Mark Fowler and Joylyn Souter-Fowler v. Commissioner.

Dkt. No. 6650-02L , TC Memo. 2004-163, July 13, 2004 .

[Appealable, barring stipulation to the contrary, to CA-9. -- CCH .]

[Code Secs. 6330 and 7122]
Practice and procedure: Collection Due Process hearing: Offer in compromise: Liens and levies: Abuse of discretion. --

An IRS Appeals officer abused his discretion in denying a married couple's offer in compromise on the grounds that the taxpayers had inadequate income to meet their living expenses and pay the proposed monthly payments. The officer appeared to rely exclusively on the IRS 's prescribed schedule of national and local average living expenses to determine that the taxpayers' basic living expenses exceeded their monthly income. However, all of the facts and circumstances, including the schedule of actual expenses submitted by the taxpayers, should have been considered to determine whether the taxpayers could pay both (Code Sec. 7122(c)(2)). The filing of the federal tax liens to secure the IRS 's interest in the unpaid tax liability was not an abuse of discretion. -- CCH .

Mark Fowler and Joylyn Souter-Fowler, pro sese; Guy H. Glaser, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

 

GERBER, Chief Judge: Respondent, on February 21, 2002 , sent Mark Fowler (petitioner) a Notice of Determination Concerning Collection Action(s) Under Section 6320¹ and/or 6330, in which respondent sustained the filing of a Federal tax lien for petitioner's 1990-92 tax liabilities. In that same notice respondent also rejected petitioner's offer in compromise. On that same date respondent sent Mark Fowler and Joylyn Souter-Fowler (petitioners) a second Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330. In this notice respondent sustained the filing of a Federal tax lien with respect to petitioners' 1994-96 tax liabilities, and respondent again rejected petitioners' offer in compromise.

 

Prior to these determinations, petitioners sought and were offered an Appeals hearing, but they did not attend due to personal reasons. One month after the scheduled hearing date, the Appeals officer issued the above determinations sustaining the filing of the Federal tax liens and rejecting petitioners' offers in compromise. With respect to both determinations, petitioners appealed to this Court.

 

The issue for consideration is whether respondent abused his discretion by rejecting petitioners' offers in compromise and by sustaining the filing of the Federal tax liens.

FINDINGS OF FACT ²

 

Petitioners resided in Garden Grove , California , when the petition in this case was filed.

Separate Liabilities

Petitioner filed his 1990 Federal income tax return late on September 6, 1991 . On July 21, 1993 , respondent mailed a statutory notice of deficiency to petitioner for his 1990 taxable year. Petitioner did not petition this Court to dispute the deficiency. On December 20, 1993 , respondent assessed the $399 income tax deficiency and a $98.74 late-filing penalty under section 6651(a)(1). In addition, $104.40 of interest was assessed. Petitioner does not contest the 1990 tax liability.

 

Petitioner timely filed his 1991 Federal income tax return that contained several mathematical errors. Respondent corrected the mathematical errors in accord with section 6213(b)(1), and assessments were made to correct the errors. Respondent subsequently selected petitioner's 1991 return for an audit examination. On April 5, 1994 , respondent mailed petitioner a statutory notice of deficiency for his 1991 taxable year determining a $545 income tax deficiency. Petitioner did not petition this Court with respect to the 1991 notice of deficiency. On September 5, 1994 , respondent assessed the $545 deficiency and $103.37 of accrued interest.

 

Petitioner filed his 1992 Federal income tax return late on July 28, 1993 . Respondent selected petitioner's 1992 return for an audit examination. On January 11, 1995 , respondent mailed petitioner a statutory notice of deficiency for his 1992 taxable year determining a $1,193 income tax deficiency and a $189 penalty for late filing under section 6651(a)(1). On July 17, 1995 , respondent assessed the deficiency, the late-filing penalty, and accrued interest in the amount of $265.92. On the same day, the late-filing penalty was abated leaving an unpaid balance of $1,458.92 for 1992.

Joint Liabilities

Petitioners were married in 1993. Under cover of a letter dated September 15, 1997 , petitioners submitted their untimely 1994, 1995, and 1996 joint Federal income tax returns. These returns were filed by respondent on September 29, 1997 . Petitioners reported tax due for 1994, 1995, and 1996 on their returns in the amounts of $402.04, $402.03, and $1,480.66, respectively.

 

On October 27, 1997 , respondent assessed the 1994 income tax liability, a late-filing penalty in the amount of $100, a failure to pay tax penalty in the amount of $62.32, and accrued interest in the amount of $128.35, for a total assessment of $692.71. On that same date, respondent assessed the 1995 income tax liability, a late-filing penalty in the amount of $100, a failure to pay tax penalty in the amount of $38.19, and accrued interest in the amount of $73.03, for a total assessment of $613.25. On November 17, 1997 , respondent assessed the 1996 income tax liability, a late-filing penalty in the amount of $333.15, a failure to pay tax penalty in the amount of $59.23, and accrued interest in the amount of $99.21, for a total assessment of $1,972.25.

Events Leading to the Issuance of the Notice of Determination

On December 21, 1999 , respondent mailed two separate Notices of Intent to Levy and Notice of Your Right to a Hearing to petitioners. The notices reflected petitioners' unpaid Federal income tax liabilities for 1990 through 1992 and 1994 through 1996. On January 26, 2000 , petitioners informed respondent of their desire to submit an offer in compromise to resolve all of their individual and joint liabilities. In response, respondent mailed petitioners a package of materials for the submission of offers in compromise for their outstanding individual and joint liabilities.

 

On April 19, 2000 , respondent received petitioners' offer to compromise the 1994 through 1996 joint liabilities for $1,150. On that same date respondent received petitioner's offer to compromise the 1990 through 1992 liabilities for $360. Both offers in compromise were submitted on Form 656, Offer in Compromise. Petitioners' offer was to make monthly payments to satisfy the liabilities. Petitioners planned to pay a portion of the offer amount from their expected tax refund for 1999.

 

On May 19, 2000 , respondent's revenue officer advised petitioners that their offers in compromise could not be processed until petitioners' 1999 Federal income tax return was filed. Under respondent's procedures, offers are not processed while taxpayers are not in compliance with the internal revenue laws.

 

Petitioners had already filed for an extension of time to file for 1999 because they were awaiting information from third parties to complete the return. On June 15, 2000 , respondent filed two Notices of Federal Tax Lien (NFTL) at the county recorder's office in Orange County , California , with respect to the individual and joint tax liabilities. Respondent sent petitioners the filed NFTLs and Notices of Right to a Collection Due Process Hearing. On July 14, 2000 , petitioners submitted Form 12153, Request for a Collection Due Process Hearing (administrative hearing), contesting the NFTLs filed by respondent and noting the pending offers in compromise.

 

Sometime in 2001, petitioners' claims were assigned to respondent's Appeals officer. On June 20, 2001 , the Appeals officer and petitioners had a telephone conversation discussing petitioners' desire to compromise all of the liabilities. The Appeals officer requested more information from petitioners, which they timely provided with a copy of their filed 1999 Federal income tax return. At some time in the process, petitioners submitted an amended offer in compromise for $2,400, to be paid in $100-monthly installments. Under those terms, the $2,400-offer could be paid in full in 2 years.

 

On October 16, 2001 , respondent's Appeals officer sent petitioners a letter informing them that he had reviewed the offers in compromise. The Appeals officer determined that the minimum offer to compromise both the individual and joint liabilities should be a total of $2,400. The Appeals officer used petitioners' estimate of their primary vehicle³ to calculate a quick sale value of $2,400, which was determined to be the minimum acceptable offer. The Appeals officer then attempted to determine whether petitioners would be able to meet the monthly installment offer obligation. In calculating petitioners' financial capability, the Appeals officer used petitioners' submitted monthly gross income figure of $4,608, but did not use petitioners' submitted $3,989 monthly expense figure. Instead of using the $3,989 expense figure provided by petitioners, the Appeals officer used $4,644, an estimated amount based on national statistical averages. Using $4,644 resulted in petitioners' estimated monthly expenses exceeding their monthly income by $36 and rendering petitioners ineligible due to their projected inability to make the $100-monthly payments.

 

The Appeals officer rejected petitioners' offers in compromise. Petitioners requested an in person hearing, but a hearing was not held due to petitioners' unavailability. On February 21, 2002 , respondent issued two separate notices of determination for the individual and joint liabilities sustaining the filing of the notices of Federal tax liens and rejecting petitioners' offers in compromise. Petitioners timely appealed to this Court for review of respondent's determinations.

OPINION

 

Petitioners contend that the Appeals officer abused his discretion by rejecting their offers in compromise and by sustaining the filing of the Federal tax liens.

 

Section 6320 provides that a taxpayer shall be notified in writing by the Secretary of the filing of a Federal tax lien and provided with an opportunity for an administrative hearing. Sec. 6320(b). Hearings under section 6320 are conducted in accordance with the procedural requirements set forth in section 6330. Sec. 6320(c).

