Ryan et al v. United States of America

Filing 73

ORDER by Judge Lucy H. Koh Denying 61 Motion for Summary Judgment; Granting 62 Motion for Summary Judgment. (lhklc2S, COURT STAFF) (Filed on 4/12/2018)

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UNITED STATES DISTRICT COURT

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NORTHERN DISTRICT OF CALIFORNIA

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SAN JOSE DIVISION

United States District Court
Northern District of California

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NANCY D. RYAN,
Plaintiff,

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ORDER DENYING PLAINTIFF'S
MOTION FOR SUMMARY JUDGMENT
AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

v.

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Case No. 16-CV-00164-LHK

UNITED STATES OF AMERICA,

Re: Dkt. Nos. 61, 62

Defendant.

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Plaintiff Nancy Ryan (“Plaintiff”) sues Defendant United States (“Defendant”) for a refund

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of a $2,214,217.24 tax penalty (the “Penalty”) that was imposed on Plaintiff and her late husband,

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Kevin Ryan (“Mr. Ryan”) (collectively, “the Ryans”) by the Internal Revenue Service (the “IRS”).

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Plaintiff and Defendant have each filed a motion for summary judgment. ECF No. 61 (“Pl.

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Mot.”); ECF No. 62 (“Def. Mot.”). Having considered the parties’ briefing, the relevant law, and

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the record in this case, the Court DENIES Plaintiff’s motion for summary judgment and GRANTS

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Defendant’s motion for summary judgment.

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I.

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BACKGROUND
A. Factual Background
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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

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During the year 2000, Mr. Ryan received $37 million in capital gains and sought advice

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from various financial firms and professionals “on the tax treatment and investment of [these]

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extraordinary gains.” ECF No. 12 (“FAC”) ¶ 12. Relying on the advice certain financial

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institutions, advisors, and accountants, Mr. Ryan purchased what turned out to be a tax shelter

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called a “Son of Boss” transaction. Id. ¶¶ 12–13, 17. This tax shelter was designed to generate

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noneconomic losses through a series of investments in foreign currency options conducted through

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single-purpose offshore partnerships. See ECF No. 64-1, Exh. 221; Reddam v. Comm’r, 755 F.3d

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1051 (9th Cir. 2014) (discussing tax shelter’s lack of economic substance). As a result, in their tax

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return for the year 2000, the Ryans reported $36,383,432 in losses that were attributable to the tax
shelter, which enabled the Ryans to avoid almost $14 million in taxes. ECF No. 64-1, Exh. 222

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line 17; ECF No. 64-2, Exh. 227.

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In March 2004, the IRS selected the Ryans’ 2000 tax return for audit. See FAC ¶ 17; ECF

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No. 64-2, Exh. 226. At that time, the end of the three-year limitations period for the IRS to assess

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taxes related to the 2000 tax return was approaching. See I.R.C. § 6501(a) (stating that “the

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amount of any tax imposed by this title shall be assessed within 3 years after the return was

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filed”). Thus, to allow more time for the audit and possible settlement negotiations, the IRS

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requested the Ryans to sign a Form 872-I, titled “Consent to Extend the Time to Assess Tax as

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well as Tax Attributable to Items of a Partnership,” which extended the IRS’s deadline to assess

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taxes related to the 2000 tax return to December 31, 2005. ECF No. 64-1, Exh. 223. The Ryans

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signed the Form 872-I on March 24, 2004. Id.

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After determining that the Ryans had bought a “Son of Boss” tax shelter, the IRS proposed

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to (1) assert a deficiency in tax of almost $14 million by disallowing more than $36 million in

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losses from the tax shelter; and (2) add a 40% accuracy-related penalty under I.R.C. § 6662. See

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FAC ¶¶ 21, 142. In order to resolve the tax dispute without litigation and “avoid” the “threatened

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imposition of a 40% [accuracy-related] penalty,” the Ryans elected to participate in a settlement

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initiative with the IRS. Id. ¶¶ 21, 23; ECF No. 64-2, Exhs. 224–25. The settlement initiative

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ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
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required the Ryans to concede liability for the almost $14 million tax deficiency and to waive their

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administrative appeal rights. See FAC ¶ 21; ECF No. 64-2, Exh. 228 ¶ 12. For its part, the IRS

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agreed to impose only a 10% accuracy-related penalty and to allow the Ryans to deduct half of

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their out-of-pocket costs from the “Son of Boss” transaction. See FAC ¶¶ 21, 29–31; ECF No. 64-

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2, Exh. 228 ¶¶ 2, 3, 8. On November 23, 2004, IRS Revenue Agent Susan Luhrs prepared a

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corrected Form 4549A, titled “Income Tax Examination Changes,” to show the Ryans’ liabilities

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resulting from the settlement. ECF No. 64-2, Exh. 227. The Form 4549A showed a tax

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deficiency of $13,974,201.00 and a corresponding 10% accuracy-related penalty of $1,397,420.10.

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Id. Agent Luhrs also prepared a Form 906 “Closing Agreement on Final Determination Covering
Specific Matters,” which reflected, inter alia, (1) the IRS’s disallowance of a total of

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$36,383,476.00 in losses for the year 2000; (2) the agreement to allow the Ryans to deduct half of

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their out-of-pocket costs from the “Son of Boss” transaction; and (3) the agreement to limit the

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accuracy-related penalty under I.R.C. § 6662 to 10%. ECF No. 64-2, Exh. 228 ¶¶ 2, 3, 8.

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The settlement initiative also required the Ryans to either pay their entire tax liability—

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$13,974,201.00, plus the 10% accuracy-related penalty, plus interest—in one lump sum upon

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execution of the closing agreement, or “agree to other financial arrangements acceptable to the

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[IRS] before the [IRS] will execute the closing agreement.” ECF No. 64-2, Exh. 224. The Ryans

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requested an installment agreement from the IRS as an alternative to paying the entire tax all at

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once. See FAC ¶¶ 24–25. The IRS required the Ryans to submit a Form 433-A financial

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statement so that the IRS could evaluate the Ryans’ ability to pay their tax. See id. ¶ 25. The

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Ryans submitted a Form-433-A and a supplemental letter disclosing (1) their unencumbered

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primary residence, worth $4.5 million; (2) their second home, also unencumbered, worth about

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$2.0 million; (3) Mr. Ryan’s Piper Jaffray account, which contained over $8 million; (4) interest

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payments due from loans that Mr. Ryan had recently made to Large Scale Biology Corporation

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(“LSBC”), a company for which Mr. Ryan was serving as Chief Executive Officer (“CEO”) at the

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time; and (5) Mr. Ryan’s LSBC salary. ECF No. 64-2, Exh. 229; ECF No. 64-3, Exhs. 230–31.

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ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
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However, the Ryans did not disclose Mr. Ryan’s Rabbi Trust to the IRS. See id. The
Rabbi Trust contained about $13 million in assets, which Mr. Ryan had elected to receive in

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annual $1 million payments. ECF No. 64-10, Exh. 266 at 37; ECF No. 64-4, Exh. 248. The Trust

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also had a clause that gave the trustee discretion to issue early distributions to Mr. Ryan if he was

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suffering a “severe financial hardship.” ECF No. 64-4, Exh. 245 at 0174; ECF No. 64-4, Exh. 246

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at WF-000375. Further, the Trust had a “haircut” clause that appeared to give Mr. Ryan the ability

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to withdraw all his assets at once, at the cost of forfeiting five percent of the assets. ECF No. 64-

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4, Exh. 245 at 0176 (“Notwithstanding any other provision of the Plan, a Participant shall be

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entitled to receive, at any time, upon written request to the Employer, a lump sum distribution

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equal to 95% of the Participant’s account.”); see also ECF No. 64-4, Exh. 246 at WF-000375

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(“The Deferred Payments shall be distributed from the Trust to Ryan . . . (3) in a lump sum

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payment of up to 100% of the Deferred Amount as elected by Ryan at any time, provided that

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Ryan shall automatically forfeit 5% of the amount withdrawn.”).

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The Ryans also failed to disclose their third home, which was located in San Jose and

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worth about $900,000 in 2006, to the IRS. See ECF No. 64-2, Exh. 229; ECF No. 64-3, Exhs.

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230–31; ECF No. 64-11, Exh. 267 at 75. Although Mr. Ryan retained title to the home, he

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considered the home to belong to his daughter and son-in-law, the McIlvains. ECF No. 64-11,

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Exh. 267 at 75.

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Based on the assets that the Ryans had chosen to disclose, the IRS agreed to negotiate an

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installment agreement. ECF No. 64-6, Exh. 259 at 39–52. Specifically, IRS Revenue Officer

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Marie Maple negotiated an installment agreement with Dennis Haase, the Ryans’ tax attorney

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(who was then employed by Plaintiff’s current counsel). See ECF No. 64-12, Exh. 268 at 10–11;

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ECF No. 63-2, Exh. 212 at US-000156. In March 2005, Revenue Officer Maple drafted a

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proposed installment agreement on a Form 433-D stating that the Ryans “agree to pay the federal

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taxes shown above, PLUS PENALTIES AND INTEREST PROVIDED BY LAW, as follows:

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$4,000,000 on 04/30/2005 and $175,000.00 on the 20th of each month thereafter until the total

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liability is paid in full.” ECF No. 64-3, Exh. 232. The proposed installment agreement also

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provided that monthly payments would increase to $275,000.00 per month on June 20, 2006. Id.

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Further, the “Additional Conditions/Terms” included a payment of “$2,000,000.00+” due on July

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15, 2005 to be funded by the sale of the Ryans’ second home or “funds from another source.” Id.

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Though the proposed installment agreement stipulated that the Ryans would make a $4 million

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payment on April 30, 2005, Attorney Haase told Revenue Officer Maple on April 8, 2005 that the

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Ryans did not have enough liquid assets to pay more than $3 million by April 30, 2005. ECF No.

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63-2, Exh. 212 at US-000168. Thus, the Ryans and the IRS agreed to reduce the initial $4 million

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payment in the installment agreement to $3 million, and the Ryans signed the installment
agreement on April 12, 2005. ECF No. 64-3, Exh. 232. Thereafter, the Ryans made a $3 million

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payment to the IRS on April 28, 2005. ECF No. 64-1, Exh. 219 at US-000003.

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On May 13, 2005, Revenue Officer Maple’s manager recommended approval of the

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installment agreement. ECF No. 63-2, Exh. 212 at US-000169. Then, on May 19, 2005, the IRS

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executed the Form 906 closing agreement that had previously been prepared by Agent Luhrs and

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signed by the Ryans in December 2004. ECF No. 64-2, Exh. 228. The Ryans made their first

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$175,000 monthly payment in June 2005, as set forth in the installment agreement. ECF No. 64-1,

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Exh. 219 at US-000003. On July 4, 2005, the IRS formally assessed against the Ryans tax

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liabilities for the year 2000 consisting of (1) $13,974,201.00 in additional taxes; (2) $2,635,083.45

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in interest; and (3) a $1,397,420.10 “IRC 6662 Accuracy Penalty.” ECF No. 64-1, Exh. 219 at

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US-000003. The IRS sent a notice and demand for payment of this tax liability to the Ryans on

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the same day. Id. at US-000017.

