09 - Individual Wasn t Excused From Tax Liability Despite Prescription Drug-induced Gambling Addiction

Transcription

1 09 - Individual Wasn t Excused From Tax Liability Despite Prescription Drug-induced Gambling Addiction Gillette, TC Memo The Tax Court has rejected a taxpayer's contention that she was not liable for the additional tax on an early individual retirement account (IRA) distribution because her prescription drug-induced gambling addiction was a disability that qualified her for an exception under Code Sec. 72(t)(2). The Court also rejected her argument that she was not liable for the alternative minimum tax (AMT) because of her gambling addiction. In addition, the Court found that the IRS settlement officer didn't abuse his discretion by not accepting her offer-in-compromise (OIC) based on public policy or equity grounds. Background on early distribution penalty. Under Code Sec. 72(t)(1), a 10% penalty is imposed on early distributions (i.e., distributions before age 59 ½) from a qualified retirement plan, unless one of the exceptions enumerated in Code Sec. 72(t)(2) applies. One of those exceptions, under Code Sec. 72(t)(2)(A)(iii), applies to a distribution that's attributable to an individual being "disabled." Disability is defined under Code Sec. 72(m)(7) as unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death, or to be of longcontinued and indefinite duration. Reg A(f)(2)(vi) provides that the standard for a mental illness to qualify as disability is that the illness require continued institutionalization or the constant supervision of the individual. Regs provide two examples of being disabled: (1) damage to the brain or a brain abnormality which has resulted in severe loss of judgment, intellect, orientation, or memory (Reg A(f)(2)(v)); and (2) mental diseases (e.g., psychosis or severe psychoneurosis) requiring continued institutionalization or constant supervision of the individual. (Reg A(f)(2)(vi)) Notwithstanding these two examples, an impairment which is remediable does not constitute a disability under Code Sec. 72(m)(7). (Reg A(f)(4)) Background on AMT. The AMT under Code Sec. 55 is a tax system separate from the regular tax. The AMT was designed to prevent a taxpayer from avoiding all tax liability by using exclusions, deductions, and credits. Under it, AMT rates are applied to AMT income determined after the taxpayer "gives back" an assortment of tax benefits. If the tax determined under these calculations exceeds the regular tax, then the larger amount is owed. Background on compromising tax liability. If there are no grounds for compromise as to doubt as to liability or doubt as to collectability, and the taxpayer does not 29

2 meet the requirements of an economic hardship, IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. (Reg (b)(3)(ii)) Such a compromise is justified if, "due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner." The taxpayer proposing the compromise is expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his or her liability in full. Notwithstanding these requirements, IRS will not accept an effective tax administration compromise if acceptance "would undermine compliance by taxpayers with the tax laws." (Reg (b)(3)) Reg (c)(3) provides examples of the types of cases that may be considered under a public policy or equity compromise. They include: (1) a taxpayer with a serious illness requiring hospitalization for a number of years who, at the time, was unable to manage his or her financial affairs, including filing tax returns; and (2) a taxpayer who learns after an audit that incorrect advice was given by IRS and is now facing additional taxes and penalties because of that advice. The Internal Revenue Manual (IRM) also lists compelling factors to consider when examining a public policy or equity OIC. They include situations where the taxpayer's liability was the result of IRS's processing error, following IRS's erroneous advice or instructions, IRS's unreasonable delay, or the criminal or fraudulent act of a third party. In addition, accepting a public policy or equity OIC may be appropriate where rejecting it would cause a significant negative impact on the taxpayer's community or "the taxpayer was incapacitated and thus unable to comply with the tax laws." A public policy or equity OIC is not appropriate unless the taxpayer's argument is based on more than his or her belief that the tax laws are unfair. (IRM pt ) Facts. In the early 2000s, Ms. Kathryn Gillette began taking the prescription medication Mirapex for restless legs syndrome, changing to pramipexole around Over the years Ms. Gillette's medication became less effective, and her doctor increased her dosage. After a particular dosage increase in April 2010, Ms. Gillette began to exhibit severe compulsive behavior, particularly compulsive gambling. Ms. Gillette's gambling worsened over the years. Occasionally she would go days without sleep and at times slept in her car if she wasn't given a complimentary night's stay at a casino. Nearly all of the money she collected from her rental properties went to casinos. When she ran out of money, she borrowed from friends and didn't pay them back, took money and credit cards from her husband's wallet, and eventually withdrew money from her retirement account in

