When the Tax Court reviews an IRS Collection Due Process (CDP) decision about collection, it always uses an abuse of discretion standard of review. That is, it does not simply substitute its judgment for that of the Office of Appeals Settlement Officer (SO), but instead looks to see whether the SO committed an error of law or made a decision that was whacko.
However, in conducting its abuse-of-discretion review, the Tax Court does not always use the same information set. It depends on where the taxpayer would take an appeal. If the taxpayer would take an appeal to the 1st, 8th, or 9th Circuits, the Tax Court will base its review solely on the administrative record provided by the IRS. No new information will be allowed. However, for appeals to any other Circuit, the Tax Court will also consider any additional information the parties bring up at trial.
Today’s case involves the administrative record review and teaches us what the practitioner can do during the CDP hearing to maximize chances in Tax Court if a petition becomes necessary. In Duane Whittaker and Candace Whittaker v. Commissioner, T.C. Memo. 2023-59 (May 15, 2023) (Judge Holmes), the taxpayers used their 2019 CDP hearing to submit an OIC. They not only provided detailed information but they also offered to provide additional substantiation if asked. Then COVID happened. In 2020 the taxpayers sent in additional information to show how their financial situation had deteriorated. Again, they offered to substantiate their claims if asked. They were not asked. That turned out to be key because it resulted in information gaps which, if filled, might have led the SO to a different conclusion.
It was these gaps in the administrative record that caused the Tax Court to find an abuse of discretion and remand the case back to Appeals to fill in the gaps. The Tax Court faulted the IRS for the gaps because the IRS had not asked for more information. Details below the fold.
Law: CDP As Information Gathering
Once the IRS assesses a tax liability against a taxpayer, it has broad and powerful administrative collection tools, notably the lien and levy powers. These tools allow it to collect the assessed liability without have to first sue in court. Bull v. United States, 295 U.S. 247, 260 (1935) (assessment has the force of a court judgment).
Collection is a process and can be a long one. After all, §6502 gives the IRS at least 10 years to collet an assessed tax. During that time the IRS hammers on taxpayers through its automated tax collection system the ACS. The system runs on the presumption that all delinquent taxpayers have the resources to pay their taxes but simply won’t. Until taxpayers provide information on why they cannot pay, they are presumed to be “won’t-pays.”
It is hard for taxpayers to stop that process—to stop the train. They have to find an actual human at the IRS and convince that person they are “can’t-pays” and not “won’t-pays” such that they should receive some alternative to fully paying the tax. Such collection alternatives include an Offer In Compromise (OIC), an Installment Agreement (IA), a Partial Pay Installment Agreement (PPIA), or even relegation to Currently Not Collectible (CNC) status. Those are all alternatives to full collection. But finding a human at the IRS can be tricky.
The Collection Due Process (CDP) provisions in §6320 and §6330 attempt to help taxpayers get to a human, to pause the collection train and work out a collection alternative. Those sections require the IRS to give taxpayers an opportunity for a CDP hearing with the Office of Appeals, either before the IRS starts levying, or immediately after it files an NFTL.
Formally, the purpose of the CDP hearing is for Appeals to review the case and make sure that administrative collection actions are appropriate. Informally, the CDP hearing has other benefits that I discuss in Lesson From The Tax Court: No Second Bite In CDP For Rejected OIC, TaxProf Blog (Mar. 1, 2021). The biggest informal benefit is the ability for taxpayers to work out a deal with the IRS. They can propose alternatives to full use of the lien and levy collection tools. True, it is about as easy to get a CDP hearing as it is to catch a butterfly—see Lesson From Tax Court: The CDP Butterfly, TaxProf Blog (July 3, 2021). Even if a taxpayer misses the CDP butterfly, however, they still have up to a year to get in front of Appeals for a similar opportunity, called an Equivalent Hearing. Treas. Reg. 301.6330-1(i).
But taxpayers have to give proper information. Getting a CDP hearing does not help taxpayers get collection alternatives unless they provide solid information to show they qualify as “can’t-pays.” IRS employees deal with a high volume of taxpayers, many of whom do not give accurate or complete information and many of whom are just using CDP as Collection Delay Process. It is no surprise that probably the most common reason IRS employees give to keep a taxpayer classified as a “won’t pay” is the taxpayer’s failure to supply requested information in a way the IRS employee needs. One sees that frequently in Notices of Determination from the Office of Appeals in CDP cases. One even sees it sometimes in Tax Court cases, such as Hernandez v. Commissioner, T.C. Memo. 2018-163 (Sept. 25, 2018), where Judge Vasquez suspended trial to give the taxpayers four extra months to provide information regarding expenses, continued to warn them they needed give information when trial resumed, and ultimately bemoaned that “petitioners refused to cooperate with the Court.” Yep. That story is all too familiar to many IRS employees both on the audit side and the collection side.