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However, in March and April of 2005—while the Ryans were negotiating the installment

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agreement with the IRS, and before the closing agreement was executed—Mr. Ryan also loaned a

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total of $3.6 million to LSBC. ECF No. 64-5, Exh. 257 at 14. LSBC was in dire straits at the

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time. Specifically, according to LSBC’s Form 10-Q for “the quarterly period ended September

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30, 2005,” LSBC had “incurred negative operating cash flows of . . . $14,566,000 during the year

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ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
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ended December 31, 2004” and was in the midst of incurring an additional negative operating cash

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flow of $7,406,000 “during the first nine months of 2005.” ECF No. 64-5, Exh. 257 at 10. Thus,

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LSBC’s “history of negative cash flow” raised “substantial doubt about [its] ability to continue as

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a going concern.” Id. at 13. Nevertheless, Mr. Ryan believed that if LSBC could survive long

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enough, he could persuade another company to take it over, which would generate a high payout

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for him. See ECF No. 64-11 at 44. Thereafter, in May 2005, Mr. Ryan’s Piper Jaffray financial

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advisor, Richard Judd, told him that his Piper Jaffray account—in which Mr. Ryan had deposited

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most of the $35 million in capital gains he had received in 2000—was nearly out of cash. ECF

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No. 64-8, Exh. 263 at 105. Judd prepared a history of all the withdrawals that Mr. Ryan had made

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from the Piper Jaffray account. Id. at 15; ECF No. 64-5, Exh. 250 at 67–68. This history showed

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that after March 2004—which is when the IRS first contacted Mr. Ryan about auditing his 2000

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tax return—in addition to the $3 million that eventually went to the IRS in April 2005, Mr. Ryan

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had withdrawn $9,794,349 from his account. See ECF No. 64-5, Exh. 250 at 67–68; ECF 64-5,

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Exh. 251. At least $3.6 million of that amount went to LSBC; the rest went to other investments.

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ECF No. 64-8, Exh. 263 at 111 (deposition testimony of Richard Judd stating that Mr. Ryan “just

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had invested, let’s say, or lent far more than he realized”).

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Thereafter, on July 15, 2005, the Ryans failed to make the $2 million payment that was due

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on that date under the installment plan. FAC ¶ 34. The Ryans had discovered earlier that month

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that their second home—which they had planned to sell in order to make the $2 million

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payment—was contaminated by mold from an undetected water leak and was thus not ready to be

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sold at that time. ECF No. 63-13, Exh. 270 at 19. As a result, on July 20, 2005, Attorney Haase

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sent a letter to Revenue Officer Maple stating that the Ryans were seeking to borrow $2 million

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against their second home because that would be a quicker way of securing the $2 million for the

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overdue July 15 payment. ECF No. 64-3, Exh. 233. Meanwhile, on August 5, 2005, Mr. Ryan

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loaned LSBC another $750,000. ECF No. 64-5, Exh. 257 at 7.

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On September 9, 2005, Haase wrote to Revenue Officer Maple to report that there was
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ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
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“just one outstanding lien” on the Ryans’ second home, and that the Ryans were “getting the

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payoff information and all required paperwork to extinguish the lien” so that the Ryans could

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obtain a home equity loan on their second home “to pay the past due $2 million lump sum

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amount.” ECF No. 64-3, Exh. 234. On the same day, Revenue Officer Maple warned Haase that

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in light of the fact that the $2 million payment was due on July 15, 2005, she could not “continue

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to hold [the payment] in abeyance” and that she “may be sending it out to local collections office.”

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ECF No. 63-2, Exh. 212 at US-000175. Upon Haase’s representation that Mr. Ryan was not

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experiencing financial difficulties and that “it[] [was] just a matter of time to get the paperwork

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straightened out for the loan,” Revenue Officer Maple told Haase that she would “hold” until
September 16, 2005, and that if Haase did not call her with a status update on September 16, she

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would “take additional collection action.” Id.

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However, by September 28, 2005, Revenue Officer Maple had still received no word from

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Haase or the Ryans, and the $2 million payment remained unpaid. Id. at US-000177. Thus,

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Maple issued a Notice of “Defaulted Installment Agreement Under IRC 6159(b)” and “Intent to

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Levy Under IRC 6331(d)” to the Ryans. ECF No. 64-3, Exh. 235. This Notice stated that the

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Ryans were not meeting the terms of the installment agreement because they had “[f]ailed to pay

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Installment Agreement when due under terms of the agreement.” Id. The Notice also stated that

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the IRS intended to terminate the installment agreement and collect the entire amount of the

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Ryans’ tax liability if the Ryans did not meet all of the conditions of the agreement. Id. Further,

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the Notice notified the Ryans that “[t]o prevent this action, you must contact [Revenue Officer

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Maple] within 30 days of this notice,” and warned that “[i]f you do not contact us within 30 days

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of the date of this notice, your installment agreement will be terminated.” Id.

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On October 20, 2005, Attorney Haase wrote to Revenue Officer Maple to notify her that

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Mr. Ryan had “removed the last lien off his California property in order to qualify for the $2

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million home equity line of credit,” and that “[s]hortly, Mr. Ryan will forward to our office the

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funds necessary to pay the $2 million lump sum payment due to the IRS and to continue the

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installment arrangement.” ECF No. 64-3, Exh. 236. However, by November 4, 2005, the $2

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million payment remained unpaid. Thus, on that date, Revenue Officer Maple recorded a Form

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668(Y)(c) “Notice of Federal Tax Lien” (“NFTL”) in Santa Clara County, where the Ryans’ real

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property was located. ECF No. 64-3, Exh. 238. The NFTL included a demand for the “Unpaid

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Balance” of the tax assessed on July 4, 2005, which amounted to $14,533,593.76, as well as

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“additional penalties, interest, and costs that may accrue.” Id.

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On November 3, 2005, Mr. Ryan asked the trustee of his Rabbi Trust, Wachovia Bank, for

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an early distribution of the assets in the Trust (which was roughly $12 million at the time, see ECF

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No. 64-5, Exh. 249), pursuant to the “severe financial hardship” clause. ECF No. 64-5, Exh. 252.
Wachovia denied Mr. Ryan’s request, and added that it had “also considered whether a

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distribution could be made through other means,” but had concluded that “the wording of the

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documents precludes other methods after the Payment Designation is made.” ECF No. 64-5, Exh.

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253. Neither Mr. Ryan nor his counsel attempted to invoke the “haircut clause.” ECF No. 64-9,

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Exh. 265 at 30–31, 52; ECF No. 64-12, Exh. 268 at 132 (deposition testimony of Attorney Haase

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stating that “we weren’t familiar with the haircut clause”).

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Meanwhile, also in the fall of 2005, LSBC defaulted on the monthly interest payments on

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the loans that Mr. Ryan had given to LSBC, and also stopped paying Mr. Ryan’s salary. FAC ¶

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71. Nevertheless, on November 22, 2005, Mr. Ryan made another loan to LSBC in the amount of

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$340,000. ECF No. 64-5, Exh. 256. LSBC never repaid Mr. Ryan’s loans and declared

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bankruptcy in January 2006. ECF No. 64-5, Exh. 254; ECF No. 64-13 Exh. 270 at 22. Its assets

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were liquidated, and Mr. Ryan recovered nothing from the liquidation. ECF No. 64-5, Exh. 254.

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On December 12, 2005, Attorney Haase called Revenue Officer Maple and left a voice

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message stating that the Ryans had obtained a commitment from a lender for a $2 million loan

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secured by the equity in the Ryans’ principal residence, which had been formally appraised to

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have a fair market value of $4.5 million. FAC §§ 45, 48; ECF No. 64-3, Exh. 241; ECF No. 63-2,

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Exh. 212 at US-000179. However, the Ryans could obtain this $2 million loan only if the IRS

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ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
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agreed to subordinate its lien on the Ryans’ principal residence to the lender’s lien. See ECF No.

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63-2, Exh. 212 at US-000179. In response, Revenue Officer Maple sent Attorney Haase written

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instructions for submitting a lien subordination application. ECF No. 64-3, Exh. 239.

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On January 17, 2006, Revenue Officer Maple put in a request to transfer the Ryans’

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account to an IRS Collection Group in California in light of the Ryans’ default on the installment

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agreement. ECF No. 63-2, Exh. 212 at US-000180–81; see ECF No. 64-7, Exh. 260 at 79–80. On

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February 2, 2006, the Ryans’ account was assigned to Revenue Officer David Palmer. ECF No.

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63-2, Exh. 212 at US-000183. Meanwhile, Attorney Haase prepared the Ryans’ lien subordination

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application and submitted it to the IRS Boston Lien Unit—as Revenue Officer Maple had
instructed—on January 18, 2006. ECF No. 64-3, Exh. 241. Attorney Haase then re-submitted the

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application to the IRS Lien Unit in Oakland, California on January 27, 2006, ECF No. 64-3, Exh.

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242, and sent a copy of the application directly to Revenue Officer Palmer on March 21, 2006.

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ECF No. 63-3, Exh. 213.

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On April 6, 2006, Revenue Officer Palmer reviewed the Ryans’ lien subordination

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application and determined that it was “complete and proper as outlined in [IRS] Pub 784.” ECF

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No. 63-2, Exh. 212 at US-000191. Palmer thus sent the application to his supervisor, Group

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Manager Douglas Hall, for review. Id. Upon his review of the Ryans’ lien subordination

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application, Group Manager Hall determined that, absent more information from the Ryans and

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their lender about why the Ryans were proposing to borrow only $2 million against a property

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valued at $4.5 million, he could not render a recommendation about whether the application

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should be granted. ECF No. 63-2, Exh. 212 at US-000191. Thus, Hall instructed Revenue Officer

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Palmer to contact Attorney Haase to “discuss the reasons for the [$]2,500,000.00 difference.” Id.

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Accordingly, Palmer told Haase on April 6, 2006 that the IRS needed to know “the maximum

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amount available in equity” on the $4.5 million property (meaning the maximum amount that the

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Ryans’ lender was willing to lend against the property), as well as other updated financial

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information, in order for Palmer and Hall to finish processing and evaluating the Ryans’

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application. Id. Haase said that he would find out this maximum amount and report back to

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Palmer. Id.
However, information about the Ryans’ maximum borrowing amount was never sent to

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Revenue Officer Palmer or anyone at the IRS. See ECF No. 64-13, Answer to RFA 93. As a

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result, Palmer never sent the Ryans’ lien subordination application to be formally approved or

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rejected. On May 11, 2006, Palmer faxed Haase a notice warning that the IRS would begin taking

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“enforced collections actions such as Notices of Levy or Seizure of property” if the Ryans failed to

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provide the IRS with updated financial information, including “[d]ocumentation from lender

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showing maximum amount of loan available,” by May 19, 2006. ECF No. 63-3, Exh. 215. In
addition to never sending the information about their maximum borrowing amount, the Ryans also

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failed to timely produce the other updated financial information requested by the IRS. See ECF

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No. 63-3, Exh. 216 (dated “May 25, 2006”). As a result, on May 24, 2006, Revenue Officer

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Palmer began levying on the Ryans’ property. ECF No. 63-2, Exh. 212 at US-000193; see FAC ¶

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69.

