Tax Court Inconsistent on Economic Hardship

June 15, 2022 by 2 Comments

Before I embark on a discussion of this innocent spouse case, I want to pause for a brief commercial interlude.  My fellow blogger, Christine Speidel, and my colleague at Harvard, Audrey Patten, have just published, through the ABA Tax Section, the third edition of “A Practitioner’s Guide to Innocent Spouse Relief.”  I read the book and it is excellent.  Here is a link to the ABA announcement about the book which contains a link you could use to purchase it if desired.  Keith

The case of Pocock v. Commissioner, T.C. Memo 2022-55 holds that payment of the tax liability at issue would create an economic hardship for Ms. Pocock.  I agree with the decision in the Pocock case but find it at odds with an earlier TC Memo decision, Sleeth v. Commissioner, my clinic appealed to the 11th Circuit where the Tax Court found in similar circumstances that equity in property precluded a determination of economic hardship. For a discussion of the Sleeth case look here. 

The situation in Pocock and Sleeth arises when a spouse with limited income owns property in which equity exists.  This fact pattern arises with some regularity and a consistent position from the Court would assist in resolving these cases at the administrative stage.  In the typical case, the requesting spouse could sell the property with equity, their home, and satisfy a portion of the outstanding liability; however, selling the house would generally create hardship for the requesting spouse who would then need to move, probably to a rental unit of lesser quality with little or no future prospect of purchasing a home.  The requesting spouse in these cases generally has no ability to extract the equity through borrowing because of low income stream to support loan repayment.  Is it economic hardship to require sale of the home to partially satisfy the outstanding joint liability or should the requesting spouse eliminate their equity in assets before basing their economic hardship request on available income?

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Fascinating Facts

The facts in Pocock interest me and should greatly concern the IRS and the public in general.  Mr. Pocock tried his hand at several income producing activities without success until he settled on an annual scheme of obtaining a six figure income by grossly inflating his withholding credits.  The Court describes in some detail his efforts to produce income the honest way before embarking on a “money brokering business.”  For reasons described in the opinion, the requesting spouse could not get her husband to discuss his business ventures without fear of physical and verbal reprisal.  She learned to avoid the topic.  He also controlled the mailbox cutting off another avenue of information that might have been available to her.

Here’s the Court’s description of his money brokering scheme:

For taxable years 1995 through 2005, Mr. Pocock fraudulently claimed large refunds on his and petitioner’s joint returns by overstating his income and federal income tax withholdings. Because the IRS did not examine or otherwise correct those returns, respondent’s account transcripts for those years show balances of zero.


On the joint returns for 1995 through 2005, Mr. Pocock reported federal income tax and withholding as follows:

Tax year        Filing date    Total tax       Withholding  Overpayment
1995              9/4/1997      $26,593        $80,674        $54,081
1996              9/8/1997      58,768           98,523           39,755
1997              2/3/1999     61,475           172,406         110,931
1998              12/10/1999 56,158           169,968         113,810
1999              5/4/2001      58,745           174,898         116,153
2000              8/29/2002    51,244           194,170         142,926
2001              12/30/2002 55,060           208,836         153,776
2002              1/11/2005    52,803           219,628         166,825
2003              1/14/2005    47,488           184,828         137,340
2004              10/21/2005 35,253           193,627         158,104
2005              1/17/2008    53,435           149,012         95,577


After receiving the above-described joint returns, the IRS issued Mr. Pocock and petitioner the following refund checks comprising the reported overpayments and, for some years, interest:


Tax year        Issue date     Amount
1997              4/30/1999    $112,621
1998              2/13/2000    115,137
2000              9/27/2002    142,926
2001              3/21/2003    153,776
2002              4/8/2005      168,594
2003              4/1/2005      138,243
2004              7/14/2006    166,077
2005              2/15/2008    95,577


Petitioner, who believed that Mr. Pocock was earning periodic commissions from his “money brokering” business, endorsed the refund checks for 1997 and 2004. Occasionally she asked about the status of their tax filings, but he never gave her a clear answer. When he showed petitioner the 2004 refund check, Mr. Pocock explained that it was part of his compensation for the closing of a deal.

