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When Does a Settlement Become Binding on a Party in the Tax Court (Part 1)

Posted on Sep. 22, 2016

In handling a case in Tax Court, parties look diligently for a path to settlement. Sometimes settlement proves easy to achieve.  Sometimes settlement seems impossible or nearly impossible.  Sometimes you seem to have a settlement and then either the taxpayer or the IRS backs away.  This three-part post looks at what happens in the last situation – where the parties appeared to have achieved settlement only to have it slip away – with the view of when can the Court bind the parties to a settlement that once existed and then  seemed to disappear.  The answer in these situations generally turns out more favorably for the IRS than for taxpayers, for reasons discussed below.  The discussion in the post appeared in the May-June edition of the Journal of Practice and Procedure.

Settlement Discussions

The research for this post resulted from a failed settlement in a clinic case. The client, a surviving spouse who had relied on her husband to primarily handle the financial matters of the couple, brought to the clinic an issue it had not previously handled concerning the ability to roll over IRA funds after the statutory 60-day period – a topic discussed in a recent guest post.  The Code gives the Service the authority to waive the statutory time frame administratively where it fins the failure to roll over the funds meets certain criteria.  The affirmative authority granted to the Service under Section 408(d)(3)(i) represents a rare instance of the legislative branch specifically ceding authority to the executive branch to override the time frame established by statute.  I think Congress saw too many situations in which taxpayers like my client ended up with a huge, unintended tax bill from small mistakes made by themselves, their financial advisors or the financial institution and created a process for the Service to have a “do-over.”  Every month or so you can see a flurry of these applications posted in Tax Notes or other publications as the Service grants or denies the requests of the individuals who made a mistake.

As the students began the representation, one of the first issues they faced concerned the ability of Appeals, or Chief Counsel, or the Tax Court, to grant the relief the taxpayer sought. The statute provides a method for obtaining a waiver administratively but does not mention relief through judicial action.  We had some concern whether the Appeals Officer had authority to settle this case by granting full or partial relief for the client to roll over the IRA well past the 60-day deadline.  Their research provided no clear answer.  The students did not want to assume that negotiation with the Appeals Officer could result in relief.

They began by providing the Appeals Officer with factual and legal information in support of granting relief and asked for confirmation that this matter could be resolved in a Tax Court proceeding. After hearing their preliminary presentation of the issue and facts, the Appeals Officer indicated that he thought the case was susceptible to settlement in the Tax Court proceeding and that he should be able to come up with a settlement that the client would like.  The discussion went on for a few months at which point it appeared that settlement was reached, allowing the client to roll over a certain percentage of the funds and causing her to take into income the balance.  The client agreed with the proposed settlement but wanted to know the financial impact.  The Appeals Officer made no mention of needing to get approval from his manager and the students did not ask about this.  The Appeals Officer provided a computation, and when the student attorneys pointed out a mistake in the computation he said he would make sure the mistake got fixed in the final computation.  The students notified the Appeals Officer that the client accepted the offer and stood ready to sign the decision document.  The students asked the Appeals Officer to write a letter to the client’s bank stating that it could transfer the funds to the retirement account in accordance with the settlement.  They were calling the Appeals Officer every two weeks trying to get an answer on that question and the Appeals Officer was deferring until he could obtain an answer from the Chief Counsel attorney about that.  At no point did he say that the entire settlement was off or that the settlement turned on getting an answer to this question.

Finally, over two months after the apparent agreement, the Appeals Officer wrote to say that his manager did not agree with the settlement and asked that the client agree to a full concession of her case and that his only concession would be waiving the penalty for substantial understatement. Throughout the negotiations, the Appeals Officer never mentioned that he had not obtained the authority of his supervisor to make the offer that he made to settle the case.  Everything he did suggested that he had authority to reach the proposed settlement.  The sudden and unexpected rejection after the conclusion of the semester left us in a quandary and put the clinic in a tight spot for the early fall trial calendar date because the students who had spent all semester working on this case had finished the class and new students had to start.  As we looked into what we might do, we examined the Tax Court precedent concerning settlements to determine if the Appeals Officer’s actions here might result in a binding settlement.

Guidance to Appeals Officers

The lines of authority for Appeals Officers and Chief Counsel docket attorneys clearly require managerial approval for settlement. I knew this but failed to explicitly mention it to the students working with the Appeals Officer because I thought the Appeals Officer would make clear his authority during the settlement process.  This experience may change my practice in preparing students for this process.  My own practice as a docket attorney and my experience dealing with Appeals Officers and Chief Counsel docket attorneys on many cases is that this approval process was constantly mentioned so that the other side knows a settlement needs further approval.  In circumstances in which the approval exists for the line employee in Appeals or in Counsel to make a settlement offer, my experience is that this is also communicated so that the taxpayer or their counsel knows that the offer already has approval.  As a government employee operating with lines of authority, making clear those lines and the stage of approval of a proposal seems like a best practice and one most employees in those offices follow.

I incorrectly assumed that my students were dealing with someone who would make that clear. The case served as a good learning tool for me and for the students working on it.  We did not necessarily want the lesson that we learned because it felt as though the rug was pulled out from underneath us after a fair negotiation, but we did not have a binding settlement with Appeals and we learned that as we researched the authority for binding settlements.  While I think an Appeals Officer or a docket attorney has a responsibility to make the lines of authority clear when making a proposal, that responsibility does not come from a requirement placed upon the individual in the Internal Revenue Manual or the Code.

The IRM does make some mention of the duty of an Appeals Officer to advise the taxpayer of the scope of their authority, but not on this point. IRM provides that the Appeals Officer should “advise taxpayers that tentative agreements not finalized using Form 870-AD or Form 906 are subject to renegotiation in the circumstances described above.”  Form 870-AD is the consent to assess form used by Appeals that seeks to bind the parties, in a non-docketed phase of the case, to the terms of the agreement so that the taxpayer cannot later bring a refund suit to recover the taxes.  Form 906 is a closing agreement form binding the parties to the agreement pursuant to IRC 7121.  The language of the IRM referring to circumstances described above refers to “Exercise care in a case where a tentative agreement was reached with the taxpayer and a change in the position of an applicable authority occurs which affects the agreement in a substantive and material manner.  If a tentative agreement was not finally reflected on Form 870-AD or Form 906 and signed by a Service official authorized by the Commissioner to approve negotiated settlements, the tentative agreement is subject to modification if the law or legal precedent relied upon to formulate the tentative agreement changes.  If the change is substantive and material, the agreement is renegotiated.  For purposes of this section, the word “substantive” means the change in law or legal precedent results in a meaningful change to Appeals’ assessment of the hazards of litigation.”

We found other IRM provisions addressing settlement and finality but nothing expressly addressing the discussion an Appeals employee might have during settlement negotiations concerning the managerial approval process. IRM discusses how to achieve greater finality in non-docketed cases through the use of Form 870-AD or Form 906 and IRM requiring the manager to review the stipulated decision in a complex Tax Court case.  This provision suggests, by negative implication, that the manager need not review the decision document prepared and sent out by the Appeals Officer in routine cases.  It does not address the issue of whether the manager must approve the settlement before the Appeals Officer sends out the decision document in a routine case.  Creating clear directives on this point in the manual provisions would give needed guidance to Appeals employees about their duties in settlement negotiations.  In docket Tax Court cases, Appeals Offices deal primarily with pro se taxpayers who will never have dealt with Appeals before and will have every reason to believe that the person with whom they are negotiating has the authority to bind the Service.  Creating clarity about when a proposal is, or is not, subject to further approval does not detract from the settlement discussions and avoids situations that can create hard feelings toward the Appeals employee and the government process.

As discussed in part 2 of this post, taxpayers in other cases have also mistakenly thought they had an agreement only to find they did not. Appeals could instruct its employees to make it clear when a proposed settlement needs further approval.  Such a practice would enhance customer service.

Although some strong case law exists on the binding nature of certain actions prior to trial, as discussed below, those cases primarily turn on action by the taxpayer and not by the government. The precedent binding the Government to an agreed settlement provides little relief to taxpayers in most instances.  These posts will examine the circumstances that can bind a party in Tax Court to an agreement as well as the circumstances that do not.  Unfortunately, the circumstances in our case fell into the non-binding category; however, the Chief Counsel attorney ultimately offered the same settlement that Appeals inextricably withdrew leaving our client happy at the end of the day.  The Chief Counsel attorney made it clear that she made the same offer because she thought it was a good offer and not because she thought a binding agreement existed. The discussion here applies only to cases in Tax Court and not to non-docketed discussions with Appeals.  The case law concerns settlement discussions between petitioners and the Government.  Those discussions could occur with either Appeals or Chief Counsel.  The same general principles should apply no matter whether Appeals or Counsel engaged in the negotiations, although interaction with the Court frequently plays a role in the outcome and that implicates Chief Counsel attorneys more than Appeals Officers.

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