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Shortly thereafter, on June 23, 2006, Mr. Ryan transferred legal title to the Ryans’ third

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home to his daughter and son-in-law, the McIlvains, in return for a promissory note that did not

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require any payments until September 2011. ECF No. 63 ¶ 30; see United States v. Ryan, 2011

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WL 1344499, at *2 (N.D. Cal. Apr. 8, 2011) (“The IRS was unable to levy upon one parcel of real

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property owned by the Ryans at the time they incurred the tax liability because the Ryans

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transferred the property to their daughter in 2006 in return for a promissory note that does not

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require any payments until September 2011.”). As discussed above, during the Ryans’ installment

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agreement negotiations with the IRS in 2005, the Ryans did not disclose their ownership of this

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third home, which was worth about $900,000 when Mr. Ryan made the transfer. ECF No. 64-2,

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Exh. 229; ECF No. 64-3, Exhs. 230–31; ECF No. 64-11, Exh. 267 at 75; see Ryan, 2011 WL

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1344499, at *2 (stating that the Ryans “concealed the 2006 transfer of real property to their

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daughter”).

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In the spring of 2007, Revenue Officer Palmer obtained a writ of entry and seized the

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Ryans’ cars, two late-model Jaguar sedans and a 1957 Ford Thunderbird. ECF No. 63 ¶ 25. Then,

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on September 30, 2007, the Ryans sold their refurbished second home for $2.7 million. FAC ¶ 79.

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Because of the IRS’s tax lien on the Ryans’ real property, the net proceeds of this sale went

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directly to the IRS. Id.

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On October 1, 2007, the IRS assessed the $2,214,217.74 Penalty at issue in this case
against the Ryans. FAC ¶ 80; ECF No. 63 ¶ 31. On the Ryans’ behalf, Attorney Haase protested

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the Penalty in an April 17, 2008 letter to Revenue Officer Palmer, and again in a July 28, 2008

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follow-up letter to Group Manager Hall. FAC ¶ 89. Palmer and Hall responded that the Penalty

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was proper and enforceable. FAC ¶¶ 90–91. Because the Ryans were still far from fully paying

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their outstanding tax liabilities, the IRS’s enforced collection activity continued. ECF No. 63 ¶ 3.

12

In 2008, the IRS determined that it was necessary to levy the Ryans’ principal residence in

13

order to facilitate collection of the Ryans’ sizable outstanding tax liability. See id. ¶ 33. Thus, on

14

October 22, 2008, the United States filed a petition for judicial approval of the levy under I.R.C. §

15

6334(e) in this District. Id. That action was assigned to Judge Jeremy Fogel. See Ryan, 2011 WL

16

1344499. In its levy petition, the United States asserted “an unpaid balance of $11,747,231.80,

17

which included unpaid principal in the amount of $8,793,147.92 and penalties and interest in the

18

amount of $2,954,083.88.” Id. at *1. However, in December 2008, Mr. Ryan again requested the

19

trustee of his Rabbi Trust to grant him an early distribution of the assets remaining in the Trust,

20

which at that time amounted to $5.9 million, under the “severe financial hardship” clause. ECF

21

No. 64-5, Exh. 254. The trustee granted Mr. Ryan’s request in February 2009, and those funds

22

were paid over to the IRS. See ECF No. 64-5, Exh. 255; ECF No. 64-1, Exh. 219. Nevertheless,

23

even with this payment, the Ryans’ “outstanding balance as of July 23, 2009 was $6,233,769.”

24

Ryan, 2011 WL 1344499 at *1.

25
26
27
28

Thus, on April 8, 2011, Judge Fogel granted the United States’ petition to levy the Ryans’
primary residence. See id. Judge Fogel concluded that the Ryans had not sufficiently
11
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

demonstrated that they had assets other than their primary residence from which their tax liabilities

2

could be satisfied. Id. at *2. Further, Judge Fogel noted that although “equity” could “play[] no

3

part” in his decision, “the Ryans would not prevail” even “if equitable considerations were to play

4

a part in” his analysis because “the Ryans ha[d] not made a voluntary payment since 2006; they

5

concealed the 2006 transfer of real property to their daughter; and despite their asserted ability to

6

satisfy their tax liability, they ha[d] not done so in the two and a half years since” the United

7

States filed its levy petition. Id. at *2.

8

Thereafter, the IRS allowed the Ryans to list their primary residence for sale, which

9

brought $3.8 million in July 2012. ECF No. 63 ¶ 35. The net proceeds of the sale went directly to
the IRS. Id. Eventually, the Ryans satisfied their remaining tax obligations—including the

11
United States District Court
Northern District of California

10

Penalty—in October 2012. Id.; FAC ¶ 98.

12

B. Procedural History

13

On July 1, 2013, the Ryans submitted a Form 843 Request for Refund to the IRS seeking

14

recovery of the Penalty. FAC ¶ 98. The IRS denied the Ryans’ claim on January 13, 2014. Id. ¶

15

99. The Ryans’ subsequent requests for reconsideration and appeal were also unsuccessful. See

16

id. ¶¶ 105, 112. Thereafter, Mr. Ryan passed away in September 2015. Id. ¶ 1.

17

Plaintiff filed the instant action on January 11, 2016. See ECF No. 1. Plaintiff then filed

18

an amended complaint on March 30, 2016, see FAC, and Defendant answered Plaintiff’s amended

19

complaint on June 2, 2016. ECF No. 14.

20

On December 15, 2016, Plaintiff moved for leave to file a second amended complaint.

21

ECF No. 27. Defendant opposed Plaintiff’s motion on December 29, 2016, ECF No. 29, and

22

Plaintiff filed a reply on January 5, 2017. ECF No. 31. On March 6, 2017, the Court denied

23

Plaintiff’s motion for leave to file a second amended complaint. ECF No. 42.

24

On February 14, 2018, Plaintiff and Defendant each filed a motion for summary judgment.

25

Pl. Mot.; Def. Mot. Oppositions were filed on February 28, 2018, ECF No. 65 (“Def. Opp.”);

26

ECF No. 66 (“Pl. Opp.”), and replies were filed on March 7, 2018. ECF No. 28 (“Def. Reply”);

27
28

12
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

ECF No. 69 (“Pl. Reply”).

2

II.

LEGAL STANDARD
Summary judgment is proper where the pleadings, discovery, and affidavits show that

3
4

there is “no genuine dispute as to any material fact and [that] the movant is entitled to judgment as

5

a matter of law.” Fed. R. Civ. P. 56(a). Material facts are those which may affect the outcome of

6

the case. See Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). A dispute as to a

7

material fact is genuine if there is sufficient evidence for a reasonable jury to return a verdict for

8

the nonmoving party. See id.
The party moving for summary judgment bears the initial burden of identifying those

9

portions of the pleadings, discovery and affidavits which demonstrate the absence of a genuine

11
United States District Court
Northern District of California

10

issue of material fact. Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). Once the moving party

12

meets its initial burden, the nonmoving party must go beyond the pleadings and, by its own

13

affidavits or discovery, “set forth specific facts showing that there is a genuine issue for trial.”

14

Fed. R. Civ. P. 56(e). If the nonmoving party fails to make this showing, “the moving party is

15

entitled to judgment as a matter of law.” Celotex Corp., 477 U.S. at 323.

16

At the summary judgment stage, the Court must view the evidence in the light most

17

favorable to the nonmoving party: if evidence produced by the moving party conflicts with

18

evidence produced by the nonmoving party, the judge must assume the truth of the evidence set

19

forth by the nonmoving party with respect to that fact. See Leslie v. Grupo ICA, 198 F.3d 1152,

20

1158 (9th Cir. 1999).

21

III.

22

DISCUSSION
Plaintiff’s action seeks a refund of the $2,214,217.24 Penalty. Thus, in her amended

23

complaint, Plaintiff argues that she is entitled to a refund of the Penalty based on the following

24

seven causes of action: (1) abuse of discretion (Count One); (2) breach of an implied covenant of

25

good faith and fair dealing (Count Two); (3) failure to provide adequate notice of the Penalty

26

(Count Three); (4) abatement of the Penalty for reasonable cause and absence of willful neglect

27
28

13
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

pursuant to I.R.C. § 6651(a)(3) (Count Four); (5) the closing agreement barred the Penalty (Count

2

Five); (6) abatement of the Penalty pursuant to the Internal Revenue Manual (Count Six); and (7)

3

the Form 872-I barred the Penalty (Count Seven). See FAC.

4

Defendant moves for summary judgment on all seven counts, see Def. Mot., while Plaintiff

5

moves for summary judgment on all counts except Count Six. See Pl. Mot. Because Counts One,

6

Two, and Four are “interrelated,” Pl. Reply at 11, the Court first addresses each of those counts in

7

turn. Then, the Court addresses Counts Three, Five, Six, and Seven in turn.

8
9

A. Count One
In Count One, Plaintiff argues that she is entitled to a refund of the Penalty because the
IRS abused its discretion by failing to grant the Ryans’ lien subordination application. See FAC

11
United States District Court
Northern District of California

10

¶¶ 114–18. As discussed above, by December 12, 2005, the Ryans had obtained a commitment

12

from a lender for a $2 million loan secured by the equity in the Ryans’ principal residence, which

13

had been formally appraised to have a fair market value of $4.5 million. FAC §§ 45, 48; ECF No.

14

64-3, Exh. 241; ECF No. 63-2, Exh. 212 at US-000179. However, the Ryans could obtain this $2

15

million loan only if the IRS agreed to subordinate its lien on the Ryans’ principal residence—

16

which had been recorded by the IRS on November 4, 2005 pursuant to I.R.C. § 6323(f), see ECF

17

No. 64-3, Exh. 238—to the lender’s lien. See ECF No. 63-2, Exh. 212 at US-000179. Thus, the

18

Ryans filed an application with the IRS requesting lien subordination and stating that they

19

intended to pay all proceeds of the $2 million loan to the IRS. See ECF No. 64-3, Exh. 241. The

20

IRS never approved the Ryans’ lien subordination application.

21

Plaintiff’s theory in Count One appears to be that (1) the IRS’s failure to approve the

22

Ryans’ lien subordination application was an abuse of discretion; and (2) Plaintiff is entitled to a

23

refund of the entire Penalty based on the IRS’s abuse of discretion because if the IRS had taken

24

the correct course of action and granted the Ryan’s application, the Ryans would have been able to

25

“avoid[] . . . default[ing] on the installment agreement and the eventual penalty.” FAC ¶ 118. For

26

the reasons explained below, the Court finds that Plaintiff has failed to provide sufficient evidence

27
28

14
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1
2

for a reasonable trier of fact to find in favor of Plaintiff on Count One.
As an initial matter, even if the IRS’s failure to approve the Ryans’ lien subordination
application was an abuse of discretion, it is far from clear that this abuse of discretion would

4

entitle Plaintiff to a refund of the Penalty. This is because Plaintiff has not submitted any

5

evidence that supports her contention that the Ryans would have been able to “avoid[] . . .

