Memphian Appeals An Offer In Compromise

I am looking at a case dealing with an offer in compromise.

You know these from the late-night television and radio advertisements to “settle your IRS debts for pennies on the dollar.”

Yeah, right.

If it were so easy, I would use it myself.

Don’t get me wrong, there are fact patterns where you probably could settle for pennies on the dollar. Unfortunately, these fact patterns tend to involve permanent injury, loss of earning power, a debilitating illness or something similar.

I will just pay my dollar on the dollar, thank you.

What caught my attention is that the case involves a Memphian and was tried in Memphis, Tennessee. I have an interest in Memphis these days.

Let’s set it up.

Taxpayer filed tax returns for 2012 through 2014 but did not pay the full amount of tax due, which was about $40 grand. A big chunk of tax was for 2014, when he withdrew almost $90,000 from his retirement account.

Why did he do this?

He was sending his kids to a private high school.

I get it. I cannot tell you how many times I have heard from Memphians that one simply cannot send their kids to a public school, unless one lives in the suburbs.

In December, 2016 he received a letter from the IRS that they were going to lien.

He put the brakes on that by requesting a Collection Due Process (CDP) hearing.

Well done.

In January he sent an installment agreement to the IRS requesting payments of $300 per month until both sides could arrive at a settlement.

The following month (February) he submitted an Offer in Compromise (OIC) for $1,500.

That went to a hearing in April. The IRS transferred the OIC request to the appropriate unit.

In late August the IRS denied the OIC.

Let’s talk about an OIC for a moment. I am thinking about a full post (or two) about OICs in the future, but let’s hit a couple of high spots right now.

The IRS takes a look at a couple of things when reviewing an OIC:

(1)  Your net worth, defined as the value of assets less any liabilities thereon.

There are certain arcane rules. For example, the IRS will probably allow you to use 80% of an asset’s otherwise fair market value. The reason is that it is considered a forced sale, meaning that you might accept a lower price than otherwise.

(2) Your earning power

This is where those late-night IRS settlement mills dwell. Have no earning power and near-zero net worth and you get pennies on the dollar.

There are twists here. For example, the IRS is probably not going to spot you a monthly Lexus payment. That is not how it works. The IRS provides tables for certain categories of living expenses, and that is the number you use when calculating how much you have “left over” to pay the IRS.

Let’s elaborate what the above means. If the IRS spots you a lower amount than you are actually spending, then the IRS sees an ability to pay that you do not have in real life.

You can ask for more than the table amount, but you have to document and advocate your cause. It is far from automatic, and, in fact, I would say that the IRS is more inclined to turn you down than to approve any increase from the table amount. I had a client several years ago who was denied veterinary bills and prescriptions for his dog, for example.

The IRS workup showed that the taxpayer had monthly income of approximately $12,700 and allowable monthly expenses of approximately $11,000. That left approximately $1,700 monthly, and the IRS wanted to get paid.

But there was one expense that made up the largest share of the IRS difference. Can you guess what it was?

It was the private school.

The IRS will not spot you private school tuition, unless there is something about your child’s needs that requires that private school. A special school for the deaf, for example, would likely qualify.

That is not what we have here.

The IRS saw an ability to pay that the taxpayer did not have in real life.

Taxpayer proposed a one-time OIC of $5,000.

The IRS said No.

They went back and forth and agreed to $200 per month, eventually increasing to $700 per month.

COMMENT: This is not uncommon for OICs. The IRS will often give you a year to rework your finances, with the expectation that you will then be able to pay more.

The taxpayer then requested abatement of interest and penalties, which was denied. Generally, those requests require the taxpayer to have a clean filing history, and that was not the case here.

The mess ended up in Tax Court.

Being a court, there are rules. The rule at play here is that the Court was limited to reviewing whether the IRS exercised abuse of discretion.

Folks, that is a nearly impossible standard to meet.

Let me give you one fact: he had net assets worth approximately $43 thousand.

His tax was approximately $40 thousand.

Let’s set aside the 80% thing. It would not take a lot of earning power for the IRS to expect him to be able to repay the full $40 grand.

He lost. There really was no surprise, as least to me.

I do have a question, though.

His monthly income was closer to $13 grand than to $12 grand.

It fair to say that is well above the average American monthly household income.

