IRS Gets Called Out In Offer In Compromise Case

 

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.

Talking Frankly About Offers In Compromise

I am reading a case involving an offer in compromise (OIC).

In general, I have become disinclined to do OIC work.

And no, it is not just a matter of being paid. I will accept discounted or pro bono work if someone’s story moves me. I recently represented a woman who immigrated from Thailand several years ago to marry an American. She filed a joint tax return for her first married year, and – sure enough – the IRS came after her when her husband filed bankruptcy. When we met, her English was still shaky, at best. She wanted to return to Thailand but wanted to resolve her tax issue first. She was terrified.   

I was upset that the IRS went after an immigrant for her first year filing U.S. taxes ever, who had limited command of the language, who was mostly unable to work because of long-term health complications and who was experiencing visible - even to me - stress-related issues.

Yes, we got her innocent spouse status. She has since returned to Thailand.

Back to offers in compromise.

There are two main reasons why I shy from OIC’s:

(1) I cannot get you pennies-on-the-dollar.

You know what I am taking about: those late-night radio or television commercials.

Do not get me wrong: it can happen. Take someone who has his/her earning power greatly reduced, say by an accident. Add in an older person, meaning fewer earning years remaining, and one might get to pennies on the dollar.

I do not get those clients.

I was talking with someone this past week who wants me to represent his OIC. He used to own a logistics business, but the business went bust and he left considerable debt in his wake. He is now working for someone else.

Facts: he is still young; he is making decent money; he has years of earning power left.

Question: Can he get an OIC?

Answer: I think there is a good chance, as his overall earning power is down.

Can he get pennies on the dollar?

He is still young; he is making decent money; he has years of earning power left. How do you think the IRS will view that request?

(2) The multi-year commitment to an OIC.

When you get into a payment plan with the IRS, there is an expectation that you will improve your tax compliance. The IRS has dual goals when it makes a deal:

(a)  Collect what it can (of course), and

(b)  Get you back into the tax system.

Get into an OIC and the IRS expects you to stay out of trouble for 5 years. 

So, if you are self-employed the IRS will expect you to make quarterly estimates. If you routinely owe, it will want you to increase your withholding so that you don’t owe. That is your end of the deal.

I have lost count of the clients over the years who did not hold-up their end of the deal.  I remember one who swung by Galactic Command to lament how he could not continue his IRS payment plan and then asked me to step outside to see his new car.

Folks, there is little to nothing that a tax advisor can do for you in that situation. It is frustrating and – frankly – a waste of time.

Let’s look at someone who tried to run the five-year gauntlet.

Ed and Cynthia Sadjadi wound up owing for 2008, 2009, 2010, and 2011.

They got an installment plan.

Then they flipped it to an OIC.

COMMENT: What is the difference? In a vanilla installment plan, you pay back the full amount of taxes. Perhaps the IRS cuts you some slack with penalties, but they are looking to recoup 100% of the taxes. In an OIC, the IRS is acknowledging that they will not get 100% of the taxes.

The Sadjadis were good until they filed their 2015 tax return. They then owed tax.

The reasoned that they had paid-off the vast majority if not all of their 2008 through 2011 taxes. They lived-up to their end of the deal. They now needed a new payment plan.

Makes sense, right?

And what does sense have to do with taxes?

The Court reminded them of what they signed way back when:

I will file tax returns and pay the required taxes for the five-year period beginning with the date and acceptance of this offer.

The IRS will not remove the original amount of my tax debt from its records until I have met all the terms and conditions of this offer.

If I fail to meet any of the terms of this offer, the IRS may levy or sue me to collect …..

The Court was short and sweet. What part of “five-year period” did the Sadjadis not understand?

Those taxes that the IRS wrote-off with the OIC?

Bam! They are back.

Yep. That is how it works.

Our case this time was Sadjadi v Commissioner, T.C. Memo 2019-58.

Having Assets And Filing An Offer In Compromise

I glanced at the case because it involved an offer in compromise, a collections hearing, a lien and currently noncollectible (CNC) status.

That is a lot going on for approximately $23 grand in tax debt.

First thing I noticed was that the taxpayer represented himself before the Tax Court. This is referred to as “pro se.” It happens quite a bit, and it usually does not work out well for the taxpayer.

I double-shudder when I think about “pro se” and going hard procedural with the IRS, such as with liens and offers in compromise.

Let’s walk through it:

(1) On November 16, 2016 the taxpayer filed an Offer in Compromise. The tax was approximately $23 grand. He offered approximately $12 grand.

COMMENT: There are several “flavors” of Offers in Compromise. This one was the traditional vanilla: inability to pay or to pay in full. Those late-night commercials are hawking this type.

