Tax Court in Brief January 31 – February 4, 2022

Tax Court in Brief January 31 – February 4, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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Tax Litigation: The Week of January 31 – February 4, 2022

• TBI Licensing, LLC v. Comm’r, No. 21146-15, T.C. No. 1 | January 31, 2022 | Halpern
• Larson v. Comm’r, T.C. Memo 2022-3 | February 2, 2022 | Jones, J. | Dkt. No. 15809-11
• Estate of Washington v. Comm’r; T.C. Memo. 2022-4 | February 2, 2022 Toro, J. | Dkt. No. 20410-19L
• Flynn v. Comm’r, T.C. Memo 2022-5 | February 3, 2022 | Urda, J. | Dkt. No. 10182-19L

TBI Licensing, LLC v. Comm’r, No. 21146-15, T.C. No. 1  January 31, 2022 | Halpern 

• Opinion

Short Summary:  This case involves the taxability of outbound transfer of intangible assets under I.R.C. §367(d).  The Taxpayer herein argued that the transfers in question were not taxable, and the IRS urged that they were.  Ultimately, the Court found that the Taxpayer’s constructive distribution of stock that Taxpayer constructively received in exchange for its intangible property was a “disposition” within the meaning of section 367(d)(2)(A)(ii)(II), thereby requiring immediate inclusion in income.  Further, no provision of the regulations allowed the Taxpayer to avoid the recognition of gain.

Key Issues:

• Whether TBI Licensing, LLC (“Taxpayer”) was required to recognize ordinary income under section 367(d)(2)(A)(ii)(II) as a result of a constructive transfer of intangible property to TBL Investment Holdings GmbH (“TBL”), a Swiss corporation.
• If the answer to (1) is yes, then whether, in determining the amount of that income, the property should be treated, as a matter of law, as having a useful life limited to 20 years.

Facts and Primary Holdings: 