6

default[ing] on the installment agreement and the eventual penalty” if the IRS had approved their

7

application. FAC ¶ 118. First, with regards to defaulting on the installment agreement, the Ryans

8

had already defaulted on the installment agreement several months before they even submitted

9

their application for lien subordination. It is undisputed that (1) under the Installment Agreement,

10

the Ryans were obligated to make a $2 million payment to the IRS by July 15, 2005; (2) the Ryans

11
United States District Court
Northern District of California

3

failed to make that $2 million payment by July 15, 2005, see FAC ¶ 34; (3) as a result, Revenue

12

Officer Maple issued a “Notice of Defaulted Installment Agreement and Notice of Intent to Levy”

13

on September 28, 2005, ECF No. 64-3, Exh. 235; and (4) the Ryans’ failure to cure the default

14

prompted Revenue Officer Maple to record a Notice of Federal Tax Lien on November 4, 2005 in

15

Santa Clara County, where the Ryans’ primary residence was located. ECF No. 64-3, Exh. 238.

16

However, the Ryans first submitted their application for lien subordination to the IRS on January

17

16, 2006. ECF No. 64-3, Exh. 241. Thus, because the Ryans undisputedly defaulted on their

18

installment agreement before even submitting their lien subordination application, any eventual

19

approval of the Ryans’ lien subordination application could not have possibly helped the Ryans

20

avoid defaulting on the installment agreement. Indeed, the Ryans’ default and subsequent failure

21

to cure that default are what prompted the IRS to record a lien on the Ryans’ primary residence in

22

the first place, and thus it makes no sense for Plaintiff to assert that the IRS’s failure to

23

subordinate its lien vitiated the Ryans’ ability to avoid defaulting on the installment agreement.

24

Second, and more importantly, there is no support in the record for Plaintiff’s assertion that

25

if the IRS had approved the Ryans’ lien subordination application, the Ryans would have been

26

able to “avoid[]” the Penalty. FAC ¶ 118. The parties do not dispute that the $2,214,217.74

27
28

15
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

Penalty in the instant case was a “failure-to-pay” penalty that was imposed on the Ryans pursuant

2

to I.R.C. § 6651(a)(3). See Pl. Mot. at 1; Def. Mot. at 14. Section 6651(a)(3) imposes a penalty

3

on any taxpayer who fails “to pay any amount in respect of any tax required to be shown on a

4

return . . . which is not so shown” within “10 business days” after the IRS issues a “notice and

5

demand” for payment of the tax, if the tax demanded is greater than $100,000. The size of the

6

penalty is 0.5 percent of the portion of the tax that the taxpayer has not yet paid “if the failure [to

7

pay] is for not more than 1 month, with an additional 0.5 percent for each additional month or

8

fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate.”

9

I.R.C. § 6651(a)(3). However, the monthly rate increases to 1.0 percent if the IRS serves levies to

10

collect the tax. Id. § 6651(d)(2). On the other hand, the monthly rate decreases to 0.25 percent if

11
United States District Court
Northern District of California

1

an installment agreement is in effect. Id. § 6651(h). In any event, a § 6651(a)(3) failure-to-pay

12

penalty starts to accrue 10 business days after the IRS’s notice and demand is issued, and increases

13

each month until either the taxpayer pays the entire tax or the penalty reaches 25 percent of the

14

entire tax, whichever comes first.

15

In the instant case, the Penalty started accruing on July 18, 2005—10 business days after

16

the IRS issued a notice and demand for payment of taxes on July 4, 2005. See ECF No. 64-1, Exh.

17

219 at US-000017 (“07-04-2005 Statutory Notice of Balance Due” listed on the “Form 4340”

18

“Certificate of Assessments, Payments, and Other Specified Matters” for “Kevin J & Nancy

19

Ryan”); E.J. Harrison & Sons, Inc. v. C.I.R., 2011 WL 2636263, at *3 n.5 (T.C. July 5, 2011) (“A

20

Statutory Notice of Balance Due entry on Form 4340 is sufficient to presumptively establish that

21

notice and demand was sent on the date corresponding to the Statutory Notice of Balance Due

22

entry.”). According to Defendant’s calculation of the Penalty, the accuracy of which Plaintiff does

23

not dispute, by January 18, 2006—two days after the Ryans submitted their lien subordination

24

application—the Ryans had already incurred $461,564.44 of the $2,214,217.74 Penalty. See ECF

25

No. 64-1, Exh. 220. Thus, in light of the fact that the Ryans had already incurred a substantial

26

portion of the Penalty before even submitting a lien subordination application, Plaintiff’s

27
28

16
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

contention that the Ryans would have been able to avoid incurring the entire Penalty altogether if

2

the IRS had approved their lien subordination application is meritless. Further, again according to

3

Defendant’s calculation of the Penalty, when the Ryans submitted their lien subordination

4

application in January 2006, they owed over $10 million to the IRS in unpaid taxes, excluding

5

interest. See ECF No. 64-1, Exh. 220. Thus, even if the IRS had approved the Ryans’ lien

6

subordination application in January 2006, thereby enabling the Ryans to obtain the $2 million

7

loan and apply all of the proceeds to their tax liability, the Ryans would still have owed over $8

8

million in unpaid taxes, excluding interest. As a result, under I.R.C. § 6651(a)(3), the Penalty

9

would have continued to accrue each month. In other words, Plaintiff offers no evidence to
suggest that the Ryans’ desired lien subordination would have enabled them to stop the Penalty

11
United States District Court
Northern District of California

10

from further accruing. Accordingly, even assuming that the IRS’s failure to approve the Ryans’

12

lien subordination application was an abuse of discretion, there is little reason to think that

13

Plaintiff would be entitled to a refund of the Penalty based on that abuse of discretion.

14

In any event, the Court finds that Plaintiff has not submitted sufficient evidence for a

15

reasonable trier of fact to conclude that the IRS abused its discretion by failing to approve the

16

Ryans’ lien subordination application. The IRS’s ability to subordinate its liens on delinquent

17

taxpayers’ property is governed by I.R.C. § 6325(d) and 26 C.F.R. § 301.6325-1(d). I.R.C. §

18

6325(d) states that the IRS “may issue a certificate of subordination of any lien” if, inter alia, the

19

IRS “believes that the amount realizable by the United States from the property to which the

20

certificate relates, or from any other property subject to the lien, will ultimately be increased by

21

reason of the issuance of such certificate and that the ultimate collection of the tax liability will be

22

facilitated by such subordination.” 26 C.F.R. § 301.6325-1(d) emphasizes that the IRS has

23

“discretion” in making its subordination decisions, and lists three examples illustrating situations

24

in which the IRS could, “in [its] discretion,” subordinate its lien in order “[t]o facilitate tax

25

collection.”

26
27
28

Based on the text of I.R.C. § 6325(d) and 26 C.F.R. § 301.6325-1(d), courts have
17
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

recognized that the IRS has considerable discretion in deciding whether to grant a taxpayer’s

2

request for lien subordination. See Behr v. United States, 2010 WL 1131383, at *18 (D. Minn.

3

2010) (“On the plain reading of [I.R.C. § 6325(d)] and [26 C.F.R. § 301.6325-1(d)(2)], as with a

4

discharge of property, subordination is within the Secretary’s discretion.”); Sandberg v. C.I.R.,

5

2011 WL 1135720, at *6 (T.C. Mar. 28, 2011) (“The IRS can issue a certificate of subordination,

6

which subordinates the tax lien on specific property. But doing so is not a ministerial act: it

7

involves judgment and discretion.” (citing I.R.C. § 6325(d) and 26 C.F.R. § 301.6325-1(d)(1)).

8

Indeed, the United States Tax Court has even stated that because lien subordination, “as expressed

9

in” the relevant statute and regulation, is “permissive,” the IRS “is generally not required to . . .

10

subordinate . . . even if the conditions [for subordination] are fully met.” Morris v. C.I.R., 2016

11
United States District Court
Northern District of California

1

WL 695385, at *7 (T.C. Feb. 4, 2016) (emphasis added); accord Green v. C.I.R., 2014 WL

12

4337019, at *3 (T.C. Sep. 2, 2014) (emphasis added). Under this expansive view of the IRS’s

13

discretion, even if the “conditions [for subordination were] fully met” in the instant case, the IRS

14

was still not “required to” approve the Ryans’ lien subordination application, and thus the IRS’s

15

failure to approve the application cannot be deemed an abuse of discretion.1 Id.

16

Further, even under a less expansive view of the IRS’s discretion, Plaintiff has not offered

17

sufficient evidence for a reasonable trier of fact to conclude that the IRS abused that discretion by

18

failing to approve the Ryans’ lien subordination application. Once again, the governing regulation

19

states that the IRS “may, in [its] discretion, issue a certification of subordination of a lien” if it

20
21
22
23
24
25
26
27
28

1

Plaintiff’s reliance on Alessio Azzari, Inc. v. C.I.R., 136 T.C. 178 (2011), is inapposite. In
Azzari, an IRS settlement officer refused to consider a request for the IRS to subordinate its lien to
a creditor’s security interest because the officer had erroneously determined that the IRS’s lien
“was already junior to the security interest held by” that creditor. Id. at 185. Thus, the officer
“did not reach” the discretionary determination “of whether subordinating the Federal tax lien
would facilitate collection.” Id. The Tax Court emphasized that the IRS “has discretion under
[I.R.C. §] 6325(d) to determine whether it is in the Government’s interest to subordinate a Federal
tax lien,” but observed that the officer’s “refusal to consider petitioner’s request to subordinate the
lien was based on an error of law,” and not on any discretionary determinations. Id. at 191. Thus,
the Tax Court held that “[t]o the extent it was based upon an error of law, [the officer’s]
determination constitutes an abuse of discretion.” Id. In the instant case, Plaintiff does not assert,
and offers no evidence to show, that the IRS’s failure to approve the Ryans’ lien subordination
application was based on any analogous errors of law as opposed to discretionary determinations.
18
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

“believes that the subordination of the lien will ultimately result in an increase in the amount

2

realized by the United States from the property subject to the lien and will facilitate the ultimate

3

collection of tax liability.” 26 C.F.R. § 301.6325-1(d)(2). Accordingly, the Internal Revenue

4

Manual (“IRM”) states that “[g]enerally, subordinations are issued only when it is in the best

5

interest of the government.” IRM 5.12.10.6.3.1. Further, the IRM instructs that because there is

6

always “a risk that [a] subordination will decrease collection,” the IRS “must exercise good

7

judgment in weighing the risks and deciding whether to subordinate the federal tax lien.” IRM

8

5.17.2.8.6.4. The IRS’s “judgment” must be “similar to the decision that an ordinarily prudent

9

business person would make in deciding whether to subordinate his/her rights in a debtor’s

10

property in order to secure additional long run benefits.” Id.

