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Offer in Compromise Rejection Sustained by Tax Court

Posted on July 14, 2022

For anyone interested in teaching at Harvard Law School, the faculty position from which I retired at the beginning of this month has now been announced. Because the faculty position belongs to the Legal Services Center and not to the Tax Clinic specifically, it’s possible that the new faculty member will direct one of the other clinics but also possible the person would direct the tax clinic. The Legal Services Center is a great place to work and a very supportive environment. I encourage any qualified applicants to apply. Keith

In Serna v. Commissioner, T.C. Memo 2022-66 the Tax Court sustains the rejection of an offer in compromise (OIC) made within the context of a Collection Due Process (CDP) case.  Since the only way to obtain Tax Court review of an offer runs through CDP, the number of decisions regarding OICs is small.  These decisions offer a window into the Court’s thinking on offers which can provide a valuable insight.

I occasionally have had clients come into the office wanting an offer similar to the one sought by Mr. Serna. He used all, or most, of a retirement distribution to buy a home and did not save enough from the distribution to pay the tax on the distribution. He seeks relief from paying tax on the distribution but does not want to pull the equity from the property purchased with the distribution to satisfy the tax. The IRS does not favor this result and wants him to fully pay his liability by tapping into the equity in the property. The facts get more complicated and will be explored below but the basic facts present in this case will almost never result in an offer acceptance by the IRS for good reason.

The tax year at issue is 2016. He paid about half of his approximately $130,000 liability for the year with his return leaving about a $65,000 balance which will have increased since that time due to interest and penalties. He offered the IRS $10,000. His initial offer was based on doubt as to collectability the standard basis for an OIC. He indicated in the offer that he purchased the house for his estranged wife so that she could live there with the couple’s four children and relieve him from paying child support. He indicated that he had moved back in with his parents and was paying them rent.

The IRS rejected his offer because the equity in the house greatly exceeded the liability even though his monthly expenses exceed his income. He appealed the rejection and changed his offer from doubt as to collectability to the more appropriate effective tax administration offer provision. When I say more appropriate, I don’t mean that the IRS should have necessarily accepted the offer but only that because his ability to pay the offer exceeded the amount of the outstanding liability, collection was not in doubt and a doubt as to collectability offer was inappropriate to the circumstances.

Along with changing the type of offer, he provided additional information. He explained that two of his children sufferance from “significant developmental disabilities and that the house was essential to them for multiple reasons.” Now, he is beginning to shape arguments that have at the least the potential to succeed but he is seeking the offer pro se and may not have had the tools to harness the most persuasive arguments. In addition to arguing for acceptance based on the needs of his children, he pointed out a long history of compliance and a lack of understanding of the tax consequence of the withdrawal.

While a long history of compliance coupled with an unusual event triggering the unpaid tax brings in facts that I always like to highlight in the cover letter to an OIC, these facts generally do not overcome the reluctance to accept an offer where sufficient funds or assets exist to satisfy the offer. The Court noted this in a footnote:

Mr. Serna additionally emphasizes his prior tax compliance in arguing the settlement officer abused her discretion. While we have no reason to doubt his history of compliance, lack of tax compliance is a bar to acceptance of an offer on effective-tax-administration grounds; compliance, conversely, does not alone justify acceptance.

A long history of compliance and a special, one-time event triggering the tax help to put the offer examiner in the right mood for accepting an offer but cannot overcome a clear ability to pay. A long history of non-compliance, makes it difficult to craft a sympathetic cover letter but, with the right economic facts, even a person with such a history can obtain an OIC.   

While the offer was pending, however, he also had a notice of federal tax lien filed against him which opened up the possibility for a new path to take in seeking offer approval – CDP. He timely made a CDP request and this gave him another person in Appeals with whom he could discuss his situation. The change, however, did not help. The Settlement Officer handling the CDP case:

noted that Mr. Serna had offered no documents to show that he was under any obligation to buy a home for his estranged wife and children. She further suggested that Mr. Serna had timed the home purchase to precede the filing of his 2016 tax return, which would have shown a balance due. The settlement officer explained that this conduct was out of the ordinary, as he had filed early for every prior tax year and employed the same tax return preparer as before.