I would like to believe that the fraud filters at the IRS work better than Mr. Pocock’s case suggests.  His scheme succeeded for a long time.  Eventually, the IRS caught on but not for three more years.  He essentially got the same amounts of refunds based on overclaiming withholding for 2006 and 2007 before his 2008 return finally caused the IRS computer or someone at the IRS to wake up.

Mr. Pocock then had the chutzpah to file a CDP request regarding the liability triggered as the IRS refused to give him credit for his bogus overpayment claim.  Only 16 years after his scheme started, criminal investigators appeared on his doorstep.  They eventually recommended prosecution of Mr. Pocock but not of petitioner.  The U.S. Attorney’s office declined to prosecute.  A footnote in the opinion suggests the declination resulted from concerns about the statute of limitations.  I wonder if extreme embarrassment over the IRS’s inability to detect the scheme also played a part in the decision.

I apologize for taking you on a long journey through facts that really have nothing to do with the issue causing me to write this post, but I was so fascinated that Mr. Pocock could use a scheme of overclaiming withholding credits for over a decade that I could not help myself from writing about it.  If you have my same voyeuristic tendencies, I recommend reading the 27 page opinion.

Innocent Spouse Claim

Not that it especially matters but it is worth noting that petitioner filed her innocent spouse request almost a decade ago in January of 2013.  By that point the IRS had established liabilities against the couple of almost $500,000 and it could have been higher.  She petitioned the Tax Court in November of 2016 so it only had her case for five and one half years before rendering an opinion.

At the time of the trial, petitioner was 68 years old.  She had total assets of slightly over $190K almost all of which came from equity in her home.  Her monthly income totaled, $1,855 resulting from social security, wages and rental income from Mr. Pocock, her ex-husband, whom she rented space to in the house.  His presence in the house did continue to cause difficulty as discussed below.

She sought relief under IRC 6015(f) and the Court cited the requirements set out in Rev. Proc. 2013-34.  The Court looked to see if she met the threshold requirements for streamlined relief.  The IRS raised concerns about three elements of the bases for relief.  First, it expressed concern about the transfer of assets from Mr. Pocock to petitioner.  After he stole from the estate of his mother, he transferred his interest in their Florida home to petitioner and her mother (a joint owner of the home.)  The Court finds that the transfer did not occur as part of a fraudulent transfer but rather as compensation for damages resulting from his mishandling of the estate case.

Next the IRS raised an objection concerning her knowledge of the scheme.  The Court found her testimony credible that she did not know what he did each year.  The returns looked proper on their face and he had told her the money resulted from his money brokering business.  The Court was also impressed with the testimony regarding why petitioner would not question him about finances.  As a result, the Court finds she had no knowledge of the overstated withholding and no reason to know the returns were incorrect.

Lastly, the Court found the liabilities resulted from Mr. Pocock’s actions and not hers meaning that the liabilities all met the test of resulting from items attributable to the non-requesting spouse.

The Court then turned its attention to the elements of a streamlined determination.

The requesting spouse is eligible for a streamlined determination by the Commissioner only in cases in which the requesting spouse establishes that she (1) is no longer married to the nonrequesting spouse (marital status requirement), (2) would suffer economic hardship if not granted relief (economic hardship requirement), and (3) did not know or have reason to know that the nonrequesting spouse would not or could not pay the underpayment of tax reported on the joint income tax return, or did not know or have reason to know that there was an understatement or deficiency on the joint income tax return (lack of knowledge requirement). The requesting spouse must establish that she satisfies each of the three elements to receive a streamlined determination granting relief. 

The IRS challenged the marital status element because they still lived in the same house; however, the Court determined that they had become roommates.  The Court did not find that the divorce served as a ruse.

The IRS challenged the economic hardship element because she had substantial equity in the house.  The Court finds:

we doubt petitioner could access the equity in the property without selling it. The record includes a statement of credit denial from a credit union, and petitioner credibly testified that her work prospects were diminishing on account of physical ailments. Given these circumstances, we do not believe petitioner could liquidate her assets to make even a partial payment of the liabilities and still meet her reasonable basic living expenses. She therefore satisfies the second prong of the economic hardship test.

