Last week’s case of Katherine Mason, et. al, v. Commissioner, T.C. Memo. 2021-64 (May 20, 2021) (Judge Holmes), teaches that the IRS Office of Appeals must consider in a CDP hearing the merits of an Offer In Compromise (OIC) that a prior office found was submitted solely to delay collection. I kid you not. Agreeing with the taxpayer that “the CDP process is aimed very deliberately to give most taxpayers an opportunity to delay collection,” Op. at 21, Judge Holmes held that the CDP Settlement Officer abused her discretion when she refused to consider an OIC on its merits, even though she found it had been properly rejected for having been submitted precisely for purposes of delay. Yes folks, welcome once again to the wacky world of Collection Delay Process. I also see the case as teaching us both the value—and the limits on value—added by judicial review. Finally, I think the taxpayer simply won the opportunity to lose again. See if you agree. Details below the fold.
Law: OIC Is An Opportunity, Not A Right
Congress has permitted the IRS to compromise internal revenue tax liabilities since 1864. Revenue Act of 1864, §44, 13 Stat. 223, 240 (June 30, 1864). The authority is currently codified in §7122. Up until the 1990's, however, the government was highly reluctant to relieve taxpayers of their tax obligations out of two concerns. First was the concern that too much compromise would undermine collections by weakening the force of the tax assessment. Taxpayers would get the attitude that they need not prioritize their tax debts because they could always negotiate a compromise. Second was the concern of favoritism or perceptions of favoritism. Why would some taxpayers get a break but not others? How could such a system avoid either the fact or appearance of corruption?
These concerns trumped concerns about taxpayer hardships. You see that in 1934, during the Great Depression, when there was a discussion between Treasury and the Attorney General’s Office about whether to liberalize OICs. Treasury (via Dean Acheson) wanted to liberalize OICs because of the economic hardships facing taxpayers. But AG Homer Cummings had the final word, saying "[t]here appears to be no statutory authority to compromise solely upon the ground that a hard case is presented, which excites sympathy or is merely appealing from the standpoint of equity, but the power to compromise clearly authorizes the settlement of any case about which uncertainty exists as to liability or collection." Op. Atty. Gen. (October 2, 1934) as quoted in Preamble to the Temporary OIC Regulations, 64 FR 39020 (Wednesday, July 21, 1999).
As a result of these concerns, the IRS adopted the concept of “maximum collection potential” under which it would accept an offer premised upon doubt as to collectability only when the amount offered represented the maximum amount the taxpayer could pay, taking into account net equity in assets and both current and future income but not taking into account the taxpayer’s other economic circumstances and not taking into account non-economic factors. Preamble, supra.
In 1992 the IRS softened that standard to the current one, what we call the “reasonable collection potential” (RCP). The idea is to allow the taxpayer room for reasonable living expenses. But that calculation is still a pure just-the-numbers-ma’am standard. Preamble, supra.
In 1998 Congress amended §7122 to liberalize the OIC opportunities. IRS Restructuring and Reform Act of 1998 (RRA98), §3462, 112 Stat. at 764. The amendments required the IRS to be use more flexible national and local expense tables to determine RCP. They prohibited the IRS from rejecting offers from low income taxpayers just because the offers were low. They prohibited collection by levy during the period an OIC “was pending.”
At the same time Congress has also recognized the concern that liberalizing the OIC program too far would encourage frivolous applications. Thus it later amended §7122 so allow the IRS to summarily reject any portion of an OIC that it believes is frivolous or submitted primarily for purposes of delay. §7122(g). Importantly, the IRS “may treat such portion as if it were never submitted and such portion shall not be subject to any further administrative or judicial review.” And while in other reforms Congress gave certain taxpayers a right to enter into a full-pay installment agreement, it made no change in the grant of discretion to the IRS to accept or reject OICs.
OIC remains an opportunity, not a right. It's a matter of administrative discretion. That is why judicial review is available in only a very limited fashion and then only when the OIC comes through the CDP process. This case shows the limits.
Law: The Creation of the ETA OIC
The RRA98 drafters were concerned that ability to pay should not be the sole determinant of whether a taxpayer should be allowed to compromise tax liabilities. I was a fly on the wall during that legislative process and recall that there was considerable discussion on what statutory language would best reflect that concern without transforming the opportunity for an OIC into an entitlement for an OIC.
