Lesson From The Tax Court: The Finality Rule For §7430 Qualified Offers

When you litigate against the IRS you may win but not prevail.  That is, even though §7430(a) promises that a “prevailing party” can recover costs and attorneys fees, it’s hard to be a "prevailing party" within the meaning of the statute.  If the government's ultimately losing position was substantially justified at the relevant time, the winning taxpayer won't be a prevailing party.  Sometimes that leads to a seemingly strange result that even if the Office of Appeals badly messes up, the taxpayer will not be a prevailing party if Chief Counsel catches the error and promptly concedes.  Keith Fogg blogged a good example of this over at Procedurally Taxing last week.

The Qualified Offer process is a substitute for being a prevailing party.  Making a properly qualified offer to settle a case removes the government's "substantially justified" defense.  Thus, if you make the offer during the administrative process, you can set up a recovery even if Chief Counsel concedes.

But making a effective Qualified Offer has its own difficulties.  Today’s lesson looks at one of the key rules for making a qualified offer: the finality rule.  In Gina C. Lewis v. Commissioner, 158 T.C. No. 3 (Mar. 3, 2022) (Judge Pugh), the taxpayer offered to settle an audit of her joint return by agreeing to 100% of a proposed deficiency.  But on a closer examination, she really just crossed her fingers, reserving the right to contest that liability through the §6015 spousal relief provisions at some unspecified later date.  So it was not really an offer to settle.  It was an offer to kick the can down the road.  Indeed, many years later, in Tax Court, the IRS agreed she was entitled to full relief under §6015(c).  Ms. Lewis then asked for costs and fees under §7430 on the grounds that the IRS had ended up worse off than if it had accepted her offer.  The Tax Court said no, for reasons discussed below the fold.

Law:  General Operation of  §7430
Section 7430(a) permits a court to award costs to any person who is a prevailing party in “any proceeding which is brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under this title.”  Costs can include those incurred both during the administrative, pre-litigation, stage of a controversy, and also during the litigation stage.  Most importantly, costs include attorneys fees.

Despite the seeming breadth of the statute, Congress guards the federal fisc jealously.  Getting an award under §7430 is not for the faint of heart.  For details on all the hoops and hurdles and barriers to recovery, you cannot do better than read Maria Dooner and Linda Galler’s excellent treatment in Chapter 18 of that overflowing cornucopia of tax practice wisdom Effectively Representing Your Client Before the IRS (8th Ed., Christine Speidel and Patrick Thomas, eds.).

The first and critical hoop is that party seeking costs and fees must be a prevailing party, which is a term of art.  To be a prevailing party, a taxpayer must convince a court that: (1) they substantially prevailed with respect to either the amount in controversy or the most significant issues presented; and (2) the Government's position was not substantially justified.  See §7430(c)(4).  Treas. Reg. 301.7430–5(a).  Those are difficult requirements to meet, particularly the substantially justification requirement.  Keith Fogg has a very nice discussion in this Procedurally Taxing post.

Even if the taxpayer is a prevailing party, they must still jump multiple other hoops. Basically, the taxpayer must show that they (1) exhausted all administrative remedies available to them, (2) did not unreasonably protract the proceeding, and (3) are not worth over $2 million (if they are individuals). §7430(b).  Then they must also show the reasonableness of the costs and attorneys fees they want.  Whew!  It’s a slog.

Today’s post is about being a prevailing party under the Qualified Offer rules.

Law: The Role of Qualified Offers
I think of the qualified offer as a substitute for the prevailing party requirement. §7430(c)(4)(E)(i).  That is, taxpayers can avoid the onerous task of proving they are a prevailing party if they had made a “qualified offer” for less than the final judgment amount.  The idea is to encourage settlement so that if the government fails to accept offer to settle the case that turns out to be a better deal that what the government gets in a final judgment, then they government must pay costs and fees. §7430(c)(4)(E)(i).  Note, however, that the taxpayer must still meet the other requirements of §7430 (net worth, etc.).

To be an effective substitute for the prevailing party requirement, a qualified offer must meet several requirements. Let’s take a look at them briefly.

