Individual Income Tax Update 

      By:  Richard M. Colombik and Linda Godfrey, Richard M. Colombik and Associates, P.C., Itasca, IL  

The following is a summary of select materials presented by the authors at the 2005/2006 Federal Tax Law Ed Program in Chicago and Springfield earlier in the year.

I. Income

A.  Contingent Fees Paid Directly to Attorneys Held Taxable Income to Clients

      In the Comm?r v. Banks, 543 U.S. 426; 125 S. Ct. 826 (2005), the Supreme Court held that a taxpayer's gross income from the proceeds of litigation included the portion of the damages recovery that was paid to his attorneys according to a contingent fee agreement.  This decision upholds the doctrine that a taxpayer cannot assign economic gain from gross income in advance to another party in order to exclude it from income. 

      The taxpayers were awarded judgments for civil rights violations.  They did not report as income the payments made to their attorneys as contingency fees.  They reported the judgment income minus the contingency fees.  The attorney-client relationship was one of agency not of joint ventures. The taxpayers retained control of the income generating assets and therefore controlled the disposition of the income. Therefore, the contingent attorney fees were an anticipatory assignment to the attorney of a portion of the client's income from any litigation recovery.  

      For the tax years in question, the legal expenses could have been taken as miscellaneous itemized deductions subject to ordinary requirements, 26 U.S.C.S. §§ 67-68.  This would not have helped because of the alternative minimum tax.  Also, after these cases arose, Congress enacted the American Jobs Creation Act of 2004, 118 Stat 1418.  The American Jobs Creation Act allowed a taxpayer to deduct attorney fees and court costs paid in connection with any action involving a claim of unlawful discrimination in computing adjusted gross income. Unfortunately, for the taxpayer, the Act was not retroactive.   

B.  Referral Fees Paid to Law Firm Associates Subject to Withholding

      In Fuchsberg & Fuchsberg v. New York Commissioner of Taxation and Finance, 13 A.D. 3d 831, 786 N.Y.S. 2d 257 (2004), the New York Supreme Court?s Appellate Division confirmed the determination that referral fees paid to associate attorneys as independent contractors separate from their salaries were to be treated as wages subject to withholding.

      The associates of the law firm received a share of the contingency fees received in personal injury cases from client referrals.  These payments were paid as if the associates were independent contractors with no withholdings.  The question was whether these fees were wages and subject to withholding. 

      The law firm treated its associates as employees.  The determination that the fees were wages and subject to withholding was supported by testimony that client referrals were part of the associate?s typical duties and not a separate and distinct service. 

C.  Job Discrimination Settlement Proceeds Held Subject to Withholding

      The U.S. Court of Appeals for the Ninth Circuit in Rivera v. Baker West Inc., 2005 U.S. App. LEXIS 27170, held the settlement proceeds paid to a plaintiff in consideration for dismissal of a suit he filed against his former employer for alleged discrimination based on his race and national origin represented lost wages subject to withholding and were not intended to compensate for personal physical injuries,

      The employee claimed the employer improperly withheld $15,000 in state and federal employment taxes from his claim settlement check.  The court held that the settlement proceeds were for lost wages and were not intended as compensation for personal injuries.  Therefore, the settlement proceeds were not entitled to exemption under 26 U.S.C.S. § 104(a)(2) and subject to income tax withholding.

D.  Convenience-of-Employer Rule Upheld

      The U.S. Supreme Court let stand a New York court decision in Huckaby v. New York State Div. of Tax Appeals, 6 A.D.3d 988, 776 N.Y.S.2d 125, 2004 N.Y. App. Div. LEXIS 5008 (N.Y. App. Div. 3d Dep?t, 2004), upholding the constitutionality of the state's "convenience of the employer" rule.  The New York State Court of Appeals stated the rule does not violate the U.S. Constitution's 14th Amendment due process or equal protection clauses.  Under the rule, income derived from work in another state by a nonresident employed by a New York employer is taxable by New York unless the employee's work is performed out of state for the employer's necessity.  