 

When an Appeals officer issues a determination regarding a disputed collection action, section 6330(d) allows a taxpayer to seek judicial review with the Tax Court or a District Court. Where the validity of the underlying tax liability is properly at issue, the Court will review the matter on a de novo basis. Sego v. Commissioner [Dec. 53,938], 114 T.C. 604, 610 (2000). However, when the validity of the underlying tax is not at issue, the Court will review the Commissioner's administrative determination for an abuse of discretion. Id. Petitioners do not dispute the validity of the underlying tax. Accordingly, our review is for an abuse of discretion.

 

We do not conduct an independent review of what would be acceptable offers in compromise. We review only whether the Appeals officer's refusal to accept the offers in compromise was arbitrary, capricious, or without sound basis in fact or law. See Woodral v. Commissioner [Dec. 53,206], 112 T.C. 19, 23 (1999). The Court considers whether the Commissioner abused his discretion in rejecting a taxpayer's position with respect to any relevant issues, including challenges to the appropriateness of the collections action, and offers of collection alternatives. See sec. 6330(c)(2)(A). This case involves collection alternatives.

 

Section 7122(a) authorizes the Secretary to compromise any civil case arising under the internal revenue laws. There are three standards that the Secretary may use to compromise a liability. The first standard is doubt as to liability, the second being doubt as to ability to collect, and the third being promotion of effective tax administration. Sec. 301.7122 -1T(b), Temporary Proced. & Admin. Regs., 64 Fed. Reg. 39024 ( July 21, 1999 ); see sec. 7122(c)(1). The record reflects that petitioners' offers are with respect to doubt as to collectibility.⁴

 

Section 7122(c) provides the standards for evaluation of such offers. Under section 7122(c)(2):

 

(A) * * * the Secretary shall develop and publish schedules of national and local allowances designed to provide that taxpayers entering into a compromise have an adequate means to provide for basic living expenses.

 

(B) Use of schedules. --The guidelines shall provide that officers and employees of the Internal Revenue Service shall determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the schedules published under subparagraph (A) is appropriate and shall not use the schedules to the extent such use would result in the taxpayer not having adequate means to provide for basic living expenses. [Emphasis added.]

 

The Appeals officer chose to use the national averages and that use resulted in petitioners' being categorized as not having adequate means to provide for basic living expenses.

 

The national average statistics are published by the Internal Revenue Service, but use of the statistics by Appeals officers is not mandatory. The Appeals officer exercised discretion in ignoring petitioners' submitted expense amount and, instead, used the national statistical amount as an estimate of petitioners' expenses. The use of the national averages for petitioners' expenses resulted in petitioners' monthly expenses exceeding their monthly income by $36. Therefore, by using the average expense figure, petitioners' income was $136 short of producing the $100 per month needed to compromise their tax liabilities for $2,400. We note that, percentagewise, the shortfall is less than 3 percent of petitioners' gross income. The Appeals officer chose to use the national statistical averages rather than the expense figures provided by petitioners. If the Appeals officer had used petitioners' submitted expense figure of $3,989, petitioners would have had $619 monthly and would have been financially capable of satisfying the $100 installments.

 

The Appeals officer is allowed to use the national schedules when considering the facts and circumstances of this case. However, if use of the schedules results in petitioners' not having adequate means to provide for basic living expenses, as here when the Appeals officer determined a negative $36 amount for basic living expenses, an installment offer may not be appropriate. See sec. 7122(c)(2)(B).

 

Under the regulations for doubt as to collectibility cases:

 

A determination of doubt as to collectibility will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer's case. To guide this determination, guidelines published by the Secretary on national and local living expense standards will be taken into account. [Sec. 301.7122 -1T(b)(3)(ii), Temporary Proced. & Admin. Regs., 64 Fed. Reg. 39024 ( July 21, 1999 ).]

 

The regulation provides that the guidelines are to be taken into account. When the Appeals officer reviewed petitioners' offers, he decided to use the guidelines because he thought petitioners' actual figures were too low. In that regard, there is no specific explanation why the Appeals officer believed that petitioners' monthly expenses of $3,989 was too low or why the guideline figure of $4,644 was more accurate. The use of the guideline expense figure resulted in a $136 shortfall in petitioners' capability to meet the $100-monthly installment to satisfy the $2,400 compromise. If petitioners' submitted monthly expenses of $3,989 had been used, there would have been a $619 surplus of income over expenses that would have enabled petitioners to meet the $100-monthly installment to satisfy the compromise.

 

In essence, the Appeals officer decided that petitioners could not live less expensively than the national average (guidelines). We find it curious that the Appeals officer relied on petitioners' figures for their vehicle and for their income, but chose not to use petitioners' figures for their monthly expenses. Petitioners made an estimate of $3,000 for the value of their primary car and the Appeals officer used this figure to calculate the quick sale value of $2,400. Based on this premise, the Appeals officer determined that an offer of $2,400 would be an appropriate amount to settle the outstanding liabilities due for 1990-92 and 1994-96. The Appeals officer requested a lump-sum payment through the sale of petitioners' primary vehicle. Petitioners rejected this approach as this was their primary vehicle and to sell it would have caused great financial harm.

 

Petitioners submitted an amended offer in compromise for $2,400, to be paid in $100 monthly installments. Under those terms, the $2,400 compromise could be paid in full in 2 years. That offer was rejected due to the Appeals officer's determination that petitioners were financially unable to make the payments. We note that petitioners had cooperated with all requests from the Internal Revenue Service in an attempt to resolve this matter.

 

Appeals officers, in the consideration of an offer in compromise should verify that the requirements of applicable law and administrative procedures have been met, and "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 sec. 6330(c)(3)(C). The verification of applicable law and administrative procedure was met in this case. However, it is questionable as to whether the proposed collection action balanced the need for efficient collection of taxes with the concern of petitioners that any collection action be no more intrusive than necessary.

 

Payment plans are one possible option for an offer in compromise. According to the instructions that accompany the Form 656, there are three possible payment plans under the short-term deferred payment offer. One plan requires full payment of the realizable value of assets within 90 days from the date the Internal Revenue Service accepts the offer, and payment, within 2 years of acceptance of the amount that they could collect over 60 months. A second plan permits a cash payment for a portion of the realizable value of petitioners' assets within 90 days of the offer being accepted, and the balance of the realizable value plus the remainder of the amount that could have been collected over 60 months within 2 years. The third plan permits monthly payments of the entire offer amount over a period not to exceed 2 years from the date of acceptance by the Internal Revenue Service. Petitioners offered $100 per month for 2 years or 24 months, which equals the $2,400-compromise amount.⁵

 

Under the various payment options, respondent would be able to file Federal tax liens to protect his interests until such time as the liability is satisfied. Accordingly, respondent's interest would be protected through the liens while respondent received monthly payments. The result of the Appeals officer's financial analysis, however, was to deny petitioners' offers in compromise. To use the national guidelines rather than actual figures in this instance was arbitrary, capricious, and without a sound basis in fact. Petitioners have stated that they are still willing to compromise their tax liabilities for $2,400, but through monthly payments rather than a lump-sum payment.⁶

 

Therefore, based on the facts and circumstances of this case, we hold that respondent abused his discretion in denying petitioners' offer to compromise their tax liabilities for $2,400. We further hold that respondent did not abuse his discretion in sustaining the filing of the Notices of Federal Tax Liens.⁷

 

An appropriate decision will be entered.

¹ Unless otherwise indicated, all section references are to the Internal Revenue Code.

² The parties' stipulation of facts is incorporated by this reference.

³ Petitioners estimated the value of their primary vehicle to be $3,000. Respondent used this figure to calculate the $2,400 quick sale value.

⁴ Doubt as to collectibility exists in any case where the taxpayer's assets and income are less than the full amount of the assessed liability. Sec. 301.7122-1T(b)(3), Temporary Proced. & Admin. Regs., 64 Fed. Reg. 39024 (July 21, 1999).

⁵ Although not relevant to the facts of this case, there is also a deferred payment offer that provides for a plan similar to the short-term deferred plan (the third plan described above). The deferred payment plan allows the entire offer amount to be made in monthly payments over the life of the collection statute. The deferred plan could result in a longer payment period than 24 months.

⁶ Petitioners and respondent agreed on the amount of the compromise. The only disagreement here is the method of payment. Based on the financial information submitted by petitioners, a payment plan is a reasonable option.

⁷ Petitioners have made no argument of merit from which an abuse of discretion could be found with respect to respondent's determination that the filing of the Notices of Federal Tax Liens was appropriate.

Chief Counsel Advice 200137001, April 12, 2001
CCH IRS Letter Rulings Report No. 1281, 09-19-01
IRS REF : Symbol: CC:PA:CBS:Br2-GL-127877-00

Uniform Issue List Information:

UIL No. 17.00.00-00

Compromises

UIL No. 9999.98-00

Miscellaneous issues

- Not able to identify under present list

[Code Sec. 7122 ]

MEMORANDUM FOR MICHAEL W. BITNER, ***** ASSOCIATE AREA COUNSEL, (SB/SE)

FROM: Joseph W. Clark, Senior Technician Reviewer, Branch 2 (Collection, Bankruptcy & Summonses)

SUBJECT: Advisory Opinion-Offers in Compromise / Processability

This memorandum responds to a request for advice received from your office on January 22, 2001 . You have asked us to consider whether an in-business taxpayer may compel the Service to process an offer in compromise under a prior version of the processability rules which were in effect before January 1, 2000 , and if not, whether the Service has the discretion to process the offer. In accordance with I.R.C. §6110(k)(3) , this Chief Counsel Advice should not be cited as precedent. This writing may contain privileged information.

