In the Knudsen case decided last month, the Ninth Circuit reversed the Tax Court and determined that the qualified offer submitted by the taxpayer, on which the IRS failed to respond during the 90 period of the offer, formed the basis for determining that the position of the IRS in the case lacked substantial justification. I previously blogged about the Tax Court case here.
The Knudsen issue concerns a loophole to the application of the qualified offer provisions the IRS tried to create in this case and others (see also Estate of Lippitz and Angle v. Comm’r.) The IRS conceded that the petitioner did not owe the liability in Knudsen before the Tax Court reached a decision. It then argued that the concession equated to a settlement of the case. Regulation section 301.7430-7(e)(example 1) provides that a settlement negates a qualified offer. The position of the IRS regarding concession, with which the Tax Court has agreed in the Knudsen case and others, has the effect of barring the beneficial presumption provided to taxpayers making a qualified offer which the IRS did not accept during the 90 day period of the offer. If correct, the IRS position that its concession prior to a Tax Court decision on the merits, allows it to ignore the 90 day period and wait until just before trial (or even after trial) to see how the case goes before conceding a case and avoiding the consequences of the presumption afforded by the qualified offer with respect to attorney’s fees. The 9th Circuit rejected the IRS argument that a concession equals a settlement on the facts presented here. In doing so, it held for the taxpayer in a case argued on the taxpayer’s behalf by students at the Lewis and Clark Low Income Taxpayer Clinic.
read more...Background on Qualified Offers
While Congress created the opportunity for taxpayers to obtain attorney’s fees in cases in which they prevailed in 1982 (see Pub. L. 97-248, title II, section 292(a),) actually obtaining attorney’s fees proved almost impossible because the statute required the taxpayer to show that the IRS position in the case was not substantially justified. (See The United States Tax Court – An Historical Analysis, 2d ed. At p. 502, et seq. for a discussion of the history of the provision.) To address this concern with the statute, in 1998 Congress added subsection 7430(g) creating the qualified offer provisions. A taxpayer making a qualified offer that the IRS does not accept during the 90 day qualified offer period and who prevails in the case achieving a result equal to or better than the amount offered, could overcome the substantially justified provision. This qualified offer provision opens the attorney’s fee spigot in a way that did not exist prior to the statute’s amendment.
Using the qualified offer provision requires that petitioner give careful thought to the correct outcome of the case and tender an offer to the IRS during a specified period. Section 7430(g)(2) requires that the offer must occur during a period “beginning on the date on which the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review of the Internal Revenue Service Office of Appeals is sent, and ending on the date which is 30 days before the date the case is first set for trial.” I have yet to make a qualified offer to Appeals that caused Appeals to do anything special. In fact, Appeals seems unconcerned about the 90 period. Chief Counsel’s office does take note of qualified offers. Their manual (see IRM 34.8.2.10) requires coordination with their National Office. This requirement makes the person submitting the qualified offer slightly unpopular since it complicates handling of the case.
Sometimes, it appears to me that qualified offers may pass the 90 day time period while sitting in Appeals before they reach Counsel. In a small case this can present Counsel with a choice to settle the case for the amount of the qualified offer or risk not only losing the case but incurring attorney’s fees that exceed the amount at issue in the case. I have had Counsel concede the case immediately prior to trial in order to avoid attorney’s fees. Based on the Tax Court’s interpretation of the statute, regulations and meaning of concession, such a tactic protects the IRS from attorney’s fees under the qualified offer provisions even though the 90 day period within which the IRS should have accepted the offer ran long before the concession.
The Loophole and the Knudesn Case
The success of this tactic causes me to label the late hour concession tactic as a loophole in the statute. It defeats one of the major purposes of the qualified offer provision: to foster early resolution of cases. This early resolution is vitally important when representing clients who may have thousands of dollars in refunds (often based on the earned income tax credit) held up pending resolution of a Tax Court matter. Through no fault of their own, many clients who are entitled to the EITC have been unable to prove eligibility during the correspondence audit process. Those individuals are forced to file a petition in Tax Court to resolve the case.
For those of us representing individuals claiming the EITC whose credit – sometimes equaling 33% or more of their annual income – remains frozen throughout the entire audit and litigation process, the hope that the qualified offer provisions would expedite the consideration of the case and the refund of the vitally important funds gets undercut by this tactic. In addition to the burden on the taxpayer, the late resolution of the case puts a burden on the clinic or pro bono attorney representing this taxpayer. While the representation occurs at no charge to the taxpayer, the clinic or pro bono attorney is entitled to compensation pursuant to IRC 7430 if the Tax Court awards attorney’s fees. These fees do not motivate clinics or pro bono attorneys but do compensate them for the time and effort of handling a case.