      The taxpayer, a Tennessee resident, worked for a New York employer.  He spent an estimated 75 percent of his work time telecommuting from his office in Tennessee and about 25 percent of his work time in New York. The taxpayer allocated his income between New York and Tennessee based on the number of days that the taxpayer worked and filed non-resident tax returns for New York. The New York State Department of Taxation and Finance found that the employee?s out-of-state work was not performed for the necessity of the employer and allocated 100 percent of the employee's income to New York State.  The court affirmed, holding that full taxation of the employee's income was proper under N.Y. Tax Law §§ 601(e), 631(b)(1)(B).  The constitutional rights were not affected by the "rule of convenience" test for determining whether or not income paid by a New York employer was taxable by the State.  The court declined to adopt a proportionality requirement to the existing due process precedent when the income was not connected with the employer's participation in interstate commerce.

E.  Individual May Reduce Gross Income by Amount Paid to Former Spouse

      In Dunkin v. Comm?r, 124 T.C. 180; 2005 U.S. Tax Ct. LEXIS 10; 124 T.C. No. 10; 35 Employee Benefits Cas. (BNA) 1189, the U.S. Tax Court ruled the taxpayer could reduce his gross income by $25,511. This is the amount the California community property law required him to pay to his former spouse because of her community property rights in his pension. 

      The IRS claimed the taxpayer was taxable on the payments since he was not yet receiving pension benefits.  The IRS claimed this was determined by I.R.C. § 402 and the qualified domestic relations order (QDRO) rules. The court disagreed and stated that the taxpayer's post-divorce wages were not community property. The rights of divorced spouses under California law did not depend on the form of the payment to the former spouse, therefore, the Federal taxation of those rights should not depend on the form of payment.  §402 did not apply because no distributions from a qualified trust were made and the use of an early retirement QDRO was not required.  Therefore the court saw no intent for federal law to supplant state law and no reason to avoid taxation according to his rights and obligations under state community property law.

F.  Amounts Received From Individual?s Employer Not Reimbursement Under Accountable Plan

      The United States Tax Court held in Namyst v. Commission of Internal Revenue, T.C. Memo2004-263; 2004 Tax Ct. Memo LEXIS 276; 88 T.C.M. (CCH) 463, payments made to the taxpayer in excess of his reimbursable expenses under an accountable plan were income. 

      The taxpayer was employed and received a salary for over two years.  The company then informed the taxpayer they could no longer afford to pay his salary.  The taxpayer and the company agreed that the taxpayer would continue working for the company at no salary but would be reimbursed for his expenses.  They also agreed the company would purchase tools the taxpayer owned and that were being used by the company?s other employees.  The IRS adjusted the taxpayer?s income to include the amounts of the reimbursement checks and the amounts the taxpayer received for the tools.  The IRS argued that it was not reasonable for the taxpayer to work for the company without a salary or an ownership interest in the company.

      The Tax Court held that since the taxpayer?s expenses were not part of an accountable plan, those amounts are to be included as compensation in his gross income.  An employer?s reimbursement plan must meet three requirements to qualify as an accountable plan.  There must be a business connection, substantiation, and a requirement for the return of excess reimbursement.  The plan for the company met the business connection and substantiation requirements but failed due to the lack of the requirement for the return of excess reimbursement. 

      It was also held that the amounts the taxpayer received for his tools should be treated as a long-term capital gain, not compensation, and included in the gross income. 

G.   Cattle Farming Activities Engaged in With Profit Motive

In Mullins v. United States of America, 334 F. Supp. 2d 1042; 2004 U.S. Dist LEXIS

15692; 2004-2 U.S. Tax Cas. (CCH) P50, 369; 94 A.F.T.R.2d (RIA) 5389, the court held the taxpayer was engaged in his cattle farm operation with an actual profit motive.  The IRS claimed the taxpayer?s farming activity was not engaged in for profit.  Therefore, no deduction related to the farming activity is allowable except as provided in 26 U.S.C.S. §183(b).  

