When is a Case Settled? When a Taxpayer Sends a Check (No) And When a Taxpayer Sends a Letter Reflecting Agreement With US Attorney (Yes)

Disputes with the IRS often involve negotiations and correspondence regarding settlement. Two recent cases involving unrepresented taxpayers demonstrate that at times the taxpayers may not fully understand the consequences of corresponding with the government. In many instances courts will turn to contract principles to examine whether the correspondence can demonstrate that the parties have a binding settlement agreement.

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In Longino v Commissioner a taxpayer sent a check and cover letter to the IRS essentially saying that if IRS cashed the check it agreed with him that he owed no additional money to the IRS. IRS cashed the check but also sought to collect on an assessment that stemmed from a case that the taxpayer lost in Tax Court. In this post I will explain how the taxpayer’s unilateral actions did not constitute a settlement, even when the IRS cashed the check.

In this case, Mr. Longino filed two tax returns for 2006, a 1040 and an amended return on October 17, 2007, a few days after filing the original return. IRS processed the returns separately. The amended return requested a refund of approximately $1,396, which the IRS sent to Mr. Longino, who cashed the check. IRS also examined Mr. Longino’s original 2006 tax return and proposed a deficiency of about $39,000, as well as an accuracy-related penalty.

Years later, in 2013, after Longino had filed a petition challenging the proposed deficiency but prior to the Tax Court rendering a decision, IRS also sent a letter to Mr. Longino informing him that he was not entitled to the $1,396 refund he claimed on the 1040X. Mr. Longino responded with a letter and included a check to the IRS for the $1,396. The letter also asked the IRS to “confirm…that we are now concluded on this tax return issue and we won’t have any more issues with IRS on that year.”  He asked the IRS to return the check to him uncashed if the IRS disagreed with him.

IRS ignored the letter, assessed the tax (it can do so when there is a Tax Court petition filed under Section 6213(b)(4)), and cashed the check. The deficiency case proceeded to trial. Mr. Longino lost. IRS attempted to collect on the unpaid assessed deficiency and filed a notice of federal tax lien. Longino filed a CDP request claiming that his letter and the IRS cashing of the $1396 check meant that he no longer had a liability for 2006. He argued that the cashing of the check in light of his letter demonstrated that the matter was resolved. He raised no other issues in the CDP request. Appeals disagreed and Mr. Longino petitioned the Tax Court again, essentially asking that the collection action was unwarranted because there was no liability.

The Tax Court disagreed, noting that he tried his deficiency case in Tax Court and lost; while there may be settlement of a Tax Court case through offer and acceptance, that was not present here. In addition, notwithstanding his letter to the IRS, and the IRS’s cashing of the check, the Tax Court held that there was no settlement as a result of his unilateral correspondence with the IRS Service Center:

Nor did petitioner reach a settlement with the IRS employee with whom he exchanged correspondence in May 2013. That correspondence occurred after we had issued our opinion in his deficiency case but before we entered our decision. The IRS service center employee with whom he corresponded did not offer to settle any tax liability. The IRS simply sent him a bill for $1,396, and he paid that bill.

The opinion cites a line of cases that establishes that submission of a check to the IRS and IRS cashing of the check is not enough to show that there was assent to the offer to settle the matter.

For good measure, the opinion notes that even if the IRS employee who reviewed the letter and authorized cashing the check were attempting to settle the case on behalf of the IRS, that employee lacked the authority to do so.

Taxpayers in Bauer Do Not Want Correspondence to Be Treated as a Settlement

The Longino case is to be contrasted with the Bauer case  out of the district court in Arizona, also decided last month. In this case the taxpayers owed over $800,000 to the IRS, and the government brought a collection suit. Federal liens attached to the property of the husband and wife; the main property was a principal residence owned by the husband but which the wife had some interest in due to her funding some of the renovations on the house.

