For most taxpayers, losing their home to the tax collector is one of their biggest fears. Last week’s decision in Martin D. Kirkley and Sheila G. Kirkley, T.C. Memo. 2020-57 (May 13, 2020) (Judge Colvin) teaches us that nothing in the law requires taxpayers to sell their home as a pre-condition to an installment agreement. There, the Office of Appeals had rejected a proposed installment agreement because it thought the law required the taxpayers to first sell all their assets, including their home. The Court remanded the case to the IRS so the Office of Appeals could apply the law correctly. Details below the fold.
Law: Home Seizures
Before 1998, the IRS was able to administratively seize and sell a taxpayer’s home to satisfy unpaid tax debt. Doing so required high level approval from within the IRS, but the decision to seize was still a decision made by the IRS.
In 1998 Congress removed the IRS’s ability to administratively seize homes. Section 6334(a)(13) now exempts the taxpayer’s principal residence from administrative seizure. The IRS can still seize a home, but §6334(e)(1) now requires prior judicial approval. Although §6331(e)(1) does not specify the nature of the judicial approval proceeding, Treas. Reg. 301.6334-1(d)(1) interprets the statute to require an adversarial hearing, where the government must give taxpayers notice and an opportunity to contest the decision to seize.
Congress also created other significant restrictions on administrative seizures in 1998. Most notably, before the IRS can seize any property of the taxpayer, Congress requires it to give the taxpayer an opportunity for a Collection Due Process (CDP) hearing. As I have explained before, the real purpose of the CDP hearing is to give taxpayers space to work out a collection plan with the IRS, either through one of the three flavors of Offers In Compromise (OIC), one of the two flavors of Installment Agreements, or one of the three flavors of spousal relief.
Even after the CDP process clears the way for seizures, Congress has thrown up a series of non-trivial obstacles before the IRS can even attempt to obtain judicial approval to seize a home. Section 6334(b) requires IRS employees to obtain an appraisal. Section 6331(j) requires a “thorough investigation” to ensure that (1) the costs of selling the property will not exceed the likely proceeds from a sale and (2) “the equity in such property is sufficient to yield net proceeds from the sale of such property....”
The changes wrought by Congress in 1998 had a dramatic impact on administrative seizures, including seizures of homes. Before 1998 IRS field employees were making about 11,000 seizures per year. See e.g. Table 19, IRS Data Book 1995 (showing 10,000 in FY94 and 11,000 in FY95). After 1998 that number plummeted. See Table 16, IRS Data Book 2000 (showing 164 seizures in FY99 and 74 seizures in FY00). The latest figures are in Table 16, IRS Data Book 2018. They show that the IRS conduced only 323 seizures in FY17 and 275 in FY18.
As for judicial action, I am not aware that the IRS has ever actually asked the DOJ Tax Division to start a §6334(e)(1) judicial seizure proceeding. The quicker and more comprehensive lawsuit is for the government to foreclose the tax lien under §7403. That seems to be what usually happens. According to the National Taxpayer Advocate’s 2017 Annual Report (Volume I, p. 444), the IRS asks the DOJ Tax Division to file over 200 foreclosure suits per year.
But what the IRS cannot do directly, it can do indirectly. It has a variety of passive-aggressive moves that put significant pressure on taxpayers to use the equity in their homes to pay their tax delinquencies. First (and most obviously), the IRS can file a Notice of Federal Tax Lien (NFTL). The purpose of the NFTL is to put the public on notice that the federal government has a claim on all the taxpayer’s property or rights to property. The technical term for that claim is “lien.” The tax lien, as made public by the NFTL, locks in the government’s claim to whatever equity is in the home over and above any prior perfected liens on the home. The lien just sits there, passively, until such time as the taxpayer has to sell the home. At that time the taxpayer has to deal with the lien, which usually means giving the IRS some or all of what the home sells for. Or, as I mention above, if the IRS really wants the money, it can ask the DOJ Tax Division to file a §7403 lien foreclosure suit.
But the IRS has other ways to pressure taxpayers to tap into their home equity. Whenever taxpayers seek some alternative to immediate full payment of their tax delinquency, the IRS has tremendous discretion to put conditions on those alternatives. For example, §6159 gives the IRS discretion to allow taxpayers to pay off their liabilities in installments. An Installment Agreement (IA) pays off the full liability. A Partial Pay Installment Agreement (PPIA) pays off an agree-upon partial amount, similar to a deferred payment OIC.
Treas. Reg. 301.6159-1 spells out some of the conditions the IRS will use before granting either an IA or PPIA. Other conditions are in the IRM. One IRM condition that supplements the regulation is to make the taxpayer extract the taxpayer’s equity in a home, either through borrowing or sale. See 184.108.40.206 (09-19-2014)(“Installment Agreement Acceptance and Rejection Determinations.”) But that condition is discretionary and the IRM says IRS employees are to evaluate the taxpayer’s ability to extract the home equity.
Specifically, the IRM says that the IRS employee should “explore the possibility of liquidating or borrowing against those assets” and then says to not even go down that path if “[f]actors such as advanced age, ill-health, or other special circumstances are determined to prevent the liquidation of the assets, or the asset is necessary for the production of income or the health and welfare of the family.”