Almost identical facts to Sleeth and the opposite result.  Ms. Sleeth had even less income and no real work history.  She was also in her 60s.  Maybe the Court in Pocock was influenced by a concession by the IRS and maybe the inconsistency is in the approach of the IRS and not the Court.  In footnote 20 the Court states:

Respondent does not contend that petitioner could sell the home and still meet her reasonable basic living expenses. To the contrary, respondent states on brief: “Respondent is not arguing that petitioner should have to sell the home in order to pay the tax liability.”

She did put on evidence that should could not borrow on the equity in the house because she did not have the income to support repayment of any loan.

Finally, the Court looks again at knowledge and determines that she did not have knowledge of the scheme.  It states that Mr. Pocock had proved to petitioner that he was untrustworthy putting her on constructive notice warranting an inquiry by her.  Because he became violent when questioned about finances, her failure to question him in this situation is excused based on the totality of the circumstances.

Conclusion

As a result, the Court determines she qualifies for streamlined relief.  As I mentioned at the outset, I agree with the opinion but find the result here with respect to economic hardship difficult to square with at least one prior opinion from the Court.  Because of the importance of that issue in innocent spouse cases, it deserves more attention at the IRS and the Court.

Filed Under: Economic Hardship, Innocent Spouse, Tax Court

A Beneficial Effect of Inflation

April 28, 2022 by 1 Comment

The IRS increased the Collection Financial Standards on April 25, 2022. The increases reflect that we have entered a period of inflation, as the amounts have not increased by this much in a very long time.

The percentage increases between 2021 and 2022 are significantly higher than they were between 2020 and 2021 for all categories, but the biggest percentage increases were in the “Out of Pocket Health Care” and “Public Transportation” categories. 

These standards can be used in IRS collection-related matters, such requesting currently non-collectable status or an offer in compromise. Important related note: The offer in compromise booklet was also updated this month. The IRS website states that the new forms must be used if you apply for an OIC on April 25, 2022 or later.

Some of the standards can be used with no questions asked, while others serve as a ceiling (i.e. the amount that can be used is the “lesser of” the standard or what the taxpayer actually spends). For certain (and arguably, all) categories, amounts in excess of the standards are allowed if the taxpayer provides a good reason and proof.

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All of the current standard amounts are available here: IRS Collection Financial Standards.

Here are is a sampling of the changes (based on a household of one):

“No questions asked” amounts:

  • Food, Clothing, Other Items: New standard is $785, which is a 9% increase from the 2021 amount of $723. Compared to a 1% increase between the 2020 amount of $715 and 2021.
  • Public Transportation: New standard is $242, which is a 12% increase from the 2021 amount of $217. Compared to a 3% decrease between the 2020 amount of $224 and 2021.

This decrease corresponds with a more substantial increase in vehicle operating costs during the same period, and likely relates to the decreased use of public transportation during the early days of the pandemic.

“No questions asked” or “higher allowed with proof” amounts:

  • Out of Pocket Health Care under 65: New standard is $75, which is a 34% increase from the 2021 amount of $56. Compared to a 0% increase between 2020 and 2021, and a 2% increase between the 2019 amount of $55 and 2021.
  • Out of pocket health care 65 and older: New standard is $153, which is a 22% increase from the 2021 amount of $125. Compared to a 0% increase between 2020 and 2021, and a 10% increase between the 2019 amount of $114 and 2021.

“Ceiling standard” amounts (though, worth arguing for more if circumstances warrant it):

  • Vehicle Ownership Costs: New standard is $588, which is a 10% increase from the 2021 amount of $533. Compared to a 2% increase between the 2020 amount of $521 and 2021.

