                        T.C. Memo. 2007-93



                      UNITED STATES TAX COURT



               INDUSTRIAL INVESTORS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14928-04L.            Filed April 23, 2007.


     William G. Wells, for petitioner.

     Elaine T. Fuller, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION



     HOLMES, Judge:   The Commissioner sent Industrial Investors,

Inc., a notice saying that he intended to levy on its property to

collect unpaid 1990, 1991, and 1992 taxes.   Industrial asked for

a collection due process (CDP) hearing.   Though Industrial is

located near Los Angeles, the revenue officer handling the case

forwarded Industrial’s files, along with a cover letter
                                - 2 -

describing in some detail why she thought the levy should be

sustained, to the IRS Appeals Office in Oklahoma City.   The

Appeals officer in Oklahoma City scheduled a telephone CDP

hearing on a day that Industrial’s representative had been

subpoenaed to testify in California State court.   Not wasting any

time after the inevitable default, the Appeals officer wrote a

notice of determination later that same day that sustained the

proposed levy.   Industrial argues that this determination was an

abuse of discretion.

                         FINDINGS OF FACT

     Industrial’s 1990-92 taxes first came before this Court in

1994 when Industrial petitioned us to redetermine its

deficiencies for those years.   That case finally settled while

our decision was pending on appeal to the Ninth Circuit.

Industrial, however, never paid and in 2004 the Commissioner

mailed it a notice stating that the IRS intended to collect by

levy.   Industrial promptly requested a CDP hearing to seek an

offer-in-compromise.   The revenue officer who had been working on

the case forwarded that request to the Oklahoma City Appeals

Office.   Accompanying the files was a cover letter from the

revenue officer.   The letter is the key to this case, and

deserves to be quoted at some length:
                              - 3 -

          Mr. Wells[1] on behalf of Industrial Investors Inc
     is requesting a collection due process hearing for
     Filed Notice of Federal Tax Lien and Notice of
     Levy/Seizure. The Notice of Federal Tax Liens
     previously filed in 1998. Therefore, no CDP hearing on
     the recorded Notices of Federal Tax Liens should be
     considered. As for the Notice of Intent to Levy, this
     should proceed accordingly.

          Since Mr. William G. Wells has had numerous
     opportunities to sell, refinance or secure a second
     mortgage on all real property owned by Industrial
     Investors Inc and has not done so to this date, it is
     time that the government secure any and all interest
     for all assets owned by the Corporation to pay the
     outstanding tax debts.

                              * * *

          Mr. William G. Wells intends to file an Offer-in-
     Compromise for his individual tax debts and those of
     this entity. However, he has been made aware that no
     offer is feasible unless all the entities he is
     associated with are in compliance with filing and
     paying tax debts. Many of the entities are not in
     compliance with filing and paying requirements just
     like Industrial Investors Inc. Therefore, an Offer-in-
     Compromise will not be contemplated unless Mr. William
     G. Wells cooperates in providing all the entities
     financial statements, tax returns and pays all the
     debts or attempts to resolve all compliance issues.

          Since Mr. Wells has delayed many of his tax issues
     via Tax Court, 9th Court of Appeals requests,
     Collection Due Process Hearing Requests etc., It is
     recommended that no further delays be granted and that
     the Internal Revenue Service be authorized to collect
     the taxes due from Industrial Investors Inc from any
     and all of the assets which are found to have equity to
     pay toward its tax debts. He also signed and agreed to
     the assessments via the Tax Court recorded date
     February 17, 1997.




     1
        William G. Wells is one of Industrial’s shareholders, as
well as its secretary, treasurer, and attorney in this case.
                                - 4 -

     On June 21, 2004, Troy Talbott, the Appeals officer handling

the case, sent Wells a letter stating that he had started the CDP

review and that Wells had until July 8--just twelve business

days--to file Industrial’s overdue tax returns for 1996 and 2001

as well as submit any collection alternatives and current

financial statements.    Two days later, Wells wrote back to

Talbott with a summary of a phone conversation they had earlier

that day, and promised to respond to Talbott’s request for

documents once he received an account history for Industrial.    He

added that he would need an extension of the July 8 due date, but

did attach copies of Industrial’s 1996 and 2001 tax returns

(which had apparently already been filed) to his letter.