ISSUE

When an in-business taxpayer submits an offer, and the processability rules pertaining to deposit, payment, and filing of employment taxes for the previous two quarters, change before the offer is accepted for processing, may the taxpayer compel the Service to apply the former processability rules? If not, may the Service exercise its discretion to process the offer?

CONCLUSION

Although the taxpayer may not compel the Service to process the offer under the prior rules, the Service may exercise its discretion to process the offer.

BACKGROUND

Your correspondence with us indicates the taxpayer, an in-business corporation, entered into an installment agreement to pay its delinquent employment taxes. After making only one payment, the taxpayer defaulted on the agreement, and after being notified by the Service that the agreement would be terminated, the taxpayer filed a Form 911 Application for Taxpayer Assistance with the Office of the Taxpayer Advocate on March 1, 1999 , requesting to file an offer in compromise. Collection received the taxpayer's offer on June 1, 1999 , and returned it on June 14, 1999 , along with a letter characterizing the offer as non-processable, and informing the taxpayer that in order to process the offer, an in-business taxpayer must demonstrate compliance by filing and full paying employment taxes for the preceding two quarters. The caseworker for the Taxpayer Advocate then met with Collection and the taxpayer's power of attorney to discuss the offer requirements, and the caseworker advised the power of attorney that the taxpayer needed to become current for the preceding two quarters.

On November, 12, 1999 , the power of attorney requested additional time to provide proof of compliance, and after a meeting on December 8, 1999 , the caseworker set a deadline of December 31, 1999 . The power of attorney provided some documentation on December 23, 1999 . On January 4, 2000 , the caseworker called to request the remainder of the documentation, and requested the taxpayer become current by January 18, 2000 , and provide the rest of the documentation by January 24, 2000 . The power of attorney provided the balance of the documentation on January 22, and January 25.

On January 25, 2000 , the caseworker told the power of attorney that as of January 1, 2000 , the rules for processing an offer in compromise from an in-business taxpayer had changed and that the new rule required the taxpayer to be "timely" rather than "current." The taxpayer advocate then asked the manager of the offer group to bypass the timeliness requirement, but he declined to do so. You have asked our advice on whether in this situation, the taxpayer may compel the Service to process his offer in compromise under the prior rule, and if not, may the Service exercise its discretion to process the offer.

DISCUSSION

The Secretary's authority to compromise cases is contained in section 7122 of the Code, which provides, "The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense." I.R.C. §7122(a) (emphasis added). Treasury regulations pertaining to that provision likewise state, "The Secretary may exercise his discretion to compromise any civil or criminal liability arising under the internal revenue laws...." Treas. Reg. §301.7122-1T(a)(1). The Secretary's authority to compromise is, thus, discretionary. The Secretary has delegated this discretionary authority to the Commissioner, who has then re-delegated it to various officials throughout the Service. See Delegation Order No. 11.

The Secretary has set the threshold requirements for consideration of a proposed compromise, and all offers in compromise must be submitted according to the prescribed procedures. See Treas. Reg. §301.7122-1T(c)(1). Further, a taxpayer may not compel the Service to accept an offer for processing. See United States v. Garden State National Bank, 607 F.2d 61, 73 (3d Cir. 1979) [79-2 USTC ¶9632 ] ("the refusal of the Service to enter into compromise negotiations, standing alone, does not amount to 'bad faith'"); United States v. Smith, 1979 U.S. Dist. LEXIS 12471 (S.D.N.Y. 1979)(the decision whether to discuss settlement is discretionary and cannot be compelled by a court); Leonhard v. Mitchell, 473 F.2d 709, 713 (2d Cir.) cert. denied, 412 U.S. 949 (1973)(mandamus cannot force a discretionary act).

In keeping with the twin policy goals of the offer in compromise program to obtain the amount potentially collectible at the earliest possible time and at the least cost to the government, IRM 5.8.3.1(2) now provides that Service personnel will "work with taxpayers to provide an opportunity to perfect ... defects or errors ... rather than returning the offers as unprocessable." The manual provides that as soon as possible upon receipt, offers should be sorted into three categories: processable, non-processable, and those which need to be perfected (usually due to missing information). IRM 5.8.3.3. If it is processable, the offer becomes pending, and if the offer is not processable, then the Service returns it to the taxpayer along with a letter detailing the reason. Treas. Reg. §301.7122-1T(c)(2); IRM 5.8.3.3(1).

In order for the Service to process an offer to compromise employment taxes from an in-business taxpayer, the manual requires the taxpayer "must have demonstrated compliance by having timely filed and timely deposited the preceding two quarters," and "timely paid all federal tax deposits due in the quarter in which the offer was submitted." IRM 5.8.3.3(4) (emphasis added). Prior to January 1, 2000 , the manual required the taxpayer be "current" for the past two quarters. The manual further provides the Service may not deviate from the processability criteria without obtaining written approval from the National Office. IRM 5.8.3.3.1(1).

In the current case, the facts as you have presented them indicate the taxpayer first submitted the offer in compromise on June 14, 1999 . When the Service sent its first letter to the taxpayer indicating non-processability, it requested the taxpayer demonstrate compliance by filing and full paying its employment taxes for the preceding two quarters. For several months, the caseworker worked with the taxpayer's power of attorney to perfect errors in the offer so that it could be processed. On several occasions, the caseworker requested the taxpayer become "current," and on January 25th, the power of attorney submitted documentation that the taxpayer had done so. Although the criteria changed before the taxpayer submitted documentation of compliance, nothing in the Code or the Regulations prevents the Service from exercising its discretion to process an offer in such a case based on the criteria existing when the offer was first submitted. Further, policy considerations favor such processing, because neither the Service nor the taxpayer would benefit from lengthening the process by requiring timeliness for the next two quarters before allowing the offer to be processed. Such a requirement in this case would have no practical effect on the taxpayer's future compliance, because Form 656 requires as a condition to the offer that taxpayers agree to comply with future filing and payment requirements in order to avoid default of the compromise agreement.

Furthermore, once a taxpayer's offer has been accepted for processing, the Service's procedures do not establish a presumption that the offer will be accepted, nor do they presume rejection as the likely result. Rather, each proposed compromise should be evaluated and considered on its own merits, in light of the facts and circumstances of the case. In each case, the Service has the discretion to decide whether to accept or reject the offer. Provided the Service exercises sound judgment and discretion when exercising its authority to compromise, we do not believe processing this offer undercuts the Service's overall compromise policy and objectives, and therefore, would not be an abuse of its discretion. Thus, provided the Service obtains the required written permission from the National Office pursuant to IRM 5.8.3.3.1(1), the Service has authority to process the offer.

If you have any further questions, please contact the attorney assigned to this matter at (202) 622-3620 .

 

Chief Counsel Advice 200128054, May 29, 2001
CCH IRS Letter Rulings Report No. 1272, 07-18-01
IRS REF : Symbol: CC:PA:CBS:Br2-GL-114537-01

Uniform Issue List Information:

UIL No. 17.16.00-00

Compromises

UIL No. 9999.98-00

Miscellaneous issues

- Not able to identify under present list

[Code Sec. 7122 ]

MEMORANDUM FOR ASSOCIATE AREA COUNSEL (SB/SE), AREA 1, LONG ISLAND

FROM: Joseph W. Clark, Senior Technician Reviewer, Branch 2 (Collection, Bankruptcy & Summonses)

SUBJECT: Delegation Order No. 11

This Chief Counsel Advice responds to your request dated March 1, 2001 . In accordance with I.R.C. §6110(k)(3) , this Chief Counsel Advice should not be cited as precedent.

ISSUES:

1. Can the Compliance Area Director accept an offer in compromise notwithstanding an opinion by the Associate Area Counsel (SB/SE) opposing acceptance of the offer?

2. Can the Compliance Area Director accept an offer in compromise if no grounds for compromise under section 301.7122 -1T of the Treasury Regulations have been established?

CONCLUSIONS:

1. Yes. Although section 7122(b) of the Internal Revenue Code requires that an opinion of Counsel be placed on file whenever a compromise is made, Counsel's opinion need not favor compromise in order for the Service to accept an offer.

2. No. Although section 7122(a) grants the Secretary broad authority to compromise, Treasury Regulations issued pursuant to that section establish that compromise can only be made on specific grounds. No compromise may be made unless one of the bases for compromise recognized by the regulations has been established.