In the end, the decision was made to omit a statutory directive in exchange for Treasury’s promise that it would create a regulation to address the concern. Sorry for the passive voice, but I don’t know exactly who made the decision. I did not directly see that part of the sausage. Again, I was just one of the “technical experts” with whom the Treasury negotiator consulted. But I know the relief we felt at dodging that statutory bullet.
The deal is reflected in the Conference Report’s directive to Treasury to expand OICs to “consider additional factors (i.e., factors other than doubt as to liability or collectibility) in determining whether to compromise the income tax liabilities of individual taxpayers.” H. Conf. Rep. 599, 105th Cong., 2d Sess. (1998) at 289. The Report instructs the IRS to “take into account factors such as equity, hardship, and public policy where a compromise of an individual taxpayer's in-come tax liability would promote effective tax administration.”
In 1999, Treasury upheld its end of the deal and published regulations creating what we know call the Effective Tax Administration OIC (ETA OIC). 64 FR 39020, supra. Whether the IRS has been effective at implementing ETA OICs is debatable. The difficulty remains the same as it has since 1864: how to properly balance the concerns of being too liberal with the concerns of being too strict. For some good academic literature on this, see e.g. Sandy Freund, “Effective Tax Administration Offers in Compromise - Why So Ineffective,” 34 Va. Tax Rev. 157 (2014), and Joseph Dugen, "Compromising Compliance? The IRS Offer in Compromise Program and Opportunities for Reform," 70 Tax Law. 609 (2017).
The Two-Stage Procedure for How the IRS Handles OICs
Offers In Compromise (OICs) are easier said than done. In FY 2018 the IRS accepted 41% of OICs submitted. IRS 2019 Data Book, Table 25. That’s historically a high percentage. FY 2019 saw the regression to the mean: a 33% acceptance rate. Id.
One of the problems with getting an OIC accepted is getting the IRS to even consider the merits of a submitted OIC. The IRS has created a two-stage procedure for handling OIC submissions. I think of it as a formal stage, then a substantive stage.
First, the IRS reviews the submission to make sure it is complete and that it is not an obvious loser. See generally, IRM 220.127.116.11.1 (09-22-2020) (“Determining Processability”). Submissions that fail this formal stage are deemed “non-processable” will not be considered on their merits. They are returned to the taxpayer to try again.
Second, submissions that pass this formal stage are then reviewed on their merits. Or at least they get to an employee who can review the merits, if the taxpayer jumps through the information-request hoops properly. If rejected, the taxpayer can then ask the Office of Appeals to review the rejection.
Both of these stages are generally done in one of two Centralized Offer In Compromise (COIC) units, one in Brookhaven and the other in Memphis.
Recall that §7122(g) permits the IRS to reject an OIC submission if the IRS determines that the submission “reflects a desire to delay or impede the administration of Federal tax laws.” §6702(b)(2)(A)(ii), as cross-referenced in §7122(g). And recall this decision is supposed to be unreviewable. The IRM has a pretty long set of instructions on how to make the delay determination. IRM 18.104.22.168 (05-10-2013).
The IRS takes the position that this delay determination authority under §7122(g) is part of the stage one processability determination. After all, §7122(g) explicitly says the delay determination means the OIC submission is to be treated as if it had never been submitted.
Today we learn otherwise.
The IRS sought to collect uncontested tax liabilities amounting to about $155,000. The liabilities arose from: (1) late-filed 2009 and 2010 returns by Ms. Mason, along with her husband; (2) 2011, 2012, and 2013 returns filed (mostly late) by Ms. Mason alone; and (3) Trust Fund Recovery Penalties (TFRP) for quarters in 2011, 2012 and 2013 and 2014 assessed against Ms. Mason for the failure of her business “Vintage Moments,” to pay trust fund taxes. The company was a licensed health care provider that ran a 5-bedroom residence for folks with dementia. This Google review website suggests it was still been in business as of a year ago.
In July 2012 the Masons entered into an installment agreement to pay their 2009 liability. They defaulted on the installment agreement in March 2013. Meanwhile, their tax debts multiplied with each passing year and, for employment taxes, each passing quarter.
While not clear from the opinion, it appears the various liabilities were all eventually assigned to the same field collection Revenue Officer (RO). She determined the Masons could full-pay the total amount using their home equity. She went to their home and met with them in person in May 2015. At the meeting she explained that they could either borrow against the equity, sell the home, or have the IRS seize and sell the home. The Masons did not want to sell their home. Or at least they did not want to use its equity to pay the IRS. They told the RO that their home was their retirement money.
