Strong, TC Memo 2016-70
The Tax Court has upheld IRS’s rejection of a taxpayer’s offer-in-compromise (OIC) that was based on doubt as to collectibility. The Court rejected the taxpayer’s argument that IRS abused its discretion by considering his business receivables as business assets for purposes of the OIC. Click here for the Opinion of the Court.
Background. Code Sec. 6331(a) authorizes IRS to levy upon property and property rights of a taxpayer liable for taxes who fails to pay those taxes within 10 days after notice and demand for payment is made. Code Sec. 6331(d) requires that IRS give written notice to the taxpayer of its intent to levy, and Code Sec. 6330(a) requires IRS to send the taxpayer written notice of his right to a hearing (a collection due process, or CDP, hearing) before IRS’s Appeals group.
If the taxpayer requests a hearing in response to a notice of levy, he may raise at the hearing any relevant issue relating to the unpaid tax or the proposed levy, including challenges to the appropriateness of the levy and collection alternatives such as an installment agreement or an OIC. (Code Sec. 6330(c)(2)(A))
Code Sec. 7122(a) authorizes IRS to compromise a taxpayer’s income tax liability. In general, the decision to accept or reject an offer as well as the terms and conditions agreed to are left to the discretion of IRS. (Reg. § 301.7122-1(a)(1), Reg. § 301.7122-1(c)(1)) One of the grounds for the compromise of a tax liability is doubt as to collectibility (Reg. § 301.7122-1(b)), which “exists in any case where the taxpayer’s assets and income are less than the full amount of the liability.” (Reg. § 301.7122-1(b)(2))
IRS will generally compromise a liability on the basis of doubt as to collectibility only if the liability exceeds the taxpayer’s reasonable collection potential (RCP), “i.e., that amount, less than the full liability, that IRS could collect through means such as administrative and judicial collection remedies.” (Murphy, (2005) 125 TC 301)
Internal Revenue Manual (IRM) pt. 126.96.36.199 provides that accounts receivable may be treated as future, as opposed to current, income when it is determined that liquidation of a receivable would be detrimental to the continued operation of an otherwise profitable business.
Facts. Mr. Strong, the taxpayer, owned a single-member disregarded limited liability company, Boise Gutter.
IRS sent Strong a notice of intent to levy with respect to unpaid Boise Gutter trust fund recovery penalties. IRS’s record showed that Strong owed $67,000 individually to IRS and that Boise Gutter owed $106,000.
In 2012, Strong timely submitted Form 12153, Request for a Collection Due Process Hearing. He submitted information that indicated that Boise Gutter had monthly income of $48,000 and monthly expenses of $45,000. And, he submitted information that he personally had monthly business income of $64,000 and monthly expenses of $62,000. Strong also reported business cash consisting of: $15,663 in checking and savings accounts and “$7,200 used for the production of income.”
He submitted an OIC which proposed a lump-sum offer of $11,500 based upon doubt as to collectibility. He attached a letter to the OIC stating that, although his business bank account balances were high, Boise Gutter had offsetting payables for normal business expenses.
Later, in response to requests from the IRS Appeals settlement officer (SO), he submitted: a) financial statements of the business, which included a profit and loss statement and a statement of distributions from the business to Strong; and b) recent federal income tax returns.
The SO reviewed Strong’s documents and noted that the U.S. Bank account had an average ending balance over a 3-month period from May through July 2012 of $14,655. The SO concluded that, according to Strong’s business bank account statements, Boise Gutter had funds to make monthly payments, maintain deposits, and pay business expenses. The SO included $33,952 of Boise Gutter’s accounts receivable that was less than 90 days past due and that was reported on its accounts receivable report, in determining Strong’s RCP. The SO calculated Strong’s RCP as $38,839. Most of the SO’s calculation of Strong’s RCP came from 50% of the fair market value of Strong’s “U.S. Bank checking account less encumbrances” ($4,253), and Boise Gutter’s accounts receivable of $33,952.
The SO also noted discrepancies between Boise Gutter’s 2012 distribution report and its 2012 P&L statement for January through September. Specifically, Boise Gutter’s 2012 distribution report listed $41,319 in distributions to Strong for the year (for a $3,443 monthly average), while Boise Gutter’s 2012 P&L statement through September 2012 claimed $2,982 in net average business income and a $233 “draw” from payroll for this period.
The SO issued a notice of determination that sustained the proposed levy action and rejected Strong’s OIC of $11,500 because it did not equal or exceed Strong’s RCP.
Court okays IRS’s rejection of the OIC. The Court rejected Strong’s argument and found that IRS did not abuse its discretion when it rejected his OIC.
The Court began by stating that an SO’s decision to reject an OIC will not be disturbed unless it is arbitrary, capricious, or without sound basis in fact or law. And, generally, courts have found no abuse of discretion where the Appeals Office has followed IRS’s guidelines to ascertain a taxpayer’s RCP and has rejected a taxpayer’s collection alternative on that basis.
Strong, citing IRM pt. 188.8.131.52, argued that the SO abused her discretion by treating his accounts receivable less than 90 days past due as business assets that were includible in the determination of his RCP. Strong also argued that the notice of determination cited only deposit account balances from peak business months as the sole facts and evidence for the determination. Strong said that the SO’s analysis failed to set forth any explanation for disregarding documents that Strong submitted showing that: (1) Strong’s accounts payable significantly offset any accounts receivable, and (2) bank account balances which reflected funds set aside from busier summer months would be necessary to cover the cost of Strong’s business during slower winter months. Finally, Strong argued that the SO neglected to incorporate income and expense figures from his tax returns in her analysis to calculate his average income for purposes of RCP.
The Court was not swayed by any of these arguments. It noted that Strong provided the SO with bank statements from only his peak business months; he did not provide material evidence to substantiate his claim that the high business account balances were necessary to cover the cost of his business during slower winter months. And, although Strong provided the SO with his tax returns to show income and expenses from Boise Gutter, a tax return is merely a statement of a taxpayer’s claim; it does not establish the truth of the matters set forth therein.
Many of the documents Strong submitted, such as Boise Gutter’s financial statements, were inconsistent with one another. Furthermore, Boise Gutter’s accounts payable, which Strong contended offset its accounts receivable for 2012, showed that most of the payables were apparently owed to Strong’s relatives as opposed to third-party vendors.
And, Strong did not provide the SO with adequate evidence to show that the liquidation of Boise Gutter’s accounts receivable would be detrimental to its survival.
These facts and the fact that Strong had an RCP more than three times his proposed OIC showed that the SO did not abuse her discretion in rejecting the OIC.