Today we welcome Diana Leyden as our guest blogger. Diana runs the low income taxpayer clinic at University of Connecticut Law School. She is a leader among tax clinicians with many innovative ideas and programs. She co-authored the chapter on Employment Tax issues in the forthcoming edition of Effectively Representing Your Client before the IRS and has written extensively on issues impacting low income taxpayers. Keith
When a client gets a Notice of Intent to Levy or Notice of Filing of Federal Tax Lien, she gets the chance to offer a collection alternative through a CDP request. What if your client has not filed some of her tax returns? Can she still proceed with a collection alternative?
Until recently, many practitioners believed that in the CDP context, collection alternatives were available as long as the client filed the last 6 years returns. Compliance, most tax practitioners believed, was met even if there were outstanding tax returns for other earlier years. However, the Tax Court in a Memorandum Decision ruled that the IRS can require the filing of all outstanding returns as a condition to considering a collection alternative of an installment agreement or an offer in compromise. Misty S. Doonis v. Commissioner, T.C. Memo. 2014-168 (Aug. 18, 2014). Judge Lauber concluded that such requirement was not an abuse of discretion. He also made other observations about CDP that merit discussion.read more...
Ms. Doonis was a self employed medical recruiter who operated as a Schedule C business. She failed to file returns for 2005 through 2011. For some reason the IRS chose to prepare substitute for returns using the IRC 6020(b) procedure for 2007 and 2008. (The case was submitted on a stipulated record, so it is not clear whether the IRS made, or attempted to make, substitute for returns for other years.) It sent separate notices of deficiency for each year and Ms. Doonis did not file a Tax Court petition with respect to either notice of deficiency. Presumably after the usual correspondence seeking payment, the IRS sent Final Notice of Intent to Levy and Ms. timely requested a CDP hearing. Ms. Doonis offered three alternatives: currently not collectible (CNC), installment agreement or offer in compromise (OIC). The Settlement Officer (SO) told her that in order for the SO to consider either the installment agreement or the OIC collection alternative, Ms. Doonis must file the returns for 2005 through 2011.
Ms. Doonis filed returns for 2006 through 2011 but did not file the 2005 return. The SO said no 2005 return, no collection alternative of either installment agreement or OIC. The SO also concluded that based on a financial statement submitted, Ms. Doonis could pay $3,896 a month toward her tax debt. Accordingly, the SO issued a determination letter sustaining the levy. Ms. Doonis petitioned the Tax Court and made several arguments.
First, Ms. Doonis argued that the Court should excuse her failure to file the 2005 return because she did not have sufficient records for that year. The Court said no because she had an affirmative duty to keep adequate records and to file.
Second, she argued that she had “no reported income for the tax year 2005 per the IRS wage and income transcripts.” As many practitioners learn, the IRS does not keep wage and income transcripts back more than 6 years. However, the representative in this case should not have rested on the fact that there were no IRS transcripts available. The Court found that she worked as a Schedule C business for all of the other years making an average of over $78,000. Her Schedule C for 2006 did not indicate that the business started that year. Thus, the assumption was that she also received gross receipts from the business in 2005; she did not submit an affidavit that she did not earn any income in 2005. Even if she had, the Court might have questioned how Ms. Doonis was able to live if she did not have any income. (Often, when faced with this situation with low-income taxpayers, we back into an approximation of gross receipts or wages for purposes of an affidavit by reviewing their living expenses, minus any sources of gifts or nontaxable income.)
Third, she argued that 2005 was more than six years prior to the time of the CDP notice and the IRS policy set out in IRM 18.104.22.168.18 generally solicits returns going back only six years. The Court found that the manual provided guidance, but the SO did not abuse discretion in requiring her to go back to 2005 to file returns.
Lastly, she argued that if she did not qualify for a collection alternative because of the unfiled return, the Court should place her in CNC status. The Court pointed out that the SO found she could pay $3,896 per month and stated that it “does not recalculate the taxpayer’s ability to pay or substitute its judgment for that of the SO.”
While the case is just a memo opinion, it has several instructive elements.
First, as the opinion suggests, the IRS does not consider CNC a collection alternative, but will entertain a request for CNC as part of a CDP request. Given the calculation of her ability to pay, she needed to show how the SO made a mistake in its calculation if she had any hope of obtaining CNC status. The Court specifically found that an SO does not abuse his discretion when using the national and local standards to calculate a taxpayer’s ability to pay. Absent some showing of a mistake, which of necessity would need to be a serious mistake given the amount of discretionary income apparently available to the taxpayer, she had no hope of convincing the Court to order the IRS to grant her CNC status.