Private school is expensive, granted.

But where was the money going?

Our case this time was Love v Commissioner, T.C. Memo 2019-92.

You Receive A Wage Garnishment

I was minding my own business. My partner sweeps into my office and says we have to take care of something right away – hopefully that very afternoon.

Hey, I am a career CPA. Some level of ADD is almost requisite to longevity in this profession.

He drops an IRS Form 668-W on my desk.

There is something I had not seen in a while.

What is a 668-W?

A wage garnishment. The IRS refers to it as a “levy.” If you get to this point, you have almost gone through the belly of the whale. The IRS has sent notice after notice, giving you a chance to contest, request abatement, defer collection or set up a payment plan. You have ignored them all. They got angry. They are now garnishing your paycheck.

This notice goes to your employer, and your employer is charged with notifying you. Your employer is going to garnish your next paycheck. Your employer does not want to go resistance here, as an employer becomes liable should they just blow it off. And then there is a 50% “hi there” penalty on top of that.

The IRS publishes tables telling you how much you get to keep. Say that the you are married, have one kid and receive a weekly net check of $1,017.65. The table indicates that you can keep $541.35. The employer withholds and remits the $476.30 balance ($1,017.65 – 541.35) to the IRS.

On the upside, the IRS is not touching your health insurance or 401(k) withholding. On the down side, it is jonesing the rest of your paycheck.

Can you live on $541.35?

That is not the point.

The point is that the IRS wants you to reenter the grid and establish a payment plan. Once you do so, the IRS will release the levy. As far as they are concerned, you should have done so already. The levy is to slap you into reality.

And you have forfeited some (at this point) important procedural rights.

Say that there is a question whether you actually owe some or all of the tax. Had you paid attention to the increasingly strident string of IRS notices, you would have noticed one titled “Notice of Intent to Levy.”

That one is serious. Not as serious as the 668-W, of course, but serious.

At that time, you had the right to request an IRS appeals hearing, called a Collection Due Process hearing. That puts you in front of an Appeals officer to plead your case, including whether you actually owe some or all of what the IRS wants.

Say you ignored the Notice of Intent.

It is a year or two later and you receive the 668-W.

You bring it to me. You may note that I am not humored.

Guess what important right you forfeited by ignoring the earlier notice?

That’s right: being able to argue whether you actually owe some or all of the tax.

That is dandy if there is no question whether you owe the money.

Not my situation. The friend has a very good case that he does not owe (at least some) of the tax.

But we are past the point where I can force a collection hearing to talk about the matter.

Is it hopeless?

Nope. A proficient tax practitioner still has tricks.

Like?

Like an offer in compromise. You know, those middle of the night commercials to settle millions of dollars of tax debt for the change in your pocket.

Is the friend broke?

Not the point.

What is the point then?

There is more than one type of offer. The one I am considering has nothing to do with your ability to pay. It instead has to do with whether you actually owe the money. The first addresses doubt as to collectability. The second addresses doubt as to liability.

It is one way to get the IRS to review the file with an eye as to liability.

Is this what we are going to do?

Doubt it.

Why not?

Because an offer will stay that levy only so long. The IRS can still demand a weekly wage levy WHILE they are considering the offer. Will it happen? Maybe yes, maybe no, but why run the risk?

What is an alternative?

File an appeal.

An appeal shuts down all collections action, meaning that I do not have to bank on the IRS’ better nature to stay that levy. Appeals allows me to introduce evidence that the friend does not owe all the assessment. I am also hoping to get penalties abated, at least some, but that would be a bonus.

Should the friend’s situation have gotten to this point?

I am sympathetic. Those who have followed me know that I am generally pro-taxpayer, but that is not what we have here. There were notices, which were ignored. There was a statutory notice of deficiency, which was ignored. After the statutory notice, taxes and penalties were officially assessed, which was also ignored. There was a chance for reconsideration, which was ignored. 

During all this there was ALWAYS a chance for a payment plan.

As I said, you may note that I am not humored.

Bill And The Gig Economy

I am inclined to title this post “Bill.”

I have known Bill for years. He lost his W-2 job and has made up for it by taking one or two (or three) “independent contractor” gigs.

