A Close Look at the IRS Shutdown

As we settle in for what may be a long shutdown of the not yet funded parts of the federal government, including the IRS, frequent commenter and occasional guest blogger, Bob Kamman, brings us a post on what to expect at the IRS. I know from email traffic among tax clinics that the fax machine at the CAF unit has been turned off meaning that those trying to notify the IRS of the power of attorney must wait for the IRS to reopen before sending in form. The turning off of the CAF fax machine is just one tangible way of knowing that the IRS has shifted to shut down mode. Bob gives an employee by employee breakdown of who is working.

 

We wrote previously about a law suit brought by National Taxpayer Advocate Nina Olson after the Taxpayer Advocate Service was deemed non-essential in its entirety during one of the most recent shutdowns. The NTA lost the suit but may have won the war, or at least partially so, because the NTA and certain TAS employees are deemed essential now which could be critical from taxpayers facing a hardship. I suspect the NTA faces a significant hardship herself because of the timing of this shutdown and the issuance of her annual report to Congress. Read on for the details distilled for us by Bob straight from the contingency plan created by the IRS. For prior coverage about government shutdowns and the IRS, see our post here which gives a broader perspective on government shutdowns and which links to prior posts on the subject. Keith

After all the work that the Internal Revenue Service put into planning for a shutdown, it would have been a shame to waste it.

The IRS contingency plan, revised on November 30, 2018, provides many useful insights into what the federal tax agency considers important and which employees it considers essential. The 110-page document can be found here.

The priorities include:

1) Open the mail. There might be checks.

2) Cash the checks.

3) Protect the statutes of limitation, for collection and assessment, from expiring.

4) Keep the computers running and keep preparing for tax season.

5) Especially, keep preparing for implementation of the 2017 tax law changes, because money for that has already been appropriated.

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IRS has a total workforce of 79,868 employees. Of those, 9,946 are “excepted” to some extent from furlough. The rest will not return to work until their jobs are funded. Most likely, they will eventually be paid for their time away, but they might miss paychecks until the shutdown ends.

If the government had to close, the last couple weeks of the year were the best time. Many employees with seniority and “use or lose” leave time, were away on planned vacations anyway.

Here are some highlights from the “Lapse in Appropriations Contingency Plan,” with a focus on several areas of importance to readers of this blog.

“Excepted” employees are categorized as A, B or C.

Category A employees have jobs that “include those authorized by law and those funded by multi-year, no-year, and revolving funds or advance appropriations that would not be affected by a lapse in an annual appropriation.” There are 1,900 of them.

Category B employees perform tasks that are “necessary for the safety of human life or protection of government property.” Oddly enough, this includes “administrative, research, and other overhead activities supporting excepted activities” such as “completion and testing of the upcoming Filing Year programs,” “processing paper tax returns through batching,” and “Upcoming Tax Year forms design and printing.” There are 8,017 of them.

Category C employees are those needed “to bring about the orderly closedown of non-excepted activities. Activities of employees during this period must be wholly devoted to close-down the function. Upon completion of these activities, these employees would be released.” There are 29 of them, including the only three from the Office of Professional Responsibility with any shutdown duties.

Chief Counsel

The Chief Counsel (lucky guy) is a Presidential appointee who is not subject to furlough.   As for the rest of the office, 286 must show up now and get paid later for these purposes:

The plan excepts, on an as needed basis, those personnel assigned to litigation that is scheduled for trial or where there is a court-imposed deadline during the first five days of a lapse. Personnel are not generally excepted to perform litigation activities where a trial or other court-imposed deadline is scheduled more than five days after the start of the lapse. Personnel assigned to those cases should seek continuances as part of an orderly shutdown. If a continuance is denied, the case will be reviewed to determine if work on the case may be excepted.

Chief Counsel personnel are also excepted, on an as needed basis to provide required legal advice necessary to protect statute expiration, and the government’s interest in bankruptcy, lien, and seizure cases. Personnel excepted to perform this work are also excepted under Category B. The employees in General Legal Services are in Category A3, because they are needed to support activities that are authorized to continue during a lapse in appropriations. The employees in Criminal Tax fall into Category B because they maintain criminal law enforcement and undercover operations. Fifty-six employees are supporting the Tax Cuts and Jobs Act and fall into Category A1 because they are funded with the special two-year appropriation provided for TCJA activities.

Appeals

18 employees are “excepted” from shutdown:

Appeals requires that a minimum number of technical staff remain active to ensure statutory deadlines are met. Taxpayer compliance cases, when appealed, must be adjudicated within a statutory timeline that is not under the control of the IRS. If cases are not monitored, statutes may lapse resulting in adverse impacts to the IRS and US government tax collection functions.

During a lapse, the Chief, Appeals will hold a daily virtual meeting with excepted personnel to identify any imminent statutory deadlines or other threats to government property. As necessary, excepted personnel will be activated to take actions that address the imminent threat. All other employees will return to furlough status until the following day.

National Taxpayer Advocate

“National Taxpayer Advocate (NTA) has identified 84 employees (the NTA and one per TAS office) who are required on an on-call basis based the necessary-for-the-safety-of-human-life-and-the-protection-of-property exception (Category B).” That’s not grammatical, but that’s what the plan says. The plan’s chart (Page 96) shows 82, not 84 employees.

 

The local Taxpayer Advocates (one per TAS office) are to report intermittently to check the mail. There might be checks, and the filing of a Taxpayer Assistance Order suspends the statute on collection. Their instructions:

Check mail one or two hours a day, up to three days a week, to comply with the IRS’s requirement to open and process checks during a shutdown while also complying with the statutory requirements that TAS maintain confidential and separate communications with taxpayers and that TAS operate independently of any other IRS office, as described in IRC §§ 7803(c)(4)(A)(iii), 7803(c)(4)(A)(iv), and 7803(c)(4)(B). Screen the mail for incoming requests for Taxpayer Assistance Orders and notify the appropriate Business Unit that a request has been made tolling any statute of limitations. See IRC § 7811(d).

Criminal Investigation

Crime never stops, so CI never shuts down. The plan notes that “in recent years, the Shutdown Contingency Plan proposed that CI attempt to continue work on our 6,352 investigations with a reduced staff. During the implementation phase of the 2011 Shutdown Plan, it became clear that it was logistically impossible for CI to operate at a nearly 50% staffing level when the federal courts, federal prosecutors and our federal law enforcement partners were planning to continue their usual law enforcement operations.”

So all 2,745 Criminal Investigation employees continue to report.

The Most Important People At IRS

A third of the IRS employees who continue to work – 3,337 of them – are in “Information Technology.”

For example, 571 “IT Specialists…support application & web services operations necessary to prevent loss of data in process and revenue collections, application support for critical systems, manage code, perform builds, process transmittals, completion and testing of Filing Year programs.”

Another 62 are needed to “Support the IT filing season systems that operate the nation’s tax infrastructure are updated and in place for the processing of approximately 200 million tax returns annually.”

