Lesson From The Tax Court: A Lesson In Pathfinding

I cannot say it enough: the IRS is not an entity.  It’s a vast organization with various offices that perform various functions.  And one key idea is that taxpayers may have multiple paths to get to a successful result.  If one office cannot help you perhaps a different one can.  At the IRS that often means if you cannot get good results in Exam or Collection you might get them in Appeals.  And sometimes you can get to Tax Court from Appeals.  But sometimes not.  It's path dependent as we learn today.

In Rita Renee Pilate v. Commissioner, T.C. Memo. 2023-136 (Nov. 9, 2023) (Judge Gustafson), the IRS was seeking to collect a tax liability.  The taxpayer was able to obtain a CDP hearing.  That path put her in front of the Office of Appeals.  She said she wanted to make an Offer In Compromise (OIC).  But she did not submit one to Appeals as part of the CDP hearing.  She did not choose that path.  After Appeals closed her CDP hearing, Ms. Pilate timely petitioned the Tax Court for review.  She also now submitted an OIC but, since her CDP case had closed, that submission put her on a different path.  The OIC was accepted but a dispute later arose on whether she complied with its terms and Appeals issued a letter defaulting her.  Since her CDP petition was still before the Tax Court, she asked the Court to review the Appeals decision to default her OIC.  The Tax Court said it could not make that review, because an OIC outside of CDP is not on the correct path for judicial review.

Details below the fold.

Background: CDP
I’ve now posted 311 “Lessons” on TaxProf Blog since September 2017.  Of those, 78 have been Lessons about the Collection Due Process (CDP) provisions.  So today I’ll just give a very brief background.

When the IRS seeks to collect an unpaid tax liability, it has some pretty awesome powers.  The CDP provisions in §6320 and §6330, however, 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.  During that time, the IRS cannot use its collection powers.  If the taxpayer does not like the outcome of their CDP hearing, they can petition the Tax Court to review.  Of course, for the taxpayer to choose the CDP pathway, they must act speedy quick.  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).

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 that pathway does not permit judicial review.  Id.

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 that CDP gives taxpayers space to potentially work out a collection alternative while pausing collection.  They can propose alternatives to full use of the lien and levy collection tools.  One of the most common collection alternatives is an Offer In Compromise (OIC).

Background: OIC
Section 7122 authorizes the IRS to compromise taxes, allowing certain taxpayers to pay less than they owe. Treas. Reg. 301.7122-1 provides that the IRS will compromise taxes when: (1) there is doubt as to the taxpayer’s actual liability; (2) there is doubt as to whether the taxpayer can actually fully pay the liability; or (3) the compromise will further effective tax administration.  OICs come in two basic flavors: a “lump sum” offer or a “periodic payment” offer. See IRM 5.8.1.15.4.  The lump sum option can actually extend for six months of payments.  The periodic payment option can go longer but cannot extend longer than 24 months. Id.

To get an OIC, taxpayers submit Form 656. This Form contains a bunch of terms that the taxpayer must agree to follow.  The most obviously important term is that the taxpayer make all the payments called for by the OIC.  For example, if the taxpayer is seeking a periodic payment offer, the taxpayer must submit the first payment with the offer and must finish paying all installments in 24 months.

OICs can be a win-win for the government and taxpayers. Taxpayers get relief from enforced collection of a legally due and owing obligation.  The government gets some money now rather than nothing later and, more importantly, brings non-compliant taxpayers back into compliance....at least for five years...at least in theory.  The National Taxpayer Advocate’s 2018 Annual Report to Congress sums up the mutual benefit this way on page 266:“The taxpayer benefits by reaching finality with his or her tax debt sooner in the collection process and paying what he or she can afford to pay, while the IRS benefits by creating a segment of noncompliant taxpayers who become more compliant.”  I am sorry but there is no working link to the actual 2018 Report, as the Taxpayer Advocate’s Webpage here explains.  I pulled that quote from my paper copy.