     Talbott, it turned out, had anticipated Wells’s request for

an account history and mailed a copy to Industrial even before

Wells asked for one.    Wells sent Talbott a brief note

acknowledging receipt of that history on June 28:

     1. Receipt acknowledged. 2. It appears that 1990-1993
     is the problem as no deductions. 3. The $1 million
     income in 1990 never happened. 4. I will be sending
     you some papers shortly.

Talbott understood this note to be an omen that Wells planned to

revisit the amount of tax owed, and replied with a letter dated

July 1, telling Wells that Industrial could not reargue the

underlying liability--it had already brought and settled a Tax

Court case for those years.    His letter also reconfirmed the July

8 deadline to provide any documentation.    With Independence Day
                              - 5 -

looming, July 8 was now just four business days away.

     On July 8, without checking with Wells to see whether he was

available, Talbott set the hearing for Monday, July 19 at 8:00

a.m. PST, specifying that it would be by telephone.2    Wells

received this letter on July 14--almost a week later--and

immediately responded with another of his own.   He explained that

he was unavailable on July 19 because he was under subpoena for a

trial in California State court beginning that very day.    Wells

again complained about the short notice and his inability to

provide the requested documents in time.   He also mentioned the

appeal to the Ninth Circuit and the subsequent settlement, and

wrote that he was attempting to obtain a copy of the settlement

agreement for Talbott.

     Talbott did not receive Wells’s letter by the morning of

July 19, so he called Wells to begin the CDP hearing promptly at

8:00 a.m. Pacific time and left a voicemail message.    Wells

called Talbott back as soon as he got the message, and ended up

leaving a voicemail of his own, again requesting additional time.

But Talbott had already drafted a notice of determination

sustaining the notice of intent to levy, and he didn’t change his


     2
       Wells makes much of California’s observance of daylight
saving time, arguing that there could be some confusion as to
what time this call was actually scheduled to begin. We
disagree. A reasonable person would understand “8:00 a.m. PST”
to mean simply “8:00 a.m. Pacific time.” We certainly refuse
to invalidate the determination because Talbott wrote “PST”
instead of “PDT.”
                                - 6 -

draft even after he received Wells’s July 14 letter--the one

making clear that a subpoena would make Wells unavailable.

Moving quickly, Talbott on July 21 issued the official notice of

determination sustaining the notice of intent to levy, a mere

month after he had sent his first letter to Wells.

     Industrial filed a timely petition in this Court and trial

was held in Los Angeles, which is near Industrial’s principal

place of business.

                               OPINION

     The Commissioner may levy on property belonging to a

taxpayer once he gives proper notice and an opportunity for a

hearing.   See secs. 6330, 6331.3   During the hearing, a taxpayer

can only challenge the existence or amount of the underlying tax

liability if he either (1) did not receive a statutory notice of

deficiency, or (2) did not otherwise have an opportunity to

dispute the liability.   Sec. 6330(c)(2)(B).   Industrial has had

its day in Tax Court, so it can no longer contest its liability--

it can win only if it shows that the Commissioner abused his

discretion.   Sego v. Commissioner, 114 T.C. 604, 610 (2000); Goza

v. Commissioner, 114 T.C. 176, 181-182 (2000).    He abuses his

discretion when he acts “arbitrarily, capriciously, or without

sound basis in fact or law.”    Woodral v. Commissioner, 112 T.C.


     3
       Unless otherwise noted, all section references are to the
Internal Revenue Code in effect for the years at issue; all Rule
references are to the Tax Court Rules of Practice and Procedure.
                               - 7 -

19, 23 (1999).   Acting without a sound basis in fact or law means

that an agency such as the IRS “makes an error of law * * * or

rests its determination on a clearly erroneous finding of fact

* * * [or] applies the correct law to facts which are not clearly

erroneous but rules in an irrational manner.”   United States v.

Sherburne, 249 F.3d 1121, 1125-26 (9th Cir. 2001); see also

Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 402-03 (1990).