And 119 employees are required to “Provide 24×7 database support, including data storage, data replication and data backup and recovery for critical IT projects in Dev/Test/Prod/DR environments to continue to work deliverables and maintain all systems related to filing season preparedness, IT Security and IT support for Essential processes/employees.”

In the Mainframe Operations Branch (the “MOB”), 131 IRS workers, among other essential duties, “Provide critical 24x7x365 coverage to applications; Process tax returns, tax deposit and refunds; continue to process successfully on IBM and Unisys mainframe systems and to provide print and electronic documents support for internal and external customers; . . . The IDSE Section provides printed notices and letters to taxpayers, as well as both printed and electronic documents to internal customer.”

The Commissioner

Don’t worry about him, either. Like Chief Counsel, he is a “Political appointee who is not subject to furlough. The Commissioner’s salary is an obligation incurred by the year, without consideration of hours of duty required and is not placed in a non-duty, non-pay status.”

And he keeps his security detail, also. There are six special agents from Criminal Investigation who serve in that capacity (probably not more than two at a time).

 

Designated Orders: A Mixed Bag – Easements and Common Issues (11/26/18 to 11/30/18)

William Schmidt of Legal Services of Kansas brings us this weeks designated orders. The orders this week contain a lot of meat. Two of the orders deal with expert witnesses and problems with those witnesses. In one case the IRS seeks to exclude a petitioner’s expert because the expert is a promoter of tax schemes rather than a true expert and in another case petitioner seeks to exclude respondent’s expert because the expert destroyed the material he thought was not relevant to his expert opinion. Many other matters, particularly regarding conservation easements, deserve attention in these orders as well. Keith

The week of November 26 to 30, 2018 had seven designated orders. The week was a mixed bag. Some orders focused on less common issues like charitable contributions of easements, while other orders looked at routine deficiency or Collection Due Process issues.

Easement Issues, Part One

Docket No. 29176-14, George A. Valanos & Frederica A. Valanos v. C.I.R., available here.

To begin with, this designated order is 30 pages. Most designated orders do not reach a page count in the double digits so it is a rarity to find one this long. As a result, there are multiple items to discuss that I will be summarizing.

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The petitioners asked the Court to determine whether the IRS improperly denied their non-cash charitable contribution deduction for a conservation easement in tax years 2005 to 2007. The IRS filed a motion for partial summary judgment that the Court denies. The sole issue stated for decision is whether the petitioners’ conservation easement deed of gift satisfied the perpetuity requirements of IRC section 170(h)(5) and 26 C.F.R. sections 1.170A-14(g)(2) and (6). Because of the genuine dispute as to material facts, Rule 121(b), and a lack of clarity and specificity in the parties’ contentions of law, the Court denied the IRS motion for partial summary judgment.

For background, the order discusses the subject property, the mortgages affecting the subject property and the conservation easement, the subordination agreements, the conservation easement, the petitioners’ tax returns and charitable deduction disallowance, and the Tax Court proceedings.

Of note is that the recalculations of petitioners’ tax liabilities resulted in deficiencies of $192,486 for 2005, $153,742 for 2006, and $104,662 for 2007. The IRS also determined that the petitioners were liable for gross valuation misstatement penalties under section 6662(h) or, in the alternative, section 6662(a). On September 3, 2014, the IRS issued a notice of deficiency, and the petitioners timely mailed their petition to Tax Court.

The Commissioner moved for partial summary judgment on the grounds that the Greater Atlantic Bank subordination was defective and therefore the conservation easement did not meet the requirements for the charitable contribution deduction. The IRS appeared to initially concede any issue with the Wells Fargo deed of trust.

After the parties fully responded to the motion for partial summary judgment, the Court issued its opinion in Palmolive Bldg. Investors, LLC v. Commissioner, 149 T.C. ___ (Oct. 10, 2017), (discussed below). The Court issued an order that invited the parties to file supplemental memoranda addressing the implications for this case.

In its supplemental filings, the IRS arguments are that similar to the Palmolive subordinations, the Greater Atlantic Bank and Wells Fargo subordinations failed to adequately meet the requirements of subordination of the lenders’ interests in insurance proceedings. The IRS reiterated the Greater Atlantic Bank argument but added the argument that the Wells Fargo subordination did not meet requirements because it did not use the term “subordinate.”

The petitioners responded with arguments that the conservation easement and subordination agreements are valid, all section 170 requirements are satisfied, and they are entitled to all the deductions taken on their original returns.

In the discussion, the order begins with general principles and reviews the principles of summary judgment, conservation easements under section 170(h), the perpetuity requirement of 26 C.F.R. section 1.170A-14(g) (broken down into mortgage subordination and extinguishment proceedings), the relation of federal taxation and state law property rights, real property ownership and mortgage theory (looking at sections on real property ownership, legal interests and equitable interests, and mortgage theory), and District of Columbia’s real property law (with this section looking at mortgages in the District of Columbia, deeds in the District of Columbia, and conveyances of personal property in the District of Columbia).

Next in the discussion is the parties’ contentions, broken down between the Greater Atlantic Bank deeds of trust and their subordination agreement, and the Wells Fargo deed of trust and its subordination agreement.

Third in the discussion is the analysis portion. The first part of the analysis begins by stating that factual disputes are not resolved under Rule 121.

Next is that Section 1.170A-14(g)(2) requires subordination of mortgages. This second part includes sections on the need for attention to local law, Greater Atlantic Bank’s subordination agreement and the Wells Fargo subordination. The Greater Atlantic Bank subordination agreement section looks at the sufficiency of one general subordination agreement for two deeds of trust, the undated subordination agreement, and compliance with District of Columbia law’s recording and other requirements (broken down further into application of state-equivalent real estate law and recording requirements – validity as to third parties). The Wells Fargo subordination looks at the failure to use the verb “subordinate” and subordination or conveyance of an executory interest.

The third part of the analysis looks at the Section 1.170A-14(g)(b) requirement that the donee receive a proportionate share of extinguishment proceeds. This is broken down further to look at Greater Atlantic Bank’s subordination as to proceeds and Wells Fargo’s subordination as to proceeds.

The fourth part of the analysis turns to mortgage theory in light of conservation easements.

The order then turns to unanswered questions. The Court provides a list of nineteen unanswered questions, stating that thorough answers to these questions would allow the Court to analyze the parties’ respective arguments and reach a conclusion of the issues discussed within the order.

In the conclusion, the Court states disputes of fact exist and that the statements from both parties need further explanation and citations to legal authority.

Judge Gustafson orders that the IRS motion for partial summary judgment is denied. The facts assumed in the order are not findings for trial, and each party must be prepared to prove the relevant facts. No later than December 21, 2018, the parties must file a joint status report (or separate reports if that is not expedient) with their recommendations as to further proceedings in this case.

Takeaway: If you want to experience the complexity of the discussion, issues and questions in this case, I recommend you click the link above. This order dives deeply into an examination of the interaction between various areas of law, such as property (subordination agreements, mortgages, and conservation easements) and tax (charitable contribution deductions) while balancing the intersection of federal law and District of Columbia law.