(2) On May 30, 2017 the IRS sent a Notice of Federal Tax Lien Filing.

The taxpayer filed for a hearing, called a Collection Due Process (CDP) hearing. I probably would have done the same.

(3) On July 11, 2017 the IRS indicated it would not accept the Offer in Compromise, at least as submitted. 

Taxpayer appealed. Again, I probably would have done the same.

(4) On September 27, 2017 the IRS settlement officer sent taxpayer a letter that the CDP hearing was being delayed until the Offer in Compromise was resolved.

COMMENT: Left hand: right hand. Happens all the time.

(5) Wouldn’t you know that the appeal of the Offer in Compromise was assigned to the same IRS settlement officer handling the Collections hearing?

(6) The IRS scheduled a telephone hearing for December 14, 2017. The settlement officer also offered to place the taxpayer’s case in currently noncollectible (CNC) status.

COMMENT: I have used CNC status over the years, especially during and after the Great Recession of 2008. The IRS realizes that there is no money to collect, so it places the case on hold, generally for a year or so. Their normal collections machinery is paused.

Mind you, the IRS is not writing-off the debt. They are allowing a break in collection activity, hoping your situation improves.

(7) Not waiting until the hearing, taxpayer on December 1 sent the settlement officer a letter addressing the rejection of his offer in compromise.

COMMENT. He should include additional or expanded financial information, as his offer was based on inability to pay. The common-sense response to rejection of an offer based on inability to pay is to expand on why one is unable to pay.

Having taken the stage, taxpayer also alleged that the IRS engaged in criminal activity.

COMMENT: Stop that. You are not winning with that behavior.

The settlement officer rescheduled the hearing for January 9th.

(8)  On December 12 taxpayer sent the settlement officer another letter lamenting the rejection of his offer in compromise.

COMMENT: Once again: no additional or expanded financial information. This action was fruitless and ill-advised.

(9) We finally get to the hearing. The settlement officer reviewed the offer in compromise. She sees debt of approximately $23 grand and assets of approximately $110 grand. Receiving no additional or expanded financial information from the taxpayer, the officer decided that rejection of the offer was appropriate.

(10) After the hearing taxpayer sent a letter to the settlement officer, complaining about the IRS Fresh Start Program and including correspondence the taxpayer previously exchanged with the Taxpayer Advocate Service.

Taxpayer was focused on the lien and highlighted a TAS letter including the statement “the IRS has determined that the lien should be withdrawn.”

He wanted the lien withdrawn.

The settlement officer, to her credit, looked into this. It did not change the outcome, but she did try.

The immediate takeaway is the someone with $100-plus grand in assets is probably not going to be able to offer-down $23 grand in tax debt, irrespective of having low income. While true as a generalization, there are several specific considerations.

(1)  Given his focus on removing an IRS lien, I presume that taxpayer’s house comprised most if not all of taxpayer’s assets. I can see not wanting to refinance when one has limited income. In truth, one probably could not refinance, as no traditional mortgage provider would originate the loan.

a.     And there is how I would respond to the request for additional financial information: by providing rejection letters from a couple of mortgage companies.

(2)  Let’s say that the house is not the lion’s share of the assets. Perhaps it is something else, like a retirement account.

a.     If a retirement account, I would argue economic hardship.

                                                                         i.      That is, taxpayer needs that asset and the income therefrom in order to meet reasonable basic living expenses. The loss of said asset would be an economic hardship.

                                                                      ii.      It is already stipulated that the taxpayer is low income. How hard of an argument is this?

(3)  In general, I am unmoved by the IRS filing a lien.

a.     I may be moved if disclosure of said lien would adversely affect one’s career or public status (a mayor or judge, for example), but those instances are few and far between.

b.     Distinguish a lien from a levy.

                                                                         i.      A lien just secures the government’s interest. A lien on my house cannot be collected until I sell the house.

                                                                      ii.      A levy is a different matter. The IRS going into your bank account is an example of a levy.

(4)  Let’s circle back to the presumption that taxpayer’s residence represented the majority of his assets, hence his focus on removing the lien. The IRS just bounced his offer. What happens next?

a.     Folks, the IRS cannot (barring exceptional circumstances) take one’s primary residence.

b.     Yep, he will get periodic and annoying IRS correspondence, but …

c.     … so what? There is little bite left in that dog.

d.     And after 10 years (without the IRS taking the matter to Court to obtain judgement), the statute of limitations will kick-in.

You can see the downside to a pro se, especially when dealing with IRS procedure. There is a lot going on here, and I suspect that – with professional advice – taxpayer could have gotten the offer. I doubt he would have gotten the lien released, though. He saved a few grand in professional fees in order to completely strike out with the IRS.

The case for the home gamers is Banks, TC Memo 2019-166.