United States District Court
Northern District of California

11

Defendant has submitted evidence indicating that approving the Ryans’ lien subordination

12

“would not have been in the IRS’s best interest,” Def. Mot. at 20, and therefore would have fallen

13

short of the “ordinarily prudent business person” standard. IRM 5.17.2.8.6.4. Specifically,

14

Defendant points to the low loan-to-value ratio proposed by the Ryans in their lien subordination

15

application. As discussed above, in their application, the Ryans proposed to borrow only $2

16

million against a property that was valued at $4.5 million—which amounts to a 44 percent loan-to-

17

value ratio. FAC §§ 45, 48; ECF No. 64-3, Exh. 241; ECF No. 63-2, Exh. 212 at US-000179. In

18

contrast, IRS Group Manager Douglas Hall, who had processed many lien subordination

19

applications as an IRS employee, testified that “under general guidelines, you would expect to see

20

something in the neighborhood of a loan equal to 80 percent of the [property] value” in successful

21

lien subordination applications. ECF No. 64-7, Exh. 260 at 75. In any event, when presented with

22

the Ryans’ lien subordination application, the IRS had to decide whether subordinating its lien

23

over the entire $4.5 million property in exchange for $2 million in loan proceeds was likely to

24

“ultimately result in an increase in the amount realized by the United States from the property

25

subject to the lien.” 26 C.F.R. § 301.6325-1(d)(2). Under these circumstances, given the low

26

loan-to-value ratio, it would be difficult to fault “an ordinarily prudent business person” for

27
28

19
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

believing that maintaining a superior lien over the $4.5 million property, instead of subordinating

2

that lien in exchange for $2 million, would ultimately be the revenue-maximizing option. IRM

3

5.17.2.8.6.4. Bolstering this notion is the fact that by maintaining its superior lien over the

4

property, the IRS was eventually able to extract $3.8 million of value out of the property by

5

levying it and forcing a sale. ECF No. 63 ¶ 35. For her part, Plaintiff offers no evidence or

6

reasons to suggest that it would have been outside the bounds of the IRS’s discretion to determine

7

that subordinating the lien over the Ryans’ primary residence in these circumstances was contrary

8

to the government’s interest.

9

Finally, and perhaps most importantly, Plaintiff has failed to raise a dispute of material fact
regarding whether the IRS abused its discretion because the record demonstrates that what

11
United States District Court
Northern District of California

10

ultimately caused the IRS to fail to act upon the Ryans’ lien subordination application was the

12

Ryans’ undisputed failure to comply with the IRS’s request for additional information that it

13

deemed necessary for purposes of making a formal decision on the Ryans’ application. As

14

Plaintiff acknowledges, the IRS never formally granted or rejected the Ryans’ lien subordination

15

application. See Pl. Opp. at 17 (asserting that the application “was never processed or acted on”

16

and was instead “de facto reject[ed]”). Instead, while supervising the processing of the Ryans’

17

application, Revenue Officer Group Manager Hall determined that, absent more information from

18

the Ryans and their lender about why the Ryans were proposing to borrow only $2 million against

19

their $4.5 million property, he could not render a recommendation about whether their application

20

should be granted. ECF No. 63-2, Exh. 212 at US-000191. Thus, Hall instructed Revenue Officer

21

Palmer to contact Attorney Haase to “discuss the reasons for the [$]2,500,000.00 difference,” and

22

in turn Palmer told Haase that the IRS needed to know “the maximum amount available in equity”

23

on the $4.5 million property (meaning the maximum amount that the Ryans’ lender was willing to

24

lend against the property) in order for Palmer and Hall to finish processing and evaluating the

25

Ryans’ application. Id. However, the Ryans never provided that information to the IRS.

26
27
28

Plaintiff does not dispute that this information was never provided to the IRS. Instead,
20
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

Plaintiff states that the Ryans “did not supply the maximum loan information because” their

2

former mortgage broker, Scott MacClure, left the mortgage brokerage firm in February 2006 and

3

thus “was not available to provide that information.” Pl. Opp. at 7. This does not excuse the

4

Ryans’ failure to provide the necessary information to the IRS.

5

In light of the Ryans’ failure to provide information that the IRS had requested and deemed

6

necessary to evaluate their lien subordination application, no reasonable trier of fact could find

7

that the IRS’s failure to act upon the application was an abuse of discretion. Indeed, the IRS is at

8

liberty to “require” any lien subordination “applicant to furnish such additional information” as the

9

IRS “may deem necessary,” Rev. Proc. 68-8 § 6, and Plaintiff provides no evidence or legal basis
to suggest that the IRS was required to process and approve the Ryans’ lien subordination

11
United States District Court
Northern District of California

10

application despite the Ryans’ failure “to furnish [the] additional information” that the IRS had

12

“deem[ed] necessary.” Id.

13

Plaintiff attempts to make a related argument that the IRS abused its discretion by

14

“mishandling” the Ryans’ lien subordination application, and appears to argue that this

15

“mishandling” is what caused the IRS to fail to act on the Ryans’ application. Pl. Mot. at 21.

16

Specifically, Plaintiff points out that neither Revenue Officer Palmer nor Group Manager Hall had

17

authority to approve or reject the Ryans’ lien subordination application because only “the IRS

18

Technical Services office” could approve or reject such applications. Pl. Mot. at 20. Based on

19

this, Plaintiff argues that Revenue Officer Palmer mishandled and improperly interfered with the

20

Ryans’ application because he failed to send the application to the “San Jose Technical Services

21

office,” thereby ensuring that the application was never “reviewed by or acted upon by” any

22

Technical Services office. Id. Defendant does not dispute that the Ryans’ lien subordination

23

application was never sent to a Technical Services office for formal approval or rejection.

24

However, Plaintiff offers no legal or factual basis to suggest that Revenue Officer Palmer

25

or any other IRS employee mishandled the Ryans’ lien subordination application. Even though

26

Palmer, as a Revenue Officer, was not authorized to formally reject the Ryans’ lien subordination

27
28

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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

application, see Kugler v. United States, 2000 WL 1274230, at *3 (W.D. Pa. July 10, 2000)

2

(stating that 26 C.F.R. § 301.6325-1(d) “does not permit a revenue officer to deny a written

3

application for a certificate of subordination”), Plaintiff acknowledges that the Ryans’ application

4

was never formally rejected by anyone. See Pl. Opp. at 17 (asserting that the application “was

5

never processed or acted on” and was instead “de facto reject[ed]”). Further, Plaintiff recognizes

6

that as a Revenue Officer, Palmer had a duty “to verify [the] completeness” of the Ryans’

7

application, Pl. Mot. at 21, and to render a recommendation about whether to grant the application.

8

Pl. Opp. at 16; see Kugler, 2000 WL 1274230 at *3 (stating that a revenue officer did not act

9

beyond his authority by recommending against granting a lien subordination application). That

10

appears to be exactly what Palmer tried to do. As explained above, after discussing the Ryans’

11
United States District Court
Northern District of California

1

lien subordination application with his supervisor, Group Manager Hall, Palmer told the Ryans’

12

attorney that the IRS needed more information about the proposed loan in order to process and

13

evaluate the Ryans’ application. However, as discussed above, the Ryans never submitted that

14

information to the IRS. In light of the Ryans’ failure to comply with the IRS’s request for

15

additional information, it is difficult to see how Palmer erred by not sending the Ryans’

16

application to a Technical Services office for a formal decision. Put another way, Plaintiff offers

17

no legal or factual basis to suggest that Revenue Officer Palmer was legally obligated to send the

18

Ryans’ application to a Technical Services office even though the Ryans never submitted the

19

information that the IRS had requested and deemed necessary for the evaluation of their

20

application.

21
22
23
24

Accordingly, the Court DENIES Plaintiff’s motion for summary judgment and GRANTS
Defendant’s motion for summary judgment as to Count One.
B. Count Two
In Count Two, Plaintiff argues that she is entitled to a refund of the Penalty because the

25

“IRS breached the implied covenant of good faith and fair dealing.” FAC at 24. Specifically,

26

Plaintiff asserts that the installment agreement between the IRS and the Ryans was a “federal

27
28

22
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

contract” that “included the implied covenant of good faith and fair dealing,” id. ¶ 120, and that

2

the IRS breached the implied covenant of good faith and fair dealing by failing to grant the Ryans’

3

lien subordination application because this failure prevented the Ryans’ from being able to cure

4

their default under the installment agreement. Id. ¶ 121.

5

The Court concludes that as a matter of law, Plaintiff cannot assert a cause of action for
breach of an implied covenant of good faith and fair dealing based on the installment agreement

7

between the Ryans and the IRS because installment agreements between taxpayers and the IRS are

8

not contracts in the common law sense. The United States District Court for the Eastern District

9

of Pennsylvania addressed this very issue in United States v. Ullman, 2002 WL 987998 (E.D. Pa.

10

May 8, 2002). That court observed that “[i]n contrast to the legal concept of a binding contract,

11
United States District Court
Northern District of California

6

which requires consideration, an installment agreement [between the IRS and a taxpayer] operates

12

pursuant to statute.” Id. at *4 (citing I.R.C. § 6159). Specifically, I.R.C. § 6159 authorizes the

13

IRS to enter into an installment agreement with a taxpayer if the IRS “determines that such

14

agreement will facilitate full or partial collection of” the taxpayer’s tax liability, and also lists the

15

circumstances under which the IRS can unilaterally terminate or modify an installment agreement.

16

Ultimately, the Ullman court concluded that an installment agreement entered into pursuant to

17

I.R.C. § 6159 “is not a contract in the sense that breach of its terms gives rise to a common law

18

breach of contract action because of the absence of consideration on the part of [the taxpayer].”

19

Ullman, 2002 WL 987998, at *4. The Court of Federal Claims cited Ullman with approval in

20

Oppenheim v. United States, 2009 WL 586118, at *6 (Ct. Fed. Cl. Mar. 6, 2009), and noted that

21

Ullman “cast[ed] doubt on the propriety of characterizing installment agreements [between

22

taxpayers and the IRS] as contracts or as being controlled by those principles.” Id. at *7.

23

The Court finds the reasoning in Ullman persuasive. As a result, the Court declines to treat

24

the installment agreement between the Ryans and the IRS as a common law contract that includes

25

an implied covenant of good faith and fair dealing. Thus, Plaintiff’s cause of action for breach of

26

that implied covenant fails as a matter of law.

27
28

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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

Further, the Court notes that even if Plaintiff could assert a cause of action for breach of an

2

implied covenant of good faith and fair dealing based on the installment agreement between the

3

Ryans and the IRS, Plaintiff has failed to present sufficient evidence to enable a reasonable trier of

4

fact to conclude that the IRS breached the implied covenant by failing to grant the Ryans’ lien

5

subordination application. Specifically, as discussed above, it is undisputed that the Ryans did not

6

comply with the IRS’s request to provide additional information about the proposed $2 million

7

loan against their $4.5 million property—which, significantly, was information that the IRS had

8

deemed necessary for determining whether the IRS was even statutorily authorized under I.R.C. §

9

6325(d) to grant the Ryans’ lien subordination application. In light of the Ryans’ undisputed
failure to provide this additional information to the IRS, the Court concludes that as a matter of

11
United States District Court
Northern District of California

10

law, Plaintiff cannot demonstrate that the IRS’s failure to approve the Ryans’ application

12

amounted to bad faith or unfair dealing.