The Tax Court noted that it reviewed his case for abuse of discretion. Mr. Serna did not allege that the Settlement Officer failed to properly verify the procedural correctness of the assessment, and the Court found that the SO “thoroughly reviewed Mr. Serna’s information and account transcripts and verified that all applicable requirements were met.”

The Court next reviewed the decision by Appeals. In doing so it stated:

“We judge the propriety of the [Office of Appeals] determination . . . on the grounds invoked by the Office of Appeals.” Elkins v. Commissioner, T.C. Memo. 2020-110, at *24; see also SEC v. Chenery Corp., 332 U.S. 194, 196 (1947); Antioco v. Commissioner, T.C. Memo. 2013-35, at *25 (“Applying Chenery in the CDP context means that we can’t uphold a notice of determination on grounds other than
those actually relied upon by the Appeals officer.”). In doing so, we look to the reasons offered in the notice of determination, as further unspooled in the settlement officer’s contemporaneous rejection memorandum and case activity notes. Accord Melasky v. Commissioner, 151 T.C. 93, 106 (2018) (“[W]e will uphold a notice of determination of less than ideal clarity if the basis for the determination may reasonably be discerned . . . .”), aff’d, 803 F. App’x 732 (5th Cir. 2020); Kasper v. Commissioner, 150 T.C. 8, 24–25 (2018) (“Although we may not accept any post hoc rationalizations for agency action provided by the Commissioner’s counsel, we may consider any ‘contemporaneous explanation of the agency decision’ contained in the record.” (quoting Tourus Records, Inc. v. Drug Enf’t Admin., 259 F.3d 731, 738 (D.C. Cir. 2001))); see Elkins, T.C. Memo. 2020-110, at *25–29.

The Court found that the IRS did not abuse its discretion in rejecting the $10,000 offer because the record indicated that he could pay more than that amount without causing economic hardship. He had enough income to cover his expenses. The liability could be satisfied by taking the equity in the house without causing him economic hardship. Although the SO might have accepted the offer, the examples in the applicable regulations did not require acceptance under this circumstance. The Court found that the SO weighed the circumstances a sale of the property would cause and demonstrated consideration of the necessary factors in determining hardship. The Court concluded by saying:

We are not blind to the fact that Mr. Serna repeatedly asserted that he was supporting not one, but four children (and his estranged wife) in the house at issue. He claimed only one of these children as a dependent on his tax return, however, and we cannot fault the settlement officer for considering only that child in her evaluation.

Nor are we persuaded by Mr. Serna’s contention that the settlement officer’s refusal to accept the OIC put at risk his children’s access to their current school district. Despite being given multiple opportunities, Mr. Serna failed to provide the settlement officer with sufficient information to credit this assertion and factor it into her evaluation.

In conclusion, we might have reached a different result than the settlement officer had we evaluated the OIC in the first instance. We nonetheless cannot say that the settlement officer abused her discretion in deciding as she did.

What could Mr. Serna have done to succeed? From the Court’s statements, it would seem that he needed to provide more evidence of what selling the house would do to the rest of his family. He never provided evidence that he had a child support obligation or that buying the house in which his estranged wife could live would satisfy that obligation. He needed additional evidence of the impact of the sale of the house if the offer were rejected. Based on his income it does not appear that he could have borrowed money through a home equity line of credit because of an inability to support the loan; however, it does not appear that he presented evidence of an inability to borrow. Such evidence would have supported the conclusion that if the offer were rejected the only way to satisfy the outstanding debt would be selling the house and displacing his estranged wife and his children.

It’s clear that he should have provided more evidence. This is a common problem for people representing themselves in an OIC. It is not clear that providing more evidence would have persuaded the SO nor is it clear that had the additional evidence been present it would have led to a different outcome at the Court but it might have. The absence of the evidence on the harm made it easy for the Court to support the finding of the SO.

Given that the IRS rarely seizes and sells personal residence, it is also not clear who is the winner here. The IRS can prevent someone in this situation from receiving an OIC; however, unless it is willing to act to cause the sale of the property, all the rejection does is put the parties back where they were before the submission of the offer. It could well be that the remainder of the 10 years on the statute of limitations will pass without payment of the tax by Mr. Serna and without sale of the house by the IRS. Mr. Serna lost this battle but it is unclear whether he will lose the war.

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