Second, if the taxpayer requests an installment agreement or OIC as a collection alternative, then the IRS requires the taxpayer to be in “full compliance” with her filing obligations. Treas. Reg. 301.6320-1(d)(2), Q&A-D8; 301-6330-1(d)(2), Q&A-D8. Requiring a taxpayer to fully comply with his or her filing obligations in order to qualify for a collection alternative in a CDP case provides an interesting contrast to the CNC rules. When the Tax Court decided Vinatieri v. Commissioner, Judge Dawson concluded (in the CDP hearing context) that Appeals abused its discretion by denying a taxpayer CNC status when the IRS proposed a levy, based on the fact that the taxpayer was not in compliance. Judge Dawson relied upon Sec. 6343(a)(1) and Treas. Reg. Sec. 301.6343-1(b)(4) to conclude that if a levy were to create an economic hardship then the release of the levy could not be conditioned on the taxpayer’s compliance with filing requirements.
Does this mean that where the OIC is for a minimal amount, because the taxpayer can prove that any levy or installment agreement would create an economic hardship, that the requirement for full filing compliance can stop a taxpayer from obtaining a collection alternative leaving them only with the option of CNC? Stated another way, a taxpayer who can demonstrate any collection action would create hardship should receive a determination that the IRS cannot proceed with the levy even though the IRS reject the OIC or IA due to a lack of compliance. The facts in Doonis did not raise this issue, as the record indicated that the taxpayer could pay $3,896 a month toward the tax debt. Outside of CDP, the IRS would return an offer to a taxpayer not in full compliance. (There seems to be inconsistency from the Centralized OIC unit as to whether substitutes for returns are considered returns for the compliance rule.) Those rules appear to follow a taxpayer into the CDP process. That result creates consistency in the application of the full compliance rules. It shows that CDP does not allow the taxpayer to reach a result she could not have achieved absent CDP, leaving CNC the only avenue for not-fully-compliant taxpayers in economic hardship situations.
Another question Doonis raises, however, is what must a taxpayer do to show that she filed the returns? For pro se taxpayers, this might be difficult. In Eladio Duarte et. ux. v. Commissioner, T.C. Memo. 2014-176 (Aug. 29, 2014), a decision issued shortly after Doonis, Judge Buch remanded the case back to the Appeals office because the record did not clearly reflect whether the taxpayer was in filing compliance. The opinion suggests many missteps by the IRS. First, despite filing a timely CDP hearing request, the IRS levied Mr. Duarte’s funds. Some levies were released, while others were not. Then the Settlement Officer insisted on proof that a tax return was filed for the year 2005, but there did not appear to be any tax debt for 2005. Mr. Duarte provided a copy of the original signed 2005 tax return. This was accepted as evidence of full compliance, a condition precedent to a face-to-face hearing. The first SO assigned to the case agreed that Mr. Duarte submitted a processable OIC and she had all the information she needed from Mr. Duarte. Despite this, no one contacted Mr. Duarte for over a year. Then another SO was assigned to the case. The SO requested a new collection statement, copies of the most recent tax return, and proof that estimated tax payments had been made.
In the intervening time, the representative lost contact with Mr. Duarte after Mr. Duarte moved. The representative sent unsigned copies of personal and business tax returns. The new SO concluded, contrary to the first SO, that Mr. Duarte could fully pay the liabilities and because Mr. Duarte did not provide a signed copy of his personal tax return for the most recent year or proof of estimate tax payments made, the SO rejected the OIC. Often taxpayers cannot afford to have outstanding tax returns prepared. Further, many unsophisticated taxpayers may have no way of calculating business expenses. This may paralyze them from filing a tax return. The upshot will always be a finding by an SO they are not in compliance and the rejection of an OIC. Unrepresented taxpayers may not realize that they can file a return, claiming no business expenses, and add the liability to the OIC. In this case, the Court concluded that the record did not show the basis for rejecting the OIC, including (it appears) whether Mr. Duarte actually filed his return and made the estimated tax payments, and so the Court remanded the case for a further hearing.
The take away from these decisions, in addition to the clear requirement for full compliance in order to obtain a collection alternative, is that a practitioner cannot rely upon the IRS policy of requiring the last six years returns to prove filing compliance for collection alternatives in a CDP case and that the burden of proving that all returns have been filed is on the taxpayer. While the decisions demonstrate consistency in declining to allow a collection alternative, they highlight that the SO a taxpayer draws could have a significant impact on their case as SOs do not display consistency in their approach to the submission of unfiled returns. Had Ms. Doonis drawn a different SO, she might have satisfied that individual with the filing of all of the returns since 2006. Perhaps, the SO deviated from the general rule because Ms. Doonis was a Schedule C taxpayer with a decent amount of income. In Duarte, if the first SO had completed the case, then the later unfiled return might not have been an issue. It would be nice to know what causes such deviations if it is something other than personal preference. If it is only personal preference amongst the SOs, it would be nice to create consistency.