Settling a Tax Court Case with an Offer in Compromise

Today we welcome first time guest blogger, Erin Stearns. Professor Stearns directs the low income taxpayer clinic at the University of Denver Sturm College of Law, Graduate Tax Program. She writes today about a little used procedure. Chief Counsel attorneys do not like to use this procedure though the manual provides for its use. I wrote some time ago about the more common use of this procedure when litigating with the Department of Justice. In the right case, settling the merits with a compromise of the payments makes a lot of sense. Keith

This post focuses on how a taxpayer with a pending U.S. Tax Court case can use a little known tool called a “Service Offer in Compromise” to be relieved of federal tax liability while avoiding the need to go to trial.

For many years, taxpayers have been using offers in compromise (“OICs”) for doubt as to collectability or effective tax administration to compromise federal tax liability, penalties, and interest for less than the amount owed. A body of law authorizes and provides guidance on such OICs. See, e.g., IRC § 7122, Treas. Reg. § 301.7122-1, and IRM § 5.8. In 2014, the most recent year for which we have statistics, the IRS received 67,935 offers and accepted approximately 27,000 offers (approximately 40%). The total value of all accepted offers in 2014 was over $179,000,000. See Trends in Compliance Activities through Fiscal Year 2014, Treasury Inspector General for Tax Administration, November 10, 2015. While another type of OIC – for Doubt as to Liability – may be used to dispute liability, discussion of such OICs is beyond the scope of this post.

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Generally the IRS must assess tax on the applicable tax year(s) before it will consider an OIC covering that period. In most instances, a taxpayer who petitions Tax Court based on a statutory notice of deficiency to challenge the alleged liability must either reach a settlement with the IRS or go to trial to determine the amount of liability owed. The Tax Court would then issue a decision approving the settlement or, if the case has gone to trial, a decision as to the correct amount of tax and penalties owed. The IRS would subsequently assess tax, penalties (if applicable), and interest based on the decision of the Tax Court. Once the liability has been assessed, the taxpayer could submit an OIC for doubt as to collectability or effective tax administration to try to settle the debt for less than he or she owes.

A Service OIC operates similarly to the OICs described above with one distinct difference: the taxpayer with a pending Tax Court case (hereafter, the “petitioner”) could submit an OIC to cover the alleged liability even though the IRS has not yet assessed the tax against him or her. A provision in the Internal Revenue Manual, effective July 25, 2012, provides authority for Service OICs. See IRM § 35.8.6.2.1.

The starting point for the petitioner who wishes to submit a Service OIC would be to contact IRS Counsel’s office to obtain its consent to filing a Service OIC.  IRM § 35.8.6.2.1(2). Counsel’s office must agree to follow certain procedures set forth in the IRM provision in order for the OIC to be a “Service OIC.” Therefore, as a practical matter, Counsel’s office could prevent the petitioner from filing a Service OIC if it refuses to follow these procedures. Id. However, assuming Counsel’s office agrees to follow the IRM procedures and allow the petitioner to file a Service OIC, the Counsel attorney assigned to the case would have to follow the procedures set forth in IRM § 35.8.6.2.1. If the case is with IRS Appeals when the petitioner requests permission to submit a Service OIC, then the Appeals Office would need to close the case and transfer it to Counsel’s office, as only Counsel’s office is authorized to follow the procedures related to Service OICs. See IRM § 35.8.6.2.1(2).

If Counsel’s office agrees to allow the petitioner to file a Service OIC, the petitioner would prepare the OIC and send it directly to Counsel’s office.  The OIC would be either an OIC for doubt as to collectability or effective tax administration, and would use the Forms 656 and 433-A(OIC) for an individual offer or 433-B(OIC) for a business offer. Counsel’s office would then send the Service OIC to the appropriate Centralized OIC unit of the IRS, where it would be processed and reviewed like any other OIC for doubt as to collectability or effective tax administration. An offer examiner or specialist would be assigned to determine the petitioner’s Reasonable Collection Potential (“RCP”) based on his or her assets and future income. The examiner may also determine that special circumstances warrant a departure from the petitioner’s RCP in the case of an effective tax administration offer. Because it typically takes the IRS at least six months to review an OIC and the petitioner’s case may be docketed for calendar call during this time, it may be necessary to file one or more motions to continue the Tax Court case generally. Counsel will likely assent to such a motion. Counsel’s office may also request that the IRS conduct an expedited review of the OIC.

The IRM provisions on Service OICs state that Counsel’s office “should” obtain from the petitioner a stipulation agreeing to the “full amount of deficiencies and penalties.” IRM § 35.8.6.2.1(3). The “full amount of deficiencies and penalties” would be either the amount alleged on the statutory notice of deficiency or a lesser amount agreed to by the parties. The Service OIC provision in the IRM gives the petitioner the choice to authorize Counsel to (1) file the stipulation with the Tax Court, or (2) hold the signed stipulation in escrow at Counsel’s office.  See IRM § 35.8.6.2.1(3). Under the first option – filing the stipulation with the Tax Court – the petitioner would be bound by the amount agreed to in the stipulation if the OIC were not accepted. Under the second option – holding the stipulation in escrow at Counsel’s office – the petitioner could request that Counsel’s office destroy or return the stipulation to the petitioner in the event that the IRS rejects the petitioner’s OIC.

Although the IRM states that Service OICs may be submitted “[i]f a settlement is reached in a docketed Tax Court case,” as a practical matter, nothing would prevent the petitioner whose stipulation was destroyed or returned from going forward and presenting new evidence to reach an agreement as to a lesser amount or try the case on its merits. While there may be some exceptions, holding the stipulation in escrow appears the more favorable option because it gives the petitioner more flexibility if the IRS rejects the OIC.

The Service OIC should be used to compromise all the petitioner’s outstanding balances and may include tax years not covered by the pending Tax Court litigation. For example, a petitioner may have assessed balances for 2011 and 2012 and may be in Tax Court for years 2013 and 2014 where balances have not yet been assessed. If the petitioner filed an OIC for doubt as to collectability, it could cover 2011 and 2012, as well as the unassessed balances for 2013 and 2014. The petitioner would want to work with Counsel’s office to ensure that the offer is treated as a Service OIC insofar as it applies to 2013 and 2014.

