10 - No Abuse of Discretion by Settlement Officer in Rejecting Offer-in- Compromise

Transcription

1 10 - No Abuse of Discretion by Settlement Officer in Rejecting Offer-in- Compromise Gustashaw,TC Memo The Tax Court has concluded that a settlement officer did not abuse his discretion in denying the taxpayers' offer-in-compromise (OIC) because their reasonable collection potential (RCP) far exceeded their final offer amount. Although the settlement officer erred by including the cash value of a life insurance policy, the Court found that this was harmless error because, after omission of the value of the life insurance policy, the taxpayers' RCP still exceeded their final offer. Background. An OIC is an offer made by the taxpayer to IRS to enter into a contract in which IRS agrees to accept an amount different from what the taxpayer owes in taxes. (Reg ) There are three grounds for such a compromise: (1) doubt as to liability; (2) doubt as to collectibility; and (3) promotion of effective tax administration. (Reg (b)) IRS will accept an OIC based on doubt as to collectibility when it's unlikely that it can collect the unpaid tax liability in full and the offer reflects the taxpayer's RCP i.e., the amount that IRS could collect through other means, including administrative and judicial collection remedies. (Rev Proc , CB 517; Murphy, (2005) 125 TC 301) A dissipated asset is any asset (liquid or illiquid) that has been "sold, transferred, or spent on non-priority items or debts and that is no longer available to pay the tax liability." (Johnson, (2011) 136 TC 475) Generally, dissipated assets are excluded from a taxpayer's RCP, but a settlement officer can look back three years from the taxpayer's offer date and include any dissipated assets. (IRM pt (2)) Facts. IRS assessed tax and penalties against William and Nancy Gustashaw for the years in issue, and the taxpayers made a partial payment of $4,500,000. IRS issued a notice of intent to levy to collect unpaid portions of their liabilities. The Gustashaws timely requested a hearing and stated that they wanted to pursue an installment agreement or an OIC. At the collection hearing, the settlement officer reviewed the Gustashaws' supporting financial information, which listed a real estate limited partnership with CHI Investments Corp. (investment partnership) valued at $199,347 and an insurance policy owned by an irrevocable life insurance trust valued at $169,425. They also listed vehicle ownership and operating expenses of $985 and $785, respectively, and out-of-pocket health care expenses of $

2 The Gustashaws' first OIC was for $750,000 to compromise Federal income tax liabilities from '98 through They included with their offer a letter from the investment partnership's president, which they used to substantiate the value of their interest. The letter included a list of the Gustashaws' investments "valued for custodial holding purposes at the amount of principal left in the Fund," totaling over $400,000. The president stated in her letter that the funds were illiquid and that there was no market for regular sale of these funds. Despite their illiquidity, the president stated that there was a possible secondary market to which a Financial Industry Regulatory Authority (FINRA) Broker/Dealer may have access, however she noted that she was unaware of how to access that. She also noted that about three years ago, one of their investors did sell their Fund holdings on this secondary market, but she believed that they received less than $.50 on the dollar valuation. The Gustashaws provided a supplemental statement requesting that the offer be considered under effective tax administration specifically, economic hardship. They argued, among other things, that liquidating their assets would leave them without adequate retirement funds and that they would not have the resources to pay their necessary living expenses, including out-of-pocket health care expenses and vehicle expenses. The settlement officer informed the Gustashaws that because their liabilities exceeded their assets and income and because of their involvement in a tax shelter, an effective tax administration OIC was inappropriate and their offer would be processed as a doubt as to collectibility offer. The Gustashaws submitted a revised OIC under doubt as to collectibility with special circumstances. As part of their revised offer, the Gustashaws included an updated financial statement on Form 433-A (OIC) (Collection Information Statement for Wage Earners and Self-Employed Individuals,) and Form 433-A (Collection Information Statement for Wage Earners and Self-Employed Individuals). Their revised Form 433-A (OIC) included, among other items, the investment partnership with a value of $162,197, discounted to $129,758, vehicle operating expenses of $1,330, and out-of-pocket health care expenses of $757. They did not include the value of an irrevocable life insurance trust or vehicle ownership expenses. Their revised Form 433-A listed the value of the investment partnership as $162,197 and the cash value of the life insurance policy in the irrevocable trust as $211,795. In addition, they listed vehicle ownership expenses of $918 despite having zero loan balances and no monthly payments on their vehicles, vehicle operating expenses of $412, and out-of-pocket health care expenses of $

3 The settlement officer inquired about a $7,588 out-of-pocket health care expense included in the Gustashaws' calculation, and they informed him that the expense occurred as a result of Mrs. Gustashaw's procedure to remove a benign tumor and that she would undergo further screening in the future. The settlement officer valued the investment partnership at $405,493, discounted at 60% for a quick sale value of $162,197, and he valued the irrevocable life insurance trust as a dissipated asset at $230,435, discounted 20% for a quick sale at $184,348. In addition, he excluded vehicle ownership expenses, allowed $644 in operating expenses, and accepted all but one of the Gustashaws' out-ofpocket health care expenses. The settlement officer determined that the $7,588 expense for Mrs. Gustashaw's procedure was a one-time expense and excluded it from his calculation. He allowed $283 for health care expenses, which was more than the national standard. While the Gustashaws' counsel and the settlement officer continued their correspondence, Mr. Gustashaw suffered a serious leg injury that required hospitalization. At the taxpayers' request, the settlement officer agreed to an adjustment for Mr. Gustashaw's leg injury and for other undisputed items. The settlement officer adjusted their RCP to $2,300,683. But despite this reduction, the settlement officer informed the Gustashaws that he was unable to recommend acceptance of their $1,507,413 offer. The settlement officer suggested that if the Gustashaws amended their offer to the amount he had determined to be their RCP, he would recommend acceptance. The Gustashaws submitted an amended offer for $1,650,000. Rejecting the offer, the settlement officer issued a notice of determination sustaining the levy. The Gustashaws filed a timely petition with the Tax Court. Parties' positions. The Gustashaws argued that the settlement officer erred in overvaluing the partnership investment and the irrevocable life insurance trust, and understating out-of-pocket health care and vehicle expenses. The Gustashaws pointed to Mr. Gustashaw's recent leg injury and Mrs. Gustashaw's removal of a benign tumor as factors indicating economic hardship. They argued that because of their age and lack of employment and Mr. Gustashaw's having been retired for roughly 16 years, an offer equal to their RCP would leave them unable to cover basic living expenses and result in economic hardship. On the other hand, IRS argued that even if the Gustashaws' RCP was adjusted for potential errors, the settlement officer's rejection of the offer would still be within his discretion because the corrected RCP still exceeded the Gustashaws' final offer. IRS further contended that any potential miscalculations would be harmless error because the Gustashaws' offer and their RCP were so far apart. 28

4 Court's conclusion. The Tax Court found that the Gustashaws had not shown that the settlement officer's actions were arbitrary, capricious, or without sound basis in fact or law. Although the settlement officer did err in his inclusion of the life insurance policy's cash value, that error was harmless and the settlement officer did not abuse his discretion in rejecting the Gustashaws' OIC. The record was clear that the settlement officer considered the Gustashaws' economic hardship arguments but ultimately found them lacking. The Court stated that even if it were to accept the Gustashaws' argument, it would not find that the settlement officer abused his discretion. The Gustashaws' liabilities were the result of participation in a tax shelter. Acceptance of the offer would place the Government in the unenviable role of an insurer against poor business decisions by taxpayers, and it would be particularly inappropriate for the Government to play that role here as reducing the risks associated with tax shelters would undermine compliance with the tax laws. Accordingly, the settlement officer's rejection of the offer was appropriate. The Court reasoned that in determining a doubt as to collectibility offer, the settlement officer must determine the taxpayer's ability to pay. A settlement based on a taxpayer's ability to pay allows the taxpayer to retain sufficient funds to cover reasonable basic living expenses, with such expenses determined by evaluating the individual facts and circumstances. Generally, IRS will reject a doubt as to collectibility OIC if the taxpayer's RCP exceeds the offer. A settlement officer's rejection of an offer below the taxpayer's RCP generally is not an abuse of discretion. Investment partnership's value. The Court noted that in considering an OIC, IRS values a taxpayer's assets at their net realizable equity. Net realizable equity is the "quick sale value (QSV) less amounts owed to secured lien holders with priority over the federal tax lien." (IRM pt (1)) IRS generally calculates the quick sale value at 80% of the fair market value of the asset. (IRM pt (3)) The Tax Court concluded that the settlement officer's determination of the investment partnership's value was reasonably based on the information provided by the Gustashaws and was not an abuse of discretion. Without any further evidence as to the investment partnership's value the settlement officer assigned a discount value of 60%, a discount far greater than advised in the IRM. The record showed that the settlement officer used the values reported by the Gustashaws and reviewed the accompanying documents indicating sales generating less than 50 cents on the dollar. These documents did not conclude that the investment partnership was worthless, only that it would be difficult to sell on the secondary market. In addition, the president's letter indicated that she was not a broker of these types of deals, simply stating that any discount a buyer "would want would 29

5 probably erase a majority of the remaining value." Finally, the letters indicated a possibility of selling the investment partnership interest on the secondary market through a FINRA broker or dealer. Despite this information, the Gustashaws did not contact a FINRA broker and failed to produce further documentation regarding the value of the investment partnership. Life insurance's value. The Court did find that the settlement officer erred by including the discounted value of the life insurance policy as a dissipated asset. While the Gustashaws made $15,000 premium payments to the life insurance policy owned by the irrevocable trust from '97 to 2009 and made $7,500 premium payments in 2010 and 2011, it was undisputed that the Gustashaws did not have an ownership interest in the policy. It was owned by an irrevocable trust. Because the Gustashaws' returns were examined in 2003, some of the premium payments to the irrevocable trust were dissipated assets. But the premium payments made before the Gustashaws' examination were not dissipated assets. Accordingly, the amount the settlement officer determined as a dissipated asset, the cash surrender value of the life insurance policy, incorrectly included the premium payments made before the Gustashaws' examination. While this timing potentially affected the Gustashaws' RCP, the Court determined that a determination of their exact RCP would be a meaningless exercise because the Gustashaws' reasonable collection potential far exceeded their final offer when this error was corrected. Out-of-pocket health care expenses. The Court found that the settlement officer did not abuse his discretion in determining the Gustashaws' out-of-pocket health care expenses. He accepted all but one of them, allowed their expenses to exceed the national standard, took into consideration Mr. Gustashaw's leg injury, and properly excluded the nonrecurring expenses of $7,588. The Court rejected the Gustashaws' argument that the one-time expense of $7,588 they incurred was representative of the future health care expenses that they might incur. They provided no support for their claim that this expense or any other health care expense would occur in the future. Instead they relied on the argument that medical expenses increase as people age. It was not an abuse of discretion for a settlement officer to set aside speculative future expenses if the record did not support their inclusion. Motor vehicle expenses. A settlement officer is required to factor in taxpayers' necessary transportation expenses in computing their RCP. Transportation expenses are necessary if they are used by taxpayers and their families to provide for their health and welfare and/or the production of income. Such expenses include ownership expenses for the purchase or lease of a vehicle and operating expenses to keep the vehicle on the road. 30

6 For ownership expenses, a taxpayer is "allowed the local standard or the amount actually paid, whichever is less, unless the taxpayer provides documentation to verify and substantiate that the higher expenses are necessary." (IRM pt (3)) If a taxpayer owns and uses a vehicle, but there is no loan or lease payment, the taxpayer is entitled only to operating expenses. (IRM pt (4)(b)) As the Gustashaws owned each of their vehicles outright, making no payments, the settlement officer disallowed ownership expenses. The Tax Court rejected the taxpayers' argument that the settlement officer abused his discretion by not allowing the local standard for ownership expenses. They contended that their vehicles will need replacing in the future and that the settlement officer should have adjusted the allowance to allow for their life expectancies and monthly shortfall. The Court found that because the Gustashaws owned their vehicles outright and did not make payments, they were entitled only to the local standard for operating expenses. The settlement officer followed the IRM and did not abuse his discretion in disallowing the taxpayers' request for ownership expenses. 31