BACKGROUND:

On July 19, 1999 , temporary regulations were issued which expanded the Secretary's authority to compromise tax liabilities under section 7122 of the Code. See T.D. 8829, Compromises, 64 Fed. Reg. 39020 ( July 21, 1999 ). In additional to the traditional compromise grounds of doubt as to liability and doubt as to collectibility, the temporary regulations authorize the Secretary to compromise when compromise will promote effective tax administration. Specifically, where there is no doubt as to either liability or collectibility, the Service may now compromise on the basis that: 1) collection of the full tax liability would create economic hardship, or 2) regardless of the taxpayer's financial condition, exceptional circumstances exist such that collection of the full liability would be detrimental to voluntary compliance by taxpayers. See Treas. Reg. §301.7122-1T(b)(4).

You have asked our advice regarding several issues revolving around this expanded compromise authority. Specifically, you have asked whether and under what circumstances the Area Director can compromise a case notwithstanding an opinion by Counsel which opposes acceptance of a taxpayer's offer when the offer is based on a purported finding that collection in full would cause the taxpayer economic hardship. First, you have asked that we address a situation in which the offer group has established that collection in full would result in economic hardship, but Counsel issues an opinion stating that the amount proposed for acceptance is nevertheless too low under the circumstances of the case. Second, you have asked our opinion of a case in which it has not been established that collection in full would result in economic hardship.

DISCUSSION:

Section 7122(a) of the Internal Revenue Code grants the Secretary the authority to compromise civil or criminal liabilities arising under the internal revenue laws. Ever since that authority was granted in 1868, the Code has also required that an opinion of Counsel be placed on file in certain cases. The current statement of this requirement provides:

Record.-Whenever a compromise is made by the Secretary in any case, there shall be placed on file in the office of the Secretary the opinion of the General Counsel for the Department of the Treasury or his delegate,¹ with his reasons therefor, with a statement of--

(1) The amount of tax assessed,

(2) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed, and

(3) The amount actually paid in accordance with the terms of the compromise.

Notwithstanding the foregoing provisions of this subsection, no such opinion shall be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. However, such compromise shall be subject to continuing quality review by the Secretary.

I.R.C. §7122(b) .

The system for obtaining review of offers recommended for acceptance is contained in the Service's IRM Handbook 5.8, Offers in Compromise, Chapter 8, and in the Chief Counsel Directives Manual, Part 34, Chapter 5 (CCDM 34.5). The opinion of Counsel is sought after a recommendation of acceptance has been made but prior to formal acceptance of the offer by the official with delegated authority to accept. IRM 5.8.8.4.3. The offer itself (Form 656), along with the Form 7249, Offer Acceptance Report, and supporting documentation, are sent to the appropriate Associate Area Counsel (SB/SE) office for review. The Service expects that Counsel's opinion will assess both whether the legal requirements for compromise are met and whether the offer conforms to the Service's policies and procedures. IRM 5.8.8.2(2).

The CCDM states that the "primary role" of Counsel "is to determine whether there is a bonafide doubt as to liability or doubt as to collectibility." CCDM 34.5.2.1(3)a. At the time this manual section was promulgated, doubt as to collectibility and doubt as to liability were the only authorized bases for compromise under then governing Treasury regulations. See Treas. Reg. §301.7122-1(a) (1960). Although the permissible bases for compromise have since been expanded in the regulations to include the promotion of effective tax administration, Counsel's role has not changed, and verifying that a basis for compromise is present continues to be the most important part of Counsel's role in reviewing proposed acceptances.

Although verifying that there is a legal basis for compromise is the principal role of Counsel, most of the manual is dedicated to Counsel's examination of the "adequacy" of the amount proposed for acceptance, a matter which is undoubtedly a question of policy. See T.D. 8829, 64 Fed. Reg. at 39023 ("[T]he amount to be paid, future compliance or other conditions precedent to satisfaction of a liability for less than the full amount due are matters left to the discretion of the Secretary."). Thus, both the offer in compromise handbook and the CCDM recognize that the role of Counsel is to review both legal and policy issues.

Asking that Counsel review policy matters does not grant a veto power or establish that Counsel has final say over whether an offer will be accepted. The procedures explicitly recognize that Counsel's concurrence in the decision to compromise is not required. See IRM 5.8.8.2(2); CCDM 34.5.2.1(3)a.5. Thus, if Counsel issues an opinion that the compromise of the case is not in keeping with the Service's acceptance policy, either because the amount offered is too low or for any other reason, the Service may nevertheless compromise the case. Because the Counsel opinion is sought prior to the issuance of an acceptance letter, the official with final authority to accept will have an opportunity to consider Counsel's concerns before the decision to accept is made final.

Your question assumes that the basis for compromise is the promotion of effective tax administration, specifically economic hardship. The Internal Revenue Manual gives the following guidance with respect to determining an acceptable offer based on considerations of economic hardship:

In offers based on economic hardship, an acceptable offer amount should be determined based on the facts and circumstances of the taxpayer's situation and the financial information analysis. For example, the taxpayer has $100,000 liability and assets and income of $125,000. To avoid economic hardship, it is determined that the taxpayer will need $75,000. The remaining $50,000 should be considered in determining an acceptable offer amount.

IRM 5.8.11.2.1(4). The standard articulated in this manual provision appears very similar to the "reasonable collection potential" standard used for doubt as to collectibility offers, see Policy Statement P-5-100, in that the Service expects a taxpayer to offer an amount equal to that which could be collected after the economic hardship has been accounted for. Counsel's disagreement with the amount determined to be acceptable pursuant to the foregoing guidance will not barr compromise of the case. As with all advice issued by Counsel, it is appropriate and proper for you to render your opinion as to whether a proposed action is in keeping with the Service's stated policies. The ultimate decision, however, remains with the Area Director or other delegated official.

A more serious issue is presented if Counsel concludes that no basis for compromise is present. Treasury regulations enacted by the Secretary in accordance with required procedures have the force and effect of law. They are mandatory, not directory, and must be followed. See Boulez v. Commissioner, 810 F.2d 209, 215 (D.C. Cir. 1987) [87-1 USTC ¶9177 ] (specifically discussing compromise regulations under section 7122 ).² In fact, the Supreme Court has recognized that it "must defer to Treasury Regulations that implement the congressional mandate in some reasonable manner." Commissioner v. Portland Cement Co., 450 U.S. 156, 169 (1981) [81-1 USTC ¶9219 ] (citations and internal quotation marks omitted). The Commissioner's delegation of authority to compromise necessarily carries with it the implicit assumption that it will be exercised in accordance with applicable law and regulations. See Boulez, 810 F.2d at 215 [87-1 USTC ¶9177 ] (stating that it "defies common sense" to infer that Secretary's delegates may waive requirements stated in regulations). Thus, no Service official may compromise a case unless it has been established that a basis for compromise, as established by Temp. Treas. Reg. §301.7122-1T, is present in the case.³

Confusion on this point may in part stem from language in prior versions of Delegation Order No. 11, which grants certain officials the authority to compromise. Prior to revision in November 1999, the delegation of authority vested in certain officials the authority to compromise "in the event Counsel renders a negative legal opinion." Delegation Order No. 11 (Rev. 25) ( September 29, 1997 ). In spite of internal guidance to the contrary, many within the Service mistakenly believed that this language authorized compromise even where there was no doubt as to either liability or collectibility. In reality, this delegation was intended to authorize certain officials to accept less than reasonable collection potential once doubt as to collectibility had been established. See Delegation Order No. 11 (Rev. 24) ( June 21, 1994 ) (stating that authority to accept notwithstanding negative Counsel opinion "applies only to offers in compromise - Doubt as to Collectibility").

The more recent delegation of compromise authority, partially in an effort to alleviate any confusion, has removed language making reference to the opinion of Counsel in favor of positive grants of authority to certain officials. The authority to accept less than could otherwise be collected in a doubt as to collectibility case, now referred to as compromise based on "special circumstances," is specifically delegated to certain officials. See Delegation Order No. 11 (Rev. 27) (November 1, 1999) (delegating authority to accept offers based on special circumstance criteria as well as authority to accept offers based on the promotion of effective tax administration); IRM 5.8.8.3 (explaining special circumstances criteria and acceptance authority).

In reviewing proposed acceptances, Counsel should defer to the offer group on factual determinations such as valuation of assets, allowable expenses, and the existence of circumstances which warrant acceptance of less than could otherwise be collected.⁴ If, having done so, Counsel is unable to verify that a basis for compromise as authorized under the regulations is present, that determination is more than a policy disagreement. Under such circumstances, the seriousness of the decision to compromise warrants opening up a dialogue with the Area Director to attempt to reach consensus. If no consensus can be reached, it is appropriate to elevate the question to higher levels of management just as would be done in any other type of case. Nevertheless, because both Compliance and Counsel are working toward the same goals, disputes of this nature should be rare.

If you have any questions, please contact the attorney assigned to this matter at 202-622-3620 .

¹ The General Counsel for the Treasury has delegated the functions relative to the review of offers in compromise to the Chief Counsel of the Internal Revenue Service. See General Counsel Order No. 4. (Rev. January 19, 2001 ).