But OICs are not always a win-win for the taxpaying public.  The historical reluctance of Congress and the IRS to be generous with OICs is that they (by definition) allow some taxpayers to avoid ever paying the full tax they owe.  These are taxpayers who failed to pay what they owed at the time they owed it.  Maybe they were princes at that time.  Now they are frogs and want relief.  That is unfair to other taxpayers who perhaps made sacrificial choices to fully pay their taxes when due.

That historic concern is one reason for the various payment and compliance requirements.  If the taxpayer becomes noncompliant with the OIC, the OIC is still a partial win for the government. It will have collected at least some money.  But now the taxpayer is at risk for resumed enforced collection of the full liability.  The IRM instructs employees to work with the taxpayer to prevent or cure noncompliance.  See IRM 5.8.9.4 (“Potential Default Cases”).  One tax lawyer’s blog suggests that the IRS will try to work with taxpayer to prevent default because “[t]he IRS does not want the compromise to default any more than you do.”  Curiously, I can find no statistics on what percentage of OICs default (whether lump sum or periodic payment).  I welcome comments from any alert reader who has that information!.

The Office that monitors OICs is called, unsurprisingly, the Monitoring OIC unit (MOIC).  See IRM 5.19.7 (“Monitoring Offer In Compromise”). IRM 1.2.2.6.1.4(4) grants MOIC the authority to terminate an OIC when the taxpayer defaults on its terms and the parties cannot agree on a work-out or modification to the original OIC (what used to be called a “compromise to the compromise.”)  See IRM 8.23.3.13 (“Modification of a Compromise”).  OICs defaulted by MOIC are uploaded into the Office of Appeals system for review.  Compare IRM 8.23.3.12 (“Potential Default Offers”) with IRM 8.23.4.7 (Potential Default Offers”).  If the Appeals Technical Employee (ATE) agrees with the MOIC decision, then “the ATE will use Letter 5412, Appeals Offer in Compromise Default Letter”  Id.

But that’s it.  Just like with Equivalent Hearings, Appeal’s action is the end of that pathway.  Its decision approving the MOIC default decision is not reviewable by the Tax Court.  The Letter 5412 is not a ticket to the Tax Court.

We learn today that the pathway the taxpayer takes to securing an OIC can make a difference in what happens when the taxpayer disagrees with an Appeals action relating to the OIC.

Let’s look at the facts.

Facts
In March of 2015 the IRS sent Ms. Pilate a Notice Of Deficiency (NOD) for tax year 2012 asserting that she had omitted income from her return and asserting a deficiency of about $120,000.  Ms. Pilate received the NOD but did not file a Tax Court petition contesting the asserted tax deficiency.  Nor did she pay the deficiency.

In August of 2019 the IRS sent Ms. Pilate a CDP Notice of Intent to Levy, indicating that it was seeking to collect a total amount due of about $222,000 which included the unpaid tax plus penalties and interest.  Great mini-lesson there about how quickly tax liabilities can balloon!

Ms. Pilate timely requested a CDP hearing but she was unable to make much progress in it, partly because of COVID.  Thus while she said she wanted to pursue an OIC she did not submit the necessary paperwork to the Appeals Officer (AO) between their first phone call on April 15, 2020 and the AO’s final warning letter dated July 10, 2020.  The AO closed the case on July 26, 2020 and issued a Notice of Determination on September 21, 2020.

Despite COVID, Ms. Pilate was able to timely file her Tax Court petition.  She was also able to put together her OIC submission materials and she submitted those shortly before her Tax Court petition on October 19, 2020.  Again, COVID delay.  About a year later, in October 2021, the IRS accepted her OIC, which called for a short series of payments.  The Opinion is silent on the terms of the OIC except that final payment was due on March 21, 2022.

Ms. Pilate and the IRS Chief Counsel assigned to the case agreed to suspend the Tax Court case pending, first, the acceptance of the OIC and then, second, the fulfillment of the accepted OIC.

Ms. Pilate apparently made all her OIC payments except the last one.  She asked for and received two extensions of time to make that last payment with the second extension good until December 20, 2022.  When she did not make her last payment by then, Appeals terminated her OIC and sent her the default letter (presumably Letter 5412 although the Opinion is silent on that fact) in February 2023.  Then Chief Counsel filed a Motion for Summary Judgment in Tax Court.