     Industrial serves up a gallimaufry of arguments that the

Commissioner abused his discretion, but we focus on four:    (1)

the cover letter sent to Talbott was an impermissible ex parte

communication; (2) Industrial was denied a face-to-face hearing

in a location close to its place of business; (3) Talbott

unilaterally scheduled a date and time for the CDP hearing

without consulting Industrial; and (4) Talbott ignored evidence

of the agreement settling Industrial’s deficiency case while it

was on appeal.   Industrial also requests an award of litigation

costs under section 7430.

1.   Ex Parte Communication

     Section 6330 sets out the process for administrative review

of decisions by the IRS to levy taxpayers’ property.   One of the

protections that section gives taxpayers is a promise that the

hearing will be conducted by an IRS employee who is impartial.

Sec. 6330(b)(3).   Congress reinforced this requirement by

directing the Commissioner to reorganize the IRS so that the
                                - 8 -

entire IRS Appeals function would be independent.    Internal

Revenue Service Restructuring and Reform Act of 1998, Pub. L.

105-206, sec. 1001(a), 112 Stat. 689.    The Commissioner then made

the guarantee of impartiality part of the IRS’s standard

operating procedure by issuing Revenue Procedure 2000-43, 2000-2

C.B. 404.    This procedure prohibits ex parte communications by

IRS employees that would appear to compromise the independence of

an Appeals officer.

       Through a series of questions and answers, the Commissioner

explains which types of communications he regards as prohibited

ex parte contacts.    Rev. Proc. 2000-43, sec. 3, 2000-2 C.B. at

405.    He begins with a general definition of ex parte

communications as those taking place between an Appeals officer

and another IRS employee in which the taxpayer does not have a

reasonable “opportunity to participate.”    Id., Q&A-1 and Q&A-21,

2000-2 C.B. at 405, 408.    He excludes the administrative file

from the definition of an ex parte communication because that

file explains what the dispute is about and establishes the

jurisdiction of IRS Appeals.    Id., Q&A-4, 2000-2 C.B. at 405.

However, the procedure warns, communications with the

“originating function” (IRS-speak for an employee whose initial

determination the Appeals Office is reviewing) may only address

“ministerial, administrative, or procedural matters and [may] not

address the substance of the issues or positions taken in the
                               - 9 -

case,” including the accuracy and relative importance of alleged

facts in the case, and the “originating function’s perception of

the demeanor or credibility of the taxpayer or taxpayer’s

representative.”   Id., Q&A-5, 2000-2 C.B. at 405-06.

     There can’t be any suspense in our holding on this point--

the cover letter sent to Talbott that accompanied the

administrative file was precisely the sort of prohibited ex parte

contact that the Commissioner and Congress wanted to ban.     It put

the revenue officer’s spin on what he thought of Wells and

Industrial, and blatantly advocated a particular result.     In two

recent cases, Drake v. Commissioner, 125 T.C. 201 (2005), and

Moore v. Commissioner, T.C. Memo. 2006-171, we held that

communications very similar to the cover letter in this case were

likewise prohibited ex parte communications.   Drake featured a

memorandum by an IRS employee telling the Appeals officer that he

believed the taxpayer and her attorney had used the Bankruptcy

Court to bypass a federal tax lien and get their hands on the

proceeds from a sale of their encumbered property.      Drake, 125

T.C. at 203.   Moore featured two IRS employees who both tried to

be helpful by suggesting that the Appeals officer consider a

nominee theory and look at the taxpayer’s “money stream.”      Moore,

supra.

     The cover letter here is full of similarly “helpful”

suggestions: telling Talbott he shouldn’t consider a CDP hearing
                              - 10 -

for the previously filed lien, recommending that the government

“secure any and all interest for all assets owned by the

Corporation,” and strongly suggesting the terms under which an

offer-in-compromise would be accepted.

     This needs to stop.   Congress wanted to give taxpayers an

opportunity to appeal their case to an IRS employee who would

take a fresh look at the facts.   Ex parte contacts not only

undermine the impartiality of the officer hearing the appeal, but

are especially pernicious because they are so hard to detect.

Wells only discovered the cover letter sent to Talbott because,

as a lawyer, he was savvy enough to ferret out its existence from

a reference in the Appeals officer’s case activity report.