Easement Issues, Part Two: The Palmolive Orders

Docket No. 23444-14, Palmolive Building Investors, LLC, DK Palmolive Building Investors Participants, LLC, Tax Matters Partner v. C.I.R.

The Tax Court issued an opinion in this case, 149 T.C. No. 18 (Oct. 10, 2017), holding that Palmolive is not entitled to a charitable contribution deduction for the contribution of a façade easement because of their failure to comply with certain requirements of IRC section 170. It is still at issue regarding Palmolive’s liability for IRS penalties asserted, which is set for trial commencing January 22, 2019, in Chicago, Illinois.

  • Order 1 available here. The IRS filed a motion for leave to file a second amendment to their answer, where they would supplement the answer with an allegation that Palmolive’s appraiser was a “promoter” and therefore not a qualified appraiser. The Court grants the motion for leave to amend, but the IRS needs to transmit a detailed written statement of the facts on which it will rely at trial to support its contention he was a “promoter.” Palmolive’s assertions in their opposition are deemed to be requests for admission for the IRS to respond to under Rule 90.
  • Order 2 available here. Palmolive filed a motion for summary judgment and the IRS filed their own motion for partial summary judgment in response. In a conference call with the parties, Judge Gustafson explained his expectations as to how he is likely to rule on the issues raised in the motions. He suggested that Palmolive “might wish to forego further filings on the motions and instead use its time to prepare for trial.” Palmolive’s counsel stated there would be no further filing on the issues 2 to 4, but would file a reply as to issue 1. The judge stated he expects to grant the IRS motion on issue 4, regarding the IRS written supervisory approval of the initial determination of penalties in compliance with IRC section 6751(b), but that the order or opinion might not be issued until soon before trial. The parties are to prepare for trial on the assumption that issue 4 will not be a subject of trial. Note: there was a subsequent designated order on issue 1 that will potentially be addressed in another blog post that is available here. Spoiler alert: Palmolive loses on issue 1.

Takeaway: This is a case with multiple filings and has complexity. One takeaway from these orders is that when the judge tells you not to do something it is in your best interest to comply.

Motion to Strike

Docket No. 14214-18, Pierre L. Broquedis v. C.I.R. (Order here).

It is not often that we see a Motion to Strike in a Tax Court case. Here, Petitioner states paragraphs and exhibits in Respondent’s answer are false or not concise statements of the facts upon which Respondent relies.

The Court cites Tax Court Rule 52, where the Court may order stricken from any pleading any redundant, immaterial, impertinent, frivolous, or scandalous matter. The Court states that motions to strike are not favored by federal courts. Matters will not be stricken from a pleading unless it is clear that it can have no possible bearing on the subject matter of the litigation. Additionally, a motion to strike will not be granted unless there is a showing of prejudice to the moving party.

The Court concludes the allegations and exhibits bear a relationship to the issues in the case. Also, petitioner failed to show that he would be materially prejudiced by a denial of his motion to strike. The Court then ordered to deny the motion to strike.

Takeaway: Since the Court states that motions to strike are not favored by federal courts, they should be avoided. While Rule 52 spells out the Court’s ability to order material stricken, this case illustrates that there are rare circumstances when the Court will grant such an order.

The Numbers Don’t Match

Docket No. 7737-18, Kelle C. Hickam & Nancy Hickam v. C.I.R. (Order here). Petitioners filed their petition with 6 numbered statements in their paragraph 5. Respondent filed an answer, admitting to certain paragraphs in the petition. Petitioners, thinking that the IRS partially conceded the case, submitted a motion for partial summary judgment. The Court states: “Petitioners, however, appear to believe that respondent’s numbered paragraphs in his answer refer to their numbered responses in the petition’s paragraph 5. They do not. Respondent’s paragraphs in his answer refer to the numbered paragraphs on the petition.” Since there are genuine disputes of material fact, the Court denied the motion.

Takeaway: While I understand that court documents are not always easy to understand, it would have been wise for these unrepresented petitioners to talk about the pleadings with someone who is familiar with court procedure. It should be a simple step to match the paragraphs between the Petitioner’s petition and the Respondent’s answer. The IRS is not going to concede material issues when they file an Answer. You’re not going to get that lucky.

Miscellaneous Short Items

  • Supervisor Conspiracy – Docket No. 15255-16SL, Robert L. Robinson v. C.I.R. (Order and Decision here). The petitioner mentions that his supervisor obstructed/impeded his payments and that there was a conspiracy. Otherwise, this looks to be a routine Collection Due Process case, granting the IRS motion for summary judgment because they followed routine procedures.
  • Materials Destroyed – Docket No. 20942-16, Donald L. Bren v. C.I.R. (Order here). Petitioner filed a motion in limine to exclude from evidence the report of respondent’s expert, Robert Shea Purdue, because he deliberately discarded documents and deleted electronic records investigated but disregarded in reaching the conclusions set forth in his report. The Court granted that motion.

 

 

Update: Can District Courts Hear Innocent Spouse Refund Suits?

We welcome back frequent guest blogger Carl Smith. Carl discusses a case, Hockin, in which the Tax Clinic at the Legal Services Center of Harvard Law School has filed an amicus brief. If you read the brief filed by Ms. Hockin, to which we link below, you will learn the underlying facts of the case. Like the vast majority of innocent spouse cases these facts describe the sad circumstances that led her to request relief. Relief here for her, if she obtains it, will not make her whole monetarily because of the Flora rule. (Of course, relief would never make her whole in the true sense because the tax system can only assist her with the tax component of the difficult situation caused by the actions of her former husband.) 

This case should not only make us think about the jurisdictional issues raised by the innocent spouse provisions but also about how the application of the Flora rule prevents taxpayers without the wherewithal to fully pay in a short span of time to obtain the return of all of the money paid to the IRS for taxes that they do not owe. This situation describes most low income taxpayers. Keith

This is an update on two cases discussed by Keith in a recent post. The post primarily discussed the case of Chandler v. United States, 2018 U.S. Dist. LEXIS 174482 (N.D. Tex. Sept. 17, 2018) (magistrate opinion), adopted by judge at 2018 U.S. Dist. LEXIS 173880 (N.D. Tex. Oct. 9, 2018). Chandler was a district court suit in which an individual sought a refund for overpaying her equitable share of taxes on a joint return, taking into account innocent spouse relief under section 6015(f). In Chandler, the district court granted a DOJ motion to dismiss for lack of jurisdiction, holding that only the Tax Court could hear suits involving innocent spouse relief. Keith wondered whether there would be an appeal of this ruling of first impression with respect to innocent spouse refund suit jurisdiction.

In his post, Keith also mentioned the existence of a similar innocent spouse refund suit under section 6015(f) pending in the district court for the District of Oregon, Hockin v. United States, Docket No. 3:17-CV-1926. In that case, a similar DOJ motion to dismiss for lack of jurisdiction was pending, arguing that district courts cannot hear refund suits involving innocent spouse relief.