• The events that gave rise to the dispute herein occurred as part of a post acquisition restructuring carried out after a business combination involving VF Corp. (“VF”) and the Timberland Co. (“Timberland”). Through its subsidiaries, VF designs, manufactures, and sells apparel and footwear under brands such as Lee, Wrangler, Nautica, Vans, and the North Face. Timberland’s business involved the design, development, manufacture, marketing, and sale of footwear, apparel, and accessories under its own brand and others, such as SmartWool.
• The VF and Timberland businesses were combined on September 13, 2011, by means of a merger into Timberland of an acquisition subsidiary of TBL International Properties, LLC (“International Properties”). In the merger, the former Timberland shareholders received cash in exchange for their Timberland stock.
• VF had organized International Properties in August 2011 as a limited liability company under Delaware law. The parties stipulated that International Properties “has been a disregarded entity from the time of its formation.
• Taxpayer is also a Delaware limited liability company whose sole member interest was owned, throughout the events in issue, by International Properties. The parties stipulated Taxpayer was treated as a corporation for U.S. federal income tax purposes at all times during the taxable year at issue.
• Before the merger in which International Properties acquired Timberland, VF transferred its membership interest in International Properties to VF Enterprises S.à.r.l. (“VF Enterprises”), an indirect foreign subsidiary of VF. As part of the postacquisition restructuring, petitioner came to own Timberland’s intangible property, including trademarks, foreign workforce, and foreign customer relationships.
• On September 22, 2011, after the close of the merger by which International Properties acquired the Timberland stock and after Taxpayer had acquired Timberland’s intangible property, VF Enterprises contributed to TBL GmbH the sole member interest in International Properties. About a week later, Taxpayer elected under Treasury Regulation § 301.7701-3(c)(1)(i) to be disregarded as an entity separate from its owner, effective September 24, 2011.
• On the Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, included with its Federal income tax return for the taxable year ended September 23, 2011, Taxpayer reported that the trademarks it acquired from Timberland had a fair market value of $1,274,100,000. The IRS assigned the same value to the trademarks in computing the deficiency in issue.
• The parties stipulated that Lee Bell, Inc. (“Lee Bell”), an indirect domestic subsidiary of VF and indirect parent of VF Enterprises, reported income under section 367(d)(2)(A)(ii)(I) in specified amounts for the taxable years 2011 through 2017. The stipulation does not attribute those amounts to Taxpayer’s constructive transfer of intangible property to TBL GmbH, but each accepts that the inclusions in Lee Bell’s income relate to that transfer. The parties also stipulated that Lee Bell never owned the intangible property that Taxpayer constructively transferred to TBL GmbH.
• Taxpayer and the IRS agree that, in the restructuring that followed the acquisition of Timberland by VF Enterprises, through International Properties, Taxpayer came to own Timberland’s intangible property and then made a constructive transfer of that property to TBL GmbH, a subsidiary of VF Enterprises. They agree that Taxpayer’s constructive transfer of intangible property occurred as part of a “reorganization” described in section 368(a)(1)(F). And they agree that, because Taxpayer—then treated as a U.S. corporation—constructively transferred intangible property to a foreign corporation in a transaction that would otherwise qualify for nonrecognition treatment under §361(a), §367(d) applies to the transfer. The parties disagree, however, on the consequences of the application of §367(d).
• A U.S. person who makes an “outbound” transfer of property to a foreign corporation might be required to recognize gain even if, had the transfer been made to a U.S. corporation, it would have been entitled to nonrecognition treatment. Section 367(a), which applies to outbound transfers of most types of property, achieves that result by providing, subject to significant exceptions, that the foreign corporation that receives the property is not treated as a corporation.
• Outbound transfers of intangible property are not covered by §367(a) but are instead addressed by §367(d). Section 367(d) generally requires the U.S. transferor of intangible property to recognize gain in the form of ordinary income, but the timing of that income recognition varies depending on the circumstances. The principal dispute between the parties centers on the timing of the income recognition required by section 367(d) .
• No provision in the regulations allows Lee Bell to assume responsibility for reporting those payments: Lee Bell was neither the U.S. transferor of the intangible property nor the recipient of the stock of TBL GmbH, the transferee foreign corporation.
• Taxpayer’s constructive distribution to VF Enterprises of the TBL GmbH stock that Taxpayer constructively received in exchange for its intangible property was a “disposition” within the meaning of section 367(d)(2)(A)(ii)(II), and no provision of the regulations allows Taxpayer to avoid the recognition of gain under that statutory provision.
• Having determined that Taxpayer must recognize gain for the taxable year in issue by reason of the application of §367(a)(2)(A)(ii)(II), the Court then went on to reject the Taxpayer’s argument that in determining the amount of that income, the property should be treated, as a matter of law, as having a useful life limited to 20 years. Instead, the Court found that, by reason of Temporary Treasury Regulation §367(d)-1T(g)(5) , the gain that a U.S. transferor must recognize under paragraph (d)(1) upon disposing of the stock of the transferee foreign corporation to an unrelated person should take into account the actual fair market value of the transferred intangible property on the date of the disposition.

Key Points of Law:

• Section 367(d)(1) applies, “[e]xcept as provided in regulations . . . if a United States person transfers any intangible property (within the meaning of section §936(h)(3)(B)) to a foreign corporation in an exchange described in section 351 or 361.” § 367(d)(1) .
• When §367(d)(1) applies to a transfer, the United States person transferring the intangible property is treated as:
  • (i) having sold such property in exchange for payments which are contingent upon the productivity, use, or disposition of such property, and
  • (ii) receiving amounts which reasonably reflect the amounts which would have been received—
    • (I) annually in the form of such payments over the useful life of such property, or
    • (II) in the case of a disposition following such transfer (whether direct or indirect), at the time of the disposition.
    • 367(d)(2)(A)
• If §367(d)(2)(A)(ii)(II) applies, as urged by the IRS, then tax is due immediately upon deemed sale of the intangible property. If §367(d)(2)(A)(ii)(I) applies, as urged by the Taxpayer, then tax is due over a much longer period of time.
• Section 367(d)(2)(A)(ii)(II) applies only in the event of a “disposition following [the] transfer” of intangible property.The IRS argued, and the Court ultimately agreed, that a disposition occurred in this case.
• For purposes of the §367(d)(2)(A)(ii)(II), the disposition “followed” the §367(d) transfer. Although such disposition occurred as part of one transaction, the constructive exchange of intangible property for TBL GmbH stock necessarily preceded – if only by a moment – its distribution of that stock to VF Enterprises.
• Generally, private letter rulings may not be used or cited as precedent. See 6110(k)(3).  However, private letter rulings may be cited to show the practice of the Commissioner.  Dover Corp. & Subs. v. Comm’r, 122 T.C. 324, 341 n.12 (2004).