     The Commissioner contends that even if the cover letter were

deemed a prohibited ex parte communication, it shouldn’t matter

since Talbott testified that the statements didn’t influence him.

This amounts to arguing that the cover letter was a harmless

error, and the Commissioner is right that harmless error is

generally no reason to remand an administrative agency’s

determination for what would be a pointless reconsideration.

See, e.g., Keene v. Commissioner, 121 T.C. 8, 21 (2003) (Halpern,

J., concurring); Kemper v. Commissioner, T.C. Memo. 2003-195.

The Commissioner made a similar argument in Moore, stating that

independent grounds would support an identical determination and

therefore any prejudice from the ex parte communication was
                                 - 11 -

irrelevant.     Moore, supra.   We disagreed with the Commissioner’s

reasoning then, and we still disagree now.

     Revenue Procedure 2000-43 prohibits ex parte communications

that appear to compromise the Appeals officer:     Actual influence

isn’t required, only a reasonable possibility that the prohibited

communication may have compromised the Appeals officer’s

impartiality.    See Drake, 125 T.C. at 209-10.   We find that this

standard is easily met here:     Our personal observation of

Talbott’s testimony--buttressed by a paper trail that shows an

unusual haste to get the hearing over with and rule against

Industrial--compels us to find that as a matter of fact he was

influenced by the cover letter, leaving no doubt that his

impartiality was compromised.     We therefore remand the case to

the IRS for a new CDP hearing before a different Appeals officer

who has not been exposed to the ex parte letter.      Drake, 125 T.C.

at 210.4


     4
       It is not entirely clear that this is the only possible
remedy. Another way to cure an ex parte communication might be
to allow the offended party to have an opportunity to review and
comment on it before the Appeals officer presiding over the
remand. This would put Industrial in the same position it would
have been in if the revenue officer had incorporated his letter
into the initial determination and made it part of the
administrative file. As we noted in Moore v. Commissioner, T.C.
Memo. 2006-171, however, the revenue procedure itself doesn’t
address specific administrative remedies. It also seems to
contemplate oral ex parte communications--for example, meetings
or conference calls--and not the sort of written communication
that blindsided Industrial. See Rev. Proc. 2000-43, sec. 3, Q&A-
21, 2000-2 C.B. 404, 408. Since the IRS hasn’t spoken on this
                                                   (continued...)
                                - 12 -

2.   Hearing Location

     Although that error is enough to force a remand, Industrial

also argues for a remand to an IRS office less than two time

zones away.    It claims that the Commissioner also abused his

discretion in deciding to hold the CDP hearing in Oklahoma City

instead of somewhere closer to Santa Monica, where Industrial has

its principal place of business.    The applicable regulation is

clear that a face-to-face CDP hearing is not required by the

Code.    Sec. 301.6330-1(d)(2), Q&A-D6, Proced. & Admin. Regs.    We

also agreed in Katz v. Commissioner, 115 T.C. 329, 337-38 (2000),

that a CDP hearing via telephone satisfies the Code’s

requirements when it is an honest attempt to accommodate a

taxpayer’s preference.    But the regulation does command the

Commissioner, if a taxpayer wants a face-to-face hearing, to

offer him “a hearing at the Appeals office closest to * * * [his]

principal place of business.”    Sec. 301.6330-1(d)(2), Q&A-D7,

Proced. & Admin. Regs.5




     4
      (...continued)
particular issue, we can leave any analysis of a different
approach to another day. At least until then, we must continue
to follow our decision in Drake.
     5
       Section 301.6330-1, Proced. & Admin. Regs., has since been
changed to enable the IRS in some situations to avoid having to
schedule face-to-face hearings at the closest Appeals Office.
See T.D. 9291, 2006-46 I.R.B. 887. However, those changes do not
apply to this case.
                              - 13 -

     The Commissioner claims that this means the taxpayer must

request a face-to-face hearing in writing, at which point the

case would be transferred to the Appeals Office closest to the

taxpayer’s principal place of business.   We addressed this very

issue in Parker v. Commissioner, T.C. Memo. 2004-226, where we

held that a written CDP hearing request was itself a request for

a face-to-face meeting in the nearest Appeals Office.   We

stressed that any contrary rule would turn Form 12153 (the

official IRS CDP-hearing-request form) into a “trap for the

unwary” since there is nothing to “[inform] taxpayers of their

right * * * to request a hearing at an Appeals Office.”      Id.