Immediately after the visit the IRS sent out a Notice of Intent to Levy and Your Rights to CDP Hearing with respect to their joint liabilities for 2009 and 2010. The Masons made two responses.
First, they assembled and submitted an OIC for all their outstanding tax liabilities, including Ms. Mason’s separate income and TFRP liabilities. They sent that OIC to one of the COIC units. It was received on May 22, 2015. Second, they asked for a CDP hearing. Each response had a different journey.
Their OIC offered to settle the $155,000 liability for $4,800. They supported the offer with a Collection Information Statements (CIS) showing monthly income barely more than monthly expenses. They claimed the total equity in all their property (apparently including rental property) was only $95,000. They certified they had filed all required tax returns.
The RO submitted a Form 657 (“Offer in Compromise Revenue Officer Report”) to the COIC recommending the OIC be returned as not processable because it was being submitted just to delay collection. As reasons, the RO noted, inter alia, that: (1) Ms. Mason was not in fact complaint in her filing obligations; (2) their principal residence had equity of $140,000; (3) they could find equivalent rental housing for the same monthly amount as their mortgage ($1,400); and (4) between August 2013 and September 2014 Ms. Mason spent at least $8,800 gambling at casinos instead of using that money to pay down her tax debt.
On June 12, the COIC adopted the RO’s recommendation and rejected the OIC per §7122(g).
Second, and parallel with submitting the OIC, the Masons timely requested a CDP hearing regarding their joint liabilities. The IRS received their CDP request on May 26, 2015, processed it on June 16, and assigned it to a Settlement Office (SO) on June 30. The SO made first contact with the Masons on July 10, 2015.
It is not clear why the Masons submited an OIC separately from their CDP request. It could be because the CDP hearing was only for their 2009 and 2010 liabilities and they wanted to do a more global settlement. If so, they were not well advised (Mr. Mason, at least was represented, Ms. Mason was not). The IRS requires separate OIC submissions for different taxpayers and different types of liabilities. It is not clear whether the Masons included a copy of the OIC with their CDP request. However, by the time they spoke with the SO, Judge Holmes writes that the Settlement Officer had a copy and knew that the COIC had returned their OIC as not processable.
The Masons asked the SO to review their returned OIC. The SO refused, saying that she was not going to second-guess the COIC’s decision which, you will recall, was based on a §7122(g) determination that, supposedly, "shall not be subject to any further administrative or judicial review.” In July 2015 the IRS sent Ms. Masons a second CDP notice, this one for her individual income tax and TFRP liabilities. Ms. Mason timely requested a CDP hearing and it was assigned to the same SO. Again, the Masons asked the SO to consider their global OIC for $4,800. Their attorney argued also for a OIC ETA because the Masons were about to enter retirement and needed their home equity to fund their retirement.
The SO again explained that she could not consider the merits of the OIC because COIC had returned it based on a §7122(g) determination and she saw no error with that determination. She again refused to consider their OIC any further and, eventually, issued the Masons a Notice of Determination which explained the reasons why the COIC had returned the OIC and concluded that the COIC had not erred. The Masons timely petitioned the Tax Court.
Lesson 1: OICs Offered In CDP Must Be Considered on their Merits.
The Masons argued that all they wanted Appeals to do was look at the merits of the $4,800 offer. They said they had circumstances (impending retirement) that qualified them for an OIC ETA. The IRS argued that the SO did what she was supposed to do: she reviewed the decision of the COIC to reject the submitted OIC and she saw no fault in that rejection. Because the Masons had submitted the OIC outside of the CDP hearing, there was no need for the SO to evaluate the appropriateness of the $4,800 offer.
Judge Holmes holds that the SO’s decision to review only the COIC’s rejection decision and not independently review the merits of the OIC was an abuse of discretion. Op at 32. Notice that this holding abrogates the language in §7122(g) that says there shall be no administrative or judicial review of a decision to not process an OIC submitted for purposes of delaying collection. Judge Holmes essentially concludes that the CDP rights given in §6330 trump the limits on OIC liberality in §7122(g). I see two reasons for this decision.
First, he finds it critical to see “what the record shows about whether the Masons actually placed an offer on the table for SO Rush to consider.” Op. at 25. After all, he reasons, an SO cannot evaluate an OIC that is not before her. Judge Holmes finds here that the SO did in fact have the complete OIC package in her case file. So she had something to review.