If the IRS accepts the Service OIC and assuming the stipulation is held in escrow, IRS Counsel would file the stipulation with the Tax Court upon learning that the Service OIC has been accepted. The amount agreed to in the stipulation would be assessed against the petitioner, but the Service OIC will relieve the petitioner of some if not most of the liability and penalties. If the IRS rejects the Service OIC, then the petitioner has the right to appeal the rejection to the IRS Appeals Office. If the Appeals Office upholds the OIC rejection, then the petitioner does not have the right to challenge the rejection as part of her Tax Court case, but may still pursue the merits of her case in Tax Court and may continue to work with Counsel to reach a settlement or take the case to trial.

The question arises of when and why it makes sense to file a Service OIC. In my experience a Service OIC can be useful in certain situations, but should be used sparingly. A Service OIC is appropriate where the petitioner could likely prove she does not owe the entire amount alleged by the IRS, but because of either complicated legal issues or substantiation problems, proving this would be cumbersome for the petitioner and the amount the petitioner would rightfully owe still exceeds what she can pay. A Service OIC should not be used in a case where the petitioner is reasonably confident that she can present evidence to reduce her liability to zero or some nominal amount by working with Appeals, Counsel’s office, or by taking a case to trial.

To illustrate when a Service OIC may be useful, assume that the IRS’s statutory notice of deficiency asserts that the petitioner was prohibited from taking a loss deduction because it exceeded her basis in an LLC. The petitioner agrees that the loss deduction did in fact exceed her basis, but is not sure to what extent because the LLC did not keep good records. At a minimum, the resulting liability would be more than she could pay. To determine the correct value for basis, and thus liability, the petitioner would need to go back and reconcile multiple years of LLC records. She does not have the time or skill to do this, and cannot afford to hire someone. The petitioner may wish to bypass this exercise and submit a Service OIC based on her RCP. Counsel’s office may agree to this to avoid protracted negotiations with the petitioner and/or a trial. Counsel’s office would likely require that petitioner sign a stipulation as to the amount alleged on the statutory notice of deficiency, and petitioner should insist that Counsel hold this stipulation in escrow. If the IRS accepts the Service OIC, then the petitioner could be relieved of a significant amount of liability and penalties.

In speaking with attorneys at Counsel’s office about Service OICs, I have learned that they can create administrative challenges because additional work is required to prepare the stipulation, and Counsel’s office must also monitor the case to ensure the IRS correctly assesses the tax, penalties and interest if and when the Service OIC is accepted. Therefore, I would hesitate to ask Counsel’s office to entertain Service OICs on a routine basis. The vast majority of time, it makes sense for petitioners to settle their cases and then proceed with an OIC once assessment has taken place. However, in certain situations, a Service OIC can be a win-win for both Counsel’s office and petitioners. Counsel’s office “wins” because the petitioner will stipulate to an amount of deficiencies and penalties owed while avoiding a trial and the Tax Court’s order will reflect the stipulated amount. The petitioner “wins” because although she is technically liable for the amount to which she stipulates, she can be relieved of some or most of this liability if the offer is accepted and she meets the terms and conditions thereof.

Summary Opinions for End of December 2015

Happy Presidents’ Day!  While some of you are at home celebrating the lives of Martin Van Buren, Chester Arthur, Tippecanoe and Tyler too, PT is still hard at work churning out tax procedure commentary.  In this SumOp, we cover a few remaining items from December that we didn’t otherwise cover (in detail).  Post includes more of Athletes, the IRS, and rich people behaving badly.  It also has a link to Frank Agostino’s January newsletter, which has a bankruptcy/OIC discussion that is really strong.

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  • The IRS has mud on its face again for wiping another hard drive, this time potentially destroying documents related to the IRS hiring of Quinn Emanuel.  Robert Woods at Forbes has coverage here.
  • Those of you who love the beautiful game should be excited Sepp’s on his way out, but worried that Mascherano’s stout defense won’t extend to his tax fraud conviction.  That’s three Barca players with tax troubles, including Messi and Neymar.  Barca should call me immediately, and bring me in house to review all their players’ finances (and/or play midfield).  Marketwatch has an article, found here, on why so many professional athletes get in tax trouble (recap:  their tax returns are more complicated than your tax return, they are super rich and young, and they often have issues handling their finances).
  • Agostino and Associates have issued their January tax controversy newsletter found here.  The bankruptcy/OIC discussion and which option to use is a great summary of something many of us probably grapple with on a weekly or even daily basis.
  • This is more substantive than procedural, but interesting.  Sometimes cases have the best names based on the underlying dispute.  Loving vs. Virginia is probably the best known.  Green v. US, a recent District Court case out of Oklahoma also fits the bill.  The case involves a bunch of green, in the form of a real estate charitable contributions (Hobby Lobby $$$ and land).  In Green, prior to the case, Chief Counsel had stated that a non-grantor trust could not deduct the full fair market value of appreciated property donated to a charity under Section 642(c)(1).  That section allows for a deduction, without limitation, for property passed to qualifying charities.  The CCA looks to various cases which indicated (tangentially) that the deduction was limited to the adjusted basis.  The District Court of the Western District of Oklahoma held that Section 642(c)(1) had no specific limitation on the deduction amount and the full FMV was allowed.
  • Morales v. Comm’r was decided by the Ninth Circuit in December.  Prior to the opinion, Carlton Smith has covered this case in detail for us, including this post in July, and he cited to it last week in discussing the 6676 penalty.   At issue in Morales was a Rand type case, where penalties were imposed on an “underpayment” created by a taxpayer improperly claiming and receiving the first time homebuyer credit. The question raised was whether a taxpayer must assign errors to each and every alleged error or whether pleadings are sufficient with only a general denial of liability. The Ninth Circuit in an unpublished opinion held that the Tax Court had properly denied the reconsideration of the penalty as the taxpayer had not specifically raised the argument that the credit did not give rise to an underpayment.
  • Before making flippant remarks about this case, I hope the US Attorney involved has obtained proper treatment for the mental illness.  Beyond the wellbeing of that individual, I do not feel terribly bad for the IRS in In Re: Murphy.  In February of 2015, the Assistant District Court found that the IRS violation of a preliminary injunction on collection actions could not be ignored due to the fact that the US Attorney was suffering from substantial mental health issues, including dementia.  In December, the Bankruptcy Court (sorry, no link) concluded it would not review the matter again, and the IRS was responsible for claims under Section 7433, even if the Service likely would have been successful in the case had the US Attorney been competent.  As we’ve seen many cases where taxpayer’s representatives have suffered from illness, but the IRS has still imposed substantial penalties, I’m not heartbroken to see the issue go the other way.
  • Way back in July of 2014, SumOp covered the tax problems of the Hit Dog, Mo Vaughn, where the Tax Court held he lacked reasonable cause for failing to file his tax returns and pay the tax due.  Mo took a swing and a miss with the Sixth Circuit also, which agreed with the Tax Court.  The Court held that simply hiring an attorney, financial advisor and accountant was not sufficient to show reasonable cause, and the fraud and embezzlement of those folks did not constitute disability.
  • Sumner Redstone did not have the best December and early January.  He probably lost a boatload in the stock market, and he was directed to undergo a mental exam to determine if he is incapacitated (his ex-ladyfriend is making this accusation – lover scorned!).  He was also found liable for gift tax from 1972!!!!!!.  Jack Townsend had coverage on his Federal Tax Crimes Blog here. Tax was around $740k.  The interest has to be pretty darn high.  There was one bit of good news, which was that no penalties were imposed.  As Jack notes, this is the interesting aspect of the case.  Underlying question involved the valuation of a closely held business interest, which was based on redemption price on intra-family sale.

