I apparently cannot stop writing about Offers and “deemed acceptance” under IRC § 7122(f). This is because I think it represents fertile ground for practitioners to help their clients, a way to hold the IRS accountable for getting things done in some semblance of a timely manner, and fix (or invalidate) an indefensible IRS Notice.
Yes, I am apparently the type of person that gets worked up over tax administration.
My prior post got at the procedural issues with Notice 2006-68, as well as some of the substantive issues in its interpretation of the statute. On the substantive question, everything hinges on what it means to “reject” an Offer in Compromise. We looked at the legislative history of the statute and found that Notice 2006-68 doesn’t quite have a slam-dunk case for following Congress’s (albeit unstated) intent. In this post, I’ll go dive into the substance a bit more: what does it (or should it) mean to “reject” an offer for purposes of IRC § 7122(f)?“read
To sum up, the statute provides that an Offer that is not rejected within 24 months of submission is “deemed accepted.” The IRS (through Notice 2006-68 and the relevant IRM) interprets this to mean that so long as a preliminary determination is made (to reject, return, or withdraw the Offer) within 24 months, it no longer matters how long it takes to reach a final resolution. I think that’s an unreasonable interpretation.
I also think that when you’re challenging a rule or interpretation as being “unreasonable,” it is important to have a ready answer for what a more reasonable replacement would be. I have no idea what the comments to Notice 2006-68 were. But had I been in practice at the time, here is what I would have submitted…
Protecting Both Taxpayer and IRS Interests: A Better Way Forward
I can understand where the IRS is coming from with Notice 2006-68. The IRS understandably doesn’t want a slew of Offers aging into acceptance just because people go to Appeals or insist on Collection Due Process (CDP) rights. Those things take time (though query whether two years should be enough in any case), and it might end up in bad Offers on $50 million dollar liabilities being erased on a foot-fault. This would be especially unfortunate in those instances where the IRS is truly carrying on negotiations with the taxpayer over those two years, but circumstances continually change.
But there are better ways to protect the IRS from being penalized on different layers of review -ways which would better ensure timely resolution of cases and are more defensible readings of the statute. Professor Camp recently wrote about the Brown case, and provides, I think, a clearer rationale for the outcome in Brown than what the Tax Court (or Notice 2006-68) provides. In a nutshell, Prof. Camp characterizes the role of IRS Appeals in CDP as “reviewing a rejection.” In that understanding the rejection does, in fact, happen with the original Offer unit, and Appeals (much like any other “Independent” adjudicatory function), just reviews that decision.
I wish I could go along with this. But as a practitioner, I cannot.
First, I cannot accept as true the proposition that IRS Appeals doesn’t “work” an Offer, and that it only reviews the rejection. As is particularly relevant to IRC § 7122(f), by the time the Offer actually gets to Appeals (usually many, many months later), circumstances have often changed. If too much time has passed, the IRS will ask for brand new bank statements, etc. Importantly, if the taxpayer raises new issues that have arisen since the original rejection Appeals will generally consider them on its own. See IRM 220.127.116.11.1.1 (08-18-2017). That, to me, seems like Appeals making their own determination by working the Offer on their own. The original rejection rationale may become, essentially, irrelevant.
Lastly, I cannot agree with the characterization as Appeals merely reviewing a rejection because that is not accurate as a matter of contract law. Note, very importantly, that IRS Appeals still has the power to accept the Offer. I will explain more about why that matters, but query whether Appeals is really reviewing a “rejection,” or only a “recommendation to reject.” Note the IRM heading on point: 18.104.22.168.4.5 (08-26-2020) “Collection Recommends Rejection” [emphasis added].
It is perhaps simplistic (though also perhaps accurate) to read IRC § 7122(f) as an analysis of just two dates: (1) when the offer was submitted and (2) when the offer was finally resolved. There is room in the statutory text, I believe, for accommodating some of the IRS’s concerns. But that room is found in contract law, and not in Appeals mission as an independent arm of the IRS.
Contract Law and Offer Analysis
The words “offer,” “rejection,” and “acceptance” are familiar to anyone that has taken a first year contract lectures or bar review. While an Offer in Compromise is a product of statute, it is “properly analyzed as a contract between parties” and “is governed by general principles of contract law.” Dutton v. CIR, 122 T.C. 133, 138 (2004).
Let’s apply some contract law principles to the transactions that I am most concerned about.
We know that when an Offer is “returned” as non-processible it is considered “rejected” for IRC § 7122(f) purposes. That is settled in the Tax Court (and 9th Circuit) via the Brown v. CIR saga. The question I’ve posed is whether that continues to hold if the determination to “return” the Offer is not upheld by Appeals. In other words, is a “preliminary” determination to return an Offer a rejection?
The Restatement of Contracts would give some fodder to the argument that such a preliminary determination is not, in fact, a rejection. The Second Restatement of Contracts § 38 covers rejections, and provides:
(2) A manifestation of intention not to accept an offer is a rejection unless the offeree manifests an intention to take it under further advisement.
