Collection Due Process Hearing

Offset of refund

In Murphy v. Commissioner, T.C. Memo 2019-72, Filed June 11, 2019, the Tax Court ruled that a Settlement Officer did not abuse discretion in failing to consider a credit from a tax year not in question, to offset a liability from the year at issue.  This was a Collection Due Process (CDP) hearing that was triggered by the filing of a final notice of intent to levy issued by the IRS relating to a balance due on 2015.  The taxpayers argued that the liability could be resolved if the Settlement Officer would address a failed claim for refund on their 2011 tax period.  For the 2011 period, the IRS has filed a Substitute for Return.  Ultimately, the taxpayers filed a return on May 7, 2016 which the IRS treated as a claim for refund and denied. During the CDP hearing, the Officer explained that the 2011 tax period was not subject to a levy notice and therefore she lacked jurisdiction to address the refund claim.  The Tax Court ruled that it lacked jurisdiction over the 2011 claim for refund.  Additionally, the Tax Court ruled the Settlement Officer had not abused her discretion in handling the matter.

Dissipation of Assets

Offer in Compromise

In John F. Campbell v. Comm’r, T.C. Memo 2019-4, Filed February 4, 2019, the Tax Court ruled that an IRS Appeals officer, in the context of reviewing an Offer in Compromise during a Collection Due Process hearing, abused his discretion when including certain dissipated assets in the calculate of Reasonable Collection Potential (RCP). The Court explained that the Internal Revenue Manual (IRM) sets forth when dissipated assets should be included in RCP.  Per IRM, dissipated assets are only included in RCP where “it can be shown that the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability,” or otherwise used the assets “for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or during a period up to six months prior to or after the tax assessment.”  The IRM instructs that the Appeals officers should use a three-year look-back period, from the date the offer is made, to determine whether it is appropriate to include dissipated assets in the RCP calculation.  The officer may look beyond this period if there is a transfer of assets within six months before or after the assessment of the tax liability.  The Court deemed it an abuse by the Appeals officer to include assets transferred 6 years before the assessment and 10 years before the Offer was submitted.  The Court was further disturbed by additional IRS allegations that the taxpayer sought to “waste his wealth,” rather than pay his tax liabilities. There was no evidence on the record, or otherwise, supporting this contention.   

Untimely Refund Claims

I.R.C. section 6511

The Tenth Circuit Court of Appeals reviewed the applicable refund statute and upheld a Tax Court ruling in Lorraine K. Linton and John R. Linton v. Commissioner of Internal Revenue, No. 18-9004 filed February 22, 2019. The IRS disallowed the Linton’s refund request for the 2008 tax year as untimely. They had paid the amount claimed as a refund more than three years and six months before they filed the return on which they claimed the refund. The Court ruled that two Code provisions govern the timeliness of a refund claim. First, the taxpayer must file the claim within three years after filing the tax return or two years after paying the tax, whichever happens later, per section 6511(a). Second, the amount of the refund is limited to the portion of the tax paid in the three years “immediately preceding the filing of the claim…plus the period of any extension of time for filing the return.” See section 6511(b)(2)(A). In this case, the taxpayers clearly filed beyond these time limits, but were arguing their CP59 response (a notice indicating there is no return filed), was an adequate claim for refund.  They made this argument because their response was within the relevant timeframe.  The Court disagreed and ruled the U.S. Supreme Court in United States v. Brockamp, 519 U.W. 347 (1997) clearly held section 6511 limitations must be strictly enforced.

Updated Guidance from the IRS on Innocent Spouse Relief

When married taxpayers file a return, they may elect to file that return jointly with their spouse.  Sometimes that is a mistake – a big one!  When filing a joint return, the Internal Revenue Code provides that both spouses will be jointly and severally liable for the tax, penalties and interest.  This blog has reviewed the various options available to spouses requesting that they be relieved from liability on the return. Just click on “Innocent Spouse Relief” under “Posts by Category” for a general  review.  Lately, we are seeing the IRS take action to update their analysis of Innocent Spouse Applications.

General guidelines provide that understatements of tax may qualify for relief under so-called “innocent spouse” or “separation of liability” provisions, while underpayments may only qualify under “equitable relief” provisions.  All three of these are under the umbrella of “innocent spouse relief” provided by the Internal Revenue Code.

Of note, earlier this year, the IRS updated internal guidance. One change made to internal guidelines earlier this year was to clarify provisions relating to actual or constructive knowledge of the understatement of tax.  Basically, in order to qualify under this particular type of Innocent Spouse relief, it is necessary to show that the requesting taxpayer did not know about the understatement and had no reason to know of the understatement.  If this requirement isn’t met, then the requesting spouse doesn’t qualify.  However, if the requesting spouse can establish that he or she was the victim of domestic abuse prior to the time that the return was signed, but did not sign the return under duress, and as a result of the prior abuse, did not challenge any of the items on the return for fear of retaliation, then the IRS will not review the requirement of showing that the requesting spouse did not know or did not have reason to know of the understatement.

Normally, the IRS will review the following factors to determine if the requesting spouse knew or had reason to know of the understatement, absent a showing of abuse: 1) the nature of the erroneous item and the amount of the erroneous item relative to the other items, 2) the couple’s financial situation, 3) the requesting spouse’s educational background and business experience, 4) the extent of the requesting spouse’s participation in the activity that resulted in the erroneous item, 5) whether the requesting spouse failed to inquire, at or before the time the return was filed, about items on the return or omitted from the return that a reasonable person would questions, and 6) whether the erroneous item represented a departure from a recurring pattern reflected in prior year’s returns.