      The taxpayer had a successful business as a manufacturer.  In 1973, the taxpayer turned the day-to-day operations over to his sons in order to spend his time fulfilling his lifelong dream of owning a farm and raising cattle.  The taxpayer worked an average of 50 hours per week on the farm that included caring for the cattle and working the land.  He maintained approximately 70 head of cattle and consulted with numerous individuals in the cattle business.  The taxpayer earned a small profit one year and substantial losses the remaining years.  A substantial profit was earned from selling farmland and timber over the years. 

      The court applied the nine factors from Regs. §1.183-2(b)(1)-(9) and cited Campbell v. Comr., 868 F.2d 833 (6^th Cir. 1989), which explains a taxpayer is engaged in an activity for profit if the taxpayer entertains an actual and honest profit objective in the activity.  The profit objective need not be reasonable or realistic.  The court held that the evidence supported a finding for the taxpayer as to the nine factors even though there were small profits and substantial losses over the 24-year period of the cattle operation.  The court found that the taxpayer did not purchase the land with the primary intent to profit from its increase in value.  The primary purpose of the land purchase was to use it for cattle raising.  The court was not persuaded that proof negated the actual and honest profit intent of the taxpayer.  The court stated that if repeated losses were the only criterion used to judge farming as a business, then a great number of farms in the country would fail the test. 

II. Returns, Payments, Interest, and Penalties

A.  Erroneously Abated Timely Assessment Held Properly Reinstated

      In Becker v. IRS, 407 F.3d 89; 2005 U.S. App. LEXIS 7339; 2005-1 U.S. Tax Cases (CCH) P50, 337; 95 A.F.T.R.2d (RIA) 2144; Bankr. L. Rep. (CCH) P80, 300, the U.S. Court of Appeals for the Second Circuit ruled that a timely imposed assessment that was within the limitations period and abated in error, may be reinstated to correct that error even after the limitations period for the initial assessment has expired unless there was a showing of reasonable and detrimental reliance on the erroneous abatement.  The court found that there was no basis that the IRS's claim was allowed to slumber until evidence had been lost, memories had faded, and witnesses had disappeared, that the debtor lacked notice of the reinstatement, or that the IRS's assertion of its claim came as a surprise.

      The debtor stated the district and bankruptcy courts erred in upholding the IRS's reinstatement of the liability assessment against him after the statute of limitations had run.  The debtor contended that it was well settled that the tax statutes of limitations were to be construed strictly against both taxpayers and the government alike since they were neutral rules, prescribed by Congress, to implement important policies of repose. Also, the IRS did not reinstate the assessment or notify the debtor of the reinstatement within a reasonable time. The debtor argued the reinstatement should not be upheld because he relied, to his detriment, on the abatement and the reassurances he received from the IRS that he no longer had any § 6672(a) liability. 

B.  Taxpayers Credited for Value of Seized Stocks Unsold Despite Request

      The U.S. Tax Court ruled in Zapara v. Commissioner, 124 T.C. 223; 2005 U.S. Tax Ct. LEXIS 15; 124 T.C. No. 14, the taxpayers were entitled to a credit for the value of the seized stock accounts as of the date by which the stocks should have been sold, which was 60 days from the date the taxpayers made their sale request.  The court remanded the case to the Internal Revenue Service Office of Appeals for purpose of determining the value of the seized stock accounts as of the date by which the stocks should have been sold. 

      The taxpayers had pled guilty to various tax-related offenses in a prior district court criminal proceeding.  A jeopardy levy was imposed on certain stock accounts owned by the taxpayers.  The taxpayers had requested the IRS sell the stock held in the accounts that were seized and to apply the proceeds to their outstanding tax liabilities.   The value of these stock accounts declined substantially when the Commissioner eventually sold the stock.

