Grab Bag – OICs: Dissipation and, not of, Weed

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OICs – 1) The IRS Takes the High-ish Road and 2) Tax Court Explains What IRS OIC Calculations Should Be and Highlights Important 2013 IRM Changes.

This post will cover two interesting developments regarding offers in compromise from over the last few months.  The first is an internal memo from SBSE (SBSE-05-0416-0016) relating to collection potential of a company in the medical marijuana industry, and specifically if the public policy position in the IRM should cause it to reject an OIC outright.  The second is the Alphson v. Comm’r case, where the Tax Court did an exhaustive review of the calculations that should go into a review of an OIC on doubt as to collectability, and noted a 2013 charge to the IRM regarding dissipation of assets.

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Public Policy – IRS has mellowed on pot shops, but only on OICs

There is a cottage industry popping up around offering “advice” on Section 280E, which the IRS continues to enforce against state legal marijuana related businesses (for those of you unfamiliar with Section 280E, it is fairly nuanced, but generally states various normal business deductions are disallowed for any enterprise dealing with schedule I narcotics, which includes the Mary Jane).  A lot of this advice seems doobious, at best, but the Service has been issuing more guidance this year.  In any event, various people in and out of that industry feel the imposition on state legal businesses is incorrect (including the largest dispensary in the US, Harborside Health in California), and feel the IRS is being overly aggressive.  In at least one way, the Service is taking a somewhat rational view of the industry, which is that it will not automatically reject an OIC from a state legal pot shop based on the IRS’ public policy provisions in the IRM (the Service will, however, calculate that collection potential in a fashion certain to bring you down).

In an internal SBSE memorandum regarding collections, the Service has instructed its employees not to reject OICs simply on public policy grounds where their actions are legal under state law.  The IRM, under IRM 5.8.7.7.2, Public Policy Rejection (Mar. 7, 2014), provides internal guidance on when to reject on OIC based on public policy.  The IRS policy is a rejection can occur on public policy grounds, even if it is clear that the funds could not be collected.  One example of why this might be appropriate under the IRM is “indicators exist showing that the financial benefits of a criminal activity are concealed or the criminal activity is continuing.”  As this is federally illegal, it is understandable why an IRS employee might have questions.

The guidance indicates there will be no blanket rejection based on the fact that the enterprise is continuing and illegal under federal law, and such offers should be considered.  This is great news, as the tax burden on these state legal businesses can be huge, but… The guidance further goes on to direct how collection potential should be calculated, which has the potential to effectively block any offer.  The guidance states the Service will only allow deductions against future income in calculating collection potential based on what is deductible under Section 280E (not that much).  This will drastically artificially inflate the collection potential to levels that likely will not provide much benefit to the taxpayer.  My guess is the IRS has the discretion to allow the deductions in calculating collection potential, which I would encourage from a revenue generation standpoint and the general reasons behind OICs, but this is, like so many other IRS problems, something Congress needs to deal with.

Alphson –OICs, Dissipating Assets, and  the IRM

The second OIC matter is Alphson v. Commissioner, TC Memo 2016-84, from May.  The case does not break any new ground, but does have a good discussion of how the Service did and should calculate collection potential, the latitude the Service has in rejecting OICs and the guidance under the IRM, and the dissipation of assets.  In Alphson, the Tax Court upheld the Service’s rejection of an offer as reasonable, even though there were minor errors in the calculation by the Service (no abuse of discretion).  Alphson apparently ran up a $200k tax bill from ’08 to ‘10.  Over the same time period, he settled some litigation and was awarded $1.2MM.  The OIC for doubt as to collectability offered $2,400, and the Service rejected the offer based on the fact that the Service felt Mr. Alphson wasted over $1MM.  Alphson claimed he was unemployed, couldn’t find work over the last three years, was broke, and had thousands of monthly expenses.

The Court noted, “we’re certainly aware of the longstanding rule that the IRM doesn’t have the force of law, but because Section 7122 gives such wide discretion to the Commissioner to establish guidelines for evaluating OICs, we’ve generally upheld a settlement officer’s determination rejecting an OIC as reasonable when he follows the IRM.”  The Court also then cited case law standing for the proposition that the Court will hold up determinations that are less than correct stating, “close enough for government work” (or folk music—just kidding, that was the Court holding, but it didn’t say “close enough for government work”).

The Court then worked through both the net equity aspect of the calculation and the future income.  Both are extensive and worth a read, but I want to highlight the net equity, specifically the dissipation discussion.  The IRS position was that Alphson had about $1.5MM in net equity, while Alphson submitted that he had $501 in net equity.  Some of the difference was due to accounts Alphson failed to list (not a strong starting point), but the largest aspect was about $1.2MM from the settlement that was not included.  The Service believed the assets were dissipated for frivolous reasons, while Alphson contended they were for necessary living expenses and should be included.

Alphson argued that language added in September 2013 to the IRM was applicable, stating dissipated assets were only those that the taxpayer had frittered away while attempting to avoid the tax.  See IRM 5.8.5.18(1) (Sept. 30, 2013).  The Court agreed the Service had not shown Alphson was attempting to avoid tax, but the provision was added after the review by the Service in June of 2013.  Under the old version, dissipated assets were simply reviewed to see if they were used on nonpriority items.  The Court found the Service properly applied this standard to the review of Alphson’s claim of necessary living expenses, including substantial credit card bills (without explanation of the charges), country club costs, and rent of $9,700 a month (nice digs).

Couple parting thoughts.  The 2013 change to the IRM, which is still there, is taxpayer friendly (I think it also changed the look back from five to three years).  The Alphson argument would have been stronger had his OIC been reviewed later in the year.  I would have also been nervous taking that case through the tax court; such a low offer and with some fairly bad facts.  Sometimes there is no other choice though.

Stephen Olsen About Stephen Olsen

Stephen J. Olsen’s practice includes tax planning and controversy matters for individuals, businesses and exempt entities for the law firm Gawthrop Greenwood, PC.

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