Insight:  The taxability of outbound transfer of intangible assets under I.R.C. §367(d) involves a complicated set of rules and regulations that must be scrutinized in detail.  Courts are likely to construe them strictly, as here, where the facts fall squarely within the provisions of the rules.

Larson v. Comm’r, T.C. Memo 2022-3 February 2, 2022 | Jones, J. | Dkt. No. 15809-11

• Opinion

Short Summary: Restricted stock of an S corporation that was placed into an employee stock ownership plan for the benefit of a control person of the S corporation was includable in the control person’s taxable income. The restrictions associated with the stock were not likely to be enforced such that there was no “substantial risk of forfeiture” to the beneficial owner, i.e., the control person. And, the control person, also a trustee of the ESOP, failed to perform fiduciary duties associated with the ESOP, further indicating the lack of any risk of forfeiture to the stock in question. Thus, the income of the S corporation should have passed through, pro rata, to the control person in the tax years in question.

Key Issues:

• Whether the Commissioner erred in finding that pass-through income from an S corporation, Morley, Inc., was includable in John Larson’s taxable income for tax years 1999 and 2000 when Larson, a control person, was the beneficial owner of Morley, Inc. stock that was contributed to an employee stock ownership plan (ESOP) but restricted by employment performance requirements and strict voting procedures?
• Whether the Commissioner erred in denying as ordinary and necessary business expenses deductible under section 162, certain expenses incurred and paid by S corporation, Morley, Inc.

Short Answers: No, and no.

Primary Holdings:

• Under the facts and circumstances of the case, the value of the stock in the S corporation was not subject to a substantial risk of forfeiture for the years in question as required by 26 U.S.C. § 83. Larson, along with the other control persons of Morley and the ESOP, failed to enforce employment performance restrictions, and Larson “grotesquely” failed to perform his fiduciary duties associated with the ESOP. Therefore, the Commissioner was correct in assessing the value of the stock in Larson’s taxable income for the applicable tax years.
• Larson’s “relationship to the officers and directors of the [S] corporation and their actions [to waive restrictions associated with the stock and to breach fiduciary duties owed to the ESOP] revealed an effort to collectively avoid enforcement of the restrictions. . . . . Mr. Larson did not put forward any convincing evidence that he could possibly lose control over the S corporation[,]” and therefore, the value of the Morley, Inc. stock was includable in Larson’s income as there was no substantial risk of forfeiture associated with the stock.
• Larson’s self-serving declarations, unreliable hearsay, and uncorroborated testimony was insufficient to establish a deduction for the business expenses in issue.

Key Points of Law:

• The Commissioner’s determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of providing that those determinations are erroneous.
• An S corporation is defined as a small business corporation for which an election under 26 U.S.C. § 1362(a) is in effect for the relevant tax year. Like partnership income, income from an S corporation flows to its shareholders, resulting in only one level of taxation. at § 1363(a). An S corporation shareholder generally determines his or her tax liability by taking into account a pro rata share of the S corporation’s income, losses, deductions, and credits. See id. at § 1366(a)(1). When qualified ESOPs meet the requirements of 26 U.S.C. § 401(a), their related trusts are generally exempt from income taxation pursuant to 26 U.S.C. § 501(a). Outstanding shares of an S corporation may be owned by an ESOP, effectively allowing S corporation profits to escape immediate federal income taxation.
• Section 83(a) governs the tax treatment of property transferred “in connection with performance of services.” Upon such a transfer, the value of such property is taxable in the first year in which the taxpayer’s rights in the property are “transferable or are not subject to a substantial risk of forfeiture.” 26 U.S.C. § 83(a)(1) (emphasis added); Reg. § 1.83-1(a)-(b). A taxpayer can defer recognition of income until his or her rights in the restricted property become “substantially vested.” Treas. Reg. § 1.83-1(a)(1).
• “[A] substantial risk of forfeiture exists only if rights in property that are transferred are conditioned, directly or indirectly, upon the future performance (or refraining from performance) of substantial services by any person.” Reg. § 1.83-3(c)(1). Whether a substantial risk of forfeiture exists depends on the facts and circumstances.
• An employment agreement made in conjunction with a restricted stock agreement is considered an “earnout restriction” whereby the property cannot be fully enjoyed until, for example, the future performance of substantial services. For purposes of subchapter S, “stock that is issued in connection with the performance of services . . . and that is substantially nonvested . . . is not treated as outstanding stock of the corporation, and the holder of that stock is not treated as a shareholder solely by reason of holding the stock.” Reg. § 1.1361-1(b)(3). When structured and performed properly, earnout restrictions can give rise to a substantial risk of forfeiture within the meaning of section 83. When such stock is not subject to a substantial risk of forfeiture, the stock so issued constitutes a passthrough income from the issuing company to the stockholder. In evaluating these requirements under section 83, the courts consider, primarily, whether there is a sufficient likelihood that the earnout restrictions (i.e., performance requirements) would be enforced.
• When restricted property is transferred to an employee “who owns a significant amount of the total combined voting power or value of all classes of stock of the employer corporation,” the IRS and courts consider factors of control, not just stock ownership percentages; de facto power to control is a focus. See Reg. § 1.83-3(c)(3)-(c)(3)(v).
• Reg. § 1.83-3(c)(3) provides five factors to consider when determining whether an employee’s interest in transferred property is subject to a substantial risk of forfeiture in instances where an employee of a corporation owns a significant amount of stock of the employer corporation:
• the employee’s relationship to other stockholders and the extent of their control, potential control and possible loss of control of the corporation,
• the position of the employee in the corporation and the extent to which he is subordinate to other employees,
• the employee’s relationship to the officers and directors of the corporation,
• the person or persons who must approve the employee’s discharge, and
• past actions of the employer in enforcing the provisions of the restrictions.
• Note: In 2001, the Internal Revenue Code was amended to require that income or loss that had previously been allocable to the ESOP be attributable to certain non-ESOP shareholders of a closely held corporation. The change, however, was prospective; it did not apply to plan years before 2005 for an ESOP that existed before 2001.
• To deduct an expense under section 162 of the Code, a taxpayer must establish that the amount was an ordinary and necessary expense paid or incurred in carrying on a trade or business. See 26 U.S.C. § 162(a). Taxpayers must substantiate the amount of any claimed deduction by maintaining the records needed to establish entitlement to such a deduction; self-serving declarations, unreliable hearsay, and uncorroborated testimony are generally insufficient means to establish such entitlement.

Estate of Washington v. Comm’r; T.C. Memo. 2022-4 February 2, 2022 Toro, J. | Dkt. No. 20410-19L

• Opinion

Short Summary: In this collection due process (CDP) case, the estate of Anthony K. Washington, deceased, Lenda Washington, personal representative (Estate), sought review of a determination by the Independent Office of Appeals that sustained a notice of intent to levy to collect Mr. Washington’s unpaid income tax liabilities for the tax years 2008 to 2010, 2014, and 2015 and rejected the Estate’s offers-in-compromise. The Commissioner moved for summary judgment, contending that that IRS Appeals’ determination rejecting the Estate’s offers-in-compromise was proper as a matter of law. The court granted the Commissioner’s motion.