Amended Form 656 – How to Respond When the IRS Has Prepared a Substitute for Return

Today we welcome first time guest blogger E. Martin Davidoff, CPA, Esq.   I have to appreciate someone else saddled with a first name they do not use.  Martin practices in New Jersey but I associate the practice of giving male children first names they do not use more to the South where I grew up.  In an age that relies on computers, attempts to avoid using your first name are fruitless.  So, I receive a lot of correspondence for Temple.  I do not know what the E. stands for in Martin’s first name but I assume he too receives correspondence from computers addressing him with that name.   I met Martin at the recent International Taxpayer Bill of Rights conference where I learned he was a paperboy from 1964 to 1969 after I incorporated a story from my days as a paperboy (1965-1970) into my presentation.  I received enough comments from past paperboys to consider writing a post connecting it to tax procedure.

Martin writes today about a change to the form used for offers in compromise.  Responding correctly to the questions on the form is important but difficult if the form does not give you the choice you think best fits the situation.  Les posted recently about a different issue that comes up in offer cases that also puzzles practitioners as they prepare the Offer form.  He wrote about figuring out what income is income for purposes of calculating taxpayer’s ability to pay focusing on a case involving Railroad retirement benefits being included in income for offer computation purposes.  Just recently, the Tax Court in Matthews v. Commissioner issued a similar opinion related to veteran’s benefits.  These two cases make it clear that the IRS draws a distinction between the first three sections of IRC 6334 directed at exempt assets and subsequent provisions of 6334 which exempt certain income streams from levy but the IRS has not provided instructions setting out its position on the issue and giving guidance to those seeking to prepare the offer form.  The IRS uses the levy exemption from assets in calculating assets taxpayers may exempt in the offer calculation.  It ignores income streams exempt from levy in calculating a taxpayer’s ability to pay on the income side.  If you read cases, you can figure this out but you do not want to have to research case law on such a basic issue.  Guidance is needed to direct the taxpayer or the representative to the correct result.

Understanding the offer process, the calculation and the Form are important components to a successful offer.  The issue Martin discusses is especially important because of the bankruptcy holdings denying discharge to late filers.  In circuits denying discharge to those who file late (See here, here and here), offer in compromise represents perhaps the only path to getting rid of the liability.  We thank Martin for his insight on the offer form.  He invites comments from others on their experience or expertise on the issues discussed in this postKeith 

Filing Requirements Section

We all have experienced clients who had been long-time non-filers and come into our offices to do an offer in compromise (“OIC”).  They have satisfied their tax obligations by accepting IRS Substitute for Return (SFR) filings or by filing the last six to eight years of tax returns.  So, the filings are done and the Taxpayer wants to file an offer in compromise.

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The 656 form revised last January posed what I had thought to be a potential problem for such clients.  A new question was added on the top of page 4 (Section 7) which simply states “Filing Requirements” and lists below two alternatives:

  1. I certify that I have filed all required tax returns; or
  2. I certify that I was not required to file a tax return for the following years: _____________.

The question is what if neither statement was true?  That is certainly the case with long-term non-filers.  Such individuals often have some unfiled returns in their past.  And, those with SFR filings have definitively not filed all required tax returns.

Yet, I know that the IRS does approve offers in compromise for those with SFR balances due.  So, what is a practitioner to do?  For these individuals, we cannot have our client check either box truthfully in such circumstances.  So, is our only alternative to not check either box and submit the form 656 with the required financial disclosure package?  Would that work?  Well, after speaking with a Senior Policy Analyst who deals with the OIC program, I learned:

  • The failure to check either box in the Filing Requirements section will NOT cause the offer to be returned or rejected; and
  • The Filing Requirements section was added to form 656 in the 2015 as a reminder to taxpayers that, generally, they need to be compliant. Such compliance at this point in time might mean: Have you filed your 2014 return? Are your 2015 tax payments paid in at the appropriate level?

So, if our client has filed the past six years returns and has unfiled returns prior to six years, we can leave the Filing Requirements section 656 blank and the IRS will process and fully evaluate my client’s offer.

A review of the IRM does not appear to contradict this conclusion.  The failure to choose either of alternatives a. or b. above does not appear in IRM 5.8.2.3.1 (07-28-2015) when determining processibility.  Furthermore, 5.8.7.2.2.1 (03-07-2014) makes clear that a return of an offer for a taxpayer who has “not remained in filing compliance” will not exceed a 6-year lookback without managerial approval.  And, prior to an offer being returned under this provision, the IRS must make a reasonable attempt to secure the delinquent filings.  Accordingly, any denial for noncompliance will not be a surprise.