The update, in a nutshell, is that Chandler was not appealed, but Hockin has been set up as a test case, where nearly all the filings are in and linked to below.

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Both under the original innocent spouse provision (section 6013(e), which existed from 1971 to 1998) and the current innocent spouse provision (section 6015, enacted in 1998), the district courts and the Court of Federal Claims had occasionally, and without objection from the DOJ, entertained suits for refund filed solely on the grounds that a taxpayer paid more than was required after the application of the innocent provisions.

Although the DOJ had apparently never done so before in any innocent spouse refund suit going back all the way to the 1970s and 1980s, in the summer of 2018, DOJ trial division lawyers in both Chandler and Hockin submitted motions to dismiss for lack of jurisdiction, arguing that, because Congress in 1998 enacted a stand-alone innocent spouse Tax Court action at section 6015(e) in which the Tax Court can find an overpayment under section 6015(b) or (f), the Tax Court is the sole court in which innocent spouse refund suits can now be filed (i.e., via section 6015(e)), and so neither the district courts nor the Court of Federal Claims has jurisdiction to entertain innocent spouse refund suits. The DOJ motions acknowledged only one rare exception to this position: Where there was a pending refund suit in a district court or the Court of Federal Claims (presumably on other issues) at a time when a taxpayer also filed a suit in the Tax Court under section 6015(e), the statute provides that the Tax Court innocent spouse suit should be transferred over to the court hearing the refund suit. Section 6015(e)(3).

In July, Keith and I were alerted to the existence of the motion in Hockin – but not the one in Chandler – by pro bono counsel for Ms. Hockin, J. Scott Moede, the Chief Deputy City Attorney of the Portland, Oregon Office of the City Attorney. Mr. Moede had taken on the Hockin case in his role as a regular voluteer with the Lewis & Clark Low-Income Taxpayer Clinic in Portland. That clinic suggested that Mr. Moede contact the Harvard Federal Tax Clinic because of the Harvard clinic’s interest in innocent spouse cases.

Working with summer students, in August, Keith and I put together a draft of a proposed amicus memorandum for Hockin arguing that the DOJ position was both ahistorical and contrary to the 1998 and 2000 legislative history of section 6015(e) that seemed to make clear that Congress enacted section 6015(e) to be added on top of all existing avenues for judicial review of innocent spouse issues, not to repeal or replace any prior avenues for judicial review.

Further, in the draft memorandum, we pointed out that the Trial Section’s motion in Hockin took a position directly contrary to the position that the DOJ Appellate Section had taken in three cases that the Harvard clinic had recently litigated. In those three cases, the DOJ Appellate Section urged the appellate courts not to worry about holding that a person who filed a late Tax Court suit under section 6015(e) must have her suit dismissed for lack of jurisdiction. The DOJ Appellate Section said that such a taxpayer could always still get judicial review of the IRS’ decision to deny innocent spouse relief by paying the tax in full, filing a refund claim, and suing for a refund in the district court or the Court of Federal Claims.

In both Hockin and Chandler, the taxpayers received a notice of determination denying innocent spouse relief, but did not try to petition the Tax Court within the 90 days provided under section 6015(e). Rather, after later making either partial (Chandler) or full (Hockin) payment, the taxpayers filed refund claims and brought refund suits in district court that were timely under the rules of sections 6511(a) and 6532(a) (though, for Hockin, the lookback rules of section 6511(b) limit the amount of the refund to only a portion of what Ms. Hockin paid). Thus, except for the full payment (Flora) rule problem in Chandler, the taxpayers had done exactly what the Appellate Section said they should do to get judicial review of innocent spouse relief rulings other than through section 6015(e).

In August, we sent a draft copy of the memorandum to the DOJ attorney in Hockin and asked whether the DOJ would object to a motion by the Harvard clinic to file it. This draft memorandum apparently triggered the DOJ’s desire to explore mediation in the case. So, the case was assigned to a magistrate for mediation, and further filings on the motion (including the amicus motion) were postponed.

Then, in September and October, the magistrate and district court judge, respectively, issued rulings in Chandler granting the DOJ’s motion to dismiss for lack of jurisdiction. That is how Keith, Mr. Moede, and I learned of the existence of the Chandler case presenting the identical jurisdictional issue. Although Ms. Chandler was represented by counsel, that counsel had filed no papers in response to the DOJ motion to dismiss in her case. Naturally, this led to the magistrate and judge in Chandler relying entirely on the DOJ’s arguments and citations in ruling for the DOJ.

In his recent post on Chandler, Keith raised the question whether the Chandler district judge ruling would be appealed to the Fifth Circuit. The first piece of news in this update is that Ms. Chandler decided not to appeal. Frankly, give the Flora full payment problem in the case, I think an appeal on the issue of whether the district court otherwise would have had jurisdiction would have been pointless.

But, the second piece of news is that, in November, mediation failed in the Hockin case. So, Hockin is now set up as a possible appellate test case, depending on the district court’s ruling.

The DOJ has now not objected to the Harvard clinic’s filing of an amicus memorandum in Hockin. That memorandum was filed on November 26.

On December, 21, Ms. Hockin (through Mr. Moede) filed her response to the DOJ motion. In her response, Ms. Hockin argued not only that the district court had jurisdiction over section 6015 innocent spouse relief refund suits, but also that she had raised in her refund claim two additional arguments: that she had never filed a joint return for the year and that the IRS should be bound to give her innocent spouse relief for the year because it had given her such relief for the immediately-following taxable year. As noted in the Harvard memorandum, the “no joint return” argument has been considered in district court refund lawsuits even predating the enactment of the first innocent spouse provision in 1971.

The DOJ will be allowed to file a reply by January 11.

On February 5, oral argument on the motion will be heard before a magistrate who was not involved in the mediation. Ms. Hockin has agreed to have this magistrate decide the jurisdictional motion without the involvement of a district court judge, but the DOJ has not yet similarly consented. If the DOJ does the same, and the magistrate dismisses the case, this would allow a direct appeal from the magistrate to the Ninth Circuit. If the DOJ does not consent, the magistrate’s ruling will have to be reviewed by a district court judge before a party could appeal any adverse ruling to the Ninth Circuit.

You can find here for Hockin, the DOJ’s motion, the Harvard clinic’s amicus memorandum, and Ms. Hockin’s response.

Finally, you may be aware of the recent amendment of 28 U.S.C. section 1631 that allows district courts and the Court of Federal Claims to transfer to the Tax Court suits improperly filed in the former courts. That amendment would not help Ms. Hockin, since her district courts suit was filed long after the 90-day period to file a Tax Court suit under section 6015(e) expired. So, her case, if transferred, would have to be dismissed by the Tax Court for lack of jurisdiction because the suit was untimely filed in the district court for purposes of the Tax Court’s stand-alone innocent spouse case jurisdictional grant. For Ms. Hockin, her only chance now for getting a refund attributable to the innocent spouse provisions is for the courts to agree that district courts have jurisdiction to consider innocent spouse refund suits.

