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Dissipation of Assets as Basis for Rejection of Offer in Compromise or Other Collection Remedy

Posted on Nov. 10, 2015

The recent Tax Court case of Chandler v. Commissioner discusses the impact of dissipated assets on collection relief.  The concept of dissipation derives from the equitable principle of seeking relief with unclean hands.  If a taxpayer wants the IRS to grant an offer in compromise, the taxpayer cannot, prior to the offer, behave in such a manner that would make the IRS a fool for accepting the offer.  The Internal Revenue Manual provides that an offer examiner can take dissipation into account in calculating a taxpayer’s reasonable collection potential.  The principle does not apply only in offer cases but the starkest examples of the application of the principle appear in these cases.  The Chandler case presents a rare example in a court case of the application of the rule.  Because of the facts of the case, the issue itself does not get flushed out as it might under other circumstances.

Sometimes the issue of the dissipation of assets produces a heated discussion between the IRS and the taxpayer because what may seem like dissipation to the IRS seems like necessary expenditures to the taxpayer. The Chandler case required no difficult analysis by the court deciding between arguments of the parties over the merits of certain expenditures.  Instead, Mr. Chandler, a frequent visitor to the Tax Court, basically admitted that he frittered the money away that might have been used to pay his past due taxes with no good excuse for why he decided to spend the money on “wine, women and song” (my words since the case does not detail the use of the money.)  In his tepid defense, Mr. Chandler stated that he spent the money on the advice of his attorney.  I will discuss that further below.

Mr. Chandler’s outstanding liabilities exceed $600,000. He owes taxes for years that span three decades not including the current one.  In 2006-2008, at a time when he had accumulated unpaid tax liability spanning almost 20 years, he pulled $400,000 out of retirement accounts.  He failed to pay taxes on the withdrawals or use any of the money to pay down his then outstanding liabilities.  He subsequently received a collection due process (CDP) notice and requested a hearing.  During the hearing the Appeals employee requested information about the use of the $400,000 but received only evasive answers.  The Appeals employee denied his request for an OIC determining that his reasonable collection potential included the $400,000 withdrawn from his retirement account.  By her calculation, he had the ability to pay about $500,000 and he offered about $2,000.

When a Appeals employee determines that a taxpayer has dissipated assets, the IRM directs them to make a decision based on the facts and circumstances of the case whether to include the dissipated assets in determining reasonable collection potential.  In the absence of an explanation by the taxpayer under circumstances like this, the Appeals employee quite logically and reasonably included the money withdrawn and spent at a time the outstanding liabilities existed in the calculation of reasonable collection potential.  The Appeals employee in these situations looks to see if the taxpayer used the funds for necessary and reasonable living expenses in making the decision to include or exclude the monies from reasonable collection potential.

By the time the taxpayer got to court in 2014 or 2015, he argued that his circumstances had changed since 2006-2008 when he pulled the money out of the retirement fund and used it without paying his taxes. Now, he has cancer and the attendant medical expenses.  He asked the court to remand the case for reconsideration of the offer based on his changed circumstances.  In many cases this type of changed circumstances might result in a remand as the court recognizes the new reality regarding a taxpayer’s ability to pay.  Here the Court found that it did “not believe the [OIC] was made in good faith.  Petitioner has been conniving for a very long time to avoid payment of his Federal income tax liabilities, and it is time to bring these delay tactics to an end.”  While the result is harsh, Mr. Chandler’s actions over many decades left the Court with no option.

Most cases involving dissipated assets do not have quite the fact pattern of abuse presented here. How do you advise your clients to use their funds in the lead up to an offer or other type of request for collection relief?  In the low income cases that come through clinics, I most often see taxpayers using money from a retirement account or from a lump sum distribution upon the determination of disability.  We try to trace the use of the proceeds in these circumstances to affirmatively explain to the IRS how the taxpayer spent the money at a time when an outstanding liability existed.  In many cases, we can show that the money covered reasonable living expenses or capital improvements to their home to make reasonable accommodations for their disability.  I have found the offer examiners to be reasonable in their exercise of judgment in these cases in almost every case.  In situations in which the alleged dissipation comes to light because of information the IRS provides to us rather than vice versa the level of skepticism rises.

In the lead up to making an offer as you review a taxpayer’s finances, it commonly occurs that the taxpayer’s assets do not match exemptions provided or the taxpayer comes into some money while you are preparing the offer. Unlike the situation where you must explain the taxpayer’s prior actions in trying to avoid the application of the dissipation rule, now you must confront what to do with money in the taxpayer’s hands.  If the taxpayer has reasonable living expenses long postponed awaiting receipt of the money, the advice is relatively simple but if the taxpayer wants to use the money for purposes other than reasonable living expenses or reasonable accommodations, a frank discussion of the use of the funds is necessary.  Once spent on something other than the taxes without a good reason for the expenditure, it will be difficult for many taxpayers to recover the money when the IRS treats it as a dissipated asset and the taxpayer may be prevented from obtaining the collection relief they want and need.  Additionally, you may have explaining to do if you provided advice regarding the expenditure.  You do not want to be in the position of having to make that type of explanation.

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