Section 8 Offer Terms

Section 8 of form 656 sets for various terms and conditions regarding offers in compromise.  Essentially, this is the contractual “small print”.  Specifically, I bring your attention to the first portion of the offer terms, part a).  That language, provides, in part:

“I also authorize the IRS to amend Section 2 on page 1 by removing any tax years on which there is currently no outstanding liability.” 

In effect, the IRS can simply cross out a year and that becomes the complete contract with my Taxpayer.  And, they do not even have to give notice that they are doing so!  Well, what happens if one is submitting an offer in compromise for a year in which there has been identify theft?  The client has filed the correct return with the IRS showing a balance due.  But, the IRS computers show no outstanding tax liability.  They might cross out the year.

So, what can we do?  Can we cross out the objectionable Section 8 language?  In speaking with the Senior Policy Analyst, the answer is a definitive NO!  The “small print” cannot be changed under any circumstances.  However, if I am aware of the situation in advance, I should bring it to the attention of the IRS up front and they will help us work through the issue.  That does not solve unknown identity thefts.  The better alternative, in my opinion, is to rewrite the provision to read:

“I also authorize the IRS to amend Section 2 on page 1 by removing any tax years on which there is currently no outstanding liability, so long as I am advised of such change prior to such change becoming effective.” 

Dissipation of Assets as Basis for Rejection of Offer in Compromise or Other Collection Remedy

The recent Tax Court case of Chandler v. Commissioner discusses the impact of dissipated assets on collection relief.  The concept of dissipation derives from the equitable principle of seeking relief with unclean hands.  If a taxpayer wants the IRS to grant an offer in compromise, the taxpayer cannot, prior to the offer, behave in such a manner that would make the IRS a fool for accepting the offer.  The Internal Revenue Manual provides that an offer examiner can take dissipation into account in calculating a taxpayer’s reasonable collection potential.  The principle does not apply only in offer cases but the starkest examples of the application of the principle appear in these cases.  The Chandler case presents a rare example in a court case of the application of the rule.  Because of the facts of the case, the issue itself does not get flushed out as it might under other circumstances.

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Sometimes the issue of the dissipation of assets produces a heated discussion between the IRS and the taxpayer because what may seem like dissipation to the IRS seems like necessary expenditures to the taxpayer. The Chandler case required no difficult analysis by the court deciding between arguments of the parties over the merits of certain expenditures.  Instead, Mr. Chandler, a frequent visitor to the Tax Court, basically admitted that he frittered the money away that might have been used to pay his past due taxes with no good excuse for why he decided to spend the money on “wine, women and song” (my words since the case does not detail the use of the money.)  In his tepid defense, Mr. Chandler stated that he spent the money on the advice of his attorney.  I will discuss that further below.

Mr. Chandler’s outstanding liabilities exceed $600,000. He owes taxes for years that span three decades not including the current one.  In 2006-2008, at a time when he had accumulated unpaid tax liability spanning almost 20 years, he pulled $400,000 out of retirement accounts.  He failed to pay taxes on the withdrawals or use any of the money to pay down his then outstanding liabilities.  He subsequently received a collection due process (CDP) notice and requested a hearing.  During the hearing the Appeals employee requested information about the use of the $400,000 but received only evasive answers.  The Appeals employee denied his request for an OIC determining that his reasonable collection potential included the $400,000 withdrawn from his retirement account.  By her calculation, he had the ability to pay about $500,000 and he offered about $2,000.

When a Appeals employee determines that a taxpayer has dissipated assets, the IRM directs them to make a decision based on the facts and circumstances of the case whether to include the dissipated assets in determining reasonable collection potential.  In the absence of an explanation by the taxpayer under circumstances like this, the Appeals employee quite logically and reasonably included the money withdrawn and spent at a time the outstanding liabilities existed in the calculation of reasonable collection potential.  The Appeals employee in these situations looks to see if the taxpayer used the funds for necessary and reasonable living expenses in making the decision to include or exclude the monies from reasonable collection potential.

By the time the taxpayer got to court in 2014 or 2015, he argued that his circumstances had changed since 2006-2008 when he pulled the money out of the retirement fund and used it without paying his taxes. Now, he has cancer and the attendant medical expenses.  He asked the court to remand the case for reconsideration of the offer based on his changed circumstances.  In many cases this type of changed circumstances might result in a remand as the court recognizes the new reality regarding a taxpayer’s ability to pay.  Here the Court found that it did “not believe the [OIC] was made in good faith.  Petitioner has been conniving for a very long time to avoid payment of his Federal income tax liabilities, and it is time to bring these delay tactics to an end.”  While the result is harsh, Mr. Chandler’s actions over many decades left the Court with no option.

Most cases involving dissipated assets do not have quite the fact pattern of abuse presented here. How do you advise your clients to use their funds in the lead up to an offer or other type of request for collection relief?  In the low income cases that come through clinics, I most often see taxpayers using money from a retirement account or from a lump sum distribution upon the determination of disability.  We try to trace the use of the proceeds in these circumstances to affirmatively explain to the IRS how the taxpayer spent the money at a time when an outstanding liability existed.  In many cases, we can show that the money covered reasonable living expenses or capital improvements to their home to make reasonable accommodations for their disability.  I have found the offer examiners to be reasonable in their exercise of judgment in these cases in almost every case.  In situations in which the alleged dissipation comes to light because of information the IRS provides to us rather than vice versa the level of skepticism rises.

In the lead up to making an offer as you review a taxpayer’s finances, it commonly occurs that the taxpayer’s assets do not match exemptions provided or the taxpayer comes into some money while you are preparing the offer. Unlike the situation where you must explain the taxpayer’s prior actions in trying to avoid the application of the dissipation rule, now you must confront what to do with money in the taxpayer’s hands.  If the taxpayer has reasonable living expenses long postponed awaiting receipt of the money, the advice is relatively simple but if the taxpayer wants to use the money for purposes other than reasonable living expenses or reasonable accommodations, a frank discussion of the use of the funds is necessary.  Once spent on something other than the taxes without a good reason for the expenditure, it will be difficult for many taxpayers to recover the money when the IRS treats it as a dissipated asset and the taxpayer may be prevented from obtaining the collection relief they want and need.  Additionally, you may have explaining to do if you provided advice regarding the expenditure.  You do not want to be in the position of having to make that type of explanation.