However, Bills get into tax trouble fast. Chances are they burned through savings upon losing the W-2 job. They turned to that 1099 gig when things got tight. At that point, they needed all the cash they could muster, meaning that replenishing savings had to wait.

The calendar turns. They come to see me for their taxes.

And we talk about self-employment tax for the first time.

You and I have FICA taken from our paycheck. We pay half and our employer pays half. It becomes almost invisible, like being robbed while on vacation.

Go self-employed and you have to pay both sides of FICA – now called self-employment tax – and it is anything but invisible. You are paying approximately 15% of what you make – off the top - and we haven’t even talked about income taxes.

You find yourself in a situation where you probably cannot pay – in full, at least – the tax from your first contractor/self-employment year.

We need a payment plan.

But there is a hitch.

What about taxes on your second contractor/self-employment year?

We need quarterly estimated taxes.

You start to question if I have lost my mind. You cannot even pay the first year, so how are you going to pay quarterly taxes for the second year?

And there you have Bill. Bills are legion.

We arrange a payment plan with the IRS.

You know what will likely blow-up a payment plan?

Filing another tax return with a large balance payable.

All right, maybe we can get the first and second year combined and work something out.

You know what will probably blow-up that payment plan?

Filing yet another tax return with a large balance payable.

Depending upon, the IRS will insist that you make estimated tax payments, as they have seen this movie too.

A taxpayer named Allen ran into that situation.

Allen owed big bucks – approximately $93,000.

The IRS issued an Intent to Levy.

He requested a CDP (Collections Due Process) hearing.

COMMENT: The CDP process was created by Congress in 1998 as a means to slow down a wild west IRS. The idea was that the IRS should not be permitted to move from compliance and assessment (receive your tax return; change your tax return) to collection (lien, levy and clear out your bank account) without an opportunity for you to have your day.  

Allen submitted financial information to the IRS. He proposed paying $500 per month.

The IRS reviewed the same information. They thought he could pay $809 per month.

COMMENT: You would be surprised what the IRS disallows when they calculate how much you can repay. You can have a pet, for example, but they will not allow veterinarian bills.

There was a hitch. Monthly payments of $809 over the remaining statute of limitations period would not sum to $93,000. The IRS can authorize this, however, and it is referred to as a partial-pay installment agreement (PPIA).

EXPLANATION: Any payment plan that does not pay the government in full over the remaining statutory collection period is referred to as a “partial pay.” The IRS looks at it more closely, as they know – going in – that they are writing-off some of the balance due.

The IRS settlement officer (SO) read the Internal Revenue Manual to say that a taxpayer could not receive a partial pay if he/she was behind on their current year estimated taxes. Allen of course was behind.

Allen said that he could not pay the estimate.

The SO closed the file.

Allen filed with the Tax Court.

Mind you, Allen was challenging IRS procedure and not the tax law itself. 

He had to show that the IRS “abused” its discretion.

It would be easier to get a rhinoceros on a park swing.

I get it, I really do. Take two SO’s. One denies you a partial pay because you are behind on estimated taxes; the other SO does not. That however is the meaning of “discretion.”

Did Allen’s SO “abuse” discretion?

The Tax Court did not think so.

Allen lost.

But there is something here I do not understand.

Why didn’t Allen make the estimated tax payment, revise his financial information (to show the depletion of cash) and forward the revised financials to the SO?

I presume that he couldn’t: he must not have had enough cash on hand.

If so, then abuse of discretion makes more sense to me: someone in Allen’s situation could NEVER meet that SO’s requirement for a payment plan.

Why?

Because he/she could never make that estimated tax payment.

The IRS Could Not Collect When Limitations Period Expired

Let’s talk a bit about the tax statute of limitations.

There are two limitations periods, and it is the second one that can lead to odd results.

(1) The first one is referred to as the limitations on assessments. This is the three-year period that we are familiar with. The IRS has three years to audit your return, for example. If they do not, then – in general – the opportunity is lost to them.

There are a number of ways to extend the three-year period. When I was young in the profession, for example, tax practitioners would “hold back” certain tax deductions until the client was closing-in on the three years. With a scant few and breathless days remaining before the period expired, they would file amended tax returns, thereby obtaining a refund for the client and simultaneously kneecapping the IRS’ ability to look at the return.

The rules have been revised allowing the IRS additional time when this happens. I have no problem with this change, as I consider the previous practice to be unacceptable. 