First, the offer must is made in writing during the “qualified offer period.”  Section 7430(g)(2)(A) defines that as the period “beginning on the date on which the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the...Independent Office of Appeals is sent” and “ending on the date which is 30 days before the date the case is first set for trial.” 

Second the offer must specify the amount offered to settle the taxpayer's liability.  §7430(g)(1)(B).  This is where you find the finality rule.  The offer can be either an amount or a percentage, but either way it needs to offer finality.  The regulations explain that to be a valid offer, “the acceptance [of the offer] by the United States will fully resolve the taxpayer's liability, and only that liability (determined without regard to adjustments that the parties have stipulated will be resolved in accordance with the outcome of a separate pending Federal, state, or other judicial or administrative proceeding, or interest, unless interest is a contested issue in the proceeding) for the type or types of tax and the taxable year or years at issue in the proceeding.” Treas. Reg. 301.7430-7(c)(3).

Courts have rejected the government’s repeated attempts to argue that lowball offers should not count.  As long as the final judgment is less than the amount offered, even by $1, the qualified offer is good. See BASR Partnership v. United States, 130 Fed. Cl. 286 (2017).  There, the taxpayers $1 offer to settle proposed $6.6 million tax liability was a qualified offer justifying award of more than $350,000 in attorneys fees when final judgment dismissing proposed assessment as untimely resulted in zero liability for taxpayer.  That's a great case to look at because there the government's position before the Court of Federal Claims was definitely substantially justified since it had been a winning position in front of the Tax Court in similar cases.  But the qualified offer eliminated that defense.

Third, the offer must not be trumped by a settlement.  §7430(c)(4)(E)(ii)(I) (qualified offers don’t apply to “any judgment issued pursuant to a settlement.”).  See Trzeciak v. Commissioner, T.C. Memo. 2012-83.  So don’t offer zero!  And don’t sign a proposed stipulation of settled issues!  It is true that one circuit has distinguished a settlement (which precludes §7430 award) from an IRS concession (which does not so preclude).  Knudsen v. Commissioner, 793 F.3d 1030 (9th Cir. 2015).  But don’t hold your breath on that one.  See Angle v. Commissioner, T.C. Memo. 2016-27 (distinguishing Knudsen).  If you offer zero and the IRS agrees, a court might still see that as a settlement and not as a concession.  So always offer at least $1.

Fourth, the offer must be explicitly designated as a “qualified offer.” §7430(g)(1)(C).  Gotta have the magic words.

Fifth, the offer must remain open until the date of trial, the date of rejection, or until 90 days have elapsed, whichever occurs first. §7430(g)(1)(D).

Finally, a qualified offer only works in proceedings where the amount of the taxpayer’s tax liability is in issue.  That is, if the taxpayer’s controversy with the IRS is about something other than the taxpayer’s tax liability, then the administrative and, later, judicial resolution of that controversy is not the kind of proceeding where the taxpayer can make a qualified offer.  Sure they might still be a prevailing party, but they cannot use the qualified offer shortcut.  The obvious type of non-qualified proceeding here is Collection Due Process (CDP) hearings and subsequent Tax Court litigation.  Treas. Reg. 301.7430-3(a)(4).  Yep.  Taxpayers who prevail in a CDP hearing (and who otherwise meet all the other §7430 requirements) cannot use the qualified offer procedure to recover costs, at least so long as the CDP hearing is only about collection.  Treas. Reg. 301.7430-3(b).  Worthan v. Commissioner, T.C. Memo. 2012-263.  But to the extent the taxpayer validly raises a liability issue in the CDP hearing—and wins on—the CDP hearing will count as an administrative proceeding for which the taxpayer can recover costs.  Id.  For example, where the taxpayer petitioned the Tax Court to review a denial of requested spousal relief and also petitioned to review an adverse CDP determination, then even though the CDP matter was not a qualified proceeding, the spousal relief matter was.  See Angle, supra (refusing to even consider §7430 award for CDP matter, then considering but rejecting §7430 award for spousal relief matter for failure to meet net worth requirements).

With that background, let’s take a look at today’s case to learn how not to make a qualified offer.