What we learn to today is that how savvy taxpayers can flip that script on the IRS. Read on.
The IRS sought to collect Mr. and Ms. Whittaker’s unpaid tax liability of $33,000 for 2015 and sent them a CDP Notice sometime in 2018. The opinion is silent on the date but that does not appear important to the story.
What is important to the story is that the Whittakers timely requested a CDP hearing and, sometime in May of 2019 (a year later? six months later? not important!) submitted a request for an Offer in Compromise along with their financial information on a completed Form 433-A. Judge Holmes emphasizes that they gave the Office of Appeals a ton of information about their finances and tried really hard to do it right. For example, when told they had neglected to submit their 20% down-payment as required by §7122(c)(1) they then “included a copy of a money order for an initial 20% payment of $325.80 for their OIC.” Op. at 3.
Judge Holmes is not entirely clear about what liability the OIC was intended to address. In the very first sentence of the opinion he says they “offered to settle their $33,000 tax bill for only $1,629.” But then in footnote 2 he says they “intended the $1,629 to satisfy their liabilities from 2004, 2005, 2006 and 2018." And those totaled “about $50,000.” And on page 7 he says again that “the OIC proposed a settlement of their tax liabilities form 2004-06 and 2018 as well.” Well, if they could get a 5% OIC (on the $33k) or an even better 3% OIC (on the $50k) , then more power to them!
But OICs are not get-out-of-tax-free cards. The Centralized Offer in Compromise (COIC) folks figured the Whittakers’ Reasonable Collection Potential (RCP) was $250,000. We learned about RCP in Lesson From The Tax Court: The Proper Baseline For Offers In Compromise, TaxProf Blog (Feb. 14, 2022). The Settlement Officer (SO) who handled the CDP hearing agreed, and “pointed out, for instance, that the Whittakers could fully pay the liability [which liability?] with just one of the investment accounts, leaving the other investment and the equity in the home.” Op. at 4 (internal quotes omitted). The SO proposed to approve collection, but did offer a streamlined IA and “gave their lawyer time to speak with the Whittakers to see if that was what they wanted.” Id.
Time. All of this took time, from the May 2019 submission to the September 2020 rejection of the OIC and the offer of a streamlined IA. In 2019 they had reported Mr. Whittaker as receiving a military pension and being self-employed full time as a personal trainer. They reported Ms. Whittaker being employed full time by a school district as well as working two part-time jobs. But that was then.
Time. The elephant in the room was the COVID Pandemic. In their September 2020 submission the Whittakers claimed that their economic situation had worsened because of the Pandemic in three material respects.
First, by September 2020 they both claimed to have retired—being in their mid-60’s—and Ms. Whittaker “was limited to working two weekends a month” at a part-time job. Op. at 5. They said that since they were now retired, the SO should no longer count their retirement accounts (or Ms. Whittaker’s pension), as lump sum assets but instead as a stream of future income. So that would reduce their RCP.
Second, relatedly, they argued that the Pandemic reduced their net monthly income to Mr. Whittaker’s military pension and Mrs. Whittaker’s part time job, and that was now less than their monthly expenses. So that would reduce their RCP.
Third, by September 2020 they claimed their home equity was far less than the $100,000 that was used to calculate their RCP. They claimed their home was so dilapidated that its actual value was waaaaay below the county tax appraisal. They also claimed their mortgage agreement prohibited or restricted refinancing to tap what equity they had.
They believed these changes justified their 3% OIC. The SO disagreed and approved the collection in a Notice of Determination (NOD). The Whittakers petitioned the Tax Court.
Lesson: Creating A Good Administrative Record
Judge Holmes was not happy with the SO’s Notice of Determination, noting that “the NOD issued by the Commissioner was sparse and contained little if any rationale behind the determination.” Op. at 14. In particular Judge Holmes was concerned that the NOD contained “no mention of the retirement accounts, not mention of the equity in the home or its condition, and no mention of the pandemic.” Id. However, Judge Holmes notes that even if the NOD had more meat to it, he would still remand for further consideration because of problematic gaps in the administrative record.