 

Update on Obtaining Transcripts from the IRS

If you have been following the news from the IRS about the ability to obtain transcripts from it, you know that at the start of 2019 the IRS plans to make it harder to obtain transcripts. The Tax Section at the ABA has been working the issue to try to get the IRS to slow down the process to make sure that it has everything in place. The IRS has been moving relatively quickly in an effort to plug security concerns. Last December it cut off e-Services to everyone who was signed up and made them sign up again with enhanced security questions before allowing access. In August of 2018 in made an announcement about its intention to create a new improved system – improved from a security perspective and not from the perspective of ease in obtaining transcripts. In September 2018 it made a follow up announcement.

In the message reproduced below from ABA Tax Section Chief Counsel, Meg Newman, she provides an update of the ongoing efforts of the community to resolve issues of security versus access. This is an important message for anyone who regularly tries to obtain transcript information from the IRS.

Dear PBTC Community,

As many of you know, in August the IRS announced changes to transcripts including redacting Wage & Income (W&I) transcripts and an end to faxing any transcripts to representatives. The people at the IRS who have been working on this issue have real security concerns about the faxing process, but have also been sincere in listening to our concerns and have worked hard to address them. The Tax Section has been included in a working group to discuss potential ways for representatives to access unredacted W&I transcripts and other transcripts prior to CAF processing of POAs. On December 13, we submitted comments to the IRS summarizing our recommendations (www.americanbar.org/content/dam/aba/administrative/…).

Yesterday the IRS held a conference call and then released the attached fact sheet summarizing their decisions for how to address the concerns we have raised. The IRS was eager to get news out on this issue, and as a result some of the language in the fact sheet may be confusing. I clarified this morning with the IRS what they intended to convey. Here is a summary of the key points and some remaining issues.

  1. As of January 7, 2019, representatives who have a need for unredacted (the IRS calls it “unmasked”) Wage & Income Transcripts can call PPS and request unredacted transcripts be sent to their secure mailboxes through eservices (the “Secure Object Repository” or the “SOR”).
    • The standard for what qualifies as a need for an unmasked transcript includes return preparation.
    • The fact sheet outlines the steps for requesting an unredacted transcript be sent to your SOR and includes the option to fax a POA to the PPS representative if one is not already on file through the CAF Unit.
    • Taxpayers can currently (and also in the future) request that an unredacted transcript be mailed to their last known address with the IRS as well.
  2. Faxing of transcripts will continue until February 4, 2019 (originally scheduled to cease on January 2, 2019, they extended it about 30 days).
  3. At some point prior to February 4, the IRS will complete the process to enable PPS representatives to send all individual transcripts to a representative’s SOR when the POA has not yet cleared the CAF Unit (through the same process we currently use to request PPS fax transcripts to us). This process for new clients, and TDS or mail for clients with a POA on file will be the only methods for representatives to obtain transcripts going forward. Taxpayers can also request transcripts be mailed to their last known address.
  4. The IRS is referring to transcripts other than W&I as “masked” or “redacted” as well. I clarified with them that only that the taxpayer’s social security number will be redacted down to the last four numbers. They assured me nothing else about an account transcript would look different in the “masked” form.
  5. We are hoping to work with the Wage & Investment Division to establish some system to get student attorneys CAF numbers more quickly so they can create eservices accounts early in the semester to access transcripts. This is a work in progress and we will send updates if we make progress.
  6. Business transcripts that are currently available through eservices will also be available through the same method as individual transcripts prior to a POA processing (this is not what the press release said, but I confirmed it is the case and they will be updating their material). The IRS is still working out a plan to replace faxing for a number of “internal transcripts and prints” relevant to the representation of large business entities. This is likely not relevant to this group, but something the Section has addressed in the working group.

The crucial and immediate message here is that anyone who does not currently have an eServices account, should start the process of obtaining an eServices account now. Some people find they can successfully open an account in one session, while others will need to have an activation code mailed to them which takes 7-10 business days. For practitioners who have student attorneys working with you, this is even more important as you will need to make the students delegated users so they can create eServices accounts.

The Tax Section is still part of the working group on this issue, so please feel free to contact me offline (megan.newman@americanbar.org) if you have feedback or questions not covered here.

Thanks,
Meg
——————————
Meg Newman
Chief Counsel
American Bar Association Section of Taxation
(202) 662-8645
megan.newman@americanbar.org

via ABA Tax Connect, Dec. 20, 2018

Effect of a Revoked Discharge on the Suspension of the Collection Statute of Limitations

On June 22, 2016, I wrote a post about the case of Bush v. United States in which the Tax Division of the Department of Justice argued that B.C. 523(a)(7) did not limit the exception to discharge with respect to the fraud penalty to a fraud penalty arising within three years of the date of the bankruptcy petition. In the Bush case the court ruled against the government and followed the precedent of three circuit court decisions from the early 1990s. After those three decisions the IRS had decided to abandon the argument that B.C. 523(a)(7) limited the exception to discharge to fraud penalty assessments arising within three years of the petition. I speculated in that post that maybe the government had changed its position though it was possible that the case merely reflected the arguments of an Assistant United States Attorney, similar to the situation in a recent post, who made a logical argument unaware of the history of the issue and the position of the government.

In the recently decided case of United States v. Joel No. 3:13-cv-01102 (W.D. Ky. Oct. 18, 2018) the taxpayer made the argument that the government lost in Bush and in the earlier cases. The government goes back to arguing that the circuit court cases were correctly decided, which suggests either that the Bush case was argued by a “rogue” government attorney or that the government has returned to the position it adopted following the three circuit losses in the early 1990s. The court ruled against the taxpayer and spent a little time parsing the confusing language of the statute. The Joel case concerns a post-bankruptcy effort by the IRS to reduce its assessment to judgment and to foreclose its lien on property held by an alleged nominee/alter ego. Most of the opinion focuses on the discharge of the underlying taxes and the effect of the prior bankruptcy case on the statute of limitations on collection.

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Depending on the impact of the prior bankruptcy, the statute could have expired prior to the filing of suit by the government. The court goes through a lengthy analysis in determining that the prior bankruptcy suspended the statute of limitations for a sufficient period of time to make the filing of the suit timely. Anyone interested in the interplay of the filing of a bankruptcy petition on the statute suspension for collection may find the case instructive. What makes this case somewhat unique and causes the taxpayer to argue about the fraud penalty is that the bankruptcy court granted Mr. Joel a discharge in his bankruptcy case and later revoked the discharge when his fraud came to light.

The fraud penalty was a minor point in the case, though because of the dollar amounts at issue the taxpayer may not have thought of it as minor. The tax years at issue are 1991, 1992 and 1993. Mr. Joel filed his first bankruptcy on November 8, 2001. He filed a chapter 7 petition and the court granted a discharge on February 7, 2002. The timing of the discharge reflects a normal time period of about three months for a debtor to obtain a discharge in a chapter 7 case with no objections. At the time of the discharge, the IRS would have written off the fraud penalty assessments as discharged pursuant to B.C. 523(a)(7) and made no further effort to collect those assessments because the discharge injunction of B.C. 524 bars creditors from collection against discharged debts.