(2) The second one is the collections period, and this one runs ten years.

Say you filed your return on April 15, 2014. You got audited and the IRS assessed $15,000 on December 15, 2015. The IRS has ten years – until December 15, 2025 – to collect.

There are things that can extend (the technical term is “toll”) the collections period. Make an offer in compromise, for example, and the period gets tolled. 

Sometimes tax practice boils down to letting the ten-year period click-off, hoping that the IRS does not initiate action. It happens. A few years ago I had a client who had moved to Florida, remarried and had her new husband involve her in an unnecessary tax situation. It was extremely unfortunate and she was extraordinarily ill-advised. He passed away, leaving her as the remaining target for the IRS to pursue. She had a fairness argument, but that meant as much as a snowball in July to IRS Collections. They have a different mind frame over there.

So I am looking at a case where a taxpayer (Grauer) had an issue with his 1998 tax return. He filed it late (in 2000).  That was his first problem. He owed around $40 grand, which quickly became almost $58 grand when the IRS was done tacking-on interest and penalties. That was his second problem. He could pay that much money about as easily as I can fly.

In 2001 he signed a waiver, extending the ten-year collections period.

What makes this point interesting to a tax nerd is that someone would not (knowingly) sign a waiver without something else going on.  In fact, Congress disallowed this in the late nineties, responding to perceived IRS abuses - especially in Collections.

Sure enough, the IRS said that he signed an installment agreement in 2001 (around the time of that waiver), but that he broke it in 2006

Grauer said that he never signed an installment agreement.

It was now 2013, and off to Tax Court they went.

The Court looked at the account transcript, which showed that the IRS had issued an earlier Notice of Intent to Levy.  This was an immediate technical issue, as the Court would not have jurisdiction past the first Notice. The IRS persuaded the Court that the transcript was wrong. 

COMMENT: Your transactions with the IRS go to your “account.” That account is updated whenever a transaction occurs. The posting will include a date, a code, and sometimes a dollar amount and perhaps a meaningful description.  Some codes are straightforward, some are cryptic. 

The Court next observed that Grauer asserted that he had not signed a payment plan. In legal jargon, this was an “affirmative defense,” and the IRS had to prove otherwise. The IRS argued that its transcript was correct and that Grauer was incorrect.

The Court was a bit flummoxed by this response. The IRS was having it both ways.

The Court told the IRS to “show us the installment agreement.” 

The IRS could not.

The Court went on to describe the IRS account transcript as “indecipherable and unconvincingly explained.”

The Court decided for the taxpayer.

Remember: ten years had passed. The waiver needed to attach to something. In the absence of something, the waiver fizzled and had no effect.

The statute had expired.

Did the taxpayer get away with something?

I don’t know, but think about the alternative. Let’s say that the IRS could post whatever it wanted – to speak bluntly, to make things up – to your account. You then get into tax controversy. You are required to prove that the IRS did not do whatever it claimed it did. Good luck to you in that scenario. I find that result considerably more unacceptable than what happened here.

Doctor Contests Whether He Had Cancellation Of Debt Income

I suspect that I am one of few people who know where Palatka, Florida is.

When I came out of graduate school I worked as an accountant in Tampa. The firm that I was with was quite aggressive in pursuing contracts for government audits, and one of the accountants there would go to Palatka on a routine enough basis. I remember him not being overly excited about it.

In case you are curious, draw a line from Gainesville (where the University of Florida is) to St Augustine and one (sort of) crosses Palatka.  

The reason we are talking about it is that I am reading a Tax Court decision about a doctor in Palatka. It is a “pro se” decision, which means that the taxpayer represented himself/herself before the Court. I can tell that the doctor tried to ramp up on IRS procedure, but he might have been better advised to hire a CPA experienced in this area.

MEMO: We have commented on this before, but many CPAs do not practice tax, and those who do may not necessarily practice IRS procedure (other than maybe answering the occasional tax notice). 

Dr Darrell Wyatt graduated from the University of Arkansas in 1978 and is board certified in obstetrics and gynecology.

He is a baby doctor.

In 2006 he was wooed by Putnam Medical Center to move to rural Florida.

