRS Appeals Office. If, after a CDP hearing, IRS Appeals sustains the assessment, the taxpayer may, within 30 days after the Appeals Office decision sustaining the assessment, petition the U.S. Tax Court for review. If the taxpayer requests CDP review more than 30 days but not more than one year after IRS issues the assessment, the taxpayer may have an “equivalent” hearing on the assessment in the IRS Appeals Office, without opportunity for Tax Court review.²⁰

The advantage of litigating in Tax Court is that the taxpayer does not first pay the assessment as a condition litigating its lawfulness. Alternatively, after paying an assessment, and filing a claim for refund, according to the provisions of law therefor, and IRS regulations established in pursuance thereof,²¹ a taxpayer may sue for a refund in U.S. District Court,²² or in the U.S. Court of Federal Claims.²³ A jury trial is available for corporations and individuals in refund litigation in U.S. District Court.²⁴

If, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the taxpayer’s liability for income tax or estate, gift, or generation-skipping transfer tax, the IRS shall have the burden of proof with respect to such issue.²⁵ Notwithstanding any other provision of the Internal Revenue Code, the IRS shall have the burden of production in any court proceeding with respect to the liability of any individual for any penalty.²⁶

Once a case is docketed in U.S. Tax Court, if the case has not already been considered by IRS Appeals, the IRS refers the case to Appeals to endeavor settlement.

If you raise due process of law, the Appeals Officer will not know how to deal with it; you will knock the Appeals Officer back on their heels. It will make your reasonable cause argument look really good.

§ 6751(b) Written, Supervisory Approval

Added by the Internal Revenue Service Restructuring Act of 1998,²⁷ IRC 6751(b)(1) provides:

No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.

IRC § 6751(b)(2) excepts from § 6751(b)(1) penalties assessed under §§ 6651 (failure to timely file a tax return or pay tax), 6654 (failure to deposit estimated tax), 6662(b)(9) (charitable contribution deduction in excess of cash contributions up to $1,000 by nonitemizer), 6662(b)(10) (qualified conservation contribution by partnership in excess of 2.5 times each partner’s relevant basis in the partnership)) or “any other penalty automatically calculated through electronic means.” IRC § 6751(b)(1) thus applies to penalty assessments involving a judgment concerning the taxpayer’s conduct, such as penalties under IRC §§ 6662 (negligence) or 6663 (willfulness). But once the taxpayer contests a penalty, any penalty, even a penalty automatically calculated through electronic means, the IRS must obtain written supervisory approval of the penalty before sustaining it.²⁸ This is one reason why a taxpayer should always interpose written objections to penalty assessments.

The legislative history of IRC § 6751 is cryptic.²⁹ The face of the statute appears to reflect Congress’ intention that IRS employees shall not assess penalties on their own, without supervision.

The IRS often does not obtain written, supervisory approval of penalties. To determine whether written, supervisory approval has been obtained for a given penalty, counsel should obtain, by direct release³⁰ or formal Freedom of Information Act³¹ request, the IRS administrative file for the penalty, and review the file produced. If required written, supervisory approval of the penalty has not been obtained, the penalty was unlawfully asserted, and cannot be sustained.³²

Assessment of International Information Return Penalties

IRC § 6039F(a) requires a taxpayer to report gifts or bequests aggregating more than $10,000 received from foreign persons during the tax year. The $10,000 is indexed for inflation. Currently, the IRS requires the reporting of foreign gifts and bequests aggregating more than $100,000 received from foreign persons during the tax year. The Reporting is done on Form 3520.

IRC § 6039F(c) provides in part:

(c) Penalty for failure to file information.– 

(1) In general.–If a United States person fails to furnish the information required by subsection (a) with respect to any foreign gift within the time prescribed therefor (including extensions)– 

(A) the tax consequences of the receipt of such gift shall be determined by the Secretary, and 

(B) such United States person shall pay (upon notice and demand by the Secretary and in the same manner as tax) an amount equal to 5 percent of the amount of such foreign gift for each month for which the failure continues (not to exceed 25 percent of such amount in the aggregate). 

(2) Reasonable cause exception.–Paragraph (1) shall not apply to any failure to report a foreign gift if the United States person shows that the failure is due to reasonable cause and not due to willful neglect.³³

The italicized language purports to authorize the IRS to impose the § 6039F penalty upon notice and demand, i.e., without an opportunity to be heard in a fair proceeding. A few years ago the IRS began doing just that, assessing upon notice and demand the penalty for failure to timely report on Form 3520, Part IV gifts from foreign persons. Such penalties are substantial—25 percent of the aggregate of gifts and bequests from foreign persons.³⁴ Such assessments violate the taxpayer’s right to due process of law guaranteed by the Fifth Amendment to the Constitution.