C.  Government Not Required to Pay Post-Judgment Interest On Award of Attorneys' Fees, Costs

      The court held in Glass v. U.S., 335 F. Supp. 2d 736; 2004 U.S. Dist LEXIS 17317; 94 A.F.T.R.2d (RIA) 5614, that the government is not required to pay interest on attorneys' fees and costs awarded under §7430.  They also held that government is allowed 60 days from the date of entry of the court order to pay the costs and attorney?s fees. 

      In July, 2000 the taxpayer filed suit seeking refunds of tax overpayments.  The government filed a counterclaim. The finding was in favor of the taxpayer and the court stated the taxpayer was entitled to reasonable and allowable costs §7430.  The taxpayer subsequently filed an application for attorneys' fees and costs.  The court granted in part and denied in part the amended application. The court specifically awarded the taxpayer nearly $30,000 in costs.  The court also ordered the government to pay the taxpayer within 30 days and if the government did not pay within 30 days, the amount would accrue post-judgment interest would accrue at the applicable federal rate on the amount until it was paid in full.   

      The government requested that the court amend its order to reflect that no interest is due on the amount awarded and to state the government does not have to pay the amounts awarded until the later of the final judgment following appeal or the normal time frame for processing such payments.  The district court granted in part and denied in part, the government's motion. The court amended its order by deleting the section ordering the government to pay any interest and allowing the government 60 days from the date of entry of the court's order to pay the amount of costs and attorneys' fees. 

D.  Taxpayer Entitled to Costs Where IRS Not Justified in Denying Interest Abatement

      In Corson v. Comr., 123 T.C. 202; 2004 U.S. Tax Ct. LEXIS 35; 123 T.C. No. 10, the U.S. Tax Court held the Internal Revenue Service was not substantially justified in denying taxpayer's request for interest abatement.   Therefore, the taxpayer, as the prevailing party as to the significant issue of the case, is entitled to attorney's fees under §7430 at the statutory rate.  

      The taxpayer was an investor in a partnership that was involved in tax shelter litigation. The taxpayer entered into settlement agreements with the IRS in 1985 providing the taxpayer could not deduct losses in excess of payments he made to or on behalf of the partnership for the tax years before 1980 or after 1982. The taxpayer?s 1981 tax year remained open until the partnership litigation was concluded.  After the partnership litigation concluded in 1999, the IRS assessed additional income tax and accrued interest for the 1983 tax year.  The IRS stated the additional tax and interest were attributable to the taxpayer?s involvement in the partnership. The taxpayer filed a claim for abatement of the interest under §6404(e)(1).   

      The IRS Appeals officer was provided with copies of the settlement agreements.  The Appeals officer refused to consider the content or effect of the settlement agreements and stated the taxpayer's ?desire and belief are not relevant factors considered under the law in abatement of interest cases.?  The Appeals officer issued a notice of determination in denying the request for abatement of interest.  The taxpayer then filed a petition with the Tax Court, appealing from the notice of determination. The taxpayer and the IRS settled this dispute, and the IRS fully abated the interest for the 1983 tax year. The taxpayer then filed a motion for attorney's fees.   

      The Tax Court granted the request for attorney's fees under §7430, finding the taxpayer was the prevailing party as to the significant issue in the case and that the IRS's position was not substantially justified.  The court also stated that T's settlement agreements constituted binding agreements under §6224(c)(1).  The court concluded that since the settlement agreements were not based on the outcome of the partnership litigation, there was no reasonable explanation for the IRS's delay in performing the ministerial act of assessment.  The court concluded that because the taxpayer exhausted the administrative remedies, and because the IRS failed to prove its position was substantially justified, the taxpayer was entitled to attorney's fees at the statutory rate.  

 E.  Timely Mailing Treated as Timely Filing and Paying

      The United States Court of Appeals for the Tenth Circuit reversed and remanded the district courts holding in Sorrentino v. Internal Revenue Service, 383 F.3d 1187; 2004 U.S. App. LEXIS 19271; 2004-2 U.S. Tax Cas. (CCH) P50, 372; 94 A.F.T.R.2d (RIA) 5904.  The Sorrentino?s filed suit after the IRS disallowed a refund due to a late filed income tax return.   

