Reasonable Collection Potential
IRC 7122
The Tax Court held in Estate of Ralph W. Baumgardner, Jr v. Comm’r of Internal Revenue, Docket No. 11343-19L, filed August 22, 2024, that the IRS Office of Appeals had not abused its discretion by rejecting an Offer in Compromise submitted by the taxpayer given the Reasonable Collection Potential (RCP) exceeded their tax debt. Taxpayers owed approximately $114,504 in tax debt. Collection efforts from the IRS resulted in the taxpayers filing an Offer in Compromise based on Effective Tax Administration (ETA). Taxpayers offered $1,825 to settle the debt. Through much procedure, the IRS adjusted its calculation of equity downwards, but continued to believe that taxpayers RCP was higher than the debt. Frankly, the taxpayers were asking for too much. This case is heavy on detail, but the primary issue relates to a couple of rental houses the taxpayers owned. In this instance, an income production issue becomes relevant as it relates to equity in the houses. In other words, should the taxpayer be expected to liquidate or otherwise account for the equity in an asset that produces income, or simply calculate the income into the financial analysis? In argument, counsel for taxpayers attempted to support their argument for negating the RCP by proposing that they would have foreseeable economic consequences relating to their future increased out of pocket health care expenses, vehicle replacement expenses and real estate considerations…including property maintenance items for their rentals that encompassed everything from plumbing and boiler repairs and maintenance to storm door replacement, vinyl siding and trim replacement, and downspout repairs. The taxpayers’ counsel made good progress with the IRS on health care expenses, as the IRS is generally sympathetic to provable expenditures. The IRS even gave up some ground on the transportation expenses. As for future expenditures associated with the rentals, the IRS deemed them too speculative and the Tax Court agreed. This was a fairly predictable outcome.
IRC 7122
The Tax Court ruled in Duane Whittaker and Candace Whittaker v. Comm’r of Internal Revenue, T.C. Memo 2023-59, filed May 15, 2023 that an IRS Settlement Officer had abused her discretion when calculating the Reasonable Collection Potential (RCP) of the taxpayers while reviewing an Offer in Compromise as a collection alternative in the context of a Collection Due Process hearing. The Court remanded the matter to the Appeals Office to consider updated financials and other directives of the Court in resolution of the matter. Taxpayers owed approximately $50,000 at submission of the Offer in Compromise. The issue before the Court was whether the IRS abused its discretion by failing to adequately consider: 1) the taxpayers’ reliance on their retirement account for income, 2) the special circumstances that they raised – specifically that they were near retirement and unable to borrow against their home, and 3) the change in their financial situation due to the pandemic. In regards to the retirement income, the taxpayers argued that under the Internal Revenue Manual (IRM) and under Treasury Regulation section 301.7122-1(c)(3)(iii)(example 2), that the IRS may characterize retirement funds as income, rather than equity, when the taxpayer is within one year of retirement and they need the funds for necessary living expenses. The Court indicated that even though the Settlement Officer made reference to this issue in the administrative record, the analysis did not make it into the determination notice from the Settlement Officer. On the issue of home equity, the taxpayers indicated they would have problems borrowing because the assessed value was not reflective of the appraised value based on the condition of the home. They offered to obtain more information for the Settlement Officer, but instead of asking for that information, the Settlement Officer merely indicated that she would not remove the equity in the home from the calculation of RCP. The Court concluded that the Settlement Officer’s conclusion that the taxpayers could tap the equity of the home was erroneous as their evidence was not, in fact, reviewed. And therefore, the Settlement Officer’s reliance on the equity to calculate the Reasonable Collection Potential was an abuse of discretion. Though the Court did not necessarily indicate that the taxpayers had sound positions on the issues they raised, this opinion should have a beneficial effect on how closely Settlement Officers address Reasonable Collection Potential in that it would be detrimental to the IRS to not inquire further about issues like these and document the provision, or lack of provision, of further evidence by the taxpayer.
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.
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 5.8.5.18(1), 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.
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