3 Eventually Ms. Gillette's compulsive behavior caught up with her financially. She stopped paying her mortgages, property taxes, maintenance expenses, and credit card bills. She received tax sale notices for her rental properties and a sheriff's warrant for unpaid State taxes. Her rental property business was nearly in ruins. Ms. Gillette's son learned of his mother's dire financial condition in June He looked into the side effects of pramipexole and learned that a known side effect in some individuals is severe compulsive behavior, particularly compulsive gambling. Ms. Gillette and her doctor developed a plan to take her off the medication. She began reducing her medication in Despite reducing her medication and knowing its side effects, she continued to gamble in 2013, 2014, and She stopped taking pramipexole and stopped gambling in Ms. Gillette and her husband filed a joint return in Among other items, she reported $1,317,348 in gambling winnings and $1,315,227 in gambling losses. She also reported an $85,231 tax liability that included additional tax of $10,400 for a premature IRA distribution and $17,851 of alternative minimum tax. Withholdings reduced her balance due to $75,954, which she did not pay. IRS issued notices of intent to levy for In a request for a collection due process hearing, the taxpayers stated that they wanted to pursue an installment agreement and an OIC. Ms. Gillette provided the settlement officer with a completed OIC citing exceptional circumstances. She included with her offer a collection information statement with accompanying financial information, a signed 2013 return, an $11,207 payment, and an explanation of her unusual circumstances. In support of her claim for exceptional circumstances, she included her medical records and various documents related to pramipexole and its side effects. She offered to compromise her 2012 tax liability for $38,968. The offer was forwarded to an IRS offer examiner who reviewed the taxpayers' financial information and determined that they had a reasonable collection potential (RCP) of $813,484. The offer examiner informed Ms. Gillette that she could satisfy her tax liability by selling two rental properties. She responded that the remaining properties were for her retirement and argued that she should not be held liable for the 10% additional tax on the early IRA distribution because of her health problems. The offer examiner rejected her OIC. He stated that she had the ability to pay the liability in full and that her special circumstances did not constitute a hardship. The offer was sent back to the settlement officer who agreed with the offer examiner's rejection. IRS conducted a supplemental hearing that specifically addressed a public policy or equity OIC. Afterwards, IRS issued a supplemental notice of determination sustaining the proposed levy. The settlement officer's report observed that the side effects of pramipexole, specifically compulsive gambling, have been known since 2006 and that Ms. Gillette made the choice to continue taking the medication. He reasoned that Ms. Gillette's actions were not reasonable or 31

4 responsible, a requirement under IRM pt (4) (Aug. 5, 2015). He also concluded that the taxpayer's arguments were not supported by the IRM and that the fact that the taxpayer thought that the law was unfair did not support the public policy acceptance of an OIC. Court's conclusion. The Tax Court found that Ms. Gillette failed to establish that an exception under Code Sec. 72(t)(2) applied and so was liable for the additional tax for an early IRA distribution. Additionally, Ms. Gillette was liable for the AMT. The Court further concluded that the settlement officer did not abuse his discretion in denying Ms. Gillette's collection alternative. The Court determined that, even accepting that Ms. Gillette suffered an impairment in 2012, any impairment was remediable and not a disability under Code Sec. 72(m)(7). Ms. Gillette was treated in a reasonable and safe manner with the help of her family and medical professionals. She was able to return to managing her rental properties and financial affairs and had not gambled since She was not disabled under Code Sec. 72(m)(7) and did not qualify for an exception under Code Sec. 72(t)(2). While Ms. Gillette argued that it was neither fair nor just that she was taxed $17,851 in AMT due to her prescription-induced gambling and that this AMT would not have been due under ordinary circumstances, the Tax Court found that there was no legal authority for exempting her from the AMT. Ms. Gillette argued that a public policy or equity OIC should be accepted because her mental illness was caused by her prescription medication. But the Court reasoned that while her circumstances were unfortunate, Ms. Gillette did not provide grounds for treating her differently from a similarly situated taxpayer who paid her liability in full. Her situation also differed from the examples given in the regs: Ms. Gillette did not require hospitalization for a number of years, she was able to file her tax returns, she collected rents from her rental properties, and she did not receive incorrect advice from IRS. Further, she did not meet any of the compelling factors outlined in the IRM. Ms. Gillette was not so incapacitated that she was unable to comply with the tax laws, rejection of their public policy or equity OIC would not have had a significant negative impact on her community, and her 2012 tax liability was not caused by IRS's error or delay or the fraudulent or criminal conduct of a third party. While the Tax Court did not dispute Ms. Gillette's medical condition, it concluded that the settlement officer did not abuse his discretion in rejecting Ms. Gillette's public policy or equity OIC. Ms. Gillette did not meet her burden of establishing that acceptance of her public policy or equity OIC would not undermine compliance. In addition, the Court noted that her circumstances were not akin to those in any of the examples in the regs or the compelling factors in the IRM. The settlement officer considered all of the issues raised by Ms. Gillette during her collection hearing and supplemental hearing, answered all of her inquires and 32

5 explained the applicable law. Further, the settlement officer determined that the collection action was no more intrusive than necessary. 33