This example in the IRM illustrates the discretion:
“If a taxpayer has the ability to pay $3,000 per month on a $200,000 liability and has a home valued at $400,000 with equity of $200,000, request that he attempt to borrow on the available equity in the home prior to granting an installment agreement. If the taxpayer does not attempt to borrow on the home he must be notified that, though the installment agreement request is pending, it will be recommended for rejection. If the taxpayer is able to get a home equity loan and the monies are used to pay taxes, the amount of the payment on the loan will be considered an allowable expense. 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.” (Emphasis supplied)
So the IRS has a lot of discretion when deciding whether to permit a taxpayer to enter into an IA or PPIA. The lesson for today is how the IRS is supposed to exercise that discretion under the law.
Mr. and Ms. Kirkley were in deep tax doo-doo, owing a shirt-ton of taxes, both to Oklahoma local and state authorities, and to the IRS. The federal liabilities alone amounted to over $4 million (for tax years 2013 and 2014).
In January 2016 the IRS sent a CDP levy notice to the Kirkleys and they timely requested a CDP hearing. During the hearing they asked for an IA, offering to pay $50,000 per month. They explained that they had been paying almost that amount each month to pay off their state and local liabilities and they had only one more of those payments to make. It appears they wanted to just keep paying about $50,000 per month only now shifting that payment to the IRS. It is not clear from the opinion whether this was a full-pay IA or a PPIA.
The Settlement Officer (SO) asked for the usual information and it appears the Kirkleys provided it. Per the IRM, the SO “explored” the possibility of the Kirkleys extracting the equity from their assets (including their home) by sending them a letter instructing them to borrow or sell. If they could not borrow they had to show the SO that they tried, by giving the SO copies of two loan applications and two bank denials. The SO told them if they could not borrow, they had to sell. If they did not sell, the IA would be rejected. It appears that the final IA offer was for the Kirkleys to pay just over $1 million from sale of assets by June 2017 and then start $50,000 per month after that.
The SO rejected the IA in December 2016. The SO said she could not accept the offer until after the Kirkleys sold their assets. That was because the information supplied by the Kirkelys showed they could only afford to pay $3,400 per month and not $50,000. The SO wrote that because payment of $3,400 per month “would not result in full payment of the taxes within the collections statute...liquidation of [assets] is mandatory.” Appeals then issued a Notice of Determination to allow the IRS to proceed with levies.
The Kirkleys asked the Tax Court for CDP review and the Tax Court determined that Appeals had abused its discretion by misapplying the law.
Lesson: Appeals Must Use the Discretion It Has
The Tax Court reviews CDP decisions by Appeals for abuse of discretion. We normally think of an abuse of discretion as being an unreasonable application of the law. However, Appeals can also abuse its discretion by applying the wrong legal rule. That is what happened here. The SO apparently thought that the law required her to reject an IA if the taxpayer had not, prior to the IA, actually obtained the money to pay by either borrowing against equity in assets or selling them.
Judge Colvin explained why statutory, regulatory, and case law gave the SO a discretion that the SO simply did not exercise. He pointed to the language in §6330(c)(3)(C) that tells the IRS to balance the need for efficient collection with the legitimate taxpayer concerns. That's discretion. He pointed to the language in the IRM on IAs that tells SOs the various reasons why they may permit IAs without requiring taxpayers to sell assets. That's discretion. He placed particular reliance on Budish v. Commissioner, T.C. Memo 2014-39 where the Tax Court had similarly rejected an SO determination to uphold an NFTL “because of her mistaken belief that she lacked discretion to do otherwise under the IRM.” (Kirkley at 13).
The error committed here by Appeals was the SO’s belief that she had no discretion. Accordingly Judge Colvin sent the case back to Appeals so the SO could do her job and explain why rejecting the IA was the right discretionary act to take. For example, here the taxpayers offered to pay $50,000 per month. But it was not clear where the money would come from. Analysis of financial information they submitted showed they could only pay $3,400 per month. That is nowhere close to $50,000. So it might be that the taxpayers were not entirely transparent with the IRS about their income stream. Wouldn't be the first time! Or it might be the $50,000/month would have come from...hold your breath...sale of assets. If that is correct, then the IRS might want to say “hey, we think you are just going to sell your assets and the dole out those proceeds to us at rate of $50,000 per year. We would rather just take the all proceeds up front, thank you very much.” Or the taxpayers might say "hey, we have a lot of built in gain and would like to minimize tax hit in future years by spreading out sales over time." The SO would need to explain how she balanced those competing concerns. Now THAT would be a proper use of the discretion given, at least IMHO.
Coda: Today’s lesson is especially useful for the current housing market. Zillow predicts home sales falling 44% nationwide during the ongoing COVID-19 pandemic. And prices will drop as well. As Judge Colvin notes, the failure to sell one’s home or obtain an equity loan is not an automatic non-starter for an IA (nor, by extension, an OIC). Sure, the IRS might still require it, but someone has to properly exercise discretion. A lesson worth remembering in the coming years.
Bryan Camp is the George H. Mahon Professor At His Residence, Somewhere Close To the Texas Tech University School of Law.