Nice thing about being a doctor is that hospitals are willing to provide “incentive” payments for things, such as moving to Putnam county Florida. The hospital made a deal with the doctor - move here and we will subsidize (read: “loan”) your practice up to $32,953 per month. That will go on for one year, and then we stop subsidizing you. At that time we would like for you to stay here and work for another 3 more years. Every month that you stay we will forgive 1/36 of the loan. Stay for 3 years and we will forgive the entire loan. Leave before then and you have to pay back whatever is still due on the loan.

He spent the year, and then he easily spent 3 more years.

The loan was forgiven in monthly increments.

The deal with Putnam Medical Center started in July, 2006. Spot the doctor a year. The 36 month period would then run from August, 2007 through July, 2010. 

He filed his 2009 return. He reported the amount forgiven in 2009. He paid no estimated taxes. He owed the IRS a boat. The IRS came in and wanted taxes and several varieties of penalties.

Let talk a little procedure.

The IRS issued a Final Notice of Intent to Levy for 2009. 

OBSERVATION: The IRS had sent a lot of correspondence to the doctor, as this is pretty far along. Levy means that the IRS can go in and tap your bank account, among other things. It is a step up from a Lien and is not a good thing.

Dr. Wyatt in turn requested a Due Process Hearing.

NOTE: The taxpayer has 30 days from the issuance of the Final Notice of Intent to Levy to request an Appeals hearing. One is still inside the IRS, but one is moving the file from Collections to Appeals. This is important as Collections truly does not care whether you owe the tax or can pay the tax, it just wants money. Appeals might cut one some slack on the amount or period over which the tax can be paid.

So far I understand. He did not pay 2009 taxes, so I presume he was under some financial distress. Surely he wanted to propose some payment alternative, and he requested the hearing because the IRS machine was going to run him over otherwise.

Wrong. The doctor presented an offer in compromise based on doubt as to liability.

OBSERVATION: The common offer in compromise is based on collectability: one does not have two nickels to rub together and is trying to get the IRS to accept some greatly reduced amount. This second type is based on the assertion: “IRS, I do not owe you, period.”

This tells me the doctor has done some homework. He submitted amended tax returns and proposed to pay approximately what his tax would have been, excluding the loan forgiveness, for tax years 2007 through 2010. 

           COMMENT: He evidently did not pay tax for four years.

The doctor did not follow certain procedural formalities, which we will spare ourselves for the time being. 

The IRS did not accept his offer. The IRS issued its Statutory Notice of Deficiency (a/k/a “SNOD”) and off they went to Tax Court.

The IRS did not his accept his offer because he did not establish doubt as to liability. In and of itself that does not bother me, as convincing the IRS on that point is like expecting your dog to not want the leftovers from your T-bone steak. 

In Court the doctor leads off his argument with:

(1) The loan was nonrecourse.

Huh? 

He is hanging his hat on that fact that the hospital never reduced the employment incentive to a promissory note. No note equals no personal liability, right?

Wrong. You can be liable and not have a written note. Granted, the written note makes it easier to prove the existence of debt, but the absence of a note does not mean that there is no debt. Had he failed to stay for 36 months, the hospital would have had right to sue under the paperwork that did exist.

He had no argument (2). 

What was he thinking? Did he really believe …?

And then it dawned on me. 

The IRS proceeded against the doctor for one year only – 2009. He would have had debt discharge income in 2007 and 2008 also, but those years were not before the Court.

But there is a logical fallacy here: The absence of something does not necessarily mean the presence of something else. The Court was looking only at 2009, which does not mean that the IRS flubbed 2007 and 2008. 

However, consider the following language by the Court:

In his Form 12153 petitioner referenced three taxable years: 2007, 2008, and 2009. The record in the instant case does not include a copy of the final notice that prompted petitioner to file Form 12153, nor does the record include a transcript of account for any year other than 2009. As discussed infra in the text, the offer-in-compromise based on doubt as to liability that petitioner subsequently submitted referenced 2007 through 2010, i.e., the four taxable years for which amounts were forgiven and canceled by the hospital. However … the notice of determination upon which the instant case is based was issued solely in respect of petitioner’s outstanding liability for 2009.”

The doctor lost on all counts for 2009.

But I cannot help but wonder if the doctor was not so much practicing procedure for 2009 as much as running out the statute of limitations for 2007 and 2008.