² In Boulez, the court was considering the requirement, contained in the regulations but not in the statute, that all compromises be in writing. We find the court's analysis even more persuasive when the issue is one of substantive authority as opposed to mere procedural safeguards. In the words of the court: "Indeed, when a compromise of tax liability is at issue, the need for rigorous compliance with pertinent regulations may be at its greatest, for not only the integrity of the public fisc but also public faith in the equitable enforcement of the tax laws hangs in the balance." 810 F.2d at 218 [87-1 USTC ¶9177 ].

³ See also Rev. Proc. 80-6 , 1980-1 C.B. 586. In explaining the various delegations of compromise authority, the revenue procedure stated: "The above delegations are 'limited' to the extent that the delegated authority must be exercised in accordance with the limitations prescribed by section 301.7122-1 of the Regulations on Procedure and Administration and with procedures established by the National Office."

⁴ At the outset, the CCDM states clearly that the factual determinations of the Service are not to be reexamined unless "patently erroneous" and that asset valuations in particular are "largely matters of administrative discretion and judgment and should rarely be questioned by Counsel." CCDM 34.5.2.1(3)a.1.

 

Docket No. 6456-02L , T.C. Memo. 2003-302, 86 TCM 506, Filed November 3, 2003 . [Appealable, barring stipulation to the contrary, to CA-6. -- CCH .]


[Code Secs . 6159, 6330 and 7122]

Collection Due Process: Hearing: Procedures: Currently not collectible status: Offers in compromise: Installment agreement: Inability to pay: Discretion to deny installment request. --

Married taxpayers' challenge to an adverse Collection Due Process determination was rejected because they failed to establish an abuse of discretion on the part of the IRS . The IRS officer appropriately concluded that the taxpayers' delinquent taxes for six years were ineligible for currently not collectible status. The officer's determination that the taxpayers had some ability to pay was supported by their proposed offer in compromise. Moreover, the officer properly applied the IRS 's policy concerning the consideration of installment agreements where a taxpayer is unable to pay. In light of the unresolved question regarding the taxpayers' ownership of real property, the rejection of their proposed offer in compromise was sustained. -- CCH .

Mark H. Westlake, for the petitioners. Caroline Krivacka, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

 

SWIFT, Judge: This case arises from a petition for judicial review timely filed in response to a notice of determination concerning collection action under section 6330.¹ The notice of determination relates to petitioners' Federal income tax liabilities for 1992, 1993, 1994, 1995, 1996, and 1997. Petitioners' liability for the underlying taxes, interest, and penalties is not disputed. The issue for decision is whether respondent's rejection of petitioners' three proposed alternatives to collection constitutes an abuse of discretion.

FINDINGS OF FACT

 

Some of the facts have been stipulated and are so found.

 

At the time of filing the petition, petitioners resided in Lebanon , Tennessee . Petitioner Donald G. Willis² operates a locksmith business as a sole proprietorship. Petitioner subcontracts much of the locksmith work. In addition, petitioner derives income from a part-time ministry. Petitioner Claudia A. Willis is not employed outside the home.

 

On January 30, 2001 , respondent sent to petitioners a final notice of intent to levy with respect to petitioners' outstanding Federal income taxes, interest, and penalties for 1992 through 1997 (cumulative liability). On March 1, 2001 , respondent received petitioners' timely request for a collection due process hearing.

 

After submitting to respondent for consideration certain personal financial information relating to petitioners, on May 9, 2001 , petitioners' counsel met with a settlement officer from respondent's Appeals Office. Petitioners' counsel requested that respondent allow petitioners to partially satisfy their cumulative liability by means of an installment agreement.

 

The settlement officer correctly advised petitioners' counsel that, under respondent's policy, an installment agreement would be acceptable only if the payments thereunder would satisfy in full the total amount of the cumulative liability within the applicable periods of limitation, plus any allowable extensions. Petitioners did not offer to make payments to respondent in an amount sufficient, within the applicable periods of limitation plus allowable extensions, to fully satisfy the cumulative liability, which, at that time, totaled approximately $125,000. As a result, respondent rejected petitioners' proposed installment agreement.

 

On July 17, 2001 , petitioner personally met with the settlement officer. At that meeting, petitioner requested that respondent designate the cumulative liability as currently not collectible (i.e., as uncollectible), and the settlement officer considered the revisions petitioner submitted to his financial information. After considering the revisions, the settlement officer concluded that petitioners had disposable monthly income of $348 and that petitioners could afford to make payment to respondent of $180 per month. As a result, the settlement officer advised petitioners that the cumulative liability could not be classified as currently not collectible. The settlement officer then suggested to petitioner that petitioners submit an offer in compromise in the amount of $180 per month for 116 months. Under this suggested offer in compromise, respondent would consider compromising the cumulative liability for a total payment by petitioners of $20,880.

 

On or about September 5, 2001 , petitioners submitted on the appropriate form the above offer in compromise as proposed by respondent's settlement officer. On September 18, 2001 , the settlement officer wrote to petitioners indicating that verification of the financial information petitioners had submitted was required before petitioners' offer in compromise could be reviewed and approved.

 

During the settlement officer's verification of petitioners' financial information, certain real estate was identified which had not been previously disclosed to respondent.³ Petitioners' mobile home in which they resided was located on the real estate. In 1996, the real estate had been purchased in petitioners' names, using a cashier's check in the amount of $8,750 as part of a $9,000 downpayment toward the $35,000 total purchase price. In 1998, nominal title to this real estate was transferred by petitioners to petitioner's mother. Although the warranty deed recording this title transfer reflects consideration of $10,000, petitioner's mother made no such payment to petitioners. Since 1999, the mobile home located on this real estate has been petitioners' primary residence.

 

Petitioners advised the settlement officer that the real estate belonged to petitioner's mother. Petitioners indicated that petitioner's mother had provided the funds for the 1996 cashier's check used to purchase the real estate. Petitioners submitted to respondent's settlement officer copies of checks and a bank statement in support of this contention. The bank statement reflects a payment by petitioner's mother of $8,750 on August 26, 1996 . The bank statement, however, also reflects a deposit of $10,532.33 into the same bank account on that same date.

 

From the time of purchase in 1996 through the time of the collection due process hearing, petitioners paid the property taxes and mortgage payments relating to the real estate. No rental agreement between petitioners and petitioner's mother was provided, and none appears to exist. On her Federal income tax returns, petitioner's mother did not include rental income or deduct mortgage interest relating to this real estate. Petitioner's mother was not called as a witness in this case.

 

Also, information obtained by the settlement officer indicated that, just prior to the above 1996 purchase of the real estate, petitioners sold a house in Nashville , Tennessee . Petitioners did not provide to the settlement officer requested information regarding the disposition of the proceeds from the sale of the Nashville house.

 

Based on valid and unresolved concerns regarding ownership of the real estate on which petitioners' mobile home residence was located, the settlement officer rejected petitioners' offer in compromise of $180 per month and calculated a minimum acceptable offer in compromise from petitioners of $529 per month for 116 months, until a total of $61,364 would be paid. In preparing computations of this new minimum amount for an acceptable offer in compromise from petitioners, the settlement officer used a fair market value for the real estate of $82,300, based upon a 2001 local property tax appraisal. The settlement officer calculated petitioners' net realizable equity in the real estate at $39,840.

 

Petitioners disputed the settlement officer's decision to consider the equity in the real estate in evaluating their offer in compromise. Petitioners, however, did not submit to respondent's settlement officer information sufficient to resolve the settlement officer's question regarding ownership of the real estate.

 

On January 17, 2002 , the settlement officer prepared an Appeals Case Memorandum sustaining the proposed levy action. On February 19, 2002 , respondent issued to petitioners a notice of determination concluding that petitioners' offer in compromise was unacceptable and denying petitioners' request to suspend collection action.

OPINION

 

Because the underlying tax liability is not in dispute, we review the settlement officer's actions under an abuse of discretion standard. Goza v. Commissioner [Dec. 53,803], 114 T.C. 176, 181-182 (2000). An abuse of discretion occurs when respondent takes action that is arbitrary or capricious, lacks sound basis in law, or is not justifiable in light of the facts and circumstances. Mailman v. Commissioner [Dec. 45,218], 91 T.C. 1079, 1084 (1988).

 

Petitioners contend that the settlement officer abused his discretion in refusing to designate petitioners' cumulative liability as currently not collectible. Petitioners also contend that the settlement officer abused his discretion in refusing to accept the proposed payments of $180 per month under either an installment agreement or an offer in compromise.

 

Generally, Appeals officers are to consider alternatives to collection offered by taxpayers in the course of collection due process proceedings. Sec. 6330(c). As indicated, petitioners proposed three alternatives to collection. We address each seriatim.

Currently Not Collectible

Generally, currently not collectible ( CNC ) status may be available when a taxpayer has no ability to make payments. 2 Administration, Internal Revenue Manual ( CCH ), sec. 5.16.1.1, at 17,803 (2000). A taxpayer's ability to make payments is determined by calculating the excess of income over necessary living expenses. 2 Administration, Internal Revenue Manual ( CCH ), sec. 5.16.1.2.1, at 17,804 (2000). CNC status may be available based on "hardship" if the levy action would prevent the taxpayer from meeting necessary living expenses.