Mr. and Mrs. Washington divorced in 2006. Mr. Washington had substantial earnings in 2008-2010 but did not timely file returns. He eventually entered an installment agreement to pay the outstanding taxes (along with additions and penalties). He died in 2015, about a year after entering the installment agreement, which terminated the agreement and left a significant tax liability for 2008-2010. Mr. Washington had substantial earnings in 2014 and 2015. He did not file a return for 2014; nor did his estate file a return for 2015.

Attempting to collect Mr. Washington’s unpaid taxes ($189,593 plus penalties and interest), the IRS mailed to the Estate a Notice LT11 Notice of Intent to Levy and Notice of Your Right to a Hearing. Ms. Washington requested a hearing (Form 12153, Request for a Collection Due Process or Equivalent Hearing), which request was referred to IRS Appeals. The Estate made an initial Offer in Compromise for $10,000. The stated basis for the offer was Doubt as to Collectability. The Centralized Offer in Compromise unit rejected that offer because it calculated the Estate’s reasonable collection potential as far exceeding its offer, based in part on the value of Mr. Washington’s 401(k) account (about $148,000). Initially, the Estate did not offer to increase its offer or propose any other collection alternative. The IRS rejected the Offer and issued a notice of determination sustaining the notice of intent to levy. Subsequently, the Estate increased its offer to $23,990, again claiming “Doubt as to Collectability.” The IRS issued a supplemental notice of determination, rejecting that increased offer and sustaining the notice of intent to levy.

Primary Holdings:

Doubt as to liability was not an issue in this case; the Estate did not challenge the tax liability.

“Neither of the Estate’s offers qualified for consideration as an offer-in-compromise based on effective tax administration. Such consideration is available only when the taxpayer is able to pay the balance in full. … [the Appeals Officer] determined that the Estate could not pay the outstanding liability in full. And the Estate conceded as much at the hearing. Accordingly, under the regulations and the IRM provisions on which the Estate relies, the Estate’s offer did not qualify for effective tax administration consideration …” Id. at 10.

Most of the court’s analysis dealt with the Estate’s “doubt as to collectability” arguments, all based on the premise that the Appeals Officer abused his discretion in rejecting the Estate’s offers because he miscalculated the Estate’s reasonable collection potential. First, the Estate claimed that Ms. Washington was a judgment lien creditor, based on the divorce decree. The court found that, while the divorce decree was undoubtedly a judgment, it did not award Ms. Washington any specific property or sum of money. Moreover, one of the larger assets the Estate relied upon for its arguments (Mr. Washington’s $100,000 life insurance policy) was excluded from the IRS’s evaluation. That is, even if the Estate were correct that Ms. Washington has priority with respect to that asset, it would not affect the IRS’s determination. The Estate’s argument that Ms. Washington was a judgment creditor also failed because there was no evidence that she had perfected her purported judgment lien.

Second, the Estate argued that Mr. Washington’s 401(k) account should not be included in its reasonable collection potential because Ms. Washington, as personal representative, had the right to designate herself rather than the Estate as the account’s beneficiary. Thus, the Estate argued, it had no interest in 401(k) proceeds unless Ms. Washington designated the Estate as beneficiary, and therefore that the United States’ tax lien could not attach to the proceeds. This argument turned on the interpretation of the couple’s Marital Settlement Agreement’s provisions dealing with the 401(k). Reviewing that agreement, the court rejected the Estate’s argument.

The Estate claimed additional errors in the IRS’s assessment of collectability but none of them (either alone or combined with others) was sufficient “to reduce the Estate’s reasonable collection potential below the amount of its revised offer-in-compromise. Therefore, even if the Estate’s assertions were correct, the mistakes would constitute harmless error and would not amount to an abuse of discretion.”

Key Points of Law

• An offer-in-compromise is an agreement between the Government and a taxpayer to settle a tax liability for less than the full amount owed. SeeR.C. § 7122(a); Treas. Reg. § 301.7122-1(a); Internal Revenue Manual (IRM) 8.23.1.1.1(1) (Aug. 23, 2021). Offers-in-compromise are authorized by section 7122(a), which provides that the Secretary may compromise any civil or criminal case arising under the internal revenue laws.
• The decision to accept or reject an offer-in-compromise is left to the Secretary’s discretion, based on three grounds: (1) doubt as to liability, (2) doubt as to collectibility, and (3) the promotion of effective tax administration. See Reg. § 301.7122-1(b).
• The Secretary may accept an offer-in-compromise on a “doubt as to collectibility” basis when the taxpayer’s assets and income render full collection unlikely. (2). Conversely, the Secretary may reject an offer-in-compromise when the taxpayer’s reasonable collection potential exceeds the amount it proposed to pay. See Johnson v. Commissioner, 136 T.C. 475, 486 (2011), aff’d, 502 F. App’x 1 (D.C. Cir. 2013). In general, any offer substantially below the taxpayer’s reasonable collection potential is rejected unless special circumstances justify acceptance of the offer. See Gustashaw v. Commissioner, T.C. Memo. 2018-215, at *15–16; Mack v. Commissioner, T.C. Memo. 2018-54, at *10; Rev. Proc. 2003-71, § 4.02(2), 2003-2 C.B. 517, 517.
• When a taxpayer’s reasonable collection potential exceeds the taxpayer’s liability—i.e., when the Secretary determines that the taxpayer is able to pay the liability in full—doubt as to collectibility is not a ground for compromise. But the Secretary may still enter into a compromise on effective tax administration grounds if (1) collection of the full liability would cause the taxpayer economic hardship or (2) exceptional circumstances exist so that collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. Treas. Reg. § 301.7122-1(b)(3)(i) and (ii). No compromise is permitted for effective tax administration reasons if compromise of the liability would undermine compliance by taxpayers with the tax laws. Id. subdiv. (iii).
• The tax court has consistently held that errors in reasonable collection potential calculations are harmless, even when considering offers-in-compromise made on a “doubt as to collectibility with special circumstances” basis, when the correct, or allegedly correct, reasonable collection potential is still greater than a taxpayer’s offer.
• Judgment lien creditors who obtain their judgments before a notice of federal tax lien is properly filed and meet certain other requirements take priority over the United States. SeeR.C. § 6323(a); Treas. Reg. § 301.6323(h)-1(g). Accordingly, a taxpayer’s reasonable collection potential is reduced by amounts owed to such judgment lien creditors. See IRM 5.8.4.3.1(1) (Apr. 30, 2015), 5.8.5.4.1(1) (Sept. 30, 2013).
• Whether an individual is a judgment lien creditor with priority over a federal tax lien is a question of federal law. SeeIn re Charco, Inc., 432 F.3d 300, 304 (4th Cir. 2005) (citing Aquilino v. United States, 363 U.S. 509, 514 (1960)). See generally United States v. McDermott, 507 U.S. 447, 449–50 (1993). To be a “judgment lien creditor” a person (1) must have a valid judgment, (2) from a court of record and competent jurisdiction, (3) for the recovery of specifically designated property or a certain sum of money. See Reg. § 301.6323(h)-1(g).

Flynn v. Comm’r, T.C. Memo 2022-5 February 3, 2022 | Urda, J. | Dkt. No. 10182-19L

• Opinion

Short Summary: The IRS can and shall make a tax return for a taxpayer if he or she fails to do so. If the IRS assesses a tax against a taxpayer, the taxpayer can attempt to enter into an offer-in-compromise for settlement of the tax liability. The IRS may accept the offer, and in making that determination, the IRS uses its promulgated national and local allowances. If a settlement officer’s decision to reject a taxpayer’s offer-in-compromise is based on those established allowances as compared to the taxpayer’s data, a court will likely uphold that determination.