      The district court applied the common law mailbox rule.  This common law rule provides that proof of mailing of a communication that is correctly addressed and bearing the correct postage creates a presumption that communication was received.  The IRS appealed this decision.   

      The IRS stated that I.R.C. §7502 replaced the common law mailbox rule.  The IRS also stated that the Sorrentino?s statements alone were not sufficient to establish an actual mailing since the taxpayer has a history of filing late returns.  The Appeals Court agreed with the IRS.  The court found that the taxpayer?s could establish timely delivery by the presentation of registered, certified, or electronic mail receipts.  The appellate court did not believe the uncorroborated self-serving testimony of mailing is sufficient to invoke the mailbox rule and therefore reversed the district court and remanded with instructions to dismiss. 

III. Taxes and Bankruptcy

A.  IRS's Levy Notice Held Violation of Bankruptcy Court's Discharge Order

      In Foltz v. United States, 324 B.R. 250; 2005 Bankr. LEXIS 738; 95 A.F.T.R.2d (RIA) 1635, the U.S. District Court for the Middle District of Pennsylvania ruled the issuance of a notice of intent to levy by the IRS to collect a trust fund tax penalty against a debtor constituted a violation of the bankruptcy court?s discharge order.  This tax penalty was not assessed until after the discharge was entered.   The debtor had received a discharge on all pre-petition debts provided for in his Chapter 13 plan.  The IRS had actual knowledge of the discharge order.  The civil penalty for the employment taxes was not assessed until after the discharge order was entered.  Therefore, the IRS asserted the debt was not subject to the debtor?s plan.

      The debtor filed a complaint against the Internal Revenue Service (IRS) alleging the IRS violated the discharge injunction by assessing and attempting to collect trust fund recovery penalties against him.  Both parties moved for summary judgment.  

      It was not disputed the debtor received a discharge on all pre-petition debts provided for in his Chapter 13 plan and the IRS had actual knowledge of the discharge order. The IRS assessed the civil penalty for the employment taxes after the discharge order was entered.  The IRS stated since the assessment occurred after the discharge was entered, the debt was not subject to the debtor's plan. The court found the proposed plan provided for the payment of all priority claims and the schedules listed the IRS as a creditor.  There was no specific reference to the trust fun claims at issue.  The IRS did not file a claim for the taxes that are the subject of this dispute.  The court held that the claim was "provided for" by the plan, and the IRS failed to file a timely proof of claim therefore the taxes were discharged. 

      The debtor's motion for summary judgment was granted since the bankruptcy court found that the tax penalty was discharged when the debtor received his personal discharge and the IRS violated the discharge injunction.

B.  Bankruptcy Abuse Prevention and Consumer Protection Act of 2005

      Effective October 17, 2005 

• Eliminates ?superdischarge?(judges allowed bankruptcy debtors to discharge tax debt from fraudulent or misfiled returns, not normally allowed)
• Debtor may shield $1 million in IRA funds, will be adjusted for inflation
• Limit applies only to IRAs
• Amounts rolled into IRAs from other qualified accounts will not be subject to the limitation
• Education IRAs and Code Sec 529 plans are exempt from bankruptcy estate
• Funds deposited between 365 and 720 days prior to bankruptcy petition filing will be exempt up to $5000.
• Funds placed in account within one year will not be exempted
• Mandatory credit counseling
• Tax Returns and proof of income required
• Fewer automatic stays 
• No eviction notices stayed
• No driver?s license suspensions stayed
• Legal action for child support not stayed
• Divorce proceedings not stayed
• New creditor priority
• Unpaid child support & alimony have priority over any other creditor
• Mandatory financial management education
• Ch 7 has eligibility requirements (?means test?)
• Current monthly income must be less than median income for your state
• If above, must file Ch 13

IV. Collections

A.  IRS Collection Effort Not Hindered by State Limitations Statute

      In O'Connor v. United States, 2005 U.S. Dist. LEXIS 18445; 96 A.F.T.R.2d (RIA) 5691,the U.S. District Court for the Eastern District of Michigan granted the government?s motion to dismiss.  The ruling that a state statute that provides a limitation period of 10 years for actions founded upon judgments does not bar IRS from seeking to collect on a 14-year-old consent judgment it had entered into with a taxpayer was upheld.