     Under Parker, Wells impliedly requested a face-to-face CDP

hearing for Industrial when he filled out and returned Form

12153.   Since Industrial never subsequently waived its right to a

hearing at the closest Appeals Office, the Commissioner erred as

a matter of law, and so also abused his discretion, in sending

Industrial’s case to Oklahoma City rather than to the Appeals

Office closest to Santa Monica.6



     6
       As Wells persuasively argued, this error might well not be
harmless. Wells was looking to hire outside counsel, but the
time and expense of moving counsel between California and
Oklahoma made it prohibitively costly. Even if Wells represented
Industrial himself, he has a hearing problem that makes telephone
conversations difficult--he therefore requires a face-to-face
hearing to effectively represent Industrial. And whether or not
the error is harmless, it is an error; and procedural flaws
should be fixed on a remand for a new hearing. Kerner v.
Celebrezze, 340 F.2d 736, 740 (2d Cir. 1965).
                              - 14 -

3.   Time of the Hearing

     Industrial claims that Talbott’s unilateral scheduling of a

telephone conference was a third abuse of discretion.   However,

Industrial didn’t raise this issue in its petition to this Court

and, under Rule 331(b)(4), the issue is therefore deemed to be

conceded.   Industrial did raise a related issue which we feel

should be mentioned: it argued that the Commissioner erred by not

permitting sufficient time to present evidence in support of

Industrial’s offer-in-compromise.   This is not a problem that

lends itself to bright lines, and will presumably be fixed on

remand.   We merely note that eighteen business days from the date

of initial contact hardly seems an adequate amount of time for a

corporation to provide all relevant documentation, and putting

Industrial into default when Wells left word that he was under

subpoena to appear in court is inexplicable.

4.   Evidence of Industrial’s Settlement Agreement

     The final argument that we discuss is Industrial’s

contention that Talbott failed to consider evidence of the

settlement between Industrial and the IRS.   Talbott refused to

review the documents because he regarded them as an attempt by

Industrial to challenge its underlying tax liability.   But it

wasn’t:   When a taxpayer argues that the assessed amount doesn’t

accurately reflect a settlement, judgment, or decision, he isn’t

challenging his liability--he’s challenging the accuracy of the
                                - 15 -

assessment-recording process.    To hold to the contrary would be

absurd.    Imagine a clerical error at the IRS that causes an

assessment of $1 million against a taxpayer who has a Tax Court

decision saying that he owes $1,000.     Not allowing him to point

that out in a CDP hearing would be tantamount to saying that IRS

clerical errors trump our decisions.     We won’t do so.

       But in this case, we can assuage Industrial’s concern.   As

later explained by Talbott’s manager, and confirmed by our own

review, the IRS’s records accurately accounted for the reduced

deficiencies that Industrial won through negotiations.     As is

customary at the IRS, these reductions were noted as abatements

of the original assessments, together with corresponding

abatements of the interest and penalties to reflect the

settlement.

5.     Reasonable Litigation Costs

       Industrial also asks for an award of reasonable litigation

costs under section 7430.    However, section 7430(a) allows us to

award costs only to a “prevailing party,” and Rule 231(a)(2)(A)

provides that a taxpayer may file a motion seeking costs within

thirty days after service of the opinion determining the issues

in the case.    We are remanding this case, not deciding the case

on the merits and in Industrial’s favor.     Its request is

therefore premature.    See Drake v. Commissioner, T.C. Memo. 2006-

151.
                              - 16 -

                            Conclusion

     Because there was an impermissible ex parte communication,

we remand this case to the IRS Appeals Office closest to Santa

Monica, California, for a new CDP hearing with an impartial

Appeals officer.   This hearing should be conducted face-to-face

unless Industrial waives its right by agreeing to a hearing by

telephone or through the mail.    The cover letter which we

determined was an ex parte communication--and this opinion with

its lengthy quotation from it--should be removed from

Industrial’s administrative file and not shown to the Appeals

officer conducting the hearing on remand.


                                      An appropriate order will

                                 be issued.