Facts
For tax years 2008, 2009, and 2010 Ms. Lewis filed joint returns with her then-husband Mr. Lewis.  The IRS audited the returns, apparently sending the taxpayers a 30-day letter sometime in 2013.  At some point during the audit, Ms. Lewis raised the issue of spousal relief.  However, she “did not provide any information to support a claim for innocent spouse relief or submit a Form 8857” Op. at 4.

Long time passes.  In December 2016, Ms. Lewis sent a letter that explicitly claimed it was making a qualified offer.  It’s a weird offer.  Here are the terms (see if you spot the weirdness—I’ll explain below):

“1. To concede 100% of the tax and 100% of the penalties for the tax years 2008, 2009, and 2010, as set forth on the attached Form 4549-A dated February 12, 2013.
 “2. To agree to the immediate assessment of the increase in tax and penalties set forth on the attached Form 4549-A.
 “3. This is an offer of assessment, not payment, Mrs. Lewis reserves all collection rights that she may qualify for now or in the future, including without limitation, the right to relief under IRC §6015 (innocent spouse), §6159 (installment agreement), §7122 (offer in compromise), §6343 (release of levy), §7811 (taxpayer assistance order), §6502 (statute of limitations on collection), §6325 (release of lien), collection due process, collection appeals program, currently non-collectible status, bankruptcy, and any other current or future law that may serve to reduce the amount or delay the payment of amounts assessed as a result of the acceptance of this qualified offer.”

Op. at 3.

Long time passes.  In March 2018 the IRS issued an NOD for the three years.  Ms. Lewis timely filed a Petition and in it requested spousal relief under either §6015(b) or (c).  Mr. Lewis filed his own Petition and also intervened in Ms. Lewis’ case.  But again, however, Ms. Lewis did not submit any information beyond the allegation that she should get relief.  The Chief Counsel attorney asked for it.  She did not respond.  Chief Counsel sent the docket to Cincinnati Centralized Innocent Spouse Operations (CCISO) to see if they would have any better luck.  CCISO ask her for information.  She did not respond.  We are left ignorant as to why.

Long time passes.  Apparently, the IRS was able to get the necessary information from the ex-spouse because in 2020 CCISO decided that Ms. Lewis was entitled to proportional spousal relief under §6105(c).  For details on how (c) relief works, see Lesson From The Tax Court: The Innocence Requirement In § 6015(c) Proportional Relief, TaxProf Blog (February 7, 2022).  Mr. Lewis settled his case and withdrew from Ms. Lewis’ case.

Given the decision from CCISO, the Chief Counsel attorney drafted a stipulated decision that granted Ms. Lewis full relief from joint and several liability for three tax years at issue.  Ms. Lewis’ representative properly declined to sign the stipulated decision, believing that she had a claim for an award under §7430 based on that weird offer made during the administrative process some four years earlier.  Remember, one of the basic rules of the Qualified Offer game is that you should not sign a stipulated decision (unless it provides for your fees!).  That’s right up there is with don’t make an offer of zero.

The taxpayer’s theory was simple: she had offered to settle her tax liabilities for the three years for 100% of what the IRS had proposed, and now she had a judgment for zero.  Zero is far, far, less than 100%!

Lesson: A Crossed-Fingers Offer Is Not A Qualified Offer
The government had many reasons why it believed that the December 2016 letter to an Exam employee should not be treated as a qualified offer with respect to Tax Court litigation four years later.  The reason that Judge Pugh found dispositive was the finality rule.

Go back and look at the offer terms again, particularly paragraph (3).  That’s where Ms. Lewis reserved her rights to contest collection.  But she did more.  She reserved her rights to contest liability as well, through the spousal relief provisions in §6015.  That’s like making a promise but crossing your fingers.  Ms. Lewis argued that claiming spousal relief was just a collection alternative, like an installment agreement request or an OIC request.  So it was not really crossing her fingers about conceding the liability.  She argued that Mr. Lewis was supposed to pay the liabilities so her reservation of rights was only to protect herself in case Mr. Lewis did not pay the liabilities.

Judge Pugh thus frames the question this way: “whether reserving the right to claim relief under section 6015 relates to collection (as she tries to frame it) or to her underlying tax liability.” Op. at 9.