Summary Opinions for June

Before covering the June tax procedure items we didn’t otherwise write on, I wanted to highlight that Keith was quoted in a Seattle Times’ article about the IRS/Microsoft litigation, where MS is questioning the length of its audit and the Service’s hiring of Quinn Emanuel to investigate its tax obligations.  Other tax procedure luminaries Stuart Bassin (who is working with Les on rewriting part of SaltzBook addressing disclosure litigation) and Professor Andy Grewal (a PT guest poster) were also quoted.   Keith’s last post on the topic can be found here, where he discusses Senator Hatch’s letter to the Commissioner questioning the use of an outside law firm on audits.

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  • The 2015 IRS annual Whistleblower Report to Congress was released in June and can be found here.  In 2014, the Service paid out around $52MM in awards, representing about 17% of the tax it claims was collected due to WB’s information.  Submissions to the WB group were up in 2014, with over 14,000 claims being filed.  Of those, about 8,600 were opened.  The report paints a slightly rosier picture of the program than what may be practitioners’ perceptions of the program.  It does note issues with taxpayer confidentiality, and whistleblower protection. The report also provides a spreadsheet of the reasons for closing cases and the time most cases have been in the program (which tends to be fairly long).
  •  This Tax Court case has a fair amount of tax procedure packed into it.  In Webber v. Comm’r, the Court found a taxpayer had retained control and incidents of ownership over life insurance held in a trust, which caused some negative tax  consequences.  In coming to this determination, the Court found that the IRS Revenue Rulings dealing with the “investor control” doctrine were entitled to Skidmore deference under the “power to persuade” standard.  The Court also found reasonable cause due to the taxpayer’s reliance on his advisor.  In the case, the advisor was an expert and was paid hourly to review the transaction, and had the pertinent information.  We just wrote this case up for SaltzBook, so I won’t go into too much detail (don’t want to give all the milk away, as we definitely want to keep selling cows).
  • Agostino & Associates has published its July Monthly Journal of Tax Controversy.  Frank and his associate Brian Burton have a nice piece on the public policy of OICs.  As always, it is interesting and essentially a mini law review article.
  • BMC Software v. Comm’r is a Fifth Circuit case we (I) missed in March that was potentially significant in how closing agreements are interpreted.  Miller & Chevalier’s Tax Appellate Blog has coverage here.  The facts are fairly specific, and the applicable Code sections do not pertain to many taxpayers.  What is important is that the Fifth Circuit reversed the district court, and held that the boilerplate in the opening paragraph stating, “for income tax purposes” did not cause the agreed treatment of a tax item for one purpose as applying for all purposes under the Code.  The Court would not read that into the agreement of the two parties, who had meticulously spelled out the specific tax treatments for one purpose.
  • Another case with multiple interesting tax procedure items.  In Riggs v. Comm’r, the Tax Court ruled on 1) whether a bankruptcy stay for the taxpayer’s successor-in-interest applied to the taxpayer, and  2) whether the IRS had to follow the taxpayer’s instructions about which debts its payment should be applied to when the Bankruptcy Court directed the payment generally.  As to the first point, the court found there was not sufficient “identity between the debtor and the [taxpayer] that the debtor may be said to be the real party defendant”, so the stay did not apply.  As to the second point, the Court found the payments were not voluntary, and therefore it did not have to follow the taxpayer’s instructions under Rev. Proc. 2002-26.  I would assume the Court would have specifically directed the payment application in the order had it been requested.
  • Hard to talk to an accountant these days and not discuss the tangible personal property change of accounting method.  The Service has provided additional time to file Form 3115 and modified some procedures.  See Rev. Proc. 2015-33.
  • For those of you who do work with Section 6672 penalties, you know the definition of willfulness and actually running a business can be in conflict.  Often, a business that is light on cash has to make a decision about which bills to pay, and sometimes the business thinks that suppliers need payment to keep product flowing.  If a responsible person makes such a decision and knows the withholding taxes are delinquent, Section 6672 penalties will almost certainly apply.  See Phillips v. US, 73 F3d 939 (9th Cir. 1996).  The Court of Federal Claims had occasion to review one such case in Gann v. US, and dismissed the government’s motion for summary judgement.  It held that determining when and whether the responsible person had knowledge of the company’s failure to pay taxes was a disputed issue of fact.  The Court found that simply showing that cash inflows and outflows indicating someone wasn’t going to get paid weren’t enough for summary judgement, and some level of actual knowledge was needed by the responsible person.  There was also some question as to whether the person was a “responsible person”, which was covered by Professor Timothy Todd on Forbes and can be found here.
  • Another attorneys’ fees case that probably would have ended differently had the client made a qualified offer.  In Mylander v. Comm’r, the Tax Court found that the taxpayer prevailed in the amount in controversy and the most significant issue, but the Service’s position was substantially justified.  The reasoning for this was because the case was complex and the taxpayer didn’t share all relevant facts or the case law for their claims.  I’m not sure how I feel about the complexity aspect or the onus being on the taxpayer to provide the applicable law  to the Service.  If the taxpayer’s position was clear, and reasonable research could have turned up the correct law, it seems unfair to make the taxpayer outline all relevant cases.  I hope those were only considered in conjunction with the missing facts, and wouldn’t have been sufficient on their own.  The Court did also mention that the current case was arguably distinguishable from the applicable prior holdings, so the Service’s position could have been somewhat reasonable no matter what.  All of this probably wouldn’t have mattered if the taxpayer had taken advantage of the qualified offer provisions (although if you make an offer, and fail to provide the IRS with the facts and the law, can you still prevail?).
  • SCOTUS has denied cert for Ford in its interest payment case involving the treatment of an advanced remittance.  Les has blogged this case twice before, most recently here.  In addition to the interest question, there was also a jurisdictional issue about whether the district courts could hear an interest disagreement or if it had to be determined by the Court of Federal Claims.  Les’ post outlines the issue and eventual court holding.
  • In Slone v. Comm’r, The 9th Circuit has decided another case on the two prong test necessary to establish a transferee is liable for the predecessor’s tax liability.  The court remanded for the tax court to review the transaction as to the first prong on federal law, but also held that the Service had to show it was a fraudulent transaction under the federal law and also had to independently show that the transferee was liable under the applicable state law.  This holding is in line with the various other recent cases, including Stern, Salus Mundi, and Diablod, which we most recently covered here.
  • Would you like to know how to file delinquent FBARs and not pay a penalty (i.e. are you mega rich and hiding money in some country with shady banking laws)?  Well, this probably doesn’t apply to you because you likely did not pay the tax due on those assets.  For those folks who paid the tax, but inadvertently failed to file the FBAR the IRS has issued updated guidance on filing late without penalties.
  • A res judicata case, which should have a familiar name for tax procedure junkies.  In Batchelor-Robjohns v. US, the 11th Circuit held the feds were barred by res judicata from raising the dead taxpayer’s income tax issues in an income tax audit when the same issue was previously litigated in an estate tax refund relating to same issue.
  • Just about a year ago, we covered Heckman v. Comm’r, where the Tax Court found the six year statute of limitations under Section 6501(e)(1)(A) applied to ESOP distributions that were not properly disclosed.  The Eighth Circuit has affirmed that ruling.  This is the link to the prior SumOp where we discussed the case.  In Heckman, the courts (Tax Court & 8Th Cir.) declined to incorporate other related entity returns to show disclosure for the individual’s return of the ESOP distribution.  It is interesting to compare that language to CNT Investors, another recent Tax Court statute of limitations case, which seemed to indicate the tax court would consider all the filings of the taxpayer and his related entities.  Although the tones are different, I do not think the holdings are necessarily in conflict.  In Heckman, there was not much disclosed that would adequately apprise the Service of the connection.  In CNT, a few key items were left off, but overall the filings painted a fairly full picture.