First, there are gaps about the existence or size of various retirement accounts. Judge Holmes notes that there are only a couple of 1099-R’s from Schwab, and they show distributions of only about $600. Op. at 5. Nor is there anything in the record establishing the size or availability of Mrs. Whittaker’s pension. “There’s also no evidence of a pension for Mrs. Whittaker or its amount.” Id. It was the IRS's fault for not securing this information.
Second, there are gaps in the record about the Whittakers’ continued employment. This was a big problem for Judge Holmes. The Whittakers claimed to both have retired by 2020, dropping their monthly income. Again, Judge Holmes faults the IRS for not putting information in the record showing their employment status. He notes that “Adjusting those [income] calculations to reflect their income after the pandemic hit would show a net income deficit. The settlement officer’s refusal to rework the worksheet despite the very considerable discrepancy in the calculation before and after the pandemic is a clear error and thus an abuse of discretion.” Op. at 14.
Finally, there are gaps about the home equity in the record. The Whittakers claimed the IRS was over-counting their home equity. And, “although the Whittakers didn’t submit such proof, they said that they would and could if the settlement officer had only asked.” Op. at 12 (emphasis supplied). Therefore, “we...find that the settlement office’s conclusion about the Whittakers’ ability to tap the equity in their home was clearly erroneous on this record.” Id. Once again, the onus is on the IRS to put information in the record showing it's decision was reasonable.
Putting this all together caused Judge Holmes to remand the case to Appeals to fill in the gaps with information and re-evaluate collection alternatives. And now that it is 2023, almost three years later, these taxpayers may have an even stronger case for an OIC. Or not! We don't know what the information will show. Meanwhile, their tax liabilities continue to grow. But that’s what Collection Delay Process does.
Bottom Line: The taxpayers had great representation here. Their attorney, Caleb Smith, created an administrative record such that any gaps would work against the IRS, not the taxpayer. How? Well, that’s our Lesson. He had his taxpayer make repeated offers to supply more information “if asked.” That allowed him to argue that gaps in the administrative record should work against the IRS because the IRS never “asked.” This is the opposite of most situations where it is the IRS repeatedly asking for information and never getting it.
Comment 1: Another lesson you might find here is that you want to draw Judge Holmes in CDP cases! In this opinion, and others, he shows a deep distrust of IRS collection personnel and process. You see that in two ways. First is his casually disparaging verbiage. E.g. “The IRS usually shuffles the OICs that taxpayers send in to a centralized unit unimaginatively called the Centralized Offer in Compromise Unit.” Op. at 3; “to use IRS jargon” Id. (emphasis supplied). This is consistent with other of his CDP opinions. See Lesson From The Tax Court: CDP Settlement Officer Must Work Previously Rejected OIC, TaxProf Blog (May 24, 2021) (characterizing an RO’s field visit to the taxpayer's home as “nice-little-home-you-got-here-shame-if-something-happened-to-it field call.” Op. at 5. That likens the RO to a gangster running a protection racket!). I would note here that the SO in this case actually proposed a collection alternative to the taxpayers. That is not their job, as Judge Lauber reminded us in Powell v. Commissioner, T.C. Memo. 2023-48, “it is the obligation of the taxpayer, not the reviewing officer, to start negotiations by making a specific proposal.” Should the Whittakers have taken the deal? I don't know. But as we recently learned, that may be the more prudent course of action. See Lesson From The Tax Court: Better Deals With Appeals, TaxProf Blog (May 1, 2023).
More importantly, the second way you see Judge Holmes' distrust of the IRS collection function is that in this case (and in that 2021 CDP case cited above) he seems to almost flip the abuse of discretion standard of review. Rather than requiring the taxpayer to show how the IRS abused its discretion, Judge Holmes reviews the record to see if agency has proved it properly applied its discretion. For example, here in their September 2022 submission the taxpayers claimed to have no equity in their home for various reasons, including claimed restrictions in their mortgage. Usually the person making a claim bears the burden to substantiate that claim. Rather than faulting the taxpayers for failing to substantiate these claims when made, Judge Holmes faults the IRS for not asking for that specific proof. Again, this approach to review demonstrates Judge Holmes' distrust of the IRS collection process. And it goes to the Lesson here of how to create a stronger administrative record for your client: volunteer to provide more information "if asked."
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. If you ask him, he can provide more information about that. He invites readers to return each Monday (or Tuesday if Monday is a federal holiday) to TaxProf Blog for another Lesson From The Tax Court.
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