After the grant of the discharge, the trustee became aware that Mr. Joel might not be a routine bankruptcy case. On January 29, 2003, the trustee brought an adversary proceeding in Mr. Joel’s bankruptcy case seeking to revoke the discharge because the debtor failed to list assets in the bankruptcy schedules and failed to surrender estate assets to the trustee. Additionally, on January 4, 2005, the IRS indicted Mr. Joel for IRC 7201 evasion of payment of his 1991-1993 taxes. In 2007, Mr. Joel pled guilty to evasion of payment and subsequent to that plea, the bankruptcy court ruled that he committed perjury in the filing of the bankruptcy schedules and revoked his discharge. This is where the position of the parties with respect to the discharge arguments gets somewhat reversed.

The IRS argues that the statute of limitations on collection should be suspended from the time of the bankruptcy filing until the time of the discharge revocation. Prior to the discharge, the IRS was prohibited from collecting the fraud assessment because of the automatic stay of B.C. 362(a). After the discharge, the IRS was prohibited from collecting because B.C. 523(a)(7) caused it to abate the assessment. It wasn’t until after the bankruptcy court revoked the discharge on June 20, 2007, that the IRS could reverse the abatement of any discharged taxes and penalties and begin to try to collect the liabilities again.

The debtor, in a quasi role reversal, argues that the fraud penalties were not discharged because of the language of 523(a)(7). Because the statute did not require the discharge of the taxes, the IRS had the ability to collect the taxes after the initial discharge lifted the automatic stay. So, the statute of limitations suspension lifted at the time of the initial discharge in 2002 and not the revocation in 2007. Because it lifted five years earlier, it had run by the time the IRS brought the suit.

The court looked carefully at the language of 523(a)(7) which provides:

A discharge under 727… of this title does not discharge an individual debtor from any debt-

(7) to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty –

(A) relating to a tax of a kind not specified in paragraph (1) of this subsection; or

(B) imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition….

The debtor first argued that (A) and (B) were conjunctive conditions and not disjunctive, such that a penalty must meet both conditions. The fraud penalty cannot meet the first condition because it relates to taxes on which the taxpayer has committed fraud, which are excepted from discharge under B.C. 523(a)(1)(C). It would make logical sense that the fraud penalty should be excepted from discharge. In many instances the IRS does not impose the fraud penalty until long after three years from the due date of the return because the IRS must amass evidence prior to imposing this penalty. The fraud penalty also represents the type of penalty that policy would dictate that the debtor should continue to owe. The legislative history of the statute implies that Congress intended the fraud penalty to continue.

The debtor’s problem here is the same one faced by the government when it litigated the meaning of this provision almost three decades ago. Subsections (A) and (B) are joined by the word “or.” The word “or” places (A) and (B) in a disjunctive and not conjunctive posture. Therefore, if either the condition of (A) or the condition of (B) applies, the provision discharges the fraud penalty. Subsection (B) refers to transactions occurring before three years before the petition date. The fraud penalty relates back to the due date of the return. Those due dates here occurred in the early 1990s, long before the filing of the bankruptcy petition.

Since the condition of (B) is met, the fraud penalty is discharged. The IRS correctly abated the fraud penalty when the bankruptcy court entered the discharge and the IRS receives the benefit of the period between the initial discharge and the revocation in calculating the statute suspension.

While this is not a huge issue, Congress should consider fixing B.C. 523(a)(7) to except from discharge the fraud penalty. Allowing the discharge of this penalty is not good policy. In most instances, I suspect the IRS will struggle to collect the fraud penalty because the individual who committed the fraud will have run through most or all of their assets before the IRS collection personnel arrive on the scene; however, cases exist in which the individual who committed fraud still has assets and the bankruptcy discharge should not protect those assets from collection.

 

IRS Updates “EZ Answer” Test Procedures for S Cases

At the recent Low-Income Taxpayer Clinic grantee conference, Keith and I were fortunate to hear from a distinguished panel of Tax Court judges discussing practice before the Court. During the panel, Special Trial Judge Leyden was asked about the most surprising thing she has learned since her 2016 transition from practitioner to judge. She commented that she has been dismayed by the sheer volume of cases that are dismissed for the petitioner’s failure to prosecute, and she encouraged participants in the Tax Court’s clinic program to suggest solutions that the Court might consider. The IRS “EZ Answer Test” may be one step towards ameliorating the problem.  

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In October of 2017, the IRS began a pilot program called EZ Answer Test. (AP-08-1017-0018, 10/20/17.) This test program allows IRS Counsel in certain offices to answer an S case without waiting to receive the Administrative File, if Counsel believes it does not need the administrative file to answer the petition. (The pilot does not apply to CDP cases.) The filing of an EZ Answer automatically transfers jurisdiction of the case to Appeals. Recently the IRS updated its EZ Answer Test procedures, tightening one of the timeframes and specifying additional procedures. (AP-08-1218-0016, 12/12/18).  

We have discussed issues relating to answers in Tax Court on PT before. In August Keith discussed updated guidance on handling premature petitions, which Bob Kamman had previously highlighted. 

The Court and IRS Chief Counsel would prefer to resolve cases on their merits. Unfortunately, the problem of nonresponsive petitioners stubbornly persists despite the combined efforts of the Court, IRS, and LITCs. As Judge Leyden noted, it is all too common for self-represented petitioners to drop out of their Tax Court cases and become nonresponsive at some point before trial. Sometimes previously-nonresponsive petitioners appear at Calendar Call if the case is not dismissed before that date, but other times petitioners seem to take no action at all after filing their petition.  

One notion that has gained some stakeholder support is that petitioners stand a better chance of remaining engaged if they are contacted early and often after filing their petition. Petitioners who do not hear anything about their case for several months at a time may give up or they may run into problems that make it difficult to remain engaged. For example, in many jurisdictions tenants can be evicted with very little notice. In Pennsylvania the law allows residential leases to provide for zero notice before an eviction action is filed in court. For someone facing a crisis like eviction with very little time to respond, the problem of keeping warm and safe may understandably occupy all of their time and energy. If the tenant has to move, documents may be lost or the taxpayer may not remember to update their address with the Court when they are able to find new housing. In other cases, taxpayers say that they  temporarily dropped off the radar due to health problems which consumed all of their attention. There are many other reasons.  

One of the main reasons for pretrial delays in S cases (between the filing of a petition and the IRS answer, and again from the filing of the answer to when Appeals contacts the taxpayer, and again from the time Appeals sends the case back to Counsel and when Counsel contacts the taxpayer) is that the IRS administrative file on the case must be physically moved from one office to another. Counsel needs the administrative file to Answer the petition. Then, most pro se cases are transferred to the Office of Appeals to attempt settlement. If the case does not settle in Appeals, the file is sent back to Counsel to prepare for trial. I do not know why the process of transferring the administrative file takes as long as it does, but I believe IRS Counsel when they say that they simply cannot get the file quickly. The IRM even has procedures for creating dummy files when the administrative file cannot reach Counsel in time to answer the case. (See IRM 8.4.1.8.1 (08-09-2011), Dummy File Procedures.)  