The Knudsen case, although coming out of a low income taxpayer clinic, did not involve the earned income tax credit but another common issue faced by low income taxpayers – the innocent spouse provisions. Ms. Knudsen had a very sympathetic case. The IRS agreed that she met the statutory qualifications for innocent spouse status; however, her case preceded the withdrawal by the IRS of its regulation requiring claimants under IRC 6105(f) to file their innocent spouse claim within two years after the first time the IRS took collection action. Because no factual dispute existed and the only question for the Tax Court involved the interpretation of the regulation concerning the timing of her request for relief, the parties submitted the case fully stipulated to the Court. Long before the submission of the case fully stipulated, petitioner, through her counsel, had submitted a qualified offer.
The IRS did not accept her qualified offer within the period of the offer because of its litigation position. Its success in three Circuits, despite its loss in the Tax Court in Lantz, gave the IRS reason to believe that its position regarding the regulation limiting the time for claiming relief under IRC 6015(f) not only met but exceeded the substantial justification for its litigating position. (Despite the Circuit court victories, opponents of the regulation would argue that the regulation was wrong from the outset and the concession simply recognized that it never expressed the intention of Congress with respect to 6015(f) relief. The concession of the issue merely recognized reality rather than conceding a matter on which it had prevailed in the courts.) Of course, if the provision of the qualified offer knocked out the analysis of the basis for its position with a statutory determination on the issue, it faced attorney’s fees if it lost.
This was the situation when the IRS voluntarily reversed its position regarding the 6015(f) regulation that imposed a two year limitation on claiming innocent spouse status. With the change of its position in the regulation, the IRS conceded the Knudsen case. It had already agreed she met the statutory requirements for relief and denied relief solely on the basis of its position in the regulation regarding the timing of the request. When the IRS conceded the case, the taxpayer prevailed in a result which exceeded her qualified offer which the IRS did not timely accept. So, she sought attorney’s fees as the prevailing party in a matter in which the IRS lacked substantial justification because of the operation of the qualified offer provisions.
Knudsen: A Satisfactory Result But an Unsatisfying Approach
The Tax Court opinion simply equated concession to settlement and determined that Ms. Knudsen could not take advantage of the provision determining that the IRS lacked substantial justification. It does not discuss how the IRS concession of an issue on which it had prevailed in three circuit courts might have influenced its decision. Similarly, the 9th Circuit does not discuss the unusual nature of the basis for the concession here which could evoke sympathy for the IRS under the circumstances of this case at least with respect to attorney’s fees. Rather, the 9th Circuit makes some broad statements about concessions not equating to settlements before continuing its discussion of the case in a manner that leaves me, at least, less satisfied than I was after reading the first parts of the opinion.
Had the 9th Circuit done a careful analysis of the differences between concession and settlement and had it addressed the purpose of the statute to foster early settlement of cases, I would have come away from the opinion more satisfied. Instead, reading the opinion as a whole you come to a place not unlike the decision in Estate of Lippitz v. Comm’r in which the Tax Court earlier granted attorney’s fees based on the qualified offer provisions after a concession by the IRS following a trial. In other words, Knudsen, despite some broad language at the outset, still has the feel of a fact based determination rather than a legal one and that may mean the IRS will continue to litigate this issue.
Continued litigation of the issue ignores the real benefit that qualified offers present – quick resolution. The failure to quickly resolve Knudsen is understandable because it was part of a larger litigation issue; however, in almost all cases involving low income taxpayers the issues are not so complex that resolution cannot take place within the 90 period if the IRS will turn to the case during that period.
Conclusion
I hope I am wrong in thinking that this issue will continue. If it does, it is an unfortunate result because the position of the IRS, that it can concede a case and avoid the problem of lack of substantial justification, means low income taxpayers seeking frozen refunds (and others seeking an early end to litigation) must wait until the eve of trial or after trial in order to achieve a settlement Congress tried to foster at an early point in litigation.
I could make a good case for the IRS position in Knudsen not having been substantially justified at any time after the Tax Court ruled against the 2-year regulation in Lantz. Thus, the qualified offer exception was not needed.
The IRS always points to the fact that the regulation’s 2-year deadline was upheld by three Circuit courts before the IRS decided not to enforce the deadline. But, that has always been an over-reading of the three Circuit court opinions.
The issue under section 6015 is whether the taxpayer is still liable for the tax shown on a joint return. This liability is of interest to the IRS not for any abstract reason, but for the expectation that the IRS will be paid part or all of this liability by the taxpayer. If you look at the three Circuit court opinions, in none of them did the IRS ever get a single judge to say that the IRS would ever be paid a penny.