 

Petitioners submitted to the settlement officer certain personal financial information in support of their request for CNC status for the cumulative liability. The settlement officer concluded that petitioners had the ability to make monthly payments and that CNC status was not appropriate. Petitioners do not challenge the settlement officer's conclusion as to their ability to make some payments toward their cumulative liability; indeed, petitioners' proposed offer in compromise, involving payments of $180 per month, would belie any such claim.

 

Petitioners clearly had some ability to make payments toward the cumulative liability. As a result, petitioners were not eligible to have the cumulative liability classified as CNC . We find no abuse of discretion in the settlement officer's decision that petitioners were not eligible for CNC status.

Installment Agreement

Section 6159 authorizes respondent to consider installment agreements when a taxpayer lacks the current ability to satisfy the full amount of taxes. At the time of the collection due process hearing in this case, respondent maintained a policy of accepting installment agreements only with terms that would result in full payment of all Federal income tax liabilities within the applicable collection periods of limitation. Internal Revenue Manual, sec. 5.14.1.1 (effective Oct. 18, 1999 to Mar. 30, 2002 ). A 5-year extension of the periods of limitation is permissible when making this determination. Internal Revenue Manual, sec. 5.14.1.7 (effective Oct. 18, 1999 to Mar. 30, 2002 ).

 

In light of the amount of petitioners' cumulative liability, an acceptable installment agreement would have required payments of approximately $1,500 per month for the 116 months in the collection periods of limitation. Even with a 5-year extension, payments of more than $1,100 per month would have been required. Petitioners do not dispute their inability to make payments in that amount.

 

After the notice of determination was issued in this case, respondent changed its policy related to installment agreements. Under respondent's new policy, respondent may allow taxpayers to enter into installment agreements to pay specific tax periods in full and to have other tax periods designated as CNC . 2 Administration, Internal Revenue Manual ( CCH ), sec. 5.14.2.2, at 17,529 (effective Mar. 30, 2002 ). Respondent's new policy, however, still requires that taxpayers borrow upon or liquidate current assets. 2 Administration, Internal Revenue Manual ( CCH ), sec. 5.14.2.2(1), at 17,529 (effective Mar. 30, 2002 ). At trial, petitioners' counsel argued that this case was not about abuse of discretion by an individual settlement officer, but rather about an "institutional abuse of discretion" in the application of the policy that respondent used when considering petitioners' proposed installment agreement. Petitioners claim respondent should have treated the cumulative liability as consisting of separate liabilities for each year and should have classified some years as CNC while allowing petitioners an installment agreement for the liabilities for other years.

 

The settlement officer properly applied the policies applicable when considering petitioners' request for an installment agreement, and we find no abuse of discretion in his action. Further, particularly in light of the unresolved question relating to ownership of the real estate, petitioners have failed to establish that they would qualify for treatment under respondent's new policy. We find no abuse of discretion in respondent's use in this case of the prior policy for installment agreements.

Offer in Compromise

Section 7122 provides authority for an offer in compromise as an alternative to collection action. An offer in compromise reduces a taxpayer's overall liability. An offer in compromise may be granted for reasons such as doubt as to the actual tax liability, doubt as to collectibility, or for other purposes relating to effective tax administration. Sec. 7122.

 

As indicated, petitioners do not dispute the amount of the cumulative liability. The proposed offer in compromise was considered on the grounds of doubt as to collectibility. In general, an offer in compromise based on doubt as to collectibility may be accepted where there are substantial questions concerning whether the tax liability will be collected in full and where the offered amount reflects realistic collection potential. 2 Administration, Internal Revenue Manual ( CCH ), sec. 5.8.1.1.3, at 16,253 (2001).

 

After reviewing the initial financial information provided by petitioners, the settlement officer suggested that petitioners' proposed offer in compromise of $180 a month for 116 months, for a total of $20,880, appeared acceptable. However, as explained above, the settlement officer's verification of petitioners' financial information uncovered a significant question regarding ownership of real estate in which an equity interest of nearly $40,000 appeared to exist. As a result, the settlement officer concluded that petitioners' offer in compromise was not acceptable.

 

Although petitioners continue to assert that the real estate belongs to petitioner's mother, petitioners failed to provide to respondent's settlement officer certain requested information in support of this assertion. For example, petitioners failed to provide information relating to the proceeds of the Nashville house that petitioners sold, information that is particularly significant because of the $10,532.33 deposit into petitioner's mother's bank account on the same day that the cashier's check used for part of the downpayment on the real estate was purchased. Moreover, the information petitioners provided to the settlement officer showed that the real estate was originally titled in petitioners' names, that petitioners transferred title for no consideration, that petitioners lived there, and that petitioners paid the property taxes and mortgage payments.

 

Generally, when challenging a levy action, taxpayers bear the responsibility of providing relevant information. Rule 142(a). The information petitioners provided to the settlement officer was insufficient to resolve the question regarding ownership of the real estate. We find no abuse of discretion in the settlement officer's determination. Other arguments made by petitioners that are not specifically addressed have been considered and rejected.

 

Based on the foregoing,

 

A decision will be entered for respondent.

¹ Unless otherwise indicated, all section references are to the Internal Revenue Code in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure.

² Hereinafter, unless otherwise indicated, references to petitioner in the singular are to petitioner Donald G. Willis.

³ The information that petitioners had submitted up until that time indicated that petitioners paid rent for the "land" on which the mobile home in which they resided was located

Docket No. 11961-01L , T.C. Memo. 2003-199, 86 TCM 28, Filed July 9, 2003 . [Appealable, barring stipulation to the contrary, to CA-9. -- CCH .]

[Code Sec. 7122]

Tax liability: Offers in compromise: Binding agreement. --

A married couple's offer to settle their tax liability for the amount of their deficiency, but excluding penalties and interest, did not constitute a binding compromise agreement. The taxpayers had received an oral confirmation from the IRS auditor that their offer had been accepted; however, the auditor believed their offer was a request for additional time to pay. In fact, the taxpayers had not submitted the offer on the appropriate form and had not received a written confirmation that the offer was accepted. Further, there was no mutual assent to the offer since the auditor misunderstood the nature of their request. -- CCH .

John and Donna Ringgold, pro sese. Sylvia L. Shaughnessy, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

 

FOLEY, Judge: The issue for decision is whether respondent abused his discretion in determining to proceed with collection of petitioners' 1997 tax liability.

FINDINGS OF FACT

 

On April 1, 1999 , John and Donna Ringgold (petitioners) executed and sent respondent Form 4549-CG, Income Tax Examination Changes, in which petitioners agreed to the immediate assessment and collection of additional tax liabilities for 1995 and 1997. The form set forth deficiencies, additions to tax, penalties, and interest through April 21, 1999 , totaling $20,100.33. In an accompanying letter, petitioners offered to settle their entire tax liability for $12,803.00 (i.e., the amount of the balance due excluding additions to tax, penalties, and interest) and requested 60 days from April 15, 1999 , to secure the necessary funds.

 

Several weeks later, Mr. Ringgold asked respondent's auditor whether the terms of his letter had been accepted. The auditor responded affirmatively, but was under the mistaken impression that petitioners' letter was merely a request for a short-term extension of time to pay the liability. On April 6, 1999 , the auditor prepared and sent to petitioners Form 433-D, Installment Agreement, for $20,100.33 (i.e., the entire amount of the liability per the audit report), put a hold on the collection activity for 120 days, and closed the file as "agreed". On June 7, 1999 , respondent made an additional assessment, and on September 6, 2000 , sent petitioners a Notice of Federal Tax Lien Filing and Your Right to a Hearing Under IRC 6320¹ relating to petitioners' 1997 tax liability.

 

On September 21, 2000 , petitioners timely filed Form 12153, Request for a Collection Due Process Hearing, in which they contended that their 1997 tax liability was satisfied pursuant to an offer in compromise.

 

The Appeals officer reviewed the files and transcripts of account and determined that respondent had not received from petitioners Form 656, Offer in Compromise, or Form 433-A, Collection Information Statement for Individuals. On June 12, 2001 , the Appeals officer held a hearing with petitioners, during which she explained to petitioners that settlement of tax liabilities for less than the amount owed requires the completion of Form 656. She informed petitioners that a binding settlement agreement had not been executed between petitioners and the auditor, but that petitioners could discuss an offer in compromise or installment agreement relating to petitioners' 1997 tax liability. Petitioners, however, declined to discuss these collection alternatives.

 

By notice dated September 7, 2001 , respondent determined to proceed with collection. In response, petitioners, while residing in San Diego , California , filed a petition and amended petition on September 20, and October 18, 2001 , respectively.

OPINION

 

Petitioners' sole contention is that they do not owe the liability for which the lien was recorded because they were "given an offer in compromise in fact" by the auditor. Respondent contends that petitioners and the auditor did not execute a binding agreement. We agree with respondent.