Aging Offers in Compromise into Acceptance

I recently attended the Tax Court Judicial Conference where I saw and old friend.  The friend worked in the General Litigation Division of IRS Chief Counsel’s office for several years before entering private practice a few decades ago.  Because the General Litigation Division, which has now merged into Procedure and Administration, had responsibility for answering collection issues for the whole office of Chief Counsel, my friend has a deep knowledge of collection issues gained as a young lawyer working in this division.

When old lawyers get together they like to complain.  At the conference he complained to me about an offer case he had submitted on which he had not received an answer in about 18 months.  My response was that rather than complaining he should hope that the non-responsiveness continues for another six months at which time the statute will deem the offer accepted.  Because he did not remember this addition to IRC 7122 in 2006, it seemed possible to me that others would also not know if it.  I know of at least one case where recently the two year period passed with no response.  Since the IRS has less and less resources with which to handle the work assigned to it, the possibility of obtaining an acceptance in this manner now seems real and not, as I once thought, theoretical.

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Public Law 109-222, Section 509(b)(2) amended IRC 7122 to add subsection (f).    Subsection (f) provides that “Any offer-in-compromise submitted under this section shall be deemed to be accepted by the Secretary if such offer is not rejected by the Secretary before the date which is 24 months after the date of the submission of such offer. …”  The legislative history states that the subsection applies to offers submitted to the IRS 60 days after May 17, 2006.

I have never had the good fortune to have an offer pass the 24 month mark before hearing from the IRS with a yea or nay.  A couple of months ago, I received an email from occasional blogger and clinic colleague, Scott Schumacher, the director of the University of Washington low income tax clinic saying that his clinic had a case that the clinic had submitted to the IRS more than 24 months ago.  He said that they had scoured the Internal Revenue Manual and found no mention of what to do when the 24 month period passed.  We talked about how to consummate the offer in these circumstances.  I suggested sending a letter and the offer payment to the offer unit thanking them for accepting the offer and tendering the offer amount.

I also saw Scott at the Tax Court Judicial Conference where he told me that before his clinic had to take the uncertain step of perfecting the offer to which the IRS had not responded in 24 months, the IRS did in fact accept the offer.  That leaves open the question of exactly how to consummate the offer in this circumstance and I welcome comments from anyone who has gone through this or anyone who thinks they know how to complete an offer to which the IRS has not decided in 24 months and for which no guidance exists.  I can understand why the IRS does not want to publish guidance on this topic.  It probably feels awkward about having to write about what to do when it drops the ball; however, some guidance would be appreciated.

One issue present if the offer is deemed accepted by the passage of time is the terms of the offer.  The offer in compromise form, Form 656, in Section 8 imposes a number of terms in subsections (a) through (p) like the one in subparagraph (g) requiring compliance for the next five years with filing and payment.  In subsection (c) it imposes the condition that the IRS will take any refund due to the taxpayer for the year the offer is accepted and all prior years.  Because these terms are on the form the taxpayer signs in submitting the offer it would seem that they apply even if the offer acceptance occurs due to the passage of 24 months since the taxpayer adopted them as part of the offer in signing the Form 656.    One of the terms in Section 8 of Form 656 that may not need to appear there because of the language of the statute concerns the taxpayer’s ability to challenge the liabilities covered by the offer.

Subsection (i) provides that “Once the IRS accepts my offer in writing, I have no right to challenge the tax debt(s) in court or by filing a refund claim or refund suit for any liability or period listed in Section 2, even if I default the terms of the accepted offer .”   Does this mean that where the taxpayer obtains acceptance by virtue of the passage of 24 months the taxpayer may still contest the underlying liabilities?  If the offer gets accepted due to the passage of time, the language of Section (8) could become important in deciding how the offer acceptance by virtue of passage of time differs from offers accepted by the IRS in the normal fashion.   I also solicit comments on this issue from those of you who have offers accepted under this provision.