First, in Lantz v. Commissioner, 607 F.3d 479 (7th Cir. 2010), Judge Posner, after upholding the regulation, dismissed the effect of his ruling as follows:
Our conclusion that Lantz’s claim for equitable relief was properly rejected is harsh. But it does not leave her remediless. The Treasury provides avenues of relief to taxpayers who would experience hardship from continued pertinacious efforts by the Internal Revenue Service to collect unpaid taxes from them. Of particular relevance to Lantz, given her meager pecuniary resources, section 6343(a)(1)(D) of the Internal Revenue Code authorizes the IRS to “release the levy upon all, or part of, the property or rights to property [of the taxpayer] levied upon if . . . [the IRS] has determined that such levy is creating an economic hardship due to the financial condition of the taxpayer.” And the levy must be released if it “is creating an economic hardship due to the financial condition of an individual taxpayer . . . [by causing the taxpayer] to be unable to pay his or her reasonable basic living expenses.” 26 C.F.R. § 301.6343-1(b)(4). See also Vinatieri v. Commissioner, 133 T.C. No. 16,2009 WL 4980692, at *5-6 (Tax Ct. Dec. 21, 2009) . The Service thus can or, depending on circumstances, must declare the taxes “currently not collectible” and stop levying on a taxpayer’s meager property, though it reserves the right to renew collection efforts should the taxpayer experience a windfall (“winning the lottery” is the conventional example). Internal Revenue Manual § 5.16.1.2.9(10) (May 5, 2009), http://www.irs.gov/irm/part5/irm_05-016-001.html (visited May 8, 2010). Ironically, the Service declared the taxes owed by Lantz’s husband–the crooked dentist–“currently not collectible.” She is entitled a fortiori to such relief, and there is no deadline for seeking it. We can at least hope that the IRS knows better than to try to squeeze water out of a stone. [Id. at 486-87]
Judge Posner showed his ignorance in concluding that because Ms. Lantz’ dead ex-husband was, at one time, put into currently not collectible status while he lived in a post-jail halfway house before he died, she too is entitled to currently not collectible status. That assumption is absurd, since Ms. Lantz had a job of her own at the time of the Tax Court litigation (albeit, a relatively low-paying one). But, you get the idea that Judge Posner’s conscience was salved by his conclusion that the harsh result would not cost the taxpayer a penny.
In Mannella v. Commissioner, 631 F.3d 115 (3d Cir. 2011), while a 2-judge majority of the 3d Cir. upheld the reg. time limit, the court remanded the case to the Tax Court for considering the issue of whether Ms. Mannella could equitably toll the time period because, she alleged, her ex-husband hid from her the NOIL that started the time period running. Id. at 125-26. Since the ex-husband apparently was willing to admit that he hid the NOIL from her, the judges had good grounds to assume that Ms. Mannella would win an equitable tolling argument when the case was tried, so would never pay a penny towards the liability, either.
Finally, in Jones v. Commissioner, 642 F.3d 459 (4th Cir. 2011), while the 4th Cir. also upheld the validity of the regulation’s time period, it remanded the case to consider (as the Tax Court had not had to do) whether Ms. Jones could get section 9100 relief from the time period. Id. at 465. Although, the majority of the Tax Court in Lantz had expressed in dicta its doubts that section 9100 relief was of practical help to the taxpayer; see 132 T.C. at 144 n.10; Judge Halpern, who in dissent said the regulation was valid, argued that section 9100 relief could solve the problem. Id. at 150-52. So, the 4th Cir. had good reason to think that 9100 relief might work to prevent Ms. Jones from ever paying a penny on her liability, also.
Because the remands in Mannella and Jones were pending when the IRS abandoned its enforcement of the regulatory time limit, and assuming that Ms. Lantz (as I was later privately told) paid nothing on the liability before the IRS changed position, the sum of the IRS great victories was that in no case did the IRS collect anything from them. Perhaps these court rulings show that the IRS’ position that Ms. Knudsen should pay money on her joint liabilities was not substantially justified, after all.
Since the case is mine, I feel obligated to correct the Estate of Lippitz decision – the deciding court was the Tax Court. The case was never appealed but had it been, it would have gone to the 7th Cir as the estate was an Illinois “resident”.
IRS Counsel is seldom a “graceful” loser but never more so than when 7430 is in play.
Karen – Thank you for the correction. The reference to the 9th Circuit was an error. My intention was to point out a case in which the post trial aspect of the concession seemed to matter to the court and not the settlement versus concession issue.