      The plaintiff challenged an Internal Revenue Service determination upholding a levy.  The plaintiff taxpayer sued the United States, claiming a 1990 consent judgment was invalid because it was not renewed within the 10-year time limit set forth under Mich. Comp. Laws § 600.5809(3). The matter was before the court on the government's motion to dismiss.

      The plaintiff's complaint was a pure question of law, and the Internal Revenue Service's determination of the issue was reviewed de novo. The three main arguments the government presented to support its motion to dismiss were: (1) venue was improper, (2) the court lacked jurisdiction to grant injunctive relief in the case, and (3) sovereign immunity applied. The court found venue was proper within the Eastern District of Michigan because a civil action could be brought where a substantial part of the events or omissions giving rise to the claim occurred. 28 U.S.C.S. § 1391(e)(2).  The court next found the United States was clearly acting in a governmental capacity in attempting to collect on the 1990 consent judgment.  Therefore, the Michigan 10-year limitations period did not bind the government in this case. 

B.  Later-Recorded State Court Judgment Yields to Federal Tax Lien

      In Collier v. United States, 2005 U.S. App. LEXIS 27175, the U.S. Court of Appeals for the Fourth Circuit ruled an unrecorded judgment in the state is not effective against a recorded federal tax lien if the state requires that a judgment be recorded before it is effective against a class of third parties acquiring liens on real property. West Virginia state law requires recordation for a judgment lien to be valid against a class of third parties consisting of deed-of-trust creditors.

      The judgment creditor filed an adversary proceeding against the United States, seeking a declaratory judgment that the judgment lien had priority over the tax lien with respect to the remaining funds in the debtor's bankruptcy estate. The bankruptcy court ruled that the tax lien had priority and the district court affirmed. Both courts reasoned that the judgment creditor's lien had not been perfected until the judgment creditor recorded it. The lien had been recorded after the United States had recorded the tax lien. Affirming, the court held that the judgment creditor was required to record the lien before it was perfected. The judgment creditor's lien did not have priority over the tax lien until the judgment creditor's lien was filed.  

C.  Taxpayers' Attorney Liable to IRS for Failing to Honor Notice of Levy

            In U.S. v. Waldvogel, 2004 U.S. Dist. LEXIS 11657; 2004-1 U.S. Tax Cas. (CCH) P50, 276; 93 A.F.T.R.2d (RIA) 2573, the court held the attorney?s failure to comply with the notice of levy that was served on him rendered him liable for the value of the property he wrongfully held. 

      The attorney represented a married couple that had decided to sell their home and auction their landscaping business. The bank held a mortgage on the home and a security interest in the business. The IRS and the bank requested the auction proceeds be placed in escrow because of outstanding debt and unpaid taxes.  The taxpayers retained an attorney to serve as escrow agent.  The auction receipts were deposited in an escrow account by the attorney.   

            The IRS served the attorney with a notice of levy that listed the wife taxpayer as the taxpayer and directed the attorney to turn over to the IRS any money, property or credit the attorney had or was obligated to pay the wife taxpayer. The bank advised the attorney they would commence legal proceedings unless the escrowed funds were turned over to them. The husband taxpayer directed the attorney to turn the proceeds over to the bank. The attorney obtained a money order payable to the bank, at the husband taxpayer?s direction, for the proceeds, and delivered it to the husband taxpayer who then turned the money order over to the bank.    