13

Further, also discussed above, the Court has already determined that Plaintiff has not

14

created a dispute of material fact as to whether the IRS, by failing to approve the Ryans’ lien

15

subordination application, abused the considerable discretion it had pursuant to I.R.C. § 6325(d)

16

and 26 C.F.R. § 301.6325-1(d) to evaluate and resolve requests for lien subordination. In

17

particular, the Court explained that (1) the IRS had to decide whether subordinating its lien over

18

the Ryans’ entire $4.5 million primary residence in exchange for $2 million in loan proceeds was

19

likely to “ultimately result in an increase in the amount realized by the United States from the

20

property subject to the lien” 26 C.F.R. § 301.6325-1(d)(2); and (2) given this low loan-to-value

21

ratio, there is little reason to think, and Plaintiff offers no evidence or reasons to suggest, that it

22

would have been outside the bounds of the IRS’s discretion to determine that rejecting the Ryans’

23

lien subordination application, and thereby maintaining the superior lien over the Ryans’ primary

24

residence, would ultimately be the revenue-maximizing option. Indeed, the fact that the IRS was

25

eventually able to extract $3.8 million of value out of the Ryans’ primary residence as a result of

26

its superior lien over the property adds credence to the notion that rejecting the Ryans’ lien

27
28

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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

subordination application would have been within its discretion. ECF No. 63 ¶ 35. For the very

2

same reasons, the Court concludes that Plaintiff has not created a dispute of material fact as to

3

whether the IRS acted in bad faith and engaged in unfair dealing by failing to approve the Ryans’

4

lien subordination application.

5
6
7
8
9

Accordingly, the Court DENIES Plaintiff’s motion for summary judgment and GRANTS
Defendant’s motion for summary judgment as to Count Two.
C. Count Four
In Count Four, Plaintiff asserts that she is entitled to a refund of the Penalty because the
Ryans’ failure to timely pay their taxes was “due to reasonable cause and not due to willful
neglect.” FAC ¶¶ 132–41; I.R.C. § 6651(a)(3). To review briefly, it is undisputed that the Penalty

11
United States District Court
Northern District of California

10

in the instant case was a “failure-to-pay” penalty that was imposed on the Ryans pursuant to I.R.C.

12

§ 6651(a)(3). See Pl. Mot. at 1; Def. Mot. at 14. Section 6651(a)(3) imposes a penalty on any

13

taxpayer who fails “to pay any amount in respect of any tax required to be shown on a return . . .

14

which is not so shown” within “10 business days” after the IRS issues a “notice and demand” for

15

payment of the tax, if the tax demanded is greater than $100,000. Further, as the Court explained

16

above, the penalty starts accruing 10 business days after the notice and demand is issued and

17

grows according to monthly rates set forth in § 6651 until either the taxpayer pays the entire tax or

18

the penalty reaches 25 percent of the entire tax, whichever comes first. In the instant case, the

19

Ryans had until July 18, 2005—10 business days after the IRS issued a notice and demand for

20

payment of taxes on July 4, 2005—to pay the IRS almost $14 million in taxes, exclusive of

21

interest and accuracy-related penalties. See ECF No. 64-1, Exh. 219 at US-000017 (“07-04-2005

22

Statutory Notice of Balance Due” listed on the “Form 4340” “Certificate of Assessments,

23

Payments, and Other Specified Matters” for “Kevin J & Nancy Ryan”); E.J. Harrison, 2011 WL

24

2636263, at *3 n.5 (“A Statutory Notice of Balance Due entry on Form 4340 is sufficient to

25

presumptively establish that notice and demand was sent on the date corresponding to the

26

Statutory Notice of Balance Due entry.”); ECF No. 64-1 at US-000003 (listing taxes, interest, and

27
28

25
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

accuracy-related penalty assessed against the Ryans on July 4, 2005). The Ryans managed to pay

2

only $3,175,000 to the IRS by July 18, 2005, and thus the Penalty started accruing on that date.

3

See ECF No. 64-1 at US-000003.

4

A taxpayer can obtain an abatement of a penalty imposed under § 6651(a)(3). However, in

5

order to obtain such an abatement, the taxpayer must meet the “heavy burden” of demonstrating

6

that his failure to pay the tax within 10 business days of the IRS’s notice and demand for payment

7

was both (1) “due to reasonable cause”; and (2) not a result of “willful neglect.” United States v.

8

Boyle, 469 U.S. 241, 245 (1985); I.R.C. § 6651(a)(3). Neither “willful neglect” nor “reasonable

9

cause” is defined by statute. However, the United States Supreme Court has stated that “willful
neglect,” as used in a related and nearby provision, § 6651(a)(1), “may be read as meaning a

11
United States District Court
Northern District of California

10

conscious, intentional failure or reckless indifference.” Boyle, 469 U.S. at 245.

12

Further, the meaning of “reasonable cause” has been fleshed out in regulations and case

13

law. Specifically, reasonable cause, as used in the subsections of § 6651(a), is defined by 26

14

C.F.R. § 301.6651-1(c)(1), which is “viewed very narrowly.” Conklin Bros. of Santa Rosa, Inc. v.

15

United States, 986 F.3d 315, 317 (9th Cir. 1993). That regulation states that a failure to timely pay

16

a tax “will be considered due to reasonable cause to the extent that the taxpayer has made a

17

satisfactory showing that he exercised ordinary business care and prudence in providing for

18

payment of his tax liability.” 26 C.F.R. § 301.6651-1(c)(1). The regulation further states that

19

“consideration will be given to all the facts and circumstances of the taxpayer’s financial

20

situation,” including “the amount and nature of the taxpayer’s expenditures in light of the income

21

(or other amounts) he could, at the time of such expenditures, reasonably expect to receive prior to

22

the date prescribed for payment of the tax.” Id. Thus, the regulation specifically warns that:

23

[A] taxpayer who invests funds in speculative or illiquid assets has not exercised
ordinary business care and prudence in providing for the payment of his tax liability
unless, at the time of the investment, the remainder of the taxpayer’s assets and
estimated income will be sufficient to pay his tax or it can be reasonably foreseen
that the speculative or illiquid investment made by the taxpayer can be utilized (by
sale or as security for a loan) to realize sufficient funds to satisfy the tax liability. A
taxpayer will be considered to have exercised ordinary business care and prudence

24
25
26
27
28

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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1
2
3
4
5
6
7
8
9
10

United States District Court
Northern District of California

11

if he made reasonable efforts to conserve sufficient assets in marketable form to
satisfy his tax liability and nevertheless was unable to pay all or a portion of the tax
when it became due.
Id. (emphases added). As such, courts have viewed claims of reasonable cause with suspicion
when the taxpayer’s failure to pay stemmed from his involvement in speculative investments. For
example, in McLaine v. C.I.R., 138 T.C. 228 (2012), the United States Tax Court, in rejecting a
petitioner’s argument that he had reasonable cause for failing to pay a tax in time because he did
not have enough liquid assets when the tax was due, stated that:
Petitioner’s illiquidity as of [the date on which the tax was due] was a problem of
his own making. After his exercise of the 1999 NQOs, petitioner had the funds
necessary to pay the taxes associated with his income from the 1999 exercise. The
fact that he lost most of those funds by investing them in high technology stocks
and ventures that ultimately failed (and did not retain sufficient funds to pay his
1999 tax) does not provide a basis for his claim of reasonable cause for his
nonpayment or late payment of tax.

12

Id. at 247. Similarly, in Schroer v. United States, 594 F. Supp. 2d 1257 (D. Colo. 2009), the

13

United States District Court for the District of Colorado held that “reliance on a speculative

14

financial transaction like the sale of real property at a given price and time, when that transaction

15

ultimately fails, does not constitute reasonable cause for the failure to pay taxes when due.” Id. at

16

1269 (citing In re Jacobs, 490 F.3d 913, 927 (11th Cir. 2007), Fran Corp. v. United States, 164

17

F.3d 814, 819–20 (2d Cir. 1999), and In re Hopkins, 1991 WL 289179, at *2 (Bankr. D. Colo.

18

Oct. 22, 1991)).

19

In the instant case, Plaintiff has failed to create a dispute of material fact as to whether the

20

Ryans had reasonable cause for failing to timely pay their taxes. In attempting to satisfy her

21

“heavy burden” of demonstrating reasonable cause, Boyle, 469 U.S. at 245, Plaintiff essentially

22

bases her reasonable cause claim exclusively on the violations she asserted in Counts One and

23

Two. That is, Plaintiff argues that the Ryans had reasonable cause for failing to pay their taxes on

24

time because (1) the IRS abused its discretion by mishandling and ultimately failing to grant the

25

Ryans’ lien subordination application; and (2) the IRS breached a covenant of good faith and fair

26

dealing implied in the installment agreement between the IRS and the Ryans. Pl. Mot. at 19–23;

27
28

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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

see also id. at 25 (stating that the Ryans “would have paid the loan proceeds but for the IRS’[s]

2

unexpected prevention of the loan closing. Imposition of the Penalty, in these circumstances, was

3

fundamentally unfair”); Pl. Reply at 11 (stating that Plaintiff’s “Count VI – Reasonable Cause,

4

Count I – Abuse of Discretion, and Count II – Breach of Contract are interrelated and have been

5

addressed together”).

6

However, the Court has already determined that Defendant is entitled to judgment as a

7

matter of law on Plaintiff’s abuse of discretion and breach of good faith and fair dealing causes of

8

action. Thus, because Plaintiff bases her reasonable cause claim in Count Four on those

9

unsuccessful causes of action, it follows that Defendant is also entitled to judgment as a matter of
law on Plaintiff’s reasonable cause claim. This alone is sufficient grounds to grant summary

11
United States District Court
Northern District of California

10

judgment in favor of Defendant on Count Four.

12

Further, there are other significant problems with Plaintiff’s reasonable cause claim. For

13

example, the IRS’s failure to approve the Ryans’ lien subordination application—which the Ryans

14

submitted to the IRS in January 2006—could not possibly have given the Ryans reasonable cause

15

for failing to pay their taxes when they were due six months earlier on July 18, 2005 (pursuant to

16

I.R.C. § 6651(a)(3)). At the very most, the IRS’s failure to approve the application could only

17

provide reasonable cause for some of the Ryans’ delay in paying taxes that were already overdue.

18

Additionally, although it is not Defendant’s burden to show that the Ryans lacked

19

reasonable cause for failing to pay their taxes on time, Defendant points to other undisputed facts

20

that indicate that the Ryans’ failure to timely pay their taxes was not due to reasonable cause.

21

First, Defendant highlights the fact that in March and April of 2005, which was after the IRS had

22

proposed to assess tax deficiency of approximately $14 million against the Ryans, see FAC ¶ 21,

23

Mr. Ryan loaned a total of $3.6 million to LSBC, a company for which Mr. Ryan was serving as

24

CEO at the time. ECF No. 64-5, Exh. 257 at 14. In 2005, LSBC was in financial trouble.

25

Specifically, according to LSBC’s Form 10-Q for “the quarterly period ended September 30,

26

2005,” LSBC had “incurred negative operating cash flows of . . . $14,566,000 during the year

27
28

28
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

ended December 31, 2004” and was in the midst of incurring an additional negative operating cash

2

flow of $7,406,000 “during the first nine months of 2005.” ECF No. 64-5, Exh. 257 at 10. Thus,

3

LSBC’s “history of negative cash flow” raised “substantial doubt about [its] ability to continue as

4

a going concern.” Id. at 13. LSBC never repaid Mr. Ryan’s loan and declared bankruptcy in

5

January 2006. ECF No. 64-5, Exh. 254; ECF No. 64-13 Exh. 270. Further, when Mr. Ryan

6

loaned the $3.6 million to LSBC, the Ryans were also in the midst of negotiating an installment

7

agreement with the IRS. See FAC ¶ 26. The Ryans had requested an installment agreement from

8

the IRS as an alternative to paying the entire tax all at once, and had submitted a Form 433-A

9

financial statement to the IRS disclosing assets that were insufficient to pay their entire tax

10

United States District Court
Northern District of California

11

liability in a single lump-sum payment. FAC ¶¶ 24–25.
In sum, despite being on notice of an impending multi-million dollar tax assessment

12

against him and his wife, and despite representing to the IRS that he and his wife did not have

13

enough money to pay that tax in a single payment, Mr. Ryan chose to lend $3.6 million to the

14

company for which he was serving as CEO. Further, that company (1) was hemorrhaging money

15

at the time; (2) had substantial doubts about its “ability to continue as a going concern,” ECF No.