I doubt that increased taxpayer engagement was the only motivation behind the IRS’s “EZ Answer Test” program, but I hope the IRS will study taxpayer engagement in conjunction with the program to see if there is any improvement. Whatever the motivation, it is laudable that the IRS is attempting to reduce the time from when a case is filed to when an Appeals employee contacts the taxpayer and substantively engages them in an attempt to settle the case. Faster pretrial timeframes generally help to keep pro se taxpayers engaged, promoting several of the rights in the Taxpayer Bill of Rights including the Right to Quality Service, the Right to Challenge the IRS’s Position and Be Heard, and the Right to Appeal an IRS Decision in an Independent Forum, not to mention (perhaps most important) the Right to Pay No More than the Correct Amount of Tax.  

Frustration with the Premium Tax Credit, Designated Orders 11/19/18 – 11/23/18

We welcome Professor Samantha Galvin from the Sturm Law School at the University of Denver who brings us this weeks designated orders. She focuses on Premium Tax Credit disputes and the possibility of success in some cases where an insurance company or health insurance marketplace erred. Professor Galvin’s success in the second clinic case she describes makes me hopeful that the final thoughts in this post on APTC and third-party fraud were not entirely off the mark. Christine

Only four orders were designated during the week of Thanksgiving. I discuss one in detail and summarize the others below.

Frustration with the Premium Tax Credit

Ovid Sachi & Helen Sachi v. CIR, Docket No. 12032-17 (here)

This first order and decision was issued in a case involving the premium tax credit (“PTC”) under section 36B. Christine Speidel and I authored the Affordable Care Act (“ACA”) chapter in the most recent edition of Effectively Representing Your Client before IRS and it was my introduction to all things ACA.

A search of Tax Court opinions reveals that only ten cases, so far, mention the PTC. I anticipate that we will see more PTC related cases as time goes on, but it is still very much a developing area and this decision seems consistent with the others. Two early cases were discussed on PT here.

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For those of you who may not know, the PTC is a credit available to taxpayers to whose incomes fall between 100% – 400% of the federal poverty line. It is intended to offset the cost of insurance premiums and make health insurance more affordable for middle and low-income taxpayers. The credit can be paid, either in part or in full, to the insurance company in advance and then taxpayers must reconcile the advance payments on form 8962 when they file their tax returns. Depending on the amount of credit received and the taxpayer’s modified adjusted gross income, the reconciliation may result in a refund if taxpayers were entitled to a larger credit than they received, or a balance due if taxpayers were entitled to a smaller credit or not entitled to any credit. I’ll avoid going into any further detail about the mechanics of the PTC, but for those looking for more information I encourage you to check out Chapter 29 in the 7th Edition of Effectively Representing.

This order itself is somewhat unexciting; respondent moves for summary judgment and petitioners do not respond. The Court goes on to provide some background information: petitioners received the PTC in 2015, but only reported half of their advance credits on  form 8962. Worse, the form’s reconciliation calculation showed that their income was higher than 400% of the federal poverty line rendering them ineligible for any credit. In their petition the taxpayers did not dispute the material facts (the total PTC amount and their modified adjusted gross income) but expressed frustration with the application process and confusing correspondence from the insurance company, the health insurance marketplace, and the IRS.

The order does not provide any information about whether the taxpayers correctly reported their anticipated income to the marketplace, or if they earned more income than expected – but these facts wouldn’t change the outcome of the case because the taxpayers are still responsible for repaying any excess credit in those situations. See McGuire v. C.I.R, 149 T.C. No. 9.

Taxpayer frustration in this area is sadly a common occurrence. We have had two Tax Court cases dealing with the PTC in my clinic. One case involved an incorrect form 1095-A which the marketplace refused to correct, but we were successful because the clients had documentation and receipts which allowed us to prove to the IRS what a correct form 1095-A would have looked like. The case was conceded by the IRS after we submitted this documentation to Appeals.

The other case involved advance PTC that was paid for a married couple; however, the insurer only effectuated a policy for the husband. The wife’s policy was never effectuated as evidenced by documentation provided to us, somewhat surprisingly, by the (now defunct) health insurance company. In other words, the Treasury was paying a credit to an insurer for a policy that did not exist, and as a result, the taxpayer never received any benefit. We were successful at the Appeals stage in the Tax Court process in this case as well.

We will see what happens in this area as it continues to develop, but it seems that success may be possible in cases where a taxpayer proves that the marketplace or insurance company made a mistake and the taxpayer did not benefit from the mistake.

Now, a summary of the other orders:

  • Napoleon v. Irabago & Zosima Irabagon v. C.I.R., Docket No. 1594-16L (here): This order and decision involves a sad instance of petitioners failing to understand their obligations in the Tax Court process and losing the opportunity to present evidence to reduce their liability. Petitioners initially petitioned the Tax Court on a notice of deficiency for 2010 and 2011. The petition was timely received but petitioners failed to pay the $60 filing fee despite being ordered to do so, and their case was ultimately dismissed. The IRS collection process proceeded, and eventually the taxpayers requested a collection due process hearing and then petitioned the Court on the notice of determination attempting to maintain their original argument (that they have proof of their expenses). Unfortunately, the Court no longer has jurisdiction to hear it.
  • Marvel Thompson v. CIR, Docket No. 29498-12 (here): This order grants respondent’s motion for summary judgment after the petitioner failed to respond. Although the Court said it could grant the motion without further analysis, it proceeds to discuss the merits of the case. Petitioner earned rents and royalties but didn’t file a return for tax years 2007 and 2008. I thought the case might take an interesting turn when petitioner stated that he had been incarcerated since 2004, so he could not have earned income, but in the end the Court finds that he has not met the burden of proving he did not earn the rent and royalty income while incarcerated.
  • Sue Hawkins v. CIR, Docket No. 19223-17 (here): After a decision was rendered in her case, petitioner wrote a letter to the Court which was accepted as a motion for reconsideration. The Court orders the IRS to respond and include information about how much of petitioner’s liability has been paid thus far. The Court also specifically orders petitioner to communicate and cooperate with the IRS as they prepare to respond to her motion and goes even further ordering that she answer their calls and letters. If she fails to do so, the initial decision will stand.

 

 

 

Gambling Addiction Does Not Justify Effective Tax Administration Offer

Gillette v Commissioner is a collection due process case arising from the tax consequences of prematurely withdrawing funds from an IRA and underpaying taxes while a taxpayer was suffering from compulsive gambling that she claimed was attributable to an addiction to prescription medication. The taxpayer sought an effective tax administration offer in compromise. While unsuccessful, the case warrants attention as there is very little law around this type of offer.