Second, he finds it critical that the OIC package was almost contemporaneous with the CDP request, albeit sent to COIC. Op. at 27-29. If this had been a really old OIC that had been rejected years before, the SO’s refusal to evaluate the merits would not be an abuse of discretion.
Putting those two ideas together leads to this: Judge Holmes deems the Masons to have submitted an OIC simultaneously to both Appeals as part of their CDP hearing and to COIC outside the CDP process. He says "The Code tell us that any OIC raised in a CDP hearing is to be considered independently (not just reviewed) by a settlement officer." Op. at 27. While Judge Holmes gives no citation for that proposition, he is likely referring to §6330(c)(3)(B) which requires the settlement officer to take into consideration "any relevant issue...including...offers of collection alternatives." He seems to me to be reading that as overruling the prohibition on administrative or judicial review in §7122(g).
Because he deemed the Masons to have resubmitted their OIC in the CDP hearing, the SO was therefore required to evaluate it on its merits and was disabled from rejecting it as not processable. If she needed more information, she should have asked for that and only if the taxpayer failed to provide the reasonably requested information would she be justified in rejecting the OIC.
Lesson 2: The Role of Judicial Review
I try to teach my students that the game to play when working a case at the IRS is to get to a different decision-maker when you get an adverse decision. Often that different decision-maker can bring perspective. In CDP that is all the more important because the Tax Court is several steps removed from the IRS employees who are making the collection decisions. The Tax Court brings perspective.
When you work in collection, you quickly become biased. You see all debtors as having the money but just not wanting to pay you. They want to prefer other creditors. That’s what it comes down to. When a person has more debt than they have money to pay it, the unpaid creditor will always feel cheated. I have no doubt there is psychological literature on this phenomenon but I also saw it in my Revenue Officer clients at the IRS. Their world was filled with folks trying to skivvy the IRS in order to pay other creditors. We might think of some of those as “good” creditors—the hospital, the doctor, the utility company, the landlord, etc. Others we might view as “bad” creditors—the bookie, the drug dealer, the casino, the private school, the bank that financed the luxury car or boat or second home, etc. So my ROs were always suspicious of taxpayers who claimed to be turnips.
Complicating matters for government creditors is that the debtor is also a citizen. That's partly what is so dangerous about outsourcing collection to private collection firms. That dual relationship between government and citizen requires balancing the need to protect the revenue with the need to protect citizens. Governments should not be pushing citizens of a financial cliff with the one hand only to then rescue them in the government safety net held by the other hand. A decision that a taxpayer is suffering “hardship” is thus really a decision about which creditors are good ones that taxpayer will be allowed to prefer over the government. That’s one way to see the expenses for support tables. You don't find gambling at casinos to be an allowable expense!
So the value added by Court review is to help find that balance. What seems to underlie Judge Holmes’ opinion here is a concern that the IRS as an institution was making a decision bottomed entirely on the jaundiced viewpoint of a single IRS employee, the RO in this case. From the distance given by the Tax Court, the OIC needed more and better review than it received. So Judge Holmes sent it back to be redone.
That same distance, however, shows the limit of value added by judicial review. It is very difficult for a Tax Court judge to get a sense of IRS process and procedure. Judge Holmes’ opinion here shows a strong, and puzzling, distrust of IRS employee actions in this case.
First, Judge Holmes disapproves of the RO’s field visit to the Mason’s home, characterizing it as a “nice-little-home-you-got-here-shame-if-something-happened-to-it field call.” Op. at 5. That disparaging statement likens the RO to a gangster running a protection racket. It's not, in my view, an appropriate statement to make in a judicial opinion. On the merits, moreover, the basis for his disapproval appears to be his assumption that (1) the RO visit was improper because Mr. Mason was represented (Ms. Mason was not) and (2) the RO failed to tell the Masons that the IRS would have to obtain judicial approval before seizing the home. Judge Holmes gives neither a factual basis for those assumptions nor a legal analysis for why either would be improper.
