Being tasked with “administering” the Internal Revenue Code is no easy job. Congress sometimes makes it even more difficult by having the IRS distribute direct payments (like the Economic Impact Payments (EIPs)) or by changing the law when filing season has already started (for example, by excluding unemployment benefits from income). Notice and comment rule-making takes time, and sometimes the IRS relies on the “quick guidance” that can be delivered through online FAQs or other sub-regulatory means.
While understandable as an interim action (really, just letting people know what the IRS “thinks” about the statute, but without force of law) it is problematic when “rights and obligations” flow from the guidance -believe it or not, sometimes the guidance is not well rooted in the statute (see posts on the incarcerated individuals and the EIP here, here and here).
It is similarly problematic when the quick guidance subtly morphs from temporary to permanent after years of inaction on finalizing regulations. And it is even more problematic (dare I say, inexcusable) when that quick guidance directly contradicts prior (still valid) notice and comment regulation. To hear more about one such instance that many PT readers have likely encountered without even realizing it, you’ll need to…“read
Dream with me, if you will, of an individual that currently makes $35,000 but can’t afford to pay their back taxes. They used to work as an Uber driver where they were hammered with SE taxes. They’ve since become an employee, but they have virtually no disposable income. They submit an Offer in Compromise proposing to pay a $1,000 “lump-sum” to settle the back taxes. Per the Offer instructions, the individual includes $200 as a 20% payment on the Offer, as well as a $205 application fee.
Time passes. Months later, this individual gets a letter returning the Offer as “non-processible” because they have not made required quarterly tax payments. Oh, and on top of that, the $405 they sent in is not coming back.
Now this individual is in your office, regaling you with this tale of woe. You want to help them at least get back the 20% payment. You look at the Treasury Regulation (301.7122-1(h)) on point. Your eyes light up:
Sums submitted with an offer to compromise a liability […] are considered deposits and will not be applied to the liability until the offer is accepted[.] If an offer […]is determined to be nonprocessable […] any amount tendered with the offer, including all installments paid on the offer, will be refunded without interest.
You recall from your law school years that Treasury Regulations are basically the highest authority of agency rulemaking. Good as gold! Your client is getting the 20% payment back, right?
And yet you’ve grown so cynical over the years you doubt yourself: if the answer is so obvious, why is your client even here? You look over the IRS Form 656 that your client submitted. Under Section 7, Offer Terms, it reads:
(h) The IRS will keep any payments that I make related to this offer. I agree that any funds submitted with this offer will be treated as a payment. I also agree that any funds submitted with periodic payments made after the submission of this offer and prior to the acceptance, rejection, or return of this offer will be treated as payments.
You wonder why the IRS Form would include terms that seem to go against their own regulations. So you continue digging…
It turns out the regulations you were so thrilled with are a bit dated. The 20% payment requirement at issue was added as part of TIPRA in 2006 and the Offer regulations are from 2002.
Fortunately, in lieu of updated regulations there is an IRS Notice on point.
Unfortunately, that IRS Notice is IRS Notice 2006-68.
The Service will treat the required 20-percent payment as a payment of tax, rather than a refundable deposit under section 7809(b) or Treas. Reg. § 301.7122-1(h).
There you have it. The Treasury Regulation clearly says money sent with an Offer is a deposit. The Notice clearly says, “not so, if it is part of the 20% payment.”
We are now at the title of this post: When regulations and sub-regulatory guidance collide, which one controls?
A Look to the Statute Before We Look to Admin Law
If the statute is clear about how to treat the payments than it shouldn’t really matter what the regulatory or sub-regulatory guidance says. The problem is when the statutory language is unclear, and there is at least some room for interpretation delegated to the agency.
And that is what we have here. To me, this is a “clearly unclear” statute.
We know that a 20% payment is (generally) required to accompany an Offer. Per IRC § 7122(c)(1)(A)(i) “In General- The submission of any lump-sum offer-in-compromise shall be accompanied by the payment of 20 percent of the amount of such offer.”
But our question is whether you can get that payment back, not whether you must submit a payment in the first place. Is the payment a deposit towards the Offer, or a payment towards the underlying tax? TIPRA doesn’t quite address this, though it does provide some more guidance. Per IRC § 7122(c)(2)(A):
Use of payment- The application of any payment made under this subsection to the assessed tax or other amounts imposed under this title with respect to such tax may be specified by the taxpayer.
There is a comfortable amount of wiggle room in this otherwise dry language.
The taxpayer gets to specify the “application” of the 20% payment towards “assessed tax or other amounts imposed under this title.” If it just read “assessed tax” that would be much clearer and reasonably read as limited to designating among the assessed taxes comprising the Offer. But the very broad phrase “other amounts imposed under this title” seems to leave the door open. Is the “TIPRA” payment an amount imposed under this title?
Note also that the statute does not say that all payments “must” be applied towards “assessed tax or other amounts imposed under this title.” It merely says that when such payments are applied, the taxpayer gets to choose how they are applied. This says literally nothing about if a returned, non-processed offer must have the payment applied to assessed taxes. That is an IRS (not Treasury) interpretation only.
You won’t find much illumination in the legislative history, though I would suggest that if anything it cuts against the IRS Notice 2006-68 interpretation. The Conference Report distinguishes the “user fee” from the “partial payment” by saying that the user fee “must be applied” to the tax liability. But it is silent as to whether the “partial payment” must be. In other words, it creates more ambiguity on the issue rather than resolves it.
Fundamentally, the question remains about the required 20% payment. Is it always a payment towards tax (non-refundable), or might it sometimes be a payment towards the Offer (potentially refundable)?
At present, all we have are the thoughts of IRS Counsel as memorialized in Notice 2006-68. Without further going into depth on the merits of its interpretation, it is time to turn to the admin law question: what about the fact that Notice 2006-68 seems to be contradicted by an actual, still enforceable, Treasury Regulation?
Let’s look to the admin law authorities… in our next post.