I am looking at an offer in compromise (OIC) case.
These cases are almost futile for a taxpayer, as the
Tax Court extends broad deference to the IRS in its analysis of and
determinations on OICs. To win requires one to show that the IRS acted in bad
faith.
COMMENT: I have soured on OICs as the years have gone by. Those commercials for “pennies on the dollar” stir unreasonable expectations and do not help. OICs are designed for people who have experienced a reversal of fortune - illness, unemployment, disability, or whatnot – which affect their ability to pay their taxes. It is not meant for someone who is irresponsible or inexplicably unfettered by decency or the responsibilities of the human condition. Not too long ago, for example, one of the clients wanted us to pursue an OIC, as he has racked up impressive tax debt but has no cash. I refused to be involved. Why? Because his cash is going to construct a $2-plus million dollar home. I am very pro-taxpayer, but this is not that. Were it up to me, we would fire him as a client.
Let’s look at the Whittaker case.
Mr. W is a veteran and was a self-employed personal
trainer. Mrs. W worked in a local school district and had a side gig as a mall security
guard. They were also very close to retirement.
The Ws owed everybody, it seems: a mortgage, student
loans, the IRS, the state of Minnesota and so on.
In 2018 the IRS sent a notice of intent to levy.
The Ws requested a collection due process (CDP) hearing.
COMMENT: The Ws were represented by the University of Minnesota tax clinic, giving students a chance to represent clients before the IRS and courts.
The IRS of course wanted numbers: the Form 433
paperwork detailing income, expenses, assets, debt and so forth.
The Ws owed the IRS approximately $33 grand. The clinic
calculated their reasonable collection potential as $1,629. They submitted a
20% payment of $325.80, per the rules, along with their OIC.
In the offer, the Ws stressed that their age and
difficult financial situation meant that soon they would have to rely on
retirement savings as a source of income rather than as a nest egg. Their house
was in disrepair and had an unusual mortgage, meaning that it was extremely unlikely
it could be refinanced to free up cash.
The IRS has a unit - the Centralized Offer in
Compromise unit – that stepped in next. Someone at the unit calculated the Ws’
RCP as $250,000, which is wildly different from $1,629. The unit spoke with representatives
at the clinic about the bad news. The clinic in turn emphasized special
circumstances that the Ws brought to the table.
That impasse transferred the OIC file to Appeals.
It was now March 2020.
Remember what happened in March 2020?
COVID.
The two sides finally spoke in September.
Appeals agreed with an RCP of $250 grand. The Settlement
Officer (SO) figured that the Ws could draw retirement monies to pay-off the
IRS.
Meanwhile Mr. W had retired and Mrs. W was gigging at
the mall only two weekends a month.
The SO was not changing her mind. She figured that Mrs.
W must have a pension from the school. She also surmised that Mr. W’s military
pension must be $2,253 per month rather than $1,394. How did she know all this?
Magic, I guess.
The W’s argued that they could not borrow against the
house. They had refinanced it under something called the Home Affordability
Refinance Program, which helps homeowners owing more than their house is worth.
A ballon payment was due in 2034, and refinancing a house that is underwater is
nearly impossible.
This did not concern the SO. She saw an assessed value
of $243,000 on the internet, subtracted an $85 thousand mortgage, which left plenty
of cash. The W’s pointed out that there was deferred maintenance on the house –
a LOT of deferred maintenance. Between the impossible mortgage and the deferred
maintenance, the house should be valued – they argued – at zero.
Nope, said the SO. The Ws could access their retirement
to pay the tax. They did not have to involve the house, so the mortgage and
deferred maintenance was a nonfactor. She then cautioned the W’s not to withdraw
retirement monies for any reason other than the IRS. If they did so, she would consider
the assets as “dissipated.” That is a bad thing.
Off to Tax Court they went. Remember my comment
earlier: low chance of success. What choice did the Ws have? At least they were
well represented by the tax clinic.
The Court saw three key issues.
Retirement Account
The W’s led off with a great argument:
This is Internal Revenue Manual 5.8.5.10, which states
that a taxpayer within one year of retirement may have his/her retirement
account(s) treated as income rather than as an asset. This is critical, as it
means the IRS should not force someone to empty their 401(k) to pay off
tax debt.
The SO was unmoved. The IRM says that the IRS “may” but
does not say “must.”
Yep, that is the warm and fuzzy we expect from the IRS.
The Court acknowledged:
We see no erroneous view of the law and no clearly erroneous assessment of facts.”
But the Court was not pleased with the IRS:
But there may be a problem for the Commissioner – this reasoning didn’t make it into the notice of determination …”
The “notice of determination” comment is the Court
saying the files were sloppy. The IRS must do certain things in a certain order,
especially with OICs. Sloppy won’t cut it.
Home Equity
The W’s had offered to provide additional information
on the loan terms, the deferred repairs to the house, the unwillingness of the
banks to refinance.
The IRS worked from assessed values.
It is like the two were talking past each other.
Here is the Court:
The IRS does need to take problems with possible refinancing a home seriously.”
The Whittakers have a point – there’s nothing in the administrative record that states or even suggests that the examiner at the Unit or the settlement officer during the CDP hearing asked for any information in addition to the appraised value.”
There is no evidence in the record of any consideration of the Whittakers’ arguments on this point.”
Oh, oh.
Here is the first slam:
We therefore find that the settlement officer’s conclusion about the Whittaker’s ability to tap the equity in their home was clearly erroneous on this record. This makes her reliance on that equity in her RCP calculations an abuse of discretion.”
COVID
The W’s had alerted the IRS that Mr. W had completely
retired and Mrs. W was working only two weekends a month. The SO disregarded
the matter, reasoning that the W’s had enough pension income to compensate.
Which pension, you ask? Would that include the pension
the SO unilaterally increased from $1,394 to $2,253 monthly?
The Commissioner now concedes that the settlement officer was mistaken, and that Mr. Whittaker had a military pension of only $1,394 per month.”
Oops.
There was the second slam.
The IRS – perhaps embarrassed – went on to note that
the Mall of America opened after being COVID-closed for three months. Speaking
of COVID, the lockdown had inspired a nationwide surge in demand for fitness
equipment. Say …, wasn’t Mr. W a personal fitness trainer?
The Court erupted:
Upholding the rejection of the Whittakers’ offer because Mrs. Whittaker’s mall job may have resumed or Mr. Whittaker might be able to run a training business using potential clients’ possible pandemic purchases is entirely speculative.”
True that.
The settlement officer ‘did not think that the loss of the Whittaker’s wage income or self-employment income … sufficiently mattered to justify reworking the Offer Worksheet.’”
The Court was getting heated.
The settlement officer’s explicit refusal to rework the worksheet despite the very considerable discrepancy in the calculation before and after the pandemic is a clear error and thus an abuse of discretion.”
The Court remanded the matter back to IRS Appeals with
clear instructions to get it right. It explicitly told the IRS to consider the material
change in the Ws’ circumstances – changes that happened during the CDP
hearing itself - and their ability to pay.
We said earlier “almost futile.” We did not say
futile. The Ws won and are headed back to IRS Appeals to revisit the OIC.
Our case this time was Whittaker v Commissioner,
T.C. Memo 2023-59.