Another issue not discussed in the statute or in any guidance concerns how long a taxpayer has to pay the offer after the passage of the 24 month period.  Once the statute deems the offer accepted, the logical extension of acceptance would be to expect performance within a reasonable period of time after acceptance.  The taxpayer’s offer promises to pay a certain amount in full or over time upon acceptance.  If the 24 months passes and the taxpayer does nothing, at what point has the taxpayer waived acceptance by not performing on the terms of the offer after acceptance.  I find nothing in Section 8 of Form 656 addressing the time period within which a taxpayer should perform after the passage of the 24 months and acceptance of the offer through that method.  Could the IRS argue at some point that if the taxpayer does not make payment within a reasonable time after a deemed acceptance that the taxpayer’s failure negates acceptance?  I also solicit comments on this aspect if anyone has had a deemed accepted offer rejected for failure to perform.

The deemed acceptance of an offer may become more prevalent as the IRS staffing problems continue to increase.  The issue points to the importance of retaining the letter from the IRS indicating receipt of an offer and calendaring an event two years thereafter in case of failure of the IRS to act.  The possibility of a time passage acceptance also makes me wonder if changing the terms of the offer might become prevalent if the IRS is not going to look at the offer form until after the 24 months expires.  Nothing in the statute requires making the offer terms laid out in Section 8 of Form 656 though I expect the IRS would return an offer with those terms altered where it reviews the offer.

I was impressed that the University of Washington clinic caught the two year time period and wonder if my clinic would have done the same.  Even though I knew of the statutory provision, my clinic has not had a practice of calendaring the two year time period.  My practice on calendaring offers needs to change.  Getting an offer acceptance based on the passage of time is certainly a slow way to learn of acceptance but it might be a very satisfactory way to get what you want and to feel better about the cuts at the IRS which you normally curse while waiting on the phone for a couple of hours.

Contrasting the Compromise Standards between the Chief Counsel, IRS and the Department of Justice in Litigated Cases

We have discussed different aspect of offer in compromise (OIC) policy before in the blog (see posts here, here, and here); however, we have not discussed the difference in policy between the IRS and the Department of Justice Tax Division (DOJ Tax) when it comes to settlement of cases. When the IRS litigates in Tax Court to determine a taxpayer’s correct liability, Chief Counsel, IRS serves as its counsel. When the IRS litigates in other contexts, DOJ Tax serves as its counsel (see previous post about this here). Even though both offices have tax litigators seeking to represent the IRS, the offices take different approaches when it comes to their approach to settling a case.

This discussion has some crossover with the discussion on the IRS policy concerning applicability of collection to the assessment of taxes. Does it make sense to devote resources to trying a case when the taxpayer has little or no ability to pay the tax should the government win the case. In many of the cases coming into the Tax Court the IRS has invested almost no resources in proposing the assessment. It has simply sent the taxpayer a computer generated letter and maybe a relatively low graded correspondence examiner has spoken to the taxpayer or reviewed mail sent by the taxpayer. The relatively high graded attorney and the Appeals Officer face the prospect of spending far more time than the examination division did in creating the case all to produce an assessment that will simply sit in the every growing inventory of the understaffed Collection Division.

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Chief Counsel will settle a case based on the merits of the issue(s) presented but will almost never look at the ability of the taxpayer to pay the tax. Even in a situation in which the effort to try the case to determine the liability might require significant resources and the likelihood of ever collecting much, if any, of the liability should assessment occur, Chief Counsel attorneys generally close their eyes to the collection potential of the case because of their office policy.  The manual provision (IRM 35.2.6(1)) giving guidance to Chief Counsel employees provides “It is preferable that all settlements be effectuated by a merits settlement rather than upon the basis of inability to pay. This general guideline is applicable even though there may be a substantial basis for concluding that the petitioner may not be able to pay the agreed deficiency. In this instance, the case should be settled on its merits, and if the petitioner is unable to pay such deficiency, he can later file an offer in compromise based upon doubt as to collectability.” Most Tax Court cases result in a settlement or a trial, during which the IRS assesses the taxpayer; moreover, the taxpayer can file an offer in compromise only after an IRS assessment.

In contrast DOJ Tax attorneys have the ability to settle cases based on the taxpayer’s ability to pay the liability at issue. According to DOJ Settlement Reference Manual, Section V.A.1, “[e]ven though the Government may have a strong case on the merits, absent other considerations, Government lawyers should not expend substantial resources to obtain an uncollectible judgment. Instead, it may be more efficient to negotiate a collectability settlement.”  When the IRS refers a case to DOJ for DOJ to handle, the ability to settle the case also travels to DOJ.  Under  IRC 7122(a), the Attorney General has the authority to settle a refund or other suit at any stage of the proceeding after the suit has been referred to the Department of Justice. “The Attorney General has the inherent power to compromise any litigation in which the Department of Justice represents the United States;”

According to one author, David J. Herzig, writing “Justice for All: Reimagining the Internal Revenue Service,” this broad power “afford[s] the Department of Justice the opportunity to settle a case for reasons of strategy rather than solely on the merits.” The IRS acknowledges that once it has referred a case to DOJ, the referral gives DOJ full authority to settle cases.  IRM 34.8.1.1(7)  discusses the authority of DOJ to consider settlements based on collectability, regardless of whether the case has been classified as “S.O.P.”

As the IRS refers cases to DOJ, it generally classifies them SOP or Standard.   If classified SOP, Settlement Option Procedure, the IRS essentially says to DOJ no need to consult with us if you want to settle the case.  If the IRS classifies the case Standard, the IRS classification essentially requests DOJ consult with the IRS in settling the case.  The consultation, however, is somewhat one-sided in that DOJ can ignore the wishes of the IRS and settle in whatever manner it deems appropriate because it has sole authority to settle.  This does not mean DOJ ignores the IRS because it does not but it does mean that the views of the IRS on the outcome of a case do not bind DOJ in its decision to settle on whatever basis it deems appropriate.

Why does Chief Counsel adopt the policy of ignoring collectability in pursuing litigation at a time of limited resources while DOJ Tax exercises discretion in pursuing cases where it perceives that doing so would not result in the collection of tax should it succeed? In giving up the bankruptcy SAUSA work, Chief Counsel acknowledged that its resources are stretched very thin. The policy the IRS has adopted in TFRP cases to consider collectability in determining whether to assess could equally apply to settlements reached by Chief Counsel attorneys. It has precedent for changing its approach in the policies of its client and in the policies of its counterparts at DOJ. Yet, in the face of severely dwindling resources, Chief Counsel’s office continues to move cases into litigation without taking into consideration the ability of the IRS to collect the assessments it has spent many hours to create.

Perhaps it is time for Chief Counsel’s office to reconsider its policy to litigate cases in which the prospects of collection appear low or non-existent. In a small number of cases, it will wrap up litigation with an offer in compromise. Guest blogger Erin Stearns will discuss that rarely used process in an upcoming post. If Chief Counsel’s office got its client to work with it in identifying clients with little prospect of collection, it could work settlements similar to DOJ and perhaps achieve a greater number of settlements resolving the collection issue at the same time as the assessment. Given the resource issues it faces, it may be time to rethink its approach to tax merits litigation.

Summary Opinions for April 10th through 24th

Another slightly stale SumOp, but again full with lots of very interesting tax procedure nuggets.  This post is very heavy on the Chief Counsel Advice, much of which deals with statutes of limitations.

I also wanted to point out that you can read Keith’s acceptance speech for the Janet R. Spragens Pro Bono Award staring on page 8 of the ABA Tax Section NewsQuarterly found here.  We previously covered Keith’s honor here.

As our readers know, we at PT are big fans of tax clinics and the wonderful work the clinics do throughout the country.  Les has an article forthcoming in the Tax Lawyer on the benefits derived by students, taxpayers, and the entire tax system, which can be found here. Keith has previously written on the history of low income taxpayer clinics, and his article can be found here.

I also have to congratulate Keith on his temporary relocation over the next year.  The University of Harvard has decided to expand its array of clinics, and will be starting a low income taxpayer clinic.  Keith will be a visiting professor at Harvard for academic year 2015-2016 to set up the clinic.

And, the other tax procedure items:

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  • Last year, Les wrote about the Nacchio case involving the ex-Qwest CEO who was convicted of insider trading and directed to pay a substantial fine and forfeit the profits from the sale of his stock in the company.  Nacchio filed for a refund of tax he paid on those profits, claiming Section 1341 would allow him to treat it as if he never had the gain.  Janet Novak of Forbes on May 1st, had an update on the case found here.  The government has agreed to stipulate the facts of the case, allowing it to bypass a hearing that would have likely discussed in detail the NSA program Mr. Nacchio turned down on behalf of Qwest prior to his investigation.  Janet has a summary of the DOJ’s various arguments as to why it should win based on the law, and it is likely such an appeal is going to occur shortly.  Interestingly, on March 27th, the Service released CCA 201513003, which discusses the Service’s view as to the deductibility of the restitution as a business expense under Section 162.  The issue was whether payments in lieu of forfeiture from a deferred prosecution agreement were deductible.  The advice attached the response from the DOJ in Nacchio where it argued the same issue, although the response was not attached to the released document.  I had initially wondered if the CCA dealt with the Nacchio case, but it appears the Service has a couple cases on the issue.
  • The Northern District of California recently decided US v. McEligot, where the Court held that taxpayers did not have an absolute right to be present during a third party interview pursuant to a summons.  In McEligot, a taxpayer’s accountant refused to answer IRS questions without the taxpayer’s lawyer present. The Court found the accountant had no right to refuse because the Service would not allow the taxpayer or his representative to be involved in the interview.
  • In other CCA news, the Service has issued its position on the assessment period for the Section 6694 preparer penalty for filing a refund request based on an unreasonable position and how long the preparer would then have to request a refund of the penalty amount.  Section 6696(d) houses the statute, and there would be a three year assessment period following the alleged improper refund request.  The preparer would then have three years to seek a refund of the penalty once paid.
  • This is a depressing case.  In Gurule v. Comm’r, the Tax Court remanded a CDP case involving the sustaining of a proposed levy, and whether the Appeals Officer abused his discretion in rejecting an OIC submitted for doubt as to collectability and, in the alternative, rejected an installment agreement (the SNOD may not have been properly sent either).  The primary issue in the collection matters was whether or not the Officer properly considered the economic hardship faced by the family.  In the case, the wife and son had severe medical issues, resulting in high bills.  Wife had a neurological disease resulting in seizures and multiple brain surgeries, and son was in an accident resulting in brain injuries.  The husband had lost his job, and he was using his 401(k) to pay necessary living expenses.  The officer treated the 401(k) loan as a dissipated asset, in particular the loans taken after the taxpayers knew of the outstanding tax.  “Dissipated assets” can be included in in the reasonable collection potential, which is a policy decision to deter delinquent taxpayers from squandering assets when they have outstanding tax liabilities.  An asset, however, should not be considered dissipated if it was needed to provide for necessary living expenses (like medical bills required to keep someone alive).  The Court also directed Appeals to request petitioners to provide documents regarding the son’s death, and how that could impact their collection potential.  While the debate raged on between the Service and the taxpayer, the taxpayer took an additional loan against his 401(k) to pay for his son’s funeral, which the Service found inappropriate.  I really need to start trying to be more thankful for what I have.
  • Chief Counsel has issued legal advice regarding who is authorized to sign a power of attorney for a partnership or LLC.  The issue and conclusion are as follows:

a. Who is authorized to sign a POA appointing a representative for a partnership or limited liability company (LLC) being examined in a TEFRA partnership-level examination?

b. Who is authorized to sign a POA appointing a representative for a partnership or limited liability company for other purposes?

CONCLUSIONS:  A general partner or, in the case of an LLC, a member-manager, may sign a POA for purposes of a TEFRA partnership-level examination or for other tax purposes of the partnership. A POA can also be secured from a limited partner or LLC member for the purposes of securing partnership item information and disclosing partnership information to the POA. In the case of an LLC that has no member who is also a manager, the non-member managers may sign the POA for purposes of establishing that it would be appropriate and helpful to secure partnership item information including securing documents and discussing the information with the designated individual.

KPMG has some coverage and insight here.

  • More tolling content due to financial disability.  In very interesting Chief Counsel Advice, the Service has taken the position that Section 6511(h) does not extend the three year limitations period for net operating losses or capital loss carrybacks.  In the advice, the Service states that Section 6511(h) specifically is limited to the statutes under (a)(b) and (c).  The NOL and capital loss carrybacks are found under Section (d)(2), and therefore not extended by financial disability.