Second, Judge Holmes disapproves of how the IRS processed the CDP request, asserting that the case activity records “show at least some attempt to slow the processing of the Masons’ CDP request before their OIC...was dealt with.” Op. at 9, note 5. Again, the basis for both his conclusion and his disapproval is unclear. He offers no facts to suggest that the IRS slow-walked the CDP request or that the processing or RO assignment time frames are unusual. I would be interested to hear from folks if their experience supports the proposition that 36 days to assign a CDP case is unusually long. From what little I know, that’s an amazingly quick timeframe. It was fast-tracking, not slow-walking. See generally, Carlton M. Smith & T. Keith Fogg, Collection Due Process Hearings Should Be Expedited, 125 Tax Notes 919 (2009). Keith does not think matters have changed since the article was published.
Third, Judge Holmes’ writes the RO “caught wind that the Masons had sent an offer to the Centralized Unit.” And then he says the RO immediately sent a Form 657 (“Offer in Compromise Revenue Officer Report”) to tell the COIC that the Masons had submitted the OIC for delay purposes. Again, the use of the phrase “caught wind” suggests something happenstance and thus suggests the Form 657 reaction was discretionary and vindictive. But submission of Form 657 is routine. There is no “caught wind” about it. When a case is in field collection and the taxpayer submits an OIC to an RO, the RO must submit Form 657when transmitting the OIC to the COIC unit. When, as here, the taxpayer submits the OIC directly the COIC unit, the IRM requires that unit to contact the RO and ask for the Form 657. See IRM 22.214.171.124 (11-05-2020)(“Form 657, Offer in Compromise/Revenue Officer Report, serves to establish coordination between the field Collection RO group, the field OIC group and the COIC sites.”). So, yes, Form 657 is part of coordination between different offices within the IRS. That does not make it a conspiracy.
Comment: The Taxpayers’ Pyrrhic Victory
The great irony in this case, of course, is that the Office of Appeals does not work OICs. Perhaps they will as a result of this opinion. But currently, when taxpayers submit OICs through the CDP process, Appeals sends the submission to—wait for it—the COIC! See generally IRM 126.96.36.199.4 (08-26-2020)(“Processing OICs”). COIC reviews the OIC for processability. If processable, Collection then investigates the offer and determines whether to accept or reject it. IRM 188.8.131.52.1.1 (“Functional Responsibilities”). Appeals then reviews that determination just as it would if the taxpayer had originally submitted the OIC outside the CDP context and the matter had come to Appeals for review.
The purpose of not letting Appeals work OICs de novo is to ensure consistently in decision-making. In fact, IRM 184.108.40.206.3 cautions SOs: “DO NOT SIGN FORM 656 as COIC is responsible for signing it as part of the processability determination. Forward the offer to COIC for processing, even if it was received without a user fee or TIPRA payment.” In other words, even if the submission is obviously non-processable, Appeals cannot make that simple determination but must let COIC do that.
This is all part of how Appeals is morphing into a mini-me Tax Court. Its job is not to work cases. It is to resolve disputes. If a taxpayer submits an OIC in CDP, Appeals sends it to COIC and Collection to do all the work. If they conclude to accept the OIC, then great! Appeals signs off. If they reject the OIC then that now creates a dispute for Appeals to resolve.
It’s not entirely clear whether Judge Holmes knows this. Judge Holmes says the SO here “abused her discretion by sustaining the proposed collection action without first independently reviewing the Masons’ offer.” But the SO's job is never to independently review an offer. It is to independently review the decision of the IRS function that reviews the offer! To be fair, this is a relatively new development. And perhaps one that this decision will slow, halt, or even reverse.
Judge Holmes says “an appropriate order will be issued.” Well if he wants the SO here to actually work the OIC herself—to calculate the RCP, to evaluate the correctness of the taxpayer’s claimed valuation of assets, to apply the allowable expense tables, etc.,—he will need to be very specific in his Order. Otherwise, the SO will follow the IRM.
This newish procedure in Appeals unsettles my students who think they learned from me the secret sauce of representation: if you don’t like the decision from one decision-maker, get the matter to a different one. But now they can learn our lesson from today: Get To Tax Court!
Coda: I highly recommend to readers the Preamble to the 1999 OIC Temp Regs. I link to it above. I make my students read it. Its lead writer was my former colleague Carol A. Campbell, who was instrumental in promoting and rolling out the ETA OICs. She also was the lead in developing the financial standards and liberalized OIC procedures. Many folks see only the work of outside scolds like TIGTA or TAS, but it's insiders like Carol who really make the difference. There are many, many, many Carols at the IRS who get no credit or recognition for their excellent work in making tax administration better for both the government and taxpayers.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech School of Law. He invites readers to return every Monday for a new Lesson From The Tax Court.