 

The law regarding compromises is well established. The regulations and procedures under section 7122 provide the exclusive method of effectuating a compromise. Shumaker v. Commissioner [81-2 USTC ¶9508], 648 F.2d 1198, 1199-1200 (9th Cir. 1981) (citing Botany Worsted Mills v. United States [1 USTC ¶348], 278 U.S. 282, 288-289 (1929)), revg. on another issue [Dec. 35,911(M)] T.C. Memo. 1979-71. Petitioners and the auditor did not enter into a binding agreement to compromise petitioners' 1997 tax liability. First, petitioners did not submit Form 433-A for respondent to determine whether there was doubt as to collectibility. See sec. 301.7122 -1(a), Proced. & Admin. Regs. Second, petitioners did not submit an offer in compromise on the appropriate form (i.e., Form 656), and were never notified in writing that an offer in compromise had been accepted. Laurins v. Commissioner [89-2 USTC 9636], 889 F.2d 910, 912 (9th Cir. 1989), affg. Norman v. Commissioner [Dec. 43,944(M)], T.C. Memo. 1987-265; sec. 301.7122 -1(d)(1), (3), Proced. & Admin. Regs. Finally, there was no mutual assent because the auditor misunderstood the nature of petitioners' request. See Dorchester Indus. Inc. v. Commissioner [Dec. 52,011], 108 T.C. 320, 330 (1997) (stating "A prerequisite to the formation of a contract is an objective manifestation of mutual assent to its essential terms") (citing Manko v. Commissioner [Dec. 50,412(M)], T.C. Memo. 1995-10), affd. without published opinion [2000-1 USTC 50,265] 208 F.3d 205 (3d Cir. 2000). Accordingly, respondent's determination is sustained.

 

Contentions we have not addressed are irrelevant, moot, or meritless.

 

To reflect the foregoing,

 

Decision will be entered for respondent.

 

Education Athletic Association, Inc. v. Commissioner

Docket No. 6396-98X., TC Memo. 1999-75, 77 TCM 1525, Filed March 10, 1999

[Appealable, barring stipulation to the contrary, to CA-8.-- CCH .]

[Code Secs. 509 , 511 , 512 , 513 , and 7122 ]

[Exempt organizations: Sale of pickle cards: Unrelated business taxable income: Publicly supported organization: Private foundation: Offer in compromise: Cashing of check.]E is an entity exempt from Federal income tax under sec. 501(a), I.R.C., as an organization described in sec. 501(c)(3), I.R.C. E's exempt activity involves primarily the promoting of athletic education. On its Form 1023, Application for Recognition of Exemption, E checked sec. 509(a)(2), I.R.C., as the reason it was not a private foundation. E's sole source of income for the 1993, 1994, and 1995 years was from the sale of pickle cards, a game of chance authorized by Nebraska statute. E paid and reported unrelated business income tax for 1993. When E transmitted its Forms 990-T, Exempt Organization Business Income Tax Return, for the years 1993, 1994, and 1995, E enclosed a check and attached a letter stating that the Check was being delivered as an offer in settlement of R's audit of E's 1993 taxable year. R cashed the check. Subsequently, R determined that E did not meet the exception requirements of sec. 509(a (2), I.R.C., and was therefore a private foundation.1. Held: the sale of pickle cards is an unrelated trade or business and income generated therefrom constitutes unrelated business taxable income to E. See secs. 512(a), 513(a), I.R.C.; Secs. 1.513-1(a) through (d), Income Tax. Regs.2. Held, further, respondent's determination that petitioner is not a publicly supported organization described in sec. 509(a)(2), I.R.C., and is therefore a private foundation, is sustained.3. Held, further, respondent's cashing of petitioner's check submitted with a letter purportedly offering to compromise petitioner's unrelated business income tax liability for 1993 does not constitute a valid offer in compromise. See sec. 7122, I.R.C.; Botany Worsted Mills v. United States , 278 U.S. 282, 288-289 (1929); sec. 301.7122 -1(d), Proced. & Admin. Regs.

Truman Clare, Omaha , Neb. , for the petitioner. William I. Miller, for the respondent.

MEMORANDUM OPINION

NIMS, Judge:

Respondent determined that petitioner qualified for exemption from Federal income tax under section 501(a) as an organization described in section 501(c)(3). Respondent further determined that petitioner does not qualify for the exception from private foundation categorization contained in section 509(a)(2). Petitioner challenges respondent's determination by invoking the jurisdiction of this Court for a declaratory judgment pursuant to section 7428.

Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure. All dollar amounts are rounded to the nearest dollar.

This case was submitted on the stipulated record pursuant to Rule 122. The evidentiary facts and representations contained in the administrative record are assumed to be true. See Rule 217(b)(1).

Background

At the time the petition was filed, petitioner's principal office was located in Omaha , Nebraska . Petitioner was organized and incorporated on January 18, 1971 , under Nebraska law as a nonprofit organization primarily to promote athletic education.

On its Form 1023, Application for Recognition of Exemption, petitioner checked section 509(a)(2) as the reason it was not a private foundation.

On August 22, 1984 , the District Director issued a favorable determination letter stating that petitioner was an organization exempt from Federal income taxation under section 501(c)(3). The letter also stated that petitioner was reasonably expected to be a publicly supported organization under sections 509(a)(1) and 170(b)(1)(A)(vi). The ruling stated that petitioner would be treated as a nonprivate foundation during an advance ruling period ending December 31, 1989 .

Petitioner's sole source of support for its 1993, 1994, and 1995 years was income from the sale of pickle cards to liquor establishments in Nebraska . Pickle cards are a game of chance authorized by Nebraska statute. See Neb. Rev. Stat. secs. 9-301 through 9-356 (1997 & Supp. 1997). Certain section 501(c)(3), (4), (5), (7), (8), (10) or (19) organizations may apply for a license to conduct a lottery by the sale of pickle cards. Id. at sec. 9-326 (1997).

A licensed manufacturer of pickle cards sells or supplies the pickle cards to licensed distributors, who then sell them to licensed organizations. Id. at secs. 9-307 (1997), 9-313 (1997), 9-331 (Supp. 1997), 9-332 (Supp. 1997), 9-340 (1997). Only licensed organizations may sell the pickle cards to licensed pickle card operators. The pickle cards may be sold to the public only (1) by licensed organizations or (2) by licensed pickle card operators. See Neb. Rev. Stat. secs. 9-328 (1997), 9-329.02 (Supp. 1997), 9-329.03 (Supp. 1997), 9-340.02 (1997), 9-345.01 (1997). Petitioner was a licensed organization under Nebraska law.

On September 27, 1996 , petitioner submitted to respondent Forms 990-T, Exempt Organization Business Income Tax Return, for the years 1993, 1994, and 1995. Petitioner reported its income from the sale of pickle cards as unrelated business taxable income (UBTI). Petitioner's gross receipts from its pickle card sales for 1993, 1994, and 1995 were $70,251, $57,944, and $26,675, respectively. Petitioner reported and paid unrelated business income tax (UBIT) in the amount of $3,825 for 1993. Petitioner further reported that it did not have UBIT liability for 1994 and 1995.

When it transmitted its Forms 990-T for 1993, 1994, and 1995 and paid the tax liability for 1993, petitioner attached a letter stating in pertinent part:

Enclosed is [a] check * * * in the amount of $573.75 for payment in full of all assessed taxes and penalties for calendar year 1993. It is my understanding that there were no taxes or penalties for 1994 and 1995. This check is being delivered to you as an offer in settlement in connection with the above-referenced tax audit and dispute. It is a condition precedent for the delivery of this check to the Internal Revenue Service that it agree to the above.

After receiving the Forms 990-T for 1993, 1994, and 1995, respondent cashed the check but did not propose additional taxes and did not issue a notice of deficiency.

On January 28, 1998 , respondent made a determination that petitioner was a private foundation under section 509(a), effective January 1, 1993 . However, petitioner's section 501(c)(3) status remained undisturbed.

Discussion

The sole issue for decision is whether respondent correctly determined that petitioner, an exempt organization under section 501(c)(3), is not a publicly supported organization described in section 509(a)(2) and therefore is a private foundation. Although the case was submitted on the stipulated record pursuant to Rule 122, petitioner bears the burden of proof as to whether it is a publicly supported organization as described in section 509(a)(2). See Rule 217(c)(2)(A).

Section 509 provides in pertinent part:

(a) General Rule.--For purposes of this title, the term "private foundation" means a domestic * * * organization described in section 501(c)(3) other than--

* * * * *

(2) an organization which--

(A) normally receives more than one-third of its support in each taxable year from any combination of--

(i) gifts, grants, contributions, or membership fees, and

(ii) gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities, in an activity which is not an unrelated trade or business (within the meaning of section 513)

* * *

(B) normally receives not more than one-third of its support in each taxable year from the sum of--

(i) gross investment income * * * and

(ii) the excess (if any) of the amount of the unrelated business taxable income (as defined in section 512) over the amount of the tax imposed by section 511.

Respondent contends that petitioner is not a publicly supported organization pursuant to section 509(a)(2) because it received all of its support from pickle card sales which is an unrelated trade or business; petitioner must therefore be characterized as a private foundation. Thus, our determination hinges upon whether the pickle card sales constitute an unrelated trade or business.