16

64-5, Exh. 257 at 13; and (3) ended up going under and never repaying Mr. Ryan any portion of

17

the $3.6 million loan amount. In light of Mr. Ryan’s decision to expend a substantial sum of

18

money on what was essentially his own failing business enterprise instead of using that money to

19

pay his tax obligations, Plaintiff’s claim that the Ryans had reasonable cause for failing to pay

20

their taxes on time is not well-taken. See McLaine, 138 T.C. at 247 (“The fact that [petitioner] lost

21

most of those funds by investing them in high technology stocks and ventures that ultimately

22

failed (and did not retain sufficient funds to pay his 1999 tax) does not provide a basis for his

23

claim of reasonable cause for his nonpayment or late payment of tax.”); Schroer, 594 F. Supp. 2d

24

at 1269 (“[R]eliance on a speculative financial transaction like the sale of real property at a given

25

price and time, when that transaction ultimately fails, does not constitute reasonable cause for the

26

failure to pay taxes when due.”). Plaintiff offers no evidence that suggests that by lending

27
28

29
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

millions of dollars to LSBC in 2005, Mr. Ryan “exercised ordinary business care and prudence in

2

providing for payment of his tax liability.” 26 C.F.R. § 301.6651-1(c)(1). Indeed, although

3

Plaintiff offers a declaration from Ronald Artale, who worked closely with Mr. Ryan as LSBC’s

4

Chief Operating Officer from 2003 to 2006, in support of her case, Mr. Artale states in his

5

declaration that in 2005 LSBC “had approached numerous potential lenders without success and

6

some potential lenders had suggested a willingness to invest but only under onerous terms.” ECF

7

No. 66-3 ¶ 8. Thus, statements from one of Plaintiff’s own declarants demonstrate that Mr.

8

Ryan’s decision to loan $3.6 million to LSBC in 2005 was in fact a very risky investment—one

9

that other lenders were willing to engage in only “under onerous terms.” Id. Moreover, Mr. Ryan

10

loaned an additional $750,000 to LSBC on August 5, 2005. ECF No. 64-5, Exh. 257 at 7. Then,

11
United States District Court
Northern District of California

1

on November 22, 2005, Mr. Ryan loaned another $340,000 to LSBC. ECF No. 64-5, Exh. 256.

12

Second, Defendant mentions the fact that on June 23, 2006, Mr. Ryan transferred legal title

13

to the Ryans’ third home in San Jose to his daughter and son-in-law, the McIlvains, in return for a

14

promissory note that did not require any payments until September 2011. ECF No. 63 ¶ 30; see

15

Ryan, 2011 WL 1344499 at *2. The Ryans did not disclose their ownership of this home, which

16

was worth about $900,000 in 2006, during their installment agreement negotiations with the IRS

17

in 2005. ECF No. 64-2, Exh. 229; ECF No. 64-3, Exhs. 230–31; ECF No. 64-11, Exh. 267 at 75;

18

see Ryan, 2011 WL 1344499 at *2 (stating that the Ryans “concealed the 2006 transfer of real

19

property to their daughter”). The Ryans could have sold this third home and applied the proceeds

20

of the sale towards their tax liabilities. Instead, the Ryans concealed the home from the IRS and

21

subsequently transferred title to the McIlvains before the IRS could issue a levy upon the property.

22

See Ryan, 2011 WL 1344499 at *2 (“The IRS was unable to levy upon one parcel of real property

23

owned by the Ryans at the time they incurred the tax liability because the Ryans transferred the

24

property to their daughter in 2006 in return for a promissory note that does not require any

25

payments until September 2011.”). The Ryans’ actions regarding their San Jose home go beyond

26

mere lack of “ordinary business care and prudence in providing for payment of [their] tax

27
28

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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

liability,” 26 C.F.R. § 301.6651-1(c)(1), and suggest a calculated avoidance of tax obligations.

2

Indeed, in approving the IRS’s levy on the Ryans’ principal residence, Judge Fogel cited the

3

Ryan’s “2006 transfer of real property to their daughter” as a reason why “the Ryans would not

4

prevail” if “equitable considerations were to play a part in the Court’s analysis” of whether to

5

approve the IRS’s levy. Ryan, 2011 WL 1344499 at *2. Similarly, in the instant case, in light of

6

the Ryans’ decision to conceal and transfer their San Jose home instead of selling it and applying

7

the proceeds to their tax obligations, Plaintiff cannot demonstrate that the Ryans had reasonable

8

cause for failing to pay their taxes on time.
Because Plaintiff has failed to create a dispute of material fact as to whether the Ryans had

9

reasonable cause for failing to timely pay their taxes, she cannot prevail on her claim for an

11
United States District Court
Northern District of California

10

abatement of the Penalty pursuant to I.R.C. § 6651(a)(3). Accordingly, the Court DENIES

12

Plaintiff’s motion for summary judgment and GRANTS Defendant’s motion for summary

13

judgment as to Count Four.

14

D. Count Three
In Count Three, Plaintiff argues that she is entitled to a refund of the Penalty because the

15
16

IRS failed to comply with certain procedural requirements before assessing the Penalty. See FAC

17

¶¶ 123–31. Specifically, Plaintiff argues in her motion for summary judgment that the IRS (1)

18

failed to send a notice and demand for payment of tax to the Ryans, which the IRS was required to

19

do within 60 days after assessing the tax in order to assess the Penalty, I.R.C. §§ 6303(a) &

20

6651(a)(3); and (2) failed to issue a notice of deficiency to the Ryans, in accordance with the

21

deficiency procedures set forth in I.R.C. §§ 6211–16, before assessing the Penalty. Pl. Mot. at 15–

22

19.

23

However, the undisputed facts demonstrate that, under the applicable law, Plaintiff has

24

failed to create a material dispute of fact as to whether the IRS violated any procedural

25

requirements related to its assessment of the Penalty. First, as to notice and demand for payment

26

of tax, Defendant’s evidence indicates that the IRS issued such notice and demand to the Ryans on

27
28

31
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

July 4, 2005. Specifically, Defendant has submitted a Form 4340 “Certificate of Assessments,

2

Payments, and Other Specified Matters” for “Kevin J & Nancy Ryan” that contains an entry called

3

“Statutory Notice of Balance Due” dated “07-04-2005.” ECF No. 64-1, Exh. 219 at US-000017.

4

The United States Tax Court has stated that “[a] Statutory Notice of Balance Due entry on Form

5

4340 is sufficient to presumptively establish that notice and demand was sent on the date

6

corresponding to the Statutory Notice of Balance Due entry.” E.J. Harrison, 2011 WL 2636263,

7

at *3 n.5. Thus, the “Statutory Notice of Balance Due” entry on the Form 4340 in the instant case

8

“presumptively establish[es]” that the IRS sent a notice and demand for payment of tax to the

9

Ryans on July 4, 2005. Id. Further, Plaintiff has “failed to provide any credible evidence to rebut

10

th[at] presumption.” Id. Plaintiff only conclusorily asserts, without any citation to the record, that

11
United States District Court
Northern District of California

1

“[t]he IRS did not send or deliver to the Ryans the statutory Notice and Demand for payment of

12

taxes required by I.R.C. [§] 6651(a)(3) before assessing the Penalty.” Pl. Mot. at 18–19.

13

The undisputed facts also establish that the IRS issued its notice and demand in

14

compliance with the timelines prescribed by I.R.C. §§ 6303(a) & 6651(a)(3). Section 6303(a)

15

requires such notice and demand to be given “within 60 days[] after the making of an assessment

16

of a tax.” Here, the IRS assessed the relevant tax—almost $14 million, exclusive of interest and

17

accuracy-related penalties—on July 4, 2005, ECF No. 64-1, Exh. 219 at US-000003, the same day

18

it sent the notice and demand for payment of that tax to the Ryans. Further, § 6651(a)(3) instructs

19

that a “failure-to-pay” penalty begins accruing 10 business days after notice and demand is issued,

20

which clearly establishes that a notice and demand must be issued at least 10 business days before

21

the IRS can assess a penalty under § 6651(a)(3). Here, the IRS assessed the Penalty on October 1,

22

2007, more than two years after it sent the notice and demand for payment of tax to the Ryans.

23

ECF No. 64-1, Exh. 219 at US-000007.

24

Second, as to deficiency procedures, although Defendant concedes that “no notice of

25

deficiency was issued to the Ryans prior to assessment of the Penalty,” Def. Opp. at 5, Defendant

26

also correctly points out that the IRS was not required to issue a notice of deficiency in order to

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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

collect the Penalty. It is well-established that penalties under § 6651(a)(3) “may be collected by

2

[the IRS] by notice and demand . . . and without recourse to the deficiency procedures,” including

3

the deficiency notice requirement set forth in § 6212. Reese v. C.I.R., 2006 WL 314422, at *5

4

(T.C. Feb. 9, 2006) (emphasis added). This is because § 6651(a)(3) penalties “are not attributable

5

to a deficiency.” Id. Instead, they “are attributable to amounts that have already been assessed but

6

remain unpaid.” Id. In other words, so long as the IRS issues a notice and demand for payment of

7

a tax—which, as explained above, it did in the instant case—the IRS may collect a § 6651(a)(3)

8

penalty for failure to timely pay that tax without issuing a notice of deficiency or complying with

9

any other deficiency procedures. See also Kimball v. C.I.R, 2008 WL 862339, at *7 (T.C. Apr. 1,

10

2008) (“Section 6651(a)(3) additions are attributable to amounts that have already been assessed

11
United States District Court
Northern District of California

1

but remain unpaid, and therefore the Commissioner may collect such additions by notice and

12

demand without assessment and without recourse to the deficiency procedures.”); Stone v. C.I.R.,

13

2005 WL 3501581, at *4 (T.C. Dec. 22, 2005) (“Since the section 6651(a)(3) addition follows

14

from the failure to pay an amount after notice and demand, it is not subject to the deficiency

15

procedures.”).

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Accordingly, the Court DENIES Plaintiff’s motion for summary judgment and GRANTS
Defendant’s motion for summary judgment as to Count Three.
E. Count Five
In Count Five, Plaintiff argues that she is entitled to a refund of the Penalty because the

20

closing agreement between the Ryans and IRS “barred the IRS from imposing the Penalty.” FAC

21

at 27. As discussed above, after the IRS audited the Ryans’ 2000 tax return and determined that

22

the Ryans had bought a “Son of Boss” tax shelter, the IRS proposed to (1) assert a deficiency in

23

tax of almost $14 million by disallowing more than $36 million in losses from the tax shelter; and

24

(2) add a 40% accuracy-related penalty under I.R.C. § 6662. See FAC ¶¶ 21, 142. In order to

25

resolve the tax dispute without litigation and “avoid” the “threatened imposition of a 40%

26

[accuracy-related] penalty,” the Ryans elected to participate in a settlement initiative with the IRS.

