Offer in Compromise

IRC Section 7122 

The United States Court of Appeals for the Third Circuit in Estate of Kwang Lee, Deceased, Anthony J. Frese, Executor v. Comm’r of Internal Revenue, Case No. 21-2921 handed down an opinion on August 23, 2022 in which the Court ruled that the denial of an Offer in Compromise for estate taxes by the IRS was appropriate and that the Executor could be held personally liable for non-payment of the Estate taxes.  The decedent in this matter passed away many years ago – in 2001.  The Executor, Anthony J. Frese miscalculated the estate tax on the estate and ultimately received a notice of deficiency in 2006 and a formal deficiency from the IRS in 2010.  However, between 2004 and 2010, the Executor distributed over $1 million in assets to the beneficiaries, including $640,000 after receiving the notice of deficiency.  The Estate filed an Offer in Compromise and tried to settle for the remaining assets of the estate.  The IRS rejected the Offer, arguing that their reasonable collection potential was higher than what was offered, in part because IRC section 3713(b) allows the government to hold the executor personally liable when the executor transfers property before satisfying a known estate tax. As such, the argument by the estate that the IRS Office of Appeals had abused its discretion in denying the Offer based on payment of the remaining assets of the estate, fails. 

Passport Revocation

IRC Section 7345

The United States Court of Appeals for the Fifth Circuit in James Franklin v. United States et al., Case No. 21-11104, handed down an opinion on September 15, 2022 in which it affirmed the United States District Court for the Northern District of Texas as it relates to revocation of the taxpayer’s passport for seriously delinquent taxes.  Plaintiff, James Franklin was found by the IRS to have not filed accurate tax returns and had not reported a foreign trust for which he was a beneficial owner.  Penalties were assessed against the taxpayer and enforcement action in the form of filing a federal tax lien, levying Social Security benefits and notifying the Department of State that the taxpayer was seriously delinquent ensued. The taxpayer ultimately sued the government over these issues and argued that the passport revocation scheme of the statute violated his rights under the Fifth Amendment because it affected his fundamental right to travel internationally.   This Court reviewed several Supreme Court rulings and provided the following guidance: the right to international travel can be regulated within the bounds of due process. The Court analyzed the passport revocation statute’s goals, protections and objectives…ultimately deeming the statute to be constitutional.  This decision is at least the second decision of a Court of Appeals on this topic in the last year.  In Jeffrey T. Maehr v. United States Department of State, Case No. 20-1124, handed down on July 20, 2021, the United States Court of Appeals for the Tenth Circuit ruled the statute to be constitutional also.

Court Affects Payments from Conservation Reserve Program

8th Circuit Ruling Affects Characterization of Payments from Conservation Reserve Program:

The US Court of Appeals for the 8th Circuit recently handed down a decision in Morehouse v. C.I.R, (8th Cir. Oct. 10, 2014), which decided whether or not payments received under the Department of Agriculture’s Conservation Reserve Program (CRP) should be included as income from self-employment on a taxpayer’s return.

In this case, the taxpayer inherited 1223 acres of land in 1994, located on three different properties in South Dakota (503 acres in Grant County, 320 acres in Roberts County, and 400 acres in Day County). All of the land was tillable cropland with exception of a gravel pit on the Grant County property and 129 acres on the Roberts County property that the taxpayer’s father placed under the CRP program. The taxpayer never farmed any of the land.

In 1997, the taxpayer enrolled the remaining acreage of the Roberts County property and the tillable land in Grant County in the CRP program. The primary purpose of the CRP program is to reduce soil erosion and improve soil conditions on highly erodible cropland by limiting the taxpayer’s use of the property. Therefore, by enrolling in the program, the taxpayer entered into a contractual obligation with the Commodity Credit Corporation (CCC) requiring him to implement conservation plans for the properties in the program. These plans required the taxpayer to establish and maintain certain types of grass or vegetative cover on the land and engage in periodic weed and pest control. As compensation for implementing the conservation plans, the taxpayer was reimbursed for a portion of his costs and was paid an “annual rental payment.”

In both 2006 and 2007, the taxpayer received CRP payments of $37,872. The taxpayer included the CRP payments on his return in both years as a rental payment received from real estate. As a result, on October 14, 2010 the IRS sent the taxpayer a notice of deficiency stating that the CRP payments should have been reported as self-employment income on a Schedule F, Profit or Loss from Farming. The taxpayer petitioned the Tax Court for review of this determination, claiming that the CRP payments were rentals from real estate under 26 U.S.C. §1402(a)(1), and therefore should be excluded from his net earnings from self-employment. However, the Tax Court sustained the service’s conclusion that the CRP payments constituted self-employment income reasoning that because the payments were proceeds from the taxpayer’s own use of the land they did not constitute rental payments.

On appeal, the primary issue centered on whether or not CRP payments should be categorized as “net earnings from self-employment.” In deciding this question, the Appeals Court first looked at types of payments that would generally be classified as self-employment income. The Court explained that self-employment income consists of the gross income derived from the taxpayer’s trade or business. Or in other words, the trade or business must give rise to the income before it can be included as self-employment income.

Contrary to the Tax Court’s opinion, the Appeals Court found that the CRP payments did not derive from the taxpayer’s activities on the land because the only reason the taxpayer engaged in any activities such as tilling and seeding on the land was because it was required by the CRP contracts. The Appeals Court further determined that because the contracts reserved a right of entry for the government onto the CRP property for purposes of inspection, that the government was “using” the land as much as if not more than the taxpayer. Therefore, the CRP payments were given to the taxpayer in consideration for this right to use and occupy the taxpayer’s property.

Next the Court looked at how similar payments to taxpayers have been categorized in the past. In doing so, the Court looked to Rev. Ruling 60-32, 1960-1 C.B. 23 (1960) concerning the CRP’s predecessor, the Soil Bank Act. In this ruling the IRS concluded that soil bank payments to people who did not operate or materially participate in a farming operation were to be viewed as rental income, not self-employment income. However, the ruling further stated that soil bank payments made to farmers were self-employment income.  Although this precedent was not controlling, the Court decided that given the significant overlap in the CRP and Soil Bank programs, and because it reflects a longstanding and reasonable interpretation of the Agency’s regulations, the revenue ruling was persuasive. Therefore, the Court decided to follow the Soil Bank Program distinction between payments to farmers and non-farmers in concluding that CRP payments to the taxpayer in this case were rental income because he was not engaged in farming operations. Looking forward it appears that at least in the 8th Circuit, taxpayers who receive payments from the CRP program will be able to include the income as rental income rather than self-employment income on their tax return, if they are not operating farming activities on the land.

If you have any questions about how this ruling might affect the characterization of your CRP payments, please feel free to contact our office.