Well...that’s not a hard question to answer.  Just go look at §6015.  Heck the title alone (“Relief From Joint and Several Liability...”) gives you the clue!  But as we know, title’s are not supposed to count when interpreting statutes.  So look at the text.  Section 6015(b) says that when an individual meets the requirements of (b), then that “individual shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year...” (emphasis supplied).  Similarly, §6015(c) says that when an individual meets its requirements, then “the individual’s liability for any deficiency which is assessed with respect to the return shall not exceed the portion of such deficiency properly allocable to the individual....” (emphasis supplied)  Finally, §6015(f) says that when the IRS decides “it is inequitable to hold the individual liable for any unpaid tax or any deficiency....the Secretary may relieve such individual of such liability.” (you guessed it: emphasis supplied once again).

Yup.  All three forms of spousal relief are tax liability determinations.  That is why both administrative and court proceedings to determine the appropriate spousal relief qualify for §7430 awards of fees and costs.  They are not collection proceedings.  See e.g. Treas. Reg. 301.7430-3(c)(3) (treating a final notice of determination denying innocent spouse relief as a notice of deficiency for §7430 purposes).

Judge Pugh explains why reserving the right to contest the very liability purportedly being conceded violates the rules on finality:

“we must read her reservation as a caveat as to liability. Consequently, her offer flunks the requirement in section 7430(g)(1)(B) that the qualified offer 'specif[y] the offered amount of the taxpayer’s liability.' An offer that reserves the right to claim relief under section 6015 does not 'specif[y] the offered amount of the taxpayer’s liability' because the amount of liability offered depends on potential—and reserved—application of section 6015 and cannot be determined until availability of section 6015 relief is considered (or reservation of the right to claim it is withdrawn)." Op. at 9.

Notice that the problem here was that Ms. Lewis failed to give the IRS the opportunity to determine her spousal relief claim before submitting the purported qualified offer.  Judge Pugh distinguishes this situation from one discussed in the regulations where the taxpayer attempts to use later-arising net operating losses to effectively pay an accepted offer.  Treas. Reg. 301.7430-7-(e) Example 4 says:  “Because the net operating losses were not at issue when the offer was made, A's offer was a qualified offer. Whether A is entitled to apply net operating losses to reduce the amount stated in the offer will depend upon the application of contract principles, local court rules, and, because net operating losses are at issue, section 6511(d) and related provisions.”

Judge Pugh points out that this example gives no help to Ms. Lewis because “the right to relief from liability under section 6015 that petitioner reserved in her offer affects the amount of her liabilities—the assessed deficiencies—for the years in issue; it is not merely a carryover item applied later to reduce payment.”  Op. at 12 (emphasis supplied).

Bottom Line: Qualified offers only work when they are a final offer.  Ms. Lewis’ offer did not do that because of the crossed-fingers reservation to contest those purportedly conceded liabilities in the future.  It was not an offer to make a full resolution of the liability.  It was an offer to kick the can down the road.  Contrast that with the situation if Ms. Lewis had actually submitted a request (with supporting information) for spousal relief and then make a qualified offer...for $1.  Now that would be an offer to fully resolve the liabilities because it would give the IRS the opportunity to consider the spousal relief merits.

Practice Pointer Coda.  Ms. Lewis’ attorney properly refused to sign the proffered stipulated decision but was, perhaps, a bit too zealous otherwise.  After Chief Counsel moved for entry of a decision totally in Ms. Lewis’ favor and also filed a notice of concession that Ms. Lewis was entitled to §6015(c), the attorney then objected, claiming that the moves were just “a litigation tactic to avoid an award of fees and costs.”  Op. at 5.  I confess I do not understand that.  The entry of a decision would not have been a stipulated decision reflecting a settlement.  It was a concession.  I don’t see how Ms. Lewis would give up any rights to an §7430 award.  In fact, she actually needed a judgment in order to make a claim for an award!  Judge Pugh goes out of her way to note that she had to order Ms. Lewis’ attorney to file a motion for litigation costs. Op. at 5.

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return each week to TaxProf Blog for what he hopes is another useful Lesson From The Tax Court.