Key Issue: Under the collection due process statute of 26 U.S.C. § 6330, did the Independent Office of Appeals abuse its discretion in rejecting an offer-in-compromise (OIC) proposed by taxpayer, Edmund Flynn, for payment of taxes, penalties, and interest assessed against him based on returns that were made and filed by the IRS after Flynn failed to file on his own?

Short Answer: No.

Primary Holding: The IRS settlement officer took into account Flynn’s monthly income and expenses and compared that data to national and local standards for allowances and collectability purposes. According to the settlement officer, Flynn’s OIC was not reasonable. Thus, that determination was not arbitrary, capricious, or without some basis in fact or law and will not be disturbed.

Standard of Review:

• The Tax Court was asked whether the Commissioner was entitled to summary judgment on the issue noted above. The purpose of summary judgment is to expedite litigation and avoid costly, time-consuming, and unnecessary trials on issues for which there is presented no genuine dispute of material fact such that a decision may be rendered as a matter of law.
• Where the underlying tax liability is not in dispute, the court reviews the determination of the Office of Appeals for abuse of discretion, meaning that the court will uphold the Office of Appeals’ determination unless it is arbitrary, capricious, or without some basis in fact or law.

Key Points of Law:

• “If any person fails to make any return required by any internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return, the Secretary shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise.” 26 U.S.C. § 6020(b)(1) (emphasis added).
• 26 U.S.C. § 7122(a) and related Treasury Regulations authorize the IRS to compromise an outstanding tax liability on grounds that include doubt as to liability, doubt as to collectability, and to promote the effective tax administration. See 26 C.F.R. § 301.7122-1(b)(1)-(3).
• Under an abuse of discretion standard, and in the context of evaluating the IRS’s settlement officer’s conduct in rejecting an OIC, the courts consider whether the settlement officer: (1) properly verified that the requirements of applicable law or administrative procedure have been met, (2) considered any relevant issues the taxpayer may have raised, and (3) considered “whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary.” See 26 U.S.C. § 6330(c)(3).
• Generally, IRS settlement officers will reject any offer substantially below the taxpayer’s “reasonable collection potential” (RCP) unless special circumstances justify acceptance of the offer. See Proc. 2003-71, § 4.02(2), 2003-2 C.B. 517, 517. The courts do not decide what would be an acceptable collection alternative. Rather, the judicial review is on whether the settlement officer abused his or her discretion in rejecting a taxpayer’s OIC.
• The IRS has published “national and local allowances” to ensure that taxpayers entering into collection alternatives have adequate means to provide for basic living expenses, and a settlement officer’s use of those standards to calculate basic living expenses. The IRM directs that generally a taxpayer is allowed the lesser of the applicable local standards or the amounts that he or she actually paid monthly with respect to housing and utility expenses. See R.M. 5.15.1.8(5) (July 24, 2019, 5.15.1.10.1 (Nov. 22, 2021).
• The Commissioner has promulgated guidelines for the evaluation of OICs, and the calculation of a taxpayer’s RCP plays a central role in that evaluation. RCP is generally calculated by multiplying a taxpayer’s monthly income available to pay taxes by the number of months remaining in the statutory period for collection and adding realizable equity in assets. See R.M. 5.8.5.1(1) (Sept. 24, 2021).
• The lifestyle of the taxpayer is relevant, but deviations from the national and local allowances set by the IRS is permitted only upon a showing that the standard amounts are “inadequate to provide for a specific taxpayer’s basic living expenses.” IRM 5.15.1.8(6) (July 24, 2019). The taxpayer bears the burden of justifying such deviation.

Tax Court Insight: The IRS “shall” make a tax return on behalf of a taxpayer, if the taxpayer fails to do so on his or her own accord. If the IRS assesses a tax liability against a taxpayer, the IRS has established national and local allowances to help taxpayers and the IRS determine whether or not, and to what extent, the IRS may enter into a compromise of a particular tax liability. Taxpayers should carefully evaluate those standards when presenting an OIC, and if deviations from the standards are in order, the taxpayer should be prepared to justify the deviation.

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