The US attorney assigned to the case and the taxpayers themselves spoke directly after the government filed its complaint. They began settlement negotiations and the US attorney sent a letter with a proposed deal essentially requiring the Bauers to get a $250,000 home equity loan and pay that money to the government within 6 months. In exchange the government would withdraw its order of foreclosure and foreclosure claim and subordinate its liens. In addition, the letter set forth the understanding that after the payment of the $250,000 the parties would be free to negotiate the payment of the balance that was owed.

The US attorney asked the Bauers to review the letter, sign the letter and return it to him. By the terms of the letter, the letter stated that it was not an offer or acceptance of an offer; instead, by signing the letter and returning it to the government it would constitute an offer from the taxpayers, which the government would then “consider and act on the settlement offer once it has received [their] signature making the offer.”

The letter also spelled out that the Bauers did not have to agree to return the letter but if they did not do so the government would pursue summary judgment.The Bauers returned the letter and also forwarded a copy of the letter to the US attorney with the subject matter of the email noted as “agreement.”

Unfortunately for the Bauers they had a change of heart and shortly after sought to renege on the deal. In part, it appeared that they were unable to secure a $250,000 loan, and were only able to get a commitment for about half of that.  The Bauers sent an email saying they were not honoring the deal. The US filed a motion seeking to enforce what it claimed was a binding agreement.

The court agreed with the US and issued an order granting the motion to enforce. In doing so, the court reviewed settlement principles and held that the parties had entered into a binding contract.  In response to the motion the Bauers argued that they were coerced into entering into the agreement and the agreement was predicated on the government’s misrepresentations about the loan (namely that the Bauers could secure the financing). As to the US attorney’s views about the viability of the loan, the court stated that under contract principles a recipient of another party’s opinion  “is not justified in relying on the other party’s assertion of opinion because the recipient has as good a basis for forming his own opinion”). Further, the court noted that the Bauers should have independently investigated the possibility of getting financing before signing the letter:

Rather than taking Mr. Stevko’s advice as a guarantee that they would be able to secure adequate financing on the home, Defendants could have used their own knowledge about the market value of their home and looked into that question for themselves. They did not inquire about loans with banks until after making the offer to the United States and did not seek to withdraw from the agreement once they discovered they could not secure more than $126,000 from such a loan.

As to the claim that they were coerced, the opinion notes that the US attorney’s statement that if the Bauers did not enter into the agreement the government would pursue summary judgment did not in itself amount to coercion. Contract principles are clear that a party’s threat of civil process does not amount to duress unless that is done in bad faith. There was nothing to suggest bad faith in this case.

Conclusion

Taxpayers when interacting with the IRS or the government may be uncertain of the impact of what they are doing. Unilateral actions such as a notation on a check and cover letter may be sufficient to designate a payment for some purposes but are not enough to settle a case.  A signed letter reflecting an agreement that the taxpayer and the government attorney negotiated is quite different and the government can seek a court order that will require the taxpayers to abide by the terms of a settled case.

 

 

Podiatrist Has to Foot The Tax Bill: No Settlement and No Basis

A case earlier this week in Tax Court, Namen v Commissioner, presents two issues worthy of highlighting: one concerns when a settlement becomes binding, and the other concerns the taxpayer/podiatrist’s efforts to prove up his basis relating to his interest in an LLC that ran a surgery center.

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First on the settlement issue. The taxpayer’s lawyer argued on brief that he had accepted an IRS offer to settle the case that IRS counsel made after trial.

Counsel for the government disagreed:

[IRS counsel] states in her answering brief that she “made an oral offer of settlement to…[taxpayer’s counsel] based on the parties not writing briefs in this case, as well as on petitioner’s spouse’s consent to the assessment of tax and additions to tax against her.”

According to IRS counsel, taxpayer’s counsel “did not call to accept the offer until the day that briefs were due and after she had already filed her opening brief.” As a result, she claimed that by filing the brief she revoked her offer.

