Many people believe that the Internal Revenue Service (IRS) always provides the right answer, particularly when an agent tells the taxpayer that there is an IRS policy that is determinative of the issue, even when there is no legal support for the position. The taxpayer, without substantial research into the IRS procedural rules, has no means of disputing such a statement. Therefore, making the statement “makes it true”.
A few months ago, in the course of representing a client in connection with an offer in compromise (OIC) (i), I was presented with such a statement by the revenue officer (RO) handling the case. The client was over 70 years of age and would soon be retiring. He owed a substantial sum for unpaid employment taxes which he would be unable to pay. Among the assets the client held was a retirement account. The RO advised me that this account was an “available asset” to be used for determining if an OIC would be considered, since “available assets” are used in determining the minimum acceptable offer. When the determination was questioned, he advised that this was IRS policy and, as such, could not be challenged. After researching the issue in the Internal Revenue Manual (IRM) (ii), I determined that the IRS policy was, in fact, that where a taxpayer has an interest in an individual retirement account or a 401k Plan and is retired or about to retire, the plan may be treated as an income item, rather than an asset, if it will be necessary to provide for basic living expenses in retirement.
I presented this to the RO and was advised by him that it was “office” policy not to exercise such discretion in the taxpayer’s favor. I then asked to discuss the matter with the RO’s supervisor. It was at this point that the RO “folded his hand” and agreed that the retirement plan should be treated as an income item, rather than as an asset, thus making it possible for the client to submit an acceptable OIC.
However, not all cases have this happy ending at the administrative level. Sometimes, IRS personnel will dig in their heels while asserting an erroneous “IRS policy” and force a taxpayer to take the matter to the Tax Court for an impartial determination. With respect to collection matters, this is generally done through the use of a collection due process (CDP) hearing. Such was the situation in the recently decided Tax Court case of Kirkley v. Commissioner. (iii)
In Kirkley, the taxpayers were seeking an installment payment agreement to satisfy outstanding liabilities in excess of $4 million. The taxpayers submitted a Request for a Collection Due Process Hearing in response to the IRS’ Notice of Federal Tax Lien Filing (lien notice) and Notice of Intent to Levy (levy notice). The taxpayers advised the IRS representative that they had been paying $47,558 per month in delinquent State or local taxes, which would be fully paid with one more payment. The taxpayers proposed to pay $50,000 per month to satisfy their unpaid Federal tax, presumably with the funds available after satisfaction of the State or local taxes. The IRS representative correctly stated that the acceptance of an offer for an installment agreement must satisfy certain guidelines. If they do not meet such guidelines, acceptance will be in the discretion of the IRS. The matter was referred to the IRS Appeals Office for action.
The Appeals Settlement Officer (ASO) sent the taxpayers a letter in which the ASO stated that, before she could approve their proposed installment agreement, the taxpayers must provide copies of two loan applications and denial letters (with respect to their real property). The ASO stated that if the taxpayers could not obtain a loan they were “expected to sell all assets, with the exception of two vehicles, and provide evidence that these assets have been placed up for sale.” Ultimately, the ASO sent a letter to the taxpayers stating that she could not accept the proposed installment agreement because: (1) the IRM did not permit the IRS to enter into an installment agreement before the taxpayers liquidated their assets and paid the proceeds to the IRS, (2) the taxpayers could not pay $50,000 per month as shown by the RO’s estimate that the taxpayers could pay only $3,438 per month, and (3) the taxpayers had “significant equity in assets that must first be liquidated.”
The IRS issued a notice of determination to the taxpayers formally rejecting the proposed installment agreement and sustaining the lien notice and the levy notice. The notice contained an attachment stating that the ASO had “confirmed that IRM 184.108.40.206(5) requires that equity be paid over before entering into the agreement.” In other words, the taxpayers must liquidate all their assets and turn them over to the IRS before an installment agreement could be entertained. (As a side note, the IRS did not take into consideration that, after paying the remaining payment due the State and local authorities, the taxpayers would be able to make the offered $50,000 monthly payment.)
The taxpayers petitioned the Tax Court for a redetermination of the IRS decision not to permit the taxpayers to enter into an installment payment agreement based upon the abuse by the IRS of its discretion evidenced by requiring liquidation of all their assets as a condition to receiving such relief. Under the rules of the Tax Court, the taxpayers have the burden of proving that the IRS had abused its discretion in denying the taxpayers an installment payment agreement. (iv) In ruling in favor of the taxpayers on this issue, the Tax Court reviewed the provisions of IRM 220.127.116.11(5) and stated that the IRM provisions the ASO cited only instruct IRS personnel to consider whether liquidating and borrowing against assets should be required. The IRM does not mandate such liquidation. In fact, an example under the cited IRM provision contains the following statement. “However, if the taxpayer applies for a loan but the loan is not approved, every effort should be made to preserve the installment agreement. It would promote voluntary compliance and be in interest of the government.” The quoted language would be contradictory of a requirement for liquidation as a condition for an installment agreement.
The Tax Court noted that the ASO’s activity sheets were devoid of any content, although she and the taxpayers had engaged in significant negotiations during the period following the ASO’s initial determination of a required liquidation of assets and the issuance of the IRS determination letter. As such, the Court found that there was no indication that the ASO balanced the need to collect tax with the legitimate concern that the collection action be no more intrusive than necessary, as required by IRC §6330(c)(3)(C). By failing to perform that analysis, the ASO abused her discretion by rejecting the request for an installment agreement and by issuing the notice of determination. Accordingly, the case was sent back for further development of the question of whether the taxpayers would be able to satisfy their payment obligation under the proposed installment agreement. It is unusual that the matter ever reached the level of a Tax Court decision. By this point, the issue should have been reviewed by supervisory level personnel, both in the Commissioner’s office and the Office of Chief Counsel for the Internal Revenue Service.
Accordingly, one should not be afraid of challenging a determination by the IRS when it seems arbitrary. If IRS personnel advise that a decision is being made based upon IRS policy (or “office” policy), a good practice would be to require them to provide a written copy of the provision, including the statutory, regulatory or internal administrative provision supporting the conclusion. A better practice would be to retain the services of an attorney with extensive experience in this area.
(i) This is the process by which a taxpayer’s liability can be eliminated by the payment of a substantially reduced amount.
(ii) The Internal Revenue Manual contains various statements of policy and procedure which IRS personnel are required to follow.
(iii) T.C. Memo 2020-57.
(iv) See, Tax Court Rule 142(a).