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The opinion situates the sad tale that led to the sizable underpayment of taxes on her 2012 tax return. Ms. Gillette is a veteran and former firefighter who managed and owned a stable of rental properties. After retiring from firefighting, she developed a serious gambling addiction that she attributed to the side effects of pramipexole, a prescription medication.

Occasionally she would go days without sleep and at times slept in her car if she wasn’t given a complimentary night’s stay at a casino. Other times she would fall asleep at blackjack tables and slot machines only to be awakened by dealers and casino attendants. Nearly all of the money she collected from her rental properties went to casinos. When she ran out of money, she borrowed from friends and didn’t pay them back, took money and credit cards from her husband’s wallet, and eventually withdrew money from her retirement account in 2012.

In 2013, following the intervention of her son who recognized that the side effects of the medication she was taking were likely contributing to her gambling, she sought medical care to wean off the drug. Within a couple of years she was no longer taking the drug and was able to stop gambling. One lingering effect though was the 2012 alternative minimum tax (AMT) of about $17,000 and early IRA withdrawal penalty of about $10,500, both of which contributed to a tax balance due of almost $76,000 on her and her husband’s 2012 tax return.

Following a notice of intent to levy, the taxpayers requested a CDP hearing, challenging the underlying AMT liability and eventually offering $38,968 to compromise the liability based on effective tax administration (ETA). The ETA offer was sought because they were not a candidate for an offer based on doubt as to collectability, as the equity in assets (including the rental properties) exceeded the tax due (in fact Appeals determined that the reasonable collection potential in light of the assets was over $800,000).

The main part of the opinion dealt with Appeals’ rejection of the ETA offer and the Tax Court’s refusal to find any abuse of discretion in Appeals’ rejection.

The case originally went up to Tax Court a couple of years ago, but the Tax Court on the IRS’s motion remanded the case back to Appeals for a supplemental hearing because the original determination had an insufficient discussion of the reasons why Appeals agreed with the offer specialist’s decision to reject the ETA offer. By requesting a remand, the IRS avoided reversal for failure to consider the taxpayer’s equitable arguments. Guest blogger Professor Scott Schumacher previously discussed this requirement on PT.

After going back to Appeals, the settlement officer considered the taxpayer’s argument and again rejected the offer, in part on a finding that the side effect of the medications, including compulsive gambling, were known since 2006 and that the taxpayer made a choice to continue taking the medication anyway. In rejecting the offer on remand, Appeals did not refer the offer to the IRS’s ETA Non-economic Hardship Group, the group the IRM states should review ETA offers in “appropriate” cases.

Before exploring this further, it is worth emphasizing the law that applies to offers based on effective tax administration. The regulations provide the standard:

If there are no grounds for compromise under paragraphs (b)(1) [doubt as to liability], (2) [doubt as to collectability], or (3)(i) [economic hardship] of this section, the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.

Reg. Sec. 301.7122-1(b)(3).

Thus, the regulations provide that the IRS may accept a compromise where there are “compelling public policy or equity considerations.”  Unlike offers based on doubt as to collectability, which essentially default to a more mechanical comparison of the offer amount relative to the taxpayer’s collection potential, this standard is relatively vague. The regs do provide some examples of cases that should be considered under a public policy or equity ETA offer:

(1) a taxpayer with a serious illness requiring hospitalization for a number of years who, at the time, was unable to manage his or her financial affairs, including filing tax returns and (2) a taxpayer who learns after an audit that incorrect advice was given by the Commissioner and is now facing additional taxes and penalties because of that advice.

The IRM also provides guidance for IRS, providing additional factors and examples:

  • where the taxpayer’s liability was the result of the Commissioner’s processing error,
  • following the Commissioner’s erroneous advice or instructions,
  • the Commissioner’s unreasonable delay, or
  • the criminal or fraudulent act of a third party

In addition the IRM states that accepting a public policy or equity offer-in-compromise may be appropriate where rejecting it would cause a significant negative impact on the taxpayer’s community or “the taxpayer was incapacitated and thus unable to comply with the tax laws.”

The main argument that the taxpayers made was that because of the drug use Ms. Gillette was mentally impaired and incompetent, essentially claiming that this was akin to an incapacitation that would justify acceptance of an offer below the collection potential.

The Tax Court disagreed, primarily by distinguishing her situation from the examples and factors cited in the regs and the IRM:

Ms. Gillette and Mr. Szczepanski argue that their public policy or equity offer-in-compromise should be accepted because Ms. Gillette’s mental illness was caused by her prescription medication. While Ms. Gillette’s circumstances are unfortunate, Ms. Gillette and Mr. Szczepanski did not provide grounds for treating them differently from a similarly situated taxpayer who paid his or her liability in full. Their situation also differs from the examples given in the regulations: Ms. Gillette did not require hospitalization for a number of years, she was able to file her tax returns, she collected rents from her rental properties, and she did not receive incorrect advice from the Commissioner.

In addition, the opinion, while acknowledging the impact of the gambling addiction, distinguished the incapacity from others that would render an inability to comply with the tax laws:

Finally Ms. Gillette and Mr. Szczepanski do not meet any of the compelling factors outlined in the IRM. Ms. Gillette was not so incapacitated that she was unable to comply with the tax laws, rejection of their public policy or equity offer- in-compromise would not have had a significant negative impact on their community, and their 2012 tax liability was not caused by an error or delay of the Commissioner or the fraudulent or criminal conduct of a third party.

Conclusion

This is a close case. No doubt the taxpayers come away feeling that the system did not adequately address their legitimate concerns. From a process standpoint, I feel their pain; the initial Appeals determination did little in explaining why the offer was originally rejected; on remand Appeals did not refer the case to the unit specifically that hears ETA offers (a point the opinion notes was not an abuse of discretion as the decision to do so is essentially one completely in Appeals’ wheelhouse); and at trial the Tax Court did not allow the testimony of the taxpayer’s doctor or VA social worker, among other witnesses.

I am not equipped to evaluate the level of the taxpayer’s incapacity or the degree to which the medication contributed to or caused the gambling that led to the liability and underpayment of taxes. It would seem to me, however, that the Tax Court might have benefited from the testimony of the doctor. While some circuits follow the record rule and limit review of CDP cases to the evidence in the administrative record, the Seventh Circuit, where the case is appealable, has declined to decide that issue. In addition, given the lack of guidance in this area, the IRM factors and examples have heightened importance, a curious result again from a process standpoint given the absence of any public input in their promulgation.

To be sure, as the opinion notes, and as the IRS emphasized, there is no explicit unfairness hook that would require the IRS to accept an ETA offer. In addition, the taxpayer has significant assets. Given the lack of case law in this area, it is likely that this case will be one that the IRS will lean on when taxpayers seek to resolve a liability even after a taxpayer makes a credible case that substance abuse has contributed to the taxpayer’s liability.

For readers interested in more on ETA offers, including suggestions on how the IRS can improve standards for evaluating the offers, check out Rutgers Law School Professor Sandy Freund’s 2014 Virginia Tax Review article Effective Tax Administration Offers-Why So Ineffective.