The Tax Court has concluded that IRS didn’t abuse its discretion in finding that a taxpayer had breached his offer-in-compromise (OIC) and deciding to proceed with its collection efforts where the OIC made timely filing and payment of tax an express condition of the agreement.
Observation: This case illustrates the dangers of losing the advantage of a large reduction in a tax liability because of a later failure to comply with an OIC.
Facts. David W. Trout entered into an OIC in ’97 that covered the ’89, ’90, ’91, and ’93 tax years. Among the terms in the OIC was one requiring Trout to timely file and pay his taxes for five years. Trout filed his ’96 tax return late, and then failed to file his ’98 and ’99 returns. He filed his ’98 taxes, showing a refund due, in November 2003, but failed to sign his ’99 return, which showed a liability of $164.
In March 2004, IRS sent Trout a notice of intent to levy and Trout requested a Collection Due Process (CDP) hearing. Trout paid his liability for ’99 but still failed to file a signed return. IRS issued a notice of determination upholding the collection action in March of 2005.
Background. IRS may compromise tax liabilities based on doubt as to collectibility; doubt as to liability; economic hardship; and extraordinary events beyond the taxpayer’s control. (Reg. § 301.7122-1(b))
In Robinette (2004), 123 TC 85, the Tax Court held that IRS‘s determination in a CDP hearing to proceed with collection after declaring taxpayer’s OIC in default was an abuse of discretion. It found that the Appeals Officer’s determination and refusal to consider the taxpayer’s specific circumstances was arbitrary and without sound basis in law. Notably, although the taxpayer filed one year’s return late in breach of the OIC, the breach wasn’t a material matter that caused IRS any, or any significant, monetary damage.
However, the Tax Court’s decision was reversed by the Eighth Circuit. It ruled that the IRS Appeals officer didn’t abuse his discretion in deciding to proceed with collection after the taxpayer failed to timely file a return as required by his OIC. The Eighth Circuit found that timely filing was an express condition in IRS‘s agreement to discharge the taxpayer’s tax liability. Although express conditions may be excused if they are immaterial to the exchange and if enforcing them would cause disproportionate forfeiture, the Eighth Circuit held that the voiding of the OIC and the reinstatement of the taxpayer’s tax liability wasn’t a disproportionate forfeiture, since it just reinstated a prior tax liability. (James M. Robinette v. Com., (2006, CA8) 97 AFTR 2d 2006-1391, revg (2004) 123 TC 85)
Taxpayer’s argument. Trout claims failure to file the ’99 return was not a material breach, relying on the Tax Court’s decision in Robinette, he claimed that IRS abused its discretion in (1) finding that Trout had not timely filed his ’98 and ’99 returns and (2) refusing to reinstate the OIC because the breach of the OIC’s obligation to timely file wasn’t material.
Conclusions. The Tax Court concluded that, applying general principles of the federal common law of contracts, Trout’s OIC agreement made timely filing and payment of tax an express condition of the OIC. IRS could hardly have used plainer language to explain the terms and conditions of the OIC or to express its intent that it would reinstate the original liability for a failure to meet any of the terms and conditions. An express condition is subject to strict performance, thus making the materiality of the breach irrelevant. The Court noted that the Appeals Officer considered reinstatement of the OIC as a collection alternative, but believed that Trout wasn’t entitled to a second chance after looking at his pattern of noncompliance. Trout was not powerless to avoid the breach, and the failure to reinstate his OIC caused no forfeiture, so IRS did not abuse its discretion in finding that Trout had breached the OIC and in determining to proceed with collection.
The Court further held that Trout did not gain the benefit of the exceptions listed in Code Sec. 7502 to the general rule that a tax return is filed when received. Code Sec. 7502 provides exceptions to this general rule for returns received after, but postmarked by the USPS on or before, their due date, and even for returns not received at all if they were sent by registered or certified mail. But under Rule 122, the Court could not make a finding on Trout’s credibility and overwhelming evidence indicated that IRS did not receive either return on time. Accordingly, IRS‘s finding that the ’98 and ’99 tax returns were not timely filed was not an abuse of discretion.