Local Standards such as “Vehicle Operating Costs” and “Housing and Utilities” also saw increases, although the percentage increases varied based on locality. For example:

  • Housing and Utilities (for the top three largest counties):
    • Los Angeles County (California): New standard is $2,544, which is a 7% increase from the 2021 amount of $2,367. Compared to a 1% increase between the 2020 amount of $2,335 and 2021.
    • Cook County (Illinois): New standard is $2,036, which is an 8% increase from the 2021 amount of $1,882. Compared to a 1% increase between the 2020 amount of $1,858 and 2021.
    • Harris County (Texas): New standard is $1,774, which is a 9% increase from the 2021 amount of $1,633. Compared to a 1% increase between the 2020 amount of $1,610 and 2021.

The standards are derived from various sources, such as the Bureau of Labor Statistics Consumer Expenditure Survey, Medical Expenditure Panel Survey, U.S. Census Bureau, and American Community Survey. There are at least two oddities that carry over from the previous numbers, the amount for housekeeping supplies and personal care products are less for a household of three than they are for a household of two.

Finally, the federal poverty limit was also increased earlier this year: 250% of FPL for a household of one is now $33,975, which is a 5% increase from the 2021 amount of $32,200. Compared with a 1% increase between the 2020 amount of $31,900 and 2021.

Filed Under: ACS, Collection policy, Economic Hardship, Offer in Compromise

Discharging Student Loan Debt

February 8, 2022 by 1 Comment

The Department of Education (DOE) recently lost a motion for reconsideration of a bankruptcy court decision involving the discharge of student loan debt.  The case is almost a purely bankruptcy matter having no real tax aspect to it, but because the bankruptcy court talks about what will happen to the debt upon its forgiveness, viz., taxable income under IRC 61, the case got picked up in the tax press and caught my eye.  If you have ever been curious about why students can almost never get rid of student loan debt, you may find this rare case in which a former student succeeds in getting past the exception to discharge interesting.  If you are looking to learn something about taxes or tax procedure, read no further.

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In Wheat v. Great Lakes Higher Education Corp, No. 18-03041 (M.D. Ala. 2022) the bankruptcy court issues an opinion explaining its earlier opinion granting Ms. Wheat a discharge.  DOE brought this motion for reconsideration because it felt that the bankruptcy court had failed to follow the applicable precedent for determining if a debtor could discharge student loan debt under the exception to discharge provided in B.C. 523(a)(8).  In the end, the bankruptcy court sustains its prior decision and provides more explanation for the reasons behind its decision.  This outcome happens frequently, as discussed in an earlier blog post on motions for reconsideration and presents a real hazard for parties who file this particular motion.  In effect, the bankruptcy court has received and taken the opportunity to write a reply to DOE’s opening brief on appeal.

The court outlines what it should consider in such a motion:

A motion to reconsider, alter, or amend a judgment, if filed within 14 days of the judgment, is governed by Federal Rule of Bankruptcy Procedure 9023, which incorporates Rule 59 of the Federal Rules of Civil Procedure. To warrant reconsideration, a motion must establish one of the following applies:

1. An intervening change in the law,

2. Consideration of newly discovered evidence, or

3. To correct clear error or prevent manifest injustice.

With this test in mind, the court explores its earlier decision and the concerns raised by DOE, which in this case plays the role of Inspector Jobert made famous in Les Miserables.

Ms. Wheat had filed a chapter 7 bankruptcy and received a discharge under B.C. 727.  That discharge rids her of her pre-petition debts; however, certain pre-petition debts are excepted from the discharge.  The excepted debts are described in B.C. 523, which applies to almost all individual bankruptcy cases.  Most often on this blog we discuss the exception in B.C. 523(a)(1) which excepts certain pre-petition tax debts or B.C. 523(a)(7) which excepts certain penalties, but there are 18 subparagraphs under 523(a) and individual debtors must consider all of them in calculating the impact of their discharge.

Debtors seeking to discharge student loan debt must meet the requirements to overcome the statutory exception to discharge for student loan debts.  The case of In re Brunner, 46 B.R. 752 (S.D.N.Y. 1985), aff’d, 831 F.2d 395 (2d Cir.1987) (per curiam) is the leading case here and the 11th Circuit adopted the Brunner test in In re Cox, 338 F.3d 1238 (11th Cir. 2003).