Section 511(a) imposes a tax on the unrelated business taxable income of certain tax-exempt organizations, including section 501(c)(3) organizations. Section 512(a)(1) defines "unrelated business taxable income" as gross income derived by any organization from any unrelated trade or business, regularly carried on by it, less allowable deductions.

Section 513(a) defines the term "unrelated trade or business" as,

in the case of any organization subject to the tax imposed by section 511, any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501 * * * [Emphasis added.]

Section 513(a)(1) through (3) contains exceptions to the above general rule, but none of the exceptions are applicable in this case. Therefore, income generated from the pickle card sales must be considered UBTI if:

(1) it is income from trade or business, (2) such trade or business is regularly carried on by the organization, and (3) the conduct of such trade or business is not substantially related (other than through the production of funds) to the organization's performance of its exempt functions. [Sec. 1.513-1(a) , Income Tax Regs.; emphasis added.]

For purposes of section 513 , the term "trade or business" has "the same meaning it has in section 162 , and generally includes any activity carried on for the production of income from the sale of goods or performance of services." Sec. 1.513-1(b) , Income Tax Regs. The term "trade or business" is not precisely defined in the Internal Revenue Code or the regulations promulgated thereunder; however, it is well established that in order for an activity to be considered a taxpayer's trade or business for purposes of section 162 , the activity must be conducted "with continuity and regularity" and "the taxpayer's primary purpose for engaging in the activity must be for income or profit." Commissioner v. Groetzinger [87-1 USTC ¶9191 ], 480 U.S. 23, 35, (1987). When a corporate taxpayer is involved, "the determinative factor in resolving the trade or business issue is whether the activity was engaged in with the intent to earn a profit." Professional Ins. Agents v. Commissioner [Dec. 38,797 ], 78 T.C. 246, 262 (1982).

In this case, petitioner's sole source of income was derived from the sale of pickle cards. Petitioner needed to make a profit from the pickle card sales in order to fund operations. Furthermore, petitioner's gross receipts from its pickle card sales for 1993, 1994, and 1995 were $70,251, $57,944, and $26,675, respectively. To produce these revenues, petitioner must have conducted the pickle card sales with continuity and regularity. Therefore, we hold that petitioner was engaged in a trade or business of selling pickle cards and regularly carried on such sales.

Petitioner argues that its sale of pickle cards is not an unrelated trade or business because, under Nebraska law, only exempt organizations may sell pickle cards, and therefore petitioner does not compete with for-profit entities. Petitioner's line of reasoning has been rejected in an analogous situation by the United States Court of Appeals for the Eighth Circuit, the Court of Appeals to which this case would normally be appealable. In Clarence LaBelle Post No. 217, VFW v. United States [78-2 USTC ¶9496 ], 580 F.2d 270, 271 (8th Cir. 1978), the taxpayer, a section 501(c)(4) organization, argued that income from an unrelated trade or business may be taxed under section 511(a) only if the trade or business competes with a taxpaying entity. Since the taxpayer's bingo operation did not compete with taxpaying entities, the taxpayer argued that it was not subject to tax. Id. After examining the legislative history of section 513 and the regulations thereunder, the Court of Appeals held that the tax on unrelated business income is not limited to income earned by a trade or business whose operations compete with taxpaying entities. Id. at 274; accord Louisiana Credit Union League v. United States [82-2 USTC ¶9717 ], 693 F.2d 525, 541-542 (5th Cir. 1982) ("The regulations under section 513 bolster our conclusion that competition is not essential to the taxability of unrelated business income."). See also Smith-Dodd Businessman's Association, Inc. v. Commissioner [Dec. 33,556 ], 65 T.C. 620, 624 (1975), where we stated that "unfair competition plays a relatively insignificant role in the application of the amended unrelated business tax".

Although section 513(f) legislatively overrides the decision in Clarence LaBelle Post No. 217, VFW v. United States , supra, by creating a special exemption for bingo games from the definition of "unrelated trade or business", we have recognized that the reasoning of that case remains sound. See Julius M. Israel Lodge of B'nai B'rith No. 2113 v. Commissioner [Dec. 50,890(M) ], T.C. Memo. 1995-439 n.6, affd. [96-2 USTC ¶50,562 ] 98 F.3d 190 (5th Cir. 1996). Therefore, the fact that petitioner did not compete with for-profit entities with respect to pickle card sales is not controlling.

Section 1.513-1(d)(2) , Income Tax Regs., provides in part that a trade or business is "related" to an exempt purpose "only where the conduct of the business activities has causal relationship to the achievement of exempt purposes (other than through the production of income); and it is 'substantially related,' * * * only if the causal relationship is a substantial one." To be considered "substantially related" to exempt purposes, the regulations require that income generated by the trade or business must "contribute importantly" to the achievement of the exempt purpose. Id. This determination depends "upon the facts and circumstances involved." Id.

In this case, pickle card sales did not contribute in the manner contemplated by section 513 and the regulations thereunder. Petitioner argues that since all proceeds from the sales were used to further petitioner's exempt activities, the income from pickle card sales is not UBTI. Petitioner's argument ignores the plain language of section 513(a) and the regulations thereunder, which, it bears repeating, provide that mere production of income to fund an exempt organization's activities is insufficient to establish a substantial causal relationship between the trade or business and the exempt activity. It follows that income generated from pickle card sales was derived from an unrelated trade or business.

Accordingly, pickle card sales income is UBTI for purposes of section 512(a) . Since all of petitioner's gross receipts were derived from pickle card sales and the sale of pickle cards constitute UBTI to petitioner, we sustain respondent's determination that petitioner is not a publicly supported organization described in section 509(a)(2) , and is therefore a private foundation.

We note petitioner's assertion that respondent accepted a purported offer in compromise, in response to which respondent allegedly agreed that the pickle card sales were not unrelated business income ( UBI ) and is therefore barred from asserting that the pickle card sales were UBTI. A fair reading of the contents of the letter attached to petitioner's check leads us to conclude that the letter merely constituted a settlement offer to resolve the dispute resulting from the IRS audit of petitioner's 1993, 1994, and 1995 years. In any event, petitioner's so-called offer in compromise does not comply with the specific requirements of section 7122 and the regulations thereunder, and must also fail for that reason. See Botany Worsted Mills v. United States , 278 U.S. 282, 288-289 (1929).

All contentions not addressed are either not germane or unpersuasive.

To reflect the foregoing,

Decision will be entered for respondent.

 

Debra L. Streck and Donald W. Streck v. Commissioner

Docket No. 25246-95., TC Memo. 1997-407, 74 TCM 545, Filed September 15, 1997

[Appealable, barring stipulation to the contrary, to CA-6.-- CCH .]

[Code Secs. 162 and 183 ]

Deductions: Substantiation of: IRS determinations: Nonprofit activities: Ranch: Profit motive: Personal and recreational benefit.--Married taxpayers failed to substantiate loss deductions in an amount greater than that already allowed by the IRS with respect to a ranch that they owned and operated as an S corporation. They produced no records and were unable to show that the ranch activity was engaged in for profit. The husband testified that they originally acquired the ranch as a getaway and that they continued to derive personal and recreational benefit from the property.

[Code Sec. 6013 ]

Innocent spouse relief: Knowledge of understatement: Reason to know: Participation in business affairs.--A wife was not entitled to innocent spouse relief because she had reason to know of substantial understatements on joint returns that she filed with her husband. She materially participated in her husband's business affairs, wrote and signed checks for all of his companies, and voted on resolutions adopted by one corporation's board of directors. In addition, the wife presented no evidence that her husband refused to disclose information or was not forthright with her regarding financial matters.

[Code Sec. 6013 ]

Innocent spouse relief: Economic benefit received.--It was not inequitable to hold a wife liable for deficiencies related to substantial understatements on joint returns that she filed with her husband because she significantly benefited from the understatements. The taxpayers purchased numerous luxury items during the years at issue, including two cars, a boat, and various residences, and they owned valuable furs and jewelry.

[Code Sec. 6653 , prior to amendment by P.L. 101-239 ]

Penalties, civil: Negligence: Evidence: None presented.--Married taxpayers who were denied deductions greater than an amount already allowed by the IRS were liable for negligence penalties. They failed to demonstrate that they were not negligent or that the IRS 's determinations were erroneous.

[Code Sec. 6661 , prior to repeal by P.L. 101-239 ]

Penalties, civil: Substantial understatement: Evidence: None presented.--Married taxpayers who were denied deductions greater than an amount already allowed by the IRS were liable for substantial understatement penalties. They failed to demonstrate the IRS 's determinations were erroneous.

[Code Secs. 7121 and 7122 ]

Settlement agreements: Taxpayers' offer: Acceptance of: Proof.--Married taxpayers who were assessed deficiencies did not have a binding settlement agreement with the IRS regarding the years at issue. Although the taxpayers submitted several Forms 656, Offer in Compromise in Any Civil or Criminal Case, and District Director's Recommendation, the IRS never accepted any of their settlement offers. An IRS employee's signing of the forms to indicate that the IRS accepted the taxpayers' waiver of the limitations period did not constitute an acceptