Gillette v Commissioner is a collection due process case arising from the tax consequences of prematurely withdrawing funds from an IRA and underpaying taxes while a taxpayer was suffering from compulsive gambling that she claimed was attributable to an addiction to prescription medication. The taxpayer sought an effective tax administration offer in compromise. While unsuccessful, the case warrants attention as there is very little law around this type of offer.
The opinion situates the sad tale that led to the sizable underpayment of taxes on her 2012 tax return. Ms. Gillette is a veteran and former firefighter who managed and owned a stable of rental properties. After retiring from firefighting, she developed a serious gambling addiction that she attributed to the side effects of pramipexole, a prescription medication.
Occasionally she would go days without sleep and at times slept in her car if she wasn’t given a complimentary night’s stay at a casino. Other times she would fall asleep at blackjack tables and slot machines only to be awakened by dealers and casino attendants. Nearly all of the money she collected from her rental properties went to casinos. When she ran out of money, she borrowed from friends and didn’t pay them back, took money and credit cards from her husband’s wallet, and eventually withdrew money from her retirement account in 2012.
In 2013, following the intervention of her son who recognized that the side effects of the medication she was taking were likely contributing to her gambling, she sought medical care to wean off the drug. Within a couple of years she was no longer taking the drug and was able to stop gambling. One lingering effect though was the 2012 alternative minimum tax (AMT) of about $17,000 and early IRA withdrawal penalty of about $10,500, both of which contributed to a tax balance due of almost $76,000 on her and her husband’s 2012 tax return.
Following a notice of intent to levy, the taxpayers requested a CDP hearing, challenging the underlying AMT liability and eventually offering $38,968 to compromise the liability based on effective tax administration (ETA). The ETA offer was sought because they were not a candidate for an offer based on doubt as to collectability, as the equity in assets (including the rental properties) exceeded the tax due (in fact Appeals determined that the reasonable collection potential in light of the assets was over $800,000).
The main part of the opinion dealt with Appeals’ rejection of the ETA offer and the Tax Court’s refusal to find any abuse of discretion in Appeals’ rejection.
The case originally went up to Tax Court a couple of years ago, but the Tax Court on the IRS’s motion remanded the case back to Appeals for a supplemental hearing because the original determination had an insufficient discussion of the reasons why Appeals agreed with the offer specialist’s decision to reject the ETA offer. By requesting a remand, the IRS avoided reversal for failure to consider the taxpayer’s equitable arguments. Guest blogger Professor Scott Schumacher previously discussed this requirement on PT.
After going back to Appeals, the settlement officer considered the taxpayer’s argument and again rejected the offer, in part on a finding that the side effect of the medications, including compulsive gambling, were known since 2006 and that the taxpayer made a choice to continue taking the medication anyway. In rejecting the offer on remand, Appeals did not refer the offer to the IRS’s ETA Non-economic Hardship Group, the group the IRM states should review ETA offers in “appropriate” cases.
Before exploring this further, it is worth emphasizing the law that applies to offers based on effective tax administration. The regulations provide the standard:
If there are no grounds for compromise under paragraphs (b)(1) [doubt as to liability], (2) [doubt as to collectability], or (3)(i) [economic hardship] of this section, the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.
Reg. Sec. 301.7122-1(b)(3).
Thus, the regulations provide that the IRS may accept a compromise where there are “compelling public policy or equity considerations.” Unlike offers based on doubt as to collectability, which essentially default to a more mechanical comparison of the offer amount relative to the taxpayer’s collection potential, this standard is relatively vague. The regs do provide some examples of cases that should be considered under a public policy or equity ETA offer:
(1) a taxpayer with a serious illness requiring hospitalization for a number of years who, at the time, was unable to manage his or her financial affairs, including filing tax returns and (2) a taxpayer who learns after an audit that incorrect advice was given by the Commissioner and is now facing additional taxes and penalties because of that advice.
The IRM also provides guidance for IRS, providing additional factors and examples:
- where the taxpayer’s liability was the result of the Commissioner’s processing error,
- following the Commissioner’s erroneous advice or instructions,
- the Commissioner’s unreasonable delay, or
- the criminal or fraudulent act of a third party
In addition the IRM states that accepting a public policy or equity offer-in-compromise may be appropriate where rejecting it would cause a significant negative impact on the taxpayer’s community or “the taxpayer was incapacitated and thus unable to comply with the tax laws.”
The main argument that the taxpayers made was that because of the drug use Ms. Gillette was mentally impaired and incompetent, essentially claiming that this was akin to an incapacitation that would justify acceptance of an offer below the collection potential.
The Tax Court disagreed, primarily by distinguishing her situation from the examples and factors cited in the regs and the IRM:
Ms. Gillette and Mr. Szczepanski argue that their public policy or equity offer-in-compromise should be accepted because Ms. Gillette’s mental illness was caused by her prescription medication. While Ms. Gillette’s circumstances are unfortunate, Ms. Gillette and Mr. Szczepanski did not provide grounds for treating them differently from a similarly situated taxpayer who paid his or her liability in full. Their situation also differs from the examples given in the regulations: Ms. Gillette did not require hospitalization for a number of years, she was able to file her tax returns, she collected rents from her rental properties, and she did not receive incorrect advice from the Commissioner.
In addition, the opinion, while acknowledging the impact of the gambling addiction, distinguished the incapacity from others that would render an inability to comply with the tax laws:
Finally Ms. Gillette and Mr. Szczepanski do not meet any of the compelling factors outlined in the IRM. Ms. Gillette was not so incapacitated that she was unable to comply with the tax laws, rejection of their public policy or equity offer- in-compromise would not have had a significant negative impact on their community, and their 2012 tax liability was not caused by an error or delay of the Commissioner or the fraudulent or criminal conduct of a third party.
This is a close case. No doubt the taxpayers come away feeling that the system did not adequately address their legitimate concerns. From a process standpoint, I feel their pain; the initial Appeals determination did little in explaining why the offer was originally rejected; on remand Appeals did not refer the case to the unit specifically that hears ETA offers (a point the opinion notes was not an abuse of discretion as the decision to do so is essentially one completely in Appeals’ wheelhouse); and at trial the Tax Court did not allow the testimony of the taxpayer’s doctor or VA social worker, among other witnesses.
I am not equipped to evaluate the level of the taxpayer’s incapacity or the degree to which the medication contributed to or caused the gambling that led to the liability and underpayment of taxes. It would seem to me, however, that the Tax Court might have benefited from the testimony of the doctor. While some circuits follow the record rule and limit review of CDP cases to the evidence in the administrative record, the Seventh Circuit, where the case is appealable, has declined to decide that issue. In addition, given the lack of guidance in this area, the IRM factors and examples have heightened importance, a curious result again from a process standpoint given the absence of any public input in their promulgation.
To be sure, as the opinion notes, and as the IRS emphasized, there is no explicit unfairness hook that would require the IRS to accept an ETA offer. In addition, the taxpayer has significant assets. Given the lack of case law in this area, it is likely that this case will be one that the IRS will lean on when taxpayers seek to resolve a liability even after a taxpayer makes a credible case that substance abuse has contributed to the taxpayer’s liability.
For readers interested in more on ETA offers, including suggestions on how the IRS can improve standards for evaluating the offers, check out Rutgers Law School Professor Sandy Freund’s 2014 Virginia Tax Review article Effective Tax Administration Offers-Why So Ineffective.