Under the Brunner test, a debtor must prove, by a preponderance of the evidence, the following components:

(1) That the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans,

(2) That additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans, and

(3) That the debtor has made good faith efforts to repay the loans.

The bankruptcy court recounts the financial and family circumstances of Ms. Wheat.  As a single mom with three children, ages 8-12, including one with special medical needs and as a daughter whose mom had significant medical needs, Ms. Wheat faces significant challenges.  Those challenges cause the calculation for her repayment amount on the student loan to be $0 at the time of the bankruptcy case.  DOE has concerns because many individuals with student loans have financial hardship, yet it wants to argue under the second prong of the test that the borrower will not necessarily face these hardships throughout the entire life of the repayment period.  Children grow up, people get better jobs, circumstances change, and DOE did not feel the bankruptcy court recognized these possibilities in applying the Brunner test.

DOE wants the bankruptcy court to apply the “certainty of hopelessness” standard some courts have adopted, essentially putting the burden on the debtor to show that there is no hope their finances will improve during the life of the repayment.  An example of someone who could meet this standard would be someone with an irreversible medical condition that kept them from working for the rest of their life.  The bankruptcy court responds that DOE’s interpretation of the rule would “swallow the rule” and make it essentially impossible for any debtor to meet the second prong of the Brunner test.  I think the court accurately describes DOE’s interpretation, which is why it is so hard to discharge student debt and why DOE has concerns about the Wheat case.  The court finds, however, that Ms. Wheat’s dire financial situation is likely to continue for so long that the realistic chances she will have the ability to repay the loan are minimal.

In its original decision the bankruptcy court referred to the tax debt that can replace the student loan debt upon forgiveness if the forgiveness triggers cancellation of debt income.  It hypothesizes that she could possibly discharge the debt after 25 years using the Income Driven Repayment Plan adopted during the Obama years.  The court points out that its discussion of her forgiveness under this plan and the possible tax consequences flowing from it did not form the exclusive basis for its decision.  It merely acknowledged the size of her potential tax bill if she paid nothing further on the loan and discharged it at the conclusion of the 25-year period.

Finally, the court addressed DOE’s argument that the discharge exception should apply in all but the most severe circumstances.  It finds this policy-based argument to go too far and spends more time detailing her dire financial circumstances, her family circumstances, and her work ethic.  It also explains why her circumstances will likely persist for a significant portion of the repayment period.  The court rejects DOE’s argument that Ms. Wheat’s children should start helping her pay the student loan when they reach the age of majority.

The test for discharging student loan debt applied here suggests a loosening of the rules, though not a major one.  Ms. Wheat is clearly struggling.  If you read cases applying the Brunner test, you understand why discharging student loan debt is so difficult.  The fact that DOE fights so hard in this case further brings that point home.  While her tax debt, if she ultimately has one, will create another debt excepted from discharge, B.C. 523(a)(1) allows the discharge of the tax debt once it ages out after three years.  The student loan provision for discharge has no similar mechanism for aging out the debt, requiring student loan borrowers to continue paying, or at least being billed for, the debt forever unless they qualify for the 10 and 25-year relief provisions passed during the Obama administration.  That’s why there is so much pressure being brought to bear on the current administration to provide relief from student debt.  Because of issues of fairness and equity, providing blanket relief will be difficult.

Filed Under: Bankruptcy, Cancellation of Debt, Economic Hardship

10th Circuit Affirms That Nursing Homes and Other Entities Lack Protection from Levy for Hardship

September 15, 2021 by Leave a Comment

In 2017, the Tax Court issued rulings in several cases regarding the application of IRC 6343(a)(1) to entities.  The lead case was Lindsay Manor Nursing Home, Inc. v. Commissioner, 148 T.C. No. 9 (2017).  I blogged about the group of cases here in a post with a catchy tag line about rolling the wheelchairs and beds to the curb.  Lindsay Manor appealed the decision.  I wrote about the outcome of that appeal which basically vacated the decision because Lindsay Manor was in receivership at the time of the Tax Court’s decision.