            The IRS sent the attorney a Final Demand on the original levy.  The attorney responded that the notice of levy directed him to turn over property belonging to wife taxpayer and when he received the notice, he had no money or property in his possession belonging to the wife taxpayer. The attorney stated he had a bank account that had contained auction proceeds deposited by the husband taxpayer and these proceeds were paid to the bank.  The attorney stated the bank had a prior interest in at least a substantial portion of the proceeds based on its chattel security agreement and that at the time he received the notice, he did not possess any property belonging to wife taxpayer, the taxpayer named in the notice of levy. 

      The court stated that a bank or other entity, including an escrow agent, served with a notice of levy has only two defenses for a failure to comply with the demand: it can claim that it is not in possession of the taxpayer's property, or it can assert that the property is subject to a prior judicial attachment or execution.  The court rejected the attorney?s argument.  The court stated it was not up to the attorney to decide how much, if any, of the proceeds the IRS was entitled to receive.  The court found the attorney?s second argument would constitute a legitimate defense if supported by evidence. The court concluded that the attorney knew the taxpayer wife had an interest in the proceeds.  

D.  Abuse of Discretions Found for IRS Issuance of Notice of Determination Before Determining Correct Tax Due

      In Borges v. United States of America, 317 F. Supp. 2d 1276; 2004 U.S. Dist. LEXIS 6347; 2004-1 U.S. Tax Cas. (CCH) P50-, 208; 93 A.F.T.R.2d (RIA) 1471, the United States District held that when a challenge to the amount of the delinquent taxes has been raised and the viability of a collection partially depends on the amount of taxes due, it is an abuse of discretion to issue the Notice of Determination before the correct amount is calculated. 

      The taxpayer had received a notice of intent to levy for delinquent employment taxes owed by their dairy operation.  Various conferences were held with the IRS Appeals Officer.  The Appeals Officer determined that an installment plan would not be viable because of the dairy?s financial information and the amount of the tax due.  The taxpayer had raised the issue of whether their tax payments had been correctly applied.  The Appeals Officer rejected the taxpayer?s request for an installment plan based on erroneous information that included an overstatement of the taxpayer?s employment taxes and an understatement of the taxpayer?s proposed monthly payment.  The Appeals Officer issued a Notice of Determination before determining the correct amount of the taxpayer?s delinquency.  The taxpayer claimed the Appeals Officer was in error by rejecting their proposed collection alternatives before determining the correct amount of taxes due. 

      The court held that the erroneous information may not have affected the Appeals Officer?s final determination.  But when a challenge to the amount of delinquent taxes has been raised and the viability of a collection alternative may depends on the amount of taxes due, the correct amount of taxes must be determined before a Notice of Determination is issued.  To do otherwise is an abuse of discretion.

E.  Tax Liens are Not Extinguished by Personal Discharge in Bankruptcy

      In Iannone v. Commission of Internal Revenue, 122 T.C. 287; 2004 U.S. Tax Ct. LEXIS 16; 122 T.C. No. 16; the United States Tax Court held that the federal tax lien that attached to the taxpayer?s property when he filed his bankruptcy petition was not extinguished as a result of the bankruptcy discharge.  Under 11 U.S.C. §522(c)(2)(B), federal tax liens are not extinguished by personal discharge in bankruptcy.  The court found that the tax liabilities were discharged. 

      The taxpayer had filed a Chapter 7 bankruptcy petition for the years 1987 through 1993 listing a 401(k) as exempt property.  The bankruptcy court granted a discharge.  The IRS issued a notice of intent to levy to the taxpayer for liabilities for the years of 1989 and 1991.  The taxpayer and the Appeals Officer were not able to resolve the issues.  A Notice of Determination was issued that concluded that the notice of intent to levy was appropriated in regards to the 401(k) account. 

      The court stated that the existing federal tax lien that attached to the taxpayer?s property when he filed his bankruptcy petition was not extinguished as a result of the bankruptcy discharge.  The court noted that when the taxpayer filed for bankruptcy, a valid federal tax lien existed on the 401(k).