The comment explains:
The rule of this Section is designed to give effect to the intentions of the parties, and a manifestation of intention on the part of either that the offeree’s power of acceptance is to continue is effective. Thus if the offeree states that he rejects the offer for the present but will reconsider it at a future time, there is no basis for a change of position by the offeror in reliance on a rejection, and under Subsection (2) there is no rejection. [emphasis added.]
What does a preliminary determination letter say? In my experience, when you are in CDP it says something to the effect of “we are recommending rejection/return of your Offer, but Appeals has the final say.” To me, that really seems to meet the “not a rejection” description in the Restatement. What is Appeals providing if not a “reconsideration” of the Offer?
Treating a preliminary determination as a final rejection is probably not tenable under contract law. Indeed, a precedential Ninth Circuit case would appear to agree with my analysis. Consider the case of U.S. v. McGee, 993 F.2d 184 (9th Cir. 1993).
In McGee, the taxpayer was working with an IRS Revenue Officer on a potential Offer. After much negotiation, the Revenue Officer decided that the proposed Offer was not acceptable. The RO sent a letter indicating as much and providing that McGee “had 15 days to appeal the ruling.” McGee never did appeal. A little less than a month later, the IRS sent a final rejection letter.
The question before the Court was when was the Offer rejected: the initial letter giving 15 days to appeal, or the final letter?
Here’s where things get interesting. The 9th Circuit found that the Offer was “rejected” only with the final letter, and not with the preliminary rejection granting appeal rights. The earlier letter was not a final rejection, the Court found, but “merely notice of a proposed rejection.” McGee at 186.
And here’s where things get even more interesting.
Recall that Brown was in the 9th Circuit. Recall also that I criticized both the Tax Court and Court of Appeals for inappropriately looking at when Offer is considered “pending” for purposes of IRC § 7122(f) (which only looks at when an Offer is “submitted”).
In McGee (which predates IRC § 7122(f) by over a decade), the issue of when the taxpayers Offer was “pending” was very important, because while an Offer is pending the statute on collection tolls. This case was purely about the statute of limitations. The taxpayer wanted to argue that the Offer was not pending because it was rejected through the IRS’s preliminary determination to recommend rejection: this would have ended the statute of limitations a little earlier.
Apparently, this issue of Offers holding the collection statute open indefinitely through the failure of the IRS to conclusively reject them had come up enough that other circuits addressed it. The general sense was that the taxpayer was protected from an indefinitely open collection statute through their ability to withdraw the Offer (thus ending the tolling of the clock). See McGee at 186.
Lastly, consider whether under contract law principles the IRS Offer Unit even has the power to reject an Offer in a CDP case. When the case is in CDP, the final determination must be made with Appeals. The Offer unit can only “recommend” acceptance or rejection. A recommendation by someone that has not been delegated authority (i.e. agency) to make a final determination does not seem like a rejection to me. The Tax Court case of Hinerfield v. CIR, 139 TC 277 (2012) makes this point nicely.
In Hinerfield, the IRS came within a month of hitting the two-year deemed accepted date on the taxpayer’s Offer. Wary of triggering that statute, a rejection was sent at the last second. What was the hold up? Apparently, the Settlement Officer wanted to accept the Offer, but IRS Area Counsel (which reviews Offers covering liabilities over $50,000 per IRC § 7122(b)) recommended against accepting. Who gets the final say?
Appeals does. Only not in the form of the Settlement Officer. It needs to be the Appeals Team Manager. The IRM, policy delegations, and multiple blog posts from Keith illustrate the importance of that point.
Changing the facts, if the SO in Hinerfield had told the taxpayer that they accepted the Offer, the IRS would not be bound. It would be an ineffective acceptance. I would say the same of a rejection conveyed to the taxpayer where the person rejecting does not have the authority to do so… say, in a preliminary determination by the Offer Unit.
But if that’s the case, how can we get to a place where the IRS is protected against offers aging into acceptance just because of Appeals review? Again, a look to contract law…
The Proposal: Counteroffers as Restarting the Clock
Let me lay my cards on the table. As I have snarkily alluded to throughout my posts, I think 24 months should be more than enough time for the IRS to reach a final determination even if the Offer goes through Appeals. I also think that there is good reason to believe that Congress, in enacting IRC § 7122(f), was looking at the issue more from a taxpayer’s perspective than an IRS processing perspective: what taxpayers want is a final conclusion, not an initial determination followed by indefinite inaction. Yet IRS Notice 2006-68 says “initial determination with indefinite inaction thereafter is completely fine.”
That isn’t fine, and it isn’t justifiable.
To me, the question is “when should the IRS reasonably get more than 24 months to evaluate an Offer?” The main reason I can think of is when the delay isn’t the fault of the IRS.
One such scenario would be when the IRS is waiting on the court to make a determination on a year involved in the Offer. In that scenario, the IRS is protected by the language of IRC § 7122(f) and doesn’t need to promulgate any regulations: “any period during which any tax liability which is the subject of such offer-in-compromise is in dispute in any judicial proceeding shall not be taken into account in determining the expiration of the 24-month period.”
Another scenario would be when the IRS has been engaged with the Offer, but the circumstances surrounding the Offer keep changing. For example, the taxpayer now owes for a new tax year or is now making more (or less) money. In those cases, what you are likely to be dealing with at the end of the day is a new Offer. Or, using contract law terminology, a “counter-offer.” Why does that matter?
Again, to the Restatement of Contracts, this time § 39 Counter-Offers:
(1) A counter-offer is an offer made by an offeree to his offeror relating to the same matter as the original offer and proposing a substituted bargain differing from that proposed by the original offer.
(2) An offeree’s power of acceptance is terminated by his making of a counter-offer, unless the offeror has manifested a contrary intention or unless the counter-offer manifests a contrary intention of the offeree.
The comments provide:
Counter-offer as rejection. It is often said that a counter-offer is a rejection, and it does have the same effect in terminating the offeree’s power of acceptance. But in other respects a counter-offer differs from a rejection. A counter-offer must be capable of being accepted; it carries negotiations on rather than breaking them off.
In my experience, the IRS makes counter-offers frequently, which usually culminate in sending the taxpayer amended Form 656 (i.e. contract) with the proposed terms. One could reasonably interpret such an IRS counter-offer as a “rejection” of the original Offer, which would thus stop the clock on IRC § 7122(f). But it would also be a submission of a new Offer, meaning that a new clock would start… thus precluding the IRS from delaying indefinitely all over again.
This, to me, appears to protect all the parties involved. Where the IRS is running up against the 24-month clock because the taxpayer’s circumstances are changing, it could easily require the taxpayer to submit an amended Form 656 to the offer examiner (or Appeals Officer) working the original case. While the IRC § 7122(f) clock would restart, I’m not sure taxpayers would be upset since they would continue to have someone at the IRS actually assigned to their Offer… and since up to this point virtually no one has succeeded on an IRC § 7122(f) claim anyway.
Conclusion: Bad Case Law, Bad Guidance, Bad Outcomes
If you can believe it, I have still more thoughts on IRC § 7122(f) that I may someday write about… but for now, this journey is at an end. When I originally read the Brown case, I saw it as the Tax Court reaching the right outcome for the wrong reasons.
After all the research I’ve put into these posts my thinking has changed. Now, I think both the outcome and the reasoning are wrong.
The taxpayer made, in my opinion, bad arguments.
First, he didn’t properly challenge Notice 2006-68. Indeed, according to the Tax Court opinion he appears to have conceded its authority, but instead argued that it is “inapplicable to CDP OICs.” Brown at 9. I don’t know why you’d concede challenging an IRS Notice (that appears to have some serious flaws) and instead draw focus to the implausible argument that the Notice doesn’t cover CDP offers. This was a tactical mistake.
Second, he tied the idea of an Offer “rejection” too closely to a Notice of Determination. Again, this seems like a flawed fixation on CDP. As the Tax Court characterizes the argument, the taxpayer considers the issuance of the Notice of Determination to be the “critical event” in IRC § 7122(f) analysis. That’s not a winning approach. The IRS can certainly reject an Offer (even in CDP) prior to issuing a Notice of Determination -it just has to be a conclusive, final rejection and not something “preliminary.” In other words, it has to be an effective rejection under contract law principles.
But from these flawed arguments the Tax Court also erred.
First, the Tax Court (and 9th Circuit) seem to think that clock on deemed acceptance doesn’t start running until an Offer is officially “pending.” That’s nonsense. Even IRS Notice 2006-68 doesn’t peg its IRC § 7122(f) analysis to a pending date. The statute specifically uses the word “submitted” rather than pending. Pending status is irrelevant to IRC § 7122(f) analysis. I hope over the course of my posts you’ll agree with me on that now.
Second, the Tax Court (with an assist from the 9th Circuit) uncritically treats a preliminary determination to return as being a rejection. Certainly, an actually returned Offer would be a rejected Offer. But if the Offer is never actually returned (or rejected), but only suggested that it will be… well, the Restatement of Contracts and the 9th Circuit (in McGee) have correctly found that is not definite enough to be a rejection.
To me, the problem with Brown isn’t that the taxpayer lost: I withhold judgment on a +$50 million tax liability being erased, and the Tax Court had to rule on the arguments that were put before it. Rather, the tragedy is that Brown will make IRC § 7122(f) claims more difficult moving forwards for the taxpayers that deserve its protection -namely, the low-income taxpayers that do, in fact, have their Offers shelved for months and then years.
Brown arguably stands for the proposition that a preliminary determination (to return or reject) an Offer is all that the IRS needs to do within 24 months. Thereafter it can take an indefinite amount of time to conclude the matter. I’ve looked at legislative history and GAO Report leading to IRC § 7122(f)… I struggle to believe that’s the outcome Congress had in mind. But because Brown is a precedential decision, others in the tax community will now have more of an uphill battle than they otherwise would have in getting to the right outcome. Nonetheless, I hope these posts have inspired you to join me in this fight.