The opinion agreed with the IRS. It did so by first noting that a settlement is a contract subject to general principles of contract law. Citing Dorchester Industries v Commissioner the opinion notes that “contract requires ‘an objective manifestation of mutual assent to its essential terms’, and mutual assent is typically established through an offer and an acceptance.” Keith wrote a three part series on this issue last year, which you can read here, here and here.

A main issue in the case was there was no evidence in the record that would allow the court to find objective manifestation of mutual assent. The taxpayer’s counsel made his argument that the case was settled only on brief, and there was no evidence in the record “apart from the unsworn statements of counsel.” Unfortunately, counsel for the taxpayer did not move to reopen the record, though the opinion notes that counsel for the government failed to move to strike. Even without evidence in the record (and I guess accepting at face value the unsworn allegations), the opinion notes that the parties’ briefs failed to spell out the terms of the alleged settlement. As such, there was not enough for the court to find that the evidence before it proved that the parties’ counsel agreed on a settlement.

The merits issue essentially turned on the podiatrist’s inability to establish his basis in the LLC. The LLC was taxed as a partnership, and the podiatrist attempted to establish that he had a basis in the interest in the LLC to allow him to deduct the distributive share of the LLC’s losses. Losses are allowed to the extent of a member’s basis in the LLC; losses in excess of the basis can be carried forward. Basis can be established by contributions and are increased by the partner’s distributive share of partnership income, and decreased by all cash distributions and the partner’s distributive share of partnership losses. The taxpayer argued as well that he was personally liable for a share of loans that were made to the LLC; that is another way to juice basis in an LLC treated as a partnership.

As with the first issue, the taxpayer lost in part because the record did not support his allegations:

However, no corroborating documents supporting his testimony were admitted into the record. Petitioner also failed to provide any credible testimony or other evidence regarding the amount of his distributive share of partnership losses and the extent of any prior adjustments to his basis. Under these circumstances, we find petitioner’s generally uncorroborated testimony inadequate to establish his basis in RMSC; we also find his testimony inadequate to establish the extent to which he is entitled to a distributive share of any losses.

Parting Thoughts

Facts at trial are key. The record that counsel makes is crucial. If the facts exist outside the record the court will generally not be able to consider those facts in resolving the dispute. Counsel must carefully consider when it wishes to bring facts to the attention of the court and pay attention carefully to evidence beyond testimony, especially when one would expect there to exist corroborating documentation that could have perhaps surfaced. Testimonial evidence can win an issue. For certain issues the court knows that limited, or no, written evidence may exist. The residence test for dependency exemption provides a common example of a situation in which little or no direct evidence often exists. With an issue where the absence of written evidence is common, the court readily accepts testimonial evidence after weighing the credibility of the testimony. By contrast, with issues in which one would expect documentary evidence, testimonial evidence often carries little weight because the absence of the documents itself undercuts the credibility of the testimony. There is an old case the Tax Court sometimes cites in these situations (Wichita Terminal Elevator Co. v Commissioner) which holds that where a party has the ability to bring forward evidence and it does not the failure to bring forward the evidence creates a presumption that the evidence would be unfavorable.

When dealing with settlements, it is important to put offers and acceptances in writing. As Keith discussed in the prior posts dealing with settlements, holding the government to a settlement that did not involve a statement in open court is very difficult. The failure here to accept the settlement prior to the preparation of the briefs may itself prove fatal to the settlement because of the argument that timing was a condition of the settlement but even without that fact the proof here lacked the kind of proof that has formed the basis of binding settlements in earlier cases with this issue. If you want to bind the government, get the offer in writing and, if possible, get the terms before the Court in a manner that implicates the Court’s schedule. Remember that in addition to other considerations you face an argument that the attorney in the case did not have authority to settle the case without the permission of a manager. Here there was no proof of managerial consent to the settlement offer and that might have proved fatal had the issue moved further. The case also lacked the element of reliance. Petitioner showed little or no harm in reliance on the alleged settlement and no action taken in reliance.