Form 3520, Parts I-III, and Form 3520-A require U.S. persons to report information concerning their interests in foreign trusts. IRC § 6048(a) requires such reporting. IRC § 6677(a) imposes penalties for U.S. persons’ failure to make reporting required by § 6048(a). Such penalties are substantial—the greater of $10,000 or 35 percent of the gross reportable amount, the aggregate value of the assets held in foreign trusts.³⁵ If the failure to report continues for more than 90 days after IRS notice to the taxpayer of the failure, the penalty increases by $10,000 for each 30-day period (or fraction thereof) the failure continues after such 90-day period.³⁶ IRC § 6677(e) purports to excuse § 6677(a) penalty assessments from deficiency procedures: “Subchapter B of chapter 63 (relating to deficiency procedures for income, estate, gift, and certain excise taxes) shall not apply in respect of the assessment or collection of any penalty imposed by subsection (a).” The imposition of such penalties upon notice and demand—without affording the taxpayer an opportunity to be heard in a fair proceeding—violates the taxpayer’s right to due process of law guaranteed by the Fifth Amendment to the Constitution.

And what of 31 USC § 5321(a)(5), purporting to authorize the Secretary of the Treasury to “impose” certain civil penalties for failure to timely file an annual FinCEN Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”), without mention of notice or an opportunity to be heard? A penalty so “imposed,” without notice and an opportunity to be heard in a fair proceeding, due process of law, would violate the account holder’s right to due process of law guaranteed by the Fifth Amendment to the U.S. Constitution. For this reason, U.S. Treasury imposes 31 USC § 5321(a) penalties only upon judgment. Therefore, a taxpayer who owes delinquent FBARs should not wait for the government to begin working-up a penalty case against him but voluntarily file the delinquent FBARs as soon as possible.³⁷ But a taxpayer need only file delinquent FBARs for the last six years, as the assessment statute of limitations on an FBAR penalty is six years, and it begins to run when the FBAR is due, whether or not it is filed.³⁸

Post-assessment procedure did not cure the Constitutional problem in United States v. Sagoo.³⁹ There the United States assessed upon notice a penalty in the amount of $1,020,922.50 against a taxpayer for willful failure to timely file FBARs, and then sued in U.S. District Court to collect the penalty. The taxpayer asserted that assessment of the penalty without affording her an opportunity for a jury trial on the assessment violated her right to a jury trial guaranteed by the Seventh Amendment to the U.S. Constitution. The District Court agreed that requiring the taxpayer to pay the penalty and then sue for a refund as preconditions to a jury trial violated her right to a jury trial on the assessment guaranteed by the Seventh Amendment, and granted the taxpayer’s motion to dismiss the assessment.

A taxpayer could apply Sagoo by analogy to argue that post-assessment procedure does not cure the lack of due process of law in assessment of a penalty. Nor does IRC § 6330 collection due process cure the lack of due process in assessment of a penalty. Upon assessment of a tax penalty, a Federal tax lien arises by operation of law encumbering all of the taxpayer’s interests in property, and the Federal tax lien remains until the assessment is satisfied or becomed unenforceable by operation of law.⁴⁰ The IRS records a Notice of Federal Tax Lien against the taxpayer in the local register of deeds office, impairing the taxpayer’s ability to sell property or pledge it as security for a debt.⁴¹ The Fifth Amendment protects interests in “life, liberty, or property.” These issues await litigation.

Conclusion

The Fifth Amendment Due Process Clause applies to Federal tax assessments. That an assessment was made without affording the taxpayer notice and an opportunity to be heard, in a fair proceeding, due process of law, can be a powerful defense to the assessment.

Stephen J. Dunn has represented taxpayers in civil and criminal controversies over 40 years. Since 2009 he has helped Americans comply with U.S. laws concerning foreign income, accounts, and entities, and defended them against penalties for alleged noncompliance. He also performs estate planning and administration for high net-worth individuals. He is an Adjunct Professor at University of Detroit-Mercy School of Law. His law firm, Dunn Counsel PLC, is based in Troy, Michigan.

The author thanks Kimberly Butlak Tyson Managing Partner of K Tyson Law, PLLC, Charlotte, North Carolina for reviewing and commenting on this article. Ms. Tyson is a veteran of nearly 20 years in the IRS Office of Chief Counsel (Large Business & International), where she was a subject matter expert for the IRS Exam Penalties Practice Network, advising and training revenue agents and attorneys nationwide on penalty issues.