The IRS has pending the finalization of procedures that weigh abuse in a spousal relationship more heavily in the analysis of relief under Innocent Spouse provisions.  Some of the changes mentioned here are based in internal guidelines associated with working applications for relief and acknowledge the proposed official guidance.  Should you have questions about Innocent Spouse relief, don’t hesitate to contact our office.

Fraudulent Transfers, Alter Ego, Nominee and Successor Liability

I.R.C. Section 6321

The United States Bankruptcy Court for the District of Arizona explores the extent to which the federal tax lien remains attached to assets transferred to others through alleged fraudulent transfers in Bullseye Holdings, LLC v. Internal Revenue Service, Case Number 4:16-ap-00449-BMW dated October 15, 2018. This action was essentially one for Declaratory relief filed by Bullseye Holdings, LLC asking the Court to determine that assets owned by the related entity Bullseye Feeders, LLC, were not encumbered by the federal tax lien. The entities at issue are owned by a variety of individuals in the same immediate family. At the time of trial, those members did not exactly know who held precise interests in the various LLC’s. The United States may impose a lien on property or rights to property belonging to a taxpayer in order to satisfy a taxpayer’s tax deficiency. Property that is fraudulently transferred remains subject to the federal tax lien against it. Additionally, where property is placed in the name of another as the taxpayer’s alter ego, nominee, or successor, federal tax liens remain attached to the property. The Court ruled that the IRS failed to prove by a preponderance of the evidence that the property was fraudulently transferred. The court went through numerous factors relating to required provisions of substantiating fraudulent transfers. It seemed the IRS simply did not do their job in Court. They did a better job relating to the Alter Ego Theory – possibly because it is easier to prove. The IRS had to prove that there was a unity of control and observing the corporate form would sanction fraud or promote injustice. Some of the factors causing the alter ego theory to be upheld were: 1) close family membership of all entities, 2) One person essentially in charge of both, 3) neither entity held formal meetings, 4) no corporate records, 5) one entity did not have a bank account, 6) no payments made on obligations from one entity to the other, 7) no consideration paid on the transfer of a few promissory notes, 8) operating agreements stated the purpose was exactly the same, 9) at the time of the transfer, one entity could not pay its debts as they become due and the property transferred was the only remaining asset of the entity. Unity of control was clearly met. As for whether or not justice requires recognizing substance over corporate form, the Court found that to invalidate the IRS lien against the Property would promote injustice. Ultimately, the lien stood against the property.

Failed Installment Agreement Proposal

Collection Due Process Hearing

In Richard H. Levin and Linda D. Levin v. Comm’r, T.C. Memo 2018-172, Filed October 15, 2018, the Tax Court ruled that IRS Appeals had acted appropriately in denying taxpayers’ proposal for an installment agreement and sustaining IRS Collections proposed levy action. Taxpayers created a liability for tax year 2010 of $468,696, prior to assessment of penalties and interest. Taxpayers’ representative proposed a payment agreement to the IRS wherein taxpayers would pay their liability within four months. During that time, taxpayers made a $50,000 payment. The IRS issued a final notice of intent to levy, at which point the taxpayers requested a Collection Due Process hearing with IRS Appeals. There is a lengthy narrative in this case regarding the details of financial information. During this time, the Appeals office indicated that the taxpayers must remain compliant with their current tax liabilities in order to qualify for a payment agreement. Taxpayers also requested a face to face meeting with IRS Appeals. IRS ultimately agreed to the face to face meeting – which caused a lengthy delay of over a year. Rather than take advantage of the time to liquidate assets and pay down the tax debt, taxpayers liquidated one of their four homes and paid off other creditors in an amount in excess of the IRS debt – approximately $575,000. These creditors included State taxing authorities and credit cards. They additionally capitalized taxpayer husband’s new law firm in the amount of $281,000. Persistently during negotiations with the IRS, the taxpayers’ representative argued that the filing of a tax lien would have a detrimental effect on taxpayer husband’s ability to earn income in his law firm. The Court ruled that the taxpayers “have repeatedly chosen not to prioritize payment of their 2010 outstanding Federal income tax liability. Indeed their failure to use net proceeds of $843,293 from the sale of their Los Angeles, California home to pay their 2010 liability was particularly brazen.” The Tax Court confirmed the reasonableness of the Appeals’ Settlement Officer to file a notice of Federal Tax Lien and to reject the taxpayers’ proposed installment agreement.

Failure to File Returns

I.R.C. section 6651

The United States Court of Federal Claims granted summary judgment in favor of the IRS to sustain penalties in the case of Shih-Fu Peng and Roisin Heneghan v. The United States, No 16-1263T, Filed October 24, 2018. The plaintiffs were assessed late filing penalties in relation to their 2012 tax return. They allege that their return was filed late due to four reasons: 1) The father of one of the taxpayers died in July 2012, 2) their child was born in January 2013, 3) The grandmother of one of the taxpayers died in October 2013, and 4) their accountant was at times unresponsive while trying to prepare their 2012 return. Of course the Court applied the standard of I.R.C . 6651(a)(1)-(2) in determining if relief was appropriate – was the failure to file due to reasonable cause and not due to willful neglect? Their argument relating to the accountant failed as they only argued that he was the reason they did not file their extension. Ultimately, their return was filed after the extension due date. As such, even if they were correct, their return was still filed late. As for the other events that delayed the taxpayers’ filing, the Court indicated that it has recognized personal hardship as reasonable cause for failure to timely fund under some circumstances – such as an illness or debilitation that, because of its severity or timing, make it virtually impossible for the taxpayer to comply. The Court also explained that a taxpayer could supply evidence of incapacity caused by mental or emotional circumstances. Unfortunately for these taxpayers, it was not clear that their life events made it “virtually impossible,” for them to comply with the filing deadline. As such, no relief was granted.