Lesson:  No Tax Court Review If Not On Proper Path
Ms. Pilate wanted the Tax Court to review the decision to default her OIC.  She said that she had good reasons for not making the final payment, because of “issues that arose . . . due to litigation (that is still ongoing) in a related case” and because of serious medical problems, medical bills, “and a resulting decrease in income.”  Op. at 6.

Judge Gustafson refused to review the decision to default the OIC because that decision was not part of the CDP pathway.  It was not part of the decision to permit the IRS to proceed with collection that was reflected in the Notice of Determination in the first place.  It was a separate determination that was reflected in the later Appeals action (again, presumably a Letter 5412).  Writes Judge Gustafson:

“Of necessity, IRS Appeals must exercise its discretion in light of the facts that exist at the time it issues its notice of determination. Here, IRS Appeals did not receive the OIC until after the conclusion of the CDP hearing and the issuance of the notice of determination. Therefore, we cannot fault IRS Appeals for not knowing the future, and we do not have jurisdiction to consider a later-submitted OIC in our review of the notice of determination.”

Bottom Line: If the taxpayer’s beef with the IRS arises from a pathway outside the CDP pathway, the taxpayer will not get Tax Court review when contesting the CDP Notice of Determination.

Comment:  Alert readers will note that Judge Gustafson gives two possible reasons for refusing to review Ms. Pilate’s claim that her OIC was improperly defaulted, both in that last sentence:  (1) “we cannot fault IRS Appeals for not knowing the future” and (2) “we do not have jurisdiction to consider a later-submitted OIC...”

It’s the second reason that is the Lesson for today.  The Tax Court will indeed sometimes fault IRS Appeals for not knowing facts that were not before it during the administrative hearing.  I discuss that in Lesson From The Tax Court: The Scope And Standard Of Review In CDP Cases, TaxProf Blog (Nov. 25, 2019).  And Congress actually tells the Tax Court to sometimes take into consideration future events.  Section 6015(e)(7) provides the following rule for how the Tax Court is supposed to review denials of taxpayer requests for spousal relief:

“Any review of a determination made under this section shall be reviewed de novo by the Tax Court and shall be based upon—(A) the administrative record established at the time of the determination, and (B) any additional newly discovered or previously unavailable evidence.”

Section 6017(e)(7) is concededly weird and was the subject of a robust ABA Tax Section presentation last May.  Alert readers will notice that it concerns the facts on which the Tax Court is to make a "de novo" determination.  But I offer it here only to reinforce the basic idea that yes, the Tax Court does indeed sometimes fault Appeals for failing to take into consideration information that was not presented to it!

Thus, I would not give too much weight to Judge Gustafson’s first reason.  His second reason seems the right analysis.  That reason—lack of jurisdiction—was the part of the robust discussion in Giamelli v. Commissioner, 129 T.C. 107 (2007), a fairly splintered opinion.  I highly recommend Judge Wherry's concurrence as a lucid explanation of the problem confronting the Tax Court in deciding the scope of its review of the Office of Appeals.  IMHO he properly puts it on Congress in explaining why the Tax Court must always consider whether it has the power to review.  In today's case, for example, I do not see how Ms. Pilate could get Tax Court review of a decision to default an OIC, even if she had properly applied for it as part of the CDP hearing.  Because then the only review the Court would give would be if Appeals denied the OIC.  Here her OIC was accepted.  And if Appeals had approved the OIC, then the CDP process would have been over.  If there is a later alleged default, that is a separate process over which Congress has not given the Tax Court review power.

I welcome comments on what I may be missing!

Finally, we see the same Lesson in spousal relief provisions: different paths have different consequences.  If the taxpayer seeks spousal relief as part of a deficiency proceeding or a CDP proceeding, that leads to a different type of review than if the taxpayer seeks relief in a stand-alone proceeding.  Perhaps I'll be blogging on that in more detail in a future Lesson From The Tax Court.

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  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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