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33
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

Id. ¶¶ 21, 23; ECF No. 64-2, Exhs. 224–25. As a result of the settlement initiative, the IRS and the

2

Ryans entered into a closing agreement in which, inter alia, the IRS (1) disallowed a total of

3

$36,383,476.00 in losses for the year 2000; (2) agreed to allow the Ryans to deduct half of their

4

out-of-pocket costs from the “Son of Boss” transaction; and (3) agreed to limit the accuracy-

5

related penalty under I.R.C. § 6662 to 10%. ECF No. 64-2, Exh. 228 ¶¶ 2, 3, 8.

6

Plaintiff argues that because the closing agreement “was a comprehensive settlement
agreement” with a “broad and all-inclusive scope,” the fact that the agreement specifically

8

addressed only one type of penalty—the 10% accuracy-related penalty under I.R.C. § 6662—

9

means that the IRS “agreed to settle,” and thereby “explicitly waived its claim to assert,” all other

10

“penalties (‘additions to tax’) applicable to the transaction,” including any “failure-to-pay” penalty

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United States District Court
Northern District of California

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under I.R.C. § 6651(a)(3). Pl. Mot. at 12; FAC ¶¶ 144–45.

12

However, under the applicable law, the closing agreement’s silence as to § 6651(a)(3)

13

penalties did not bar the IRS from assessing the Penalty in the instant case. Closing agreements

14

between taxpayers and the IRS are authorized and governed by I.R.C. § 7121. Further, contrary to

15

Plaintiff’s insistence that the closing agreement was a “broad,” “all-inclusive,” and

16

“comprehensive settlement agreement,” the United States Tax Court has stated that the parties to a

17

§ 7121 closing agreement—like the one in the instant case—“are bound only as [to] the specific

18

matters agreed upon” in the closing agreement. Magarian v. C.I.R., 97 T.C. 1, 5–6 (1991) (citing

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Zaentz v. C.I.R., 90 T.C. 49, 761–72 (1988)). This is further reinforced by the fact that the specific

20

type of closing agreement in the instant case was a “Form 906,” which is titled “Closing

21

Agreement on Final Determination Covering Specific Matters,” ECF No. 64-2, Exh. 228

22

(emphasis added), and is therefore “used with respect to the closing of specific matters affecting

23

tax liability.” Magarian, 97 T.C. at 5 (emphasis added). Thus, because penalties under I.R.C. §

24

6651(a)(3) were not among the specific matters agreed upon in the closing agreement, the IRS was

25

not “bound” by the closing agreement with respect to § 6651(a)(3) penalties in any way, and

26

cannot be deemed to have “waived its claim to assert” a § 6651(a)(3) penalty based solely upon

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34
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

the closing agreement’s resolution of another type of penalty. Indeed, “as a general rule[,] closing

2

agreements do not relate to additions to tax,” including § 6651(a)(3) penalties. Magarian, 97 T.C.

3

at 6. Here, the mere fact that the closing agreement addressed another type of addition to tax is

4

not enough to rebut this “general rule.” Id. Instead, if the Ryans “had intended to settle with

5

respect to any of the [other] possible additions to tax for the taxable year [2000], they should have

6

insisted upon the inclusion of specific language to that effect in the [c]losing [a]greement.” Id. at

7

6–7. “Without such language, . . . the specific matters agreed upon by the parties must be

8

respected.” Id. at 7 (concluding that a closing agreement did not bar the IRS from assessing

9

additions to tax that were not mentioned in the closing agreement).

10

Further, even if it was appropriate to consider extrinsic evidence to determine the scope of

United States District Court
Northern District of California

11

the closing agreement, such evidence would not benefit Plaintiff. Plaintiff relies on the

12

installment agreement, but nothing about the installment agreement indicates that the IRS waived

13

its ability to collect a failure-to-pay penalty under § 6651(a)(3) by signing the closing agreement.

14

Indeed, the I.R.C. contemplates that § 6651(a)(3) penalties will accrue even when an installment

15

agreement is in effect. Specifically, I.R.C. § 6651(h) states that if an installment agreement is in

16

effect while a penalty under any of the subsections of § 6651(a) is accruing, the growth rate of the

17

penalty must be decreased to 0.25 percent of the outstanding tax liability per month. Further, in

18

the instant case, the installment agreement between the IRS and the Ryans expressly allowed for

19

the recovery of “PENALTIES AND INTEREST PROVIDED BY LAW” in addition to the

20

$17,488,221.95 balance due. ECF No. 64-3, Exh. 232. Because that $17,488,221.95 balance

21

included the 10 percent accuracy-related penalty (along with almost $14 million in taxes, plus

22

interest on those taxes), the installment agreement’s reference to “PENALTIES” implies that the

23

IRS did not waive its ability to assess a § 6651(a)(3) penalty against the Ryans. At the very least,

24

the installment agreement does not help Plaintiff create a dispute of material fact about whether

25

the closing agreement affirmatively barred the IRS from assessing a § 6651(a)(3) penalty against

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the Ryans.

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35
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

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Accordingly, the Court DENIES Plaintiff’s motion for summary judgment and GRANTS
Defendant’s motion for summary judgment as to Count Five.
F. Count Six
In Count Six, Plaintiff argues that she is entitled to a refund of the Penalty because the IRS

5

should grant a “first-time abatement” of the Penalty “pursuant to the Internal Revenue Manual.”

6

FAC ¶¶ 146–54. Plaintiff appears to be referring to I.R.M. 20.1.1.3.3.2.1, which is an

7

“administrative waiver” that allows the IRS to provide “administrative relief” from certain

8

penalties, including penalties under § 6651(a)(3), if the taxpayer meets certain eligibility criteria.

9

However, the IRS asserts that it has “absolute discretion to grant or deny a request” for a firsttime-abatement under I.R.M. 20.1.1.3.3.2.1. Def. Mot. at 23. Further, and in any event, the IRS

11
United States District Court
Northern District of California

10

correctly points out that Plaintiff’s claim for a first-time abatement pursuant to the Internal

12

Revenue Manual cannot prevail because “[t]he Internal Revenue Manual does not have the force

13

of law and does not confer rights on taxpayers.” Fargo v. Comm’r, 447 F.3d 706, 713 (9th Cir.

14

2006). Perhaps in recognition of this fact, Plaintiff does not oppose Defendant’s motion for

15

summary judgment as to Count Six. Accordingly, the Court GRANTS the Defendant’s motion for

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summary judgment as to Count Six.

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G. Count Seven
In Count Seven, Plaintiff argues that she is entitled to a refund of the Penalty because the

19

Form 872-I that the taxpayers signed on March 24, 2004 barred the IRS from assessing the

20

Penalty. FAC ¶¶ 155–61; see ECF No. 64-1, Exh. 223. When the IRS selected the Ryans’ 2000

21

tax return for an audit in March 2004, see FAC ¶ 17; ECF No. 64-2, Exh. 226, the end of the

22

three-year limitations period for the IRS to assess taxes related to that return, which is set forth in

23

I.R.C. § 6501(a), was approaching. See I.R.C. § 6501(a) (stating that “the amount of any tax

24

imposed by this title shall be assessed within 3 years after the return was filed”). Thus, the IRS

25

asked the Ryans to sign a Form 872-I, titled “Consent to Extend the Time to Assess Tax as well as

26

Tax Attributable to Items of a Partnership,” which extended the IRS’s deadline to assess taxes

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36
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

related to the 2000 tax return to December 31, 2005. ECF No. 64-1, Exh. 223. The parties were

2

authorized by I.R.C. § 6501(c)(4) to agree to this extension of the § 6501(a) limitations period.

3

See I.R.C. § 6501(c)(4) (“Where, before the expiration of the time prescribed in this section for the

4

assessment of any tax imposed by this title . . . both the Secretary and the taxpayer have consented

5

in writing to its assessment after such time, the tax may be assessed at any time prior to the

6

expiration of the period agreed upon.”). Plaintiff asserts that the Penalty, which was imposed on

7

October 1, 2007, was “untimely and invalid” because it was assessed “well beyond the extended

8

assessment deadline (December 31, 2005)” that the Ryans agreed to in the Form 872-I. Pl. Mot. at

9

19.

10

Plaintiff’s argument is unavailing, however, because as a matter of law, the Penalty was

United States District Court
Northern District of California

11

not subject to the extended assessment deadline set forth in the Form 872-I. It is well-established

12

that I.R.C. § 6501(a), which, as discussed above, establishes a three-year limitations period for the

13

assessment of taxes, does not apply to the assessment of “failure-to-pay” penalties under §

14

6651(a)(3). As the IRS correctly points out, “[e]very court to consider the issue” has held that §

15

6651(a)(3) penalties are not subject to the statute of limitations in § 6501(a). Def. Mot. at 24;

16

United States v. Lund, 2012 WL 3779105, at *1 (D. Ore. Aug. 31, 2012) (stating that “every court

17

to consider the issue has held that § 6651(a)(3) creates an exception to the three year statute of

18

limitations” in § 6501(a)); Bob Hamric Chevrolet, Inc. v. U.S. I.R.S., 849 F. Supp. 500, 515 (W.D.

19

Tex. 1994) (finding that a § 6651(a)(3) penalty based on a 1983 tax return was timely even though

20

it was assessed in 1991); United States v. Krasnow, 548 F. Supp. 686 (S.D.N.Y. 1982) (holding

21

that § 6651(a)(3) penalties are not subject to the limitations period set forth in § 6501(a)); see also

22

In re Gurley, 335 B.R. 389, 393 (Bankr. W.D. Tenn. 2005) (stating that “[t]he IRS correctly points

23

out in its memorandum that the limitations period set out at § 6501(a) does not apply to [a] failure

24

to pay penalty” under § 6651(a)(2)). Further, the Form 872-I that the Ryans signed was merely an

25

agreement, authorized under § 6501(c)(4), to extend the IRS’s tax assessment deadline beyond the

26

default limitations period set by § 6501(a). Thus, there is little reason to think, and Plaintiff

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37
Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT

1

provides no factual or legal basis to suggest, that the extended December 31, 2005 deadline was

2

somehow applicable to the Penalty even though the original deadline was not. As a result, the

3

October 1, 2007 Penalty was not barred by the December 31, 2005 deadline set forth in the Form

4

872-I.
Accordingly, the Court DENIES Plaintiff’s motion for summary judgment and GRANTS

5
6

Defendant’s motion for summary judgment as to Count Seven.

7

IV.

8
9
10

CONCLUSION
For the foregoing reasons, the Court DENIES Plaintiff’s motion for summary judgment

and GRANTS Defendant’s motion for summary judgment.
IT IS SO ORDERED.

United States District Court
Northern District of California

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Dated: April 12, 2018
______________________________________
LUCY H. KOH
United States District Judge

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Case No. 16-CV-00164-LHK
ORDER DENYING PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT