11 - Court Rejects Taxpayer's Objections to IRS Collection Actions

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1 11 - Court Rejects Taxpayer's Objections to IRS Collection Actions McAvey, TC Memo The Tax Court has held that IRS did not abuse its discretion with respect to various of its collection actions including rejecting the taxpayers' offer in compromise (OIC) and requesting that they waive their net operating loss (NOL) and capital loss carryforwards in return for IRS concessions. Background on collection due process (CDP) hearings. The IRS Office of Appeals (Appeals) is responsible for conducting administrative hearings in collection matters. (Code Sec. 6330(b)(1)) Once IRS decides to levy, it must notify the taxpayer in writing of the right to a hearing under Code Sec. 6330(a)(1) (i.e., a CDP hearing). If a taxpayer makes a timely written request and states the grounds for the requested hearing, the taxpayer is entitled to a fair hearing conducted by an impartial officer from the Appeals Office, who must verify that the requirements of any applicable law or administrative procedure have been met in processing the case. (Code Sec. 6330(c)(1), Code Sec. 6330(c)(3)(A)) The Appeals Office must also consider any issues raised by the taxpayer that relate to the unpaid tax or proposed levy, including offers of collection alternatives and challenges to the appropriateness of the collection action. (Code Sec. 6330(c)(2)(A), Code Sec. 6330(c)(3)(B)) At a CDP hearing, a person may challenge the existence or amount of his or her underlying tax liability if the person did not receive a notice of deficiency or did not otherwise have an opportunity to dispute such tax liability. (Code Sec. 6330(c)(2)(B)) Code Sec. 6330(c)(4)(A) bars CDP review of any issue that was raised and considered in any previous administrative or judicial proceeding if the person seeking to raise the issue participated meaningfully in the proceeding. A taxpayer who is dissatisfied with the findings or conclusions of the CDP hearing can appeal the determination to the Tax Court. (Code Sec. 6330(d)(1)) When the Tax Court receives an appeal from a CDP hearing, however, its review is limited to issues that were properly raised during the CDP hearing. (Goza, (2000) 114 TC 176) Where the taxpayer's underlying liability is not properly at issue, the Tax Court reviews IRS's decision for abuse of discretion only. A determination that is arbitrary, capricious, or without sound basis in fact or law is an abuse of discretion. (Woodral v. Comm., (1999) 112 TC 19, Venhuizen, TC Memo ) Background offers in compromise. 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 38

2 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 reasonable collection potential (RCP) i.e., the amount that IRS thinks it can get from the taxpayer's assets and income. (Internal Revenue Manual (IRM) pt ) Background closing agreements. IRS may enter into a written agreement with any taxpayer relating to his liability for any internal revenue tax. (Code Sec. 7121(a)) The agreement, a final closing agreement, is, in effect, a mutual release that binds both parties. In the absence of fraud, malfeasance, etc., (1) the case cannot be reopened as to matters agreed upon or the agreement modified by any officer, employee, or agent of the U.S.; (2) in any suit, action, or proceeding, the agreement, or any determination, assessment, collection, payment, abatement, refund, or credit made in accordance with the agreement, may not be annulled, modified, set aside, or disregarded. (Code Sec. 7121(b)) Background approval of penalty by IRS supervisor. Under Code Sec. 7491(c), IRS has the burden of production (i.e., to come forward initially with evidence) in any court proceeding with respect to the liability of any individual for any penalty imposed by the Code. Under Code Sec. 6751(a), IRS must provide information about any penalty it imposes under the Code. Under Code Sec. 6751(b)(1), no penalty can be assessed "unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate." The Tax Court has held that showing compliance with Code Sec. 6751(b)(1) is part of IRS's burden of production under Code Sec. 7491(c). (Graev, (2017) 149 TC No. 23) Facts. The taxpayers, Mr. and Mrs. McAvey, entered into closing agreements with IRS for their 2004 and 2005 income tax liabilities. The closing agreements related to certain partnerships the McAveys partly owned. In these agreements, the McAveys agreed to assessment and collection of certain liabilities (including accuracy-related penalties). IRS issued a Notice of Intent to Levy with respect to the 2004 and 2005 income tax liabilities. According to the notice, the McAveys owed $354,000 for 2004 and $392,000 for The McAveys properly submitted a request for a CDP hearing. They attached a statement indicating they were seeking an OIC on the basis of doubt as to collectibility and proposed to pay a total of $300,000 to satisfy their tax, interest and penalty liabilities. 39

3 The McAveys' OIC was accompanied by a completed Form 433-A, Collection Information Statement; it listed, among other assets, interests in partnerships and real estate in Cornwall, New York (Cornwall property). According to the McAveys' 2015 Form 1040, U.S. Individual Tax Returns, their partnerships had been passing through substantial amounts of income to them. IRS's OIC group found that (1) the McAveys' equity in assets, including their partnership interests, residence, Cornwall property, and cars, was $1,897,350 and (2) the McAveys' annual net income was $2,454,550. Both findings were attributable in large part to the McAveys' equity in and income from partnerships. On the basis of these findings, the OIC group concluded that the McAveys' RCP was at least $4,351,900. Because it concluded that the McAveys' RCP exceeded their $300,000 OIC, the OIC group recommended that the OIC be denied. At their CDP hearing, the McAveys claimed that the partnership interests were worthless and that the income they had reported on their most recent income tax returns was "self-charged interest", i.e., allegedly phantom income attributable to interest income accrued by the partnership on loans to the partners. To support these claims, the McAveys provided 2015 Forms 1065, U.S. Return of Partnership Income; these returns did not, however, report any loans to partners on lines 7 of Schedules L, Balance Sheets per Books. The Appeals Officer (AO) was unconvinced by the McAveys' explanation of their partnership interests and income. In particular, it was unclear to the AO why partners would, over a period of several years, persist in a worthless investment that generated substantial amounts of (allegedly) phantom income. The AO suggested that the McAveys amend the terms of their OIC to include a collateral agreement which would have waived the McAveys' claim to certain unused net operating losses (NOLs) and capital losses; in exchange the AO agreed to exclude any possible equity in, or income from, the partnerships for purposes of calculating the McAveys' RCP. The McAveys sold the Cornwall property after requesting the CDP hearing and submitting their OIC. The net proceeds of the sale were $133,511 after state taxes. The McAveys claimed that they used the proceeds to pay living expenses. The AO asked the McAveys to provide evidence of the use of the proceeds; the McAveys did not do so. The AO agreed, without proof, to accept that $14,000 of the proceeds had been spent on living expenses. The AO included the remainder of the proceeds $119,000 in the McAveys' RCP as dissipated assets. The AO informed the McAveys that their RCP was $473,350, after including $119,000 of the proceeds of the Cornwall property sale as dissipated assets and excluding the McAveys' partnership interests from consideration. The AO informed Mr. Becker, the taxpayers' accountant, that the McAveys' OIC would not be accepted unless the McAveys increased their offer to $473,350 and agreed to a collateral agreement waiving their unused NOLs and capital losses. Mr. Becker 40

4 then proposed a future income collateral agreement in lieu of increasing the McAveys' $300,000 offer to $473,350. The AO refused the proposal. The taxpayers did not act by the deadline given them by the AO, the AO issued a notice of determination denying the McAveys' OIC and sustaining the levy, and the McAveys brought this suit for review of IRS's actions. The McAveys did not challenge their underlying liabilities at the CDP hearing the only issue discussed was the McAveys' OIC and therefore their underlying liabilities were not at issue in this case. The Court rejects all of taxpayer's arguments. The McAveys made several arguments with respect to IRS's collection activities, all of which were rejected by the Court....The Cornwall property. The McAveys disputed the AO's inclusion in their RCP, as dissipated assets, of $119,000 of the proceeds from the Cornwall property sale. The Court said that a dissipated asset is any asset that has been sold, transferred, or spent on nonpriority items or debts and that is no longer available to pay the tax liability. A consequence of including dissipated assets in RCP is that the taxpayer is fictitiously assumed to have funds that he or she no longer has, an assumption that may be discouraging to the delinquent taxpayer. The reason for including dissipated assets in RCP is to deter delinquent taxpayers from wasting money that they owe and should pay as tax. (Johnson, (2011) 136 TC 475) The Court then said that the Cornwall property was sold during the administrative proceeding. The record showed that the AO asked the McAveys' representative for proof that the proceeds of the Cornwall property sale had been spent on necessary living expenses (as the McAveys claimed). The McAveys never provided any such proof. The AO nevertheless treated $14,000 of the proceeds as if they had been spent on necessary living expenses; the remainder was included in the McAveys' RCP. In the light of the McAveys' failure to provide or support a basis for excluding the remainder from their RCP, there was no abuse of discretion in this decision....collateral agreement as to NOLs and capital losses. A collateral agreement is an agreement added to the basic payment agreement arising from an accepted OIC. "A collateral agreement enables the government to collect funds in addition to the amount actually secured by the offer or to add additional terms not included in the standard Form 656 agreement, thereby recouping part or all of the difference between the amount of the offer or additional terms of the offer and the liability compromised." (IRM pt ) 41

5 The McAveys made the following argument against the collateral agreement: The AO insisted that they agree to waive the entire amount of their NOLs. By insisting on this requirement, the Appeals officer was demanding payment in full. That result existed because the tax savings, forfeited by waiving the NOLs, coupled with the total cash payments demanded by the AO, approximately equalled the full amount of the tax. The Court said that this argument was without merit. Allowance for OICs under Code Sec does not mean that IRS must compromise the amount it seeks to collect if the taxpayer can fully pay. In any event, there was no abuse of discretion in the AO's suggesting that the McAveys amend their OIC to include a collateral agreement waiving NOLs and capital losses. It is generally IRS's policy that collateral agreements waiving losses are appropriate to consider in situations where the taxpayer's RCP is less than the amount of liability. (IRM pt ) As the McAveys claimed that their RCP was less than the amount of their debt, there was no abuse of discretion in the AO's request for a collateral agreement. Moreover, the Court said, it appeared that the collateral agreement was essentially offered in exchange for excluding the McAveys' partnership interests and income from calculation of their RCP. The documents the McAveys provided to the AO in support of their claims did not answer why, if the partnerships were worthless, the partners were choosing to report large amounts of interest income rather than wind up the partnerships. There may have been a perfectly reasonable answer, but the McAveys did not provide it. Consequently, it was not unreasonable for the AO to propose an alternative solution which avoided the issue, namely, the collateral agreement....future income collateral agreement. The McAveys also protested against the AO rejecting their future income collateral agreement offer. According to the Internal Revenue Manual (IRM), IRS generally considers future income collateral agreements "when the investigation reveals that a substantial increase in the taxpayer's future income is expected." (IRM pt ) The Court noted that the McAveys claimed during the CDP hearing that they had little or no income (other than the income from their partnerships) and no appreciable cashflow. The Court said that the record did not indicate that the McAveys ever claimed that they expected an increase in their future income, and the McAveys did not contend otherwise. It was therefore not an abuse of discretion for the AO to refuse to consider the future income collateral agreement....penalties and Section 6751(b)(1). The McAveys also argued that the AO abused her discretion in failing to verify that there was written supervisory 42

6 approval pursuant to Code Sec. 6751(b)(1) of the initial determinations of the penalties that were assessed against the McAveys. IRS agreed that the AO did not verify compliance with Code Sec. 6751(b)(1) but contended that the closing agreements provided the basis for these penalty assessments so as to satisfy any requirement under Code Sec. 6751(b)(1). The Court said that, to the extent of matters agreed upon, closing agreements are final. It said that the McAveys did not allege or support any fraud, malfeasance, or misrepresentation of material fact with respect to the closing agreements. Consequently, the closing agreements could not be annulled, modified, set aside, or disregarded by the Court. The closing agreements specifically provided that the McAveys consented to assessment of the penalties in question. In signing these agreements, the McAveys therefore agreed to waive the procedural requirement of Code Sec. 6751(b)(1). Consequently, the Court said, it was clear that if there was any error in the AO's failure to obtain verification of compliance with Code Sec. 6751(b)(1), it was harmless error because neither IRS nor the Court could set aside the McAveys' valid closing agreements or the McAveys' consent to assessment contained therein. 43