Now, another nursing home in the same group of cases, Seminole Nursing Home, Inc., has made its way to the 10th Circuit after being told in the Tax Court that it did not qualify for hardship.  The 10th Circuit decision upholds the decision of the Tax Court and the validity of the Treas. Reg. 301.6343-1(b)(4)(i).  I don’t know if the nursing home has been keeping itself open in the four years since the Tax Court decision, but now it must either succeed in getting the Supreme Court to hear the case, pay the outstanding tax, work out some form of payment agreement or, potentially, watch the IRS shut it down.

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This case came to the Tax Court as a Collection Due Process case.  IRS Appeals rejected Seminole’s offer of an installment agreement prior to the Tax Court case, stating:

Seminole had sufficient assets to pay its tax debt in full; and (2) it was ineligible for an installment agreement because it had not made all its required federal tax deposits for 2014. The Office also rejected Seminole’s economic-hardship argument, explaining that Treasury Regulation § 301.6343-1(b)(4) limits economic-hardship relief to individual taxpayers. And it determined that “[i]n balancing the least intrusive method of collection with the need to efficiently administer the tax laws and the collection of revenue, . . . the balance favors issuance of the levy, and is no more intrusive than necessary.”

The 10th Circuit engaged in a Chevron analysis to determine if the regulation appropriately interpreted the statute.  Seminole argued that the Code provides an unambiguous answer at step one, citing to IRC 7701(a)(14) for support that entities are persons under the IRC.  That section defines person to include “an individual, a trust, estate, partnership, association, company or corporation.”  Seminole also pointed out that IRC 6343(a)(1)(D) makes no distinction between individual and corporate taxpayers.

While the language of the definitional provision in IRC 7701 appears favorable to Seminole’s argument, the 10th Circuit notes that the preface to the definitions says they apply “[w]hen used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof.”  It finds that the use of the word taxpayer elsewhere in the Code makes clear the word can be limited to individuals.  It says that corporations can experience economic hardship, citing an earlier case in which it made such a holding, but looking at the exemptions to levy in IRC 6343, it finds they all essentially apply to individuals and not to entities. 

The court finds it important that Seminole did not attempt to show what economic hardship for entities would look like.  It also noted that no one commenting on the regulation suggested the result for which Seminole argues.  Looking at the situation as a whole, it decides that the statute does not compel a result, leaving the Treasury free to apply its expertise in writing a regulation.

Seminole did not make the argument about disqualification of the Settlement Officer for looking at the file before the hearing that was made in the companion case of Lindsay Manor, but it did make a second argument using the reversal of the Lindsay Manor case as a basis for arguing the underlying Tax Court decision in its case lost its foundation upon the vacating of the Tax Court’s decision in Lindsay Manor for mootness.  The 10th Circuit says, however, that it did not vacate Lindsay Manor on the merits but only because of mootness at the time of the Tax Court’s ruling.  It finds that the adoption of the reasoning of Lindsay Manor to the facts of Seminole did not create an abuse of discretion.

The Seminole case fills the hole created by the mootness of Lindsay Manor.  While the outcome does not provide a surprise, this is a major victory for the IRS regarding the interpretation of the statute.  This doesn’t mean there will not be further challenges in other circuits.  The decision does, however, provide the kind of support that will greatly assist the IRS should those challenges arise.

Limiting economic hardship to individuals seems consistent with the statutory scheme of the levy provisions.  Because of the hardship that closing down a nursing home could create for the individuals living there, nursing home cases provide one of the best litigating vehicles for challenging the limits created by the regulation.  Still, the hardship is directly the hardship of the entity and not of the individuals who reside at the facility.  The situation becomes very sympathetic if the economic hardship experienced by the entity results from government delays.  Other cases have addressed the imposition of the trust fund recovery penalty upon nursing home operators who could not make the necessary tax payments because of significant delays in Medicare payments.  If the cause of the hardship is another part of the government, courts should look for ways to mitigate the taxpayer’s problem even where the taxpayer is an entity but limiting the concept of hardship to individuals generally seems appropriate.  It’s hard to say the 10th Circuit was wrong in upholding the regulation as a reasonable interpretation of the statute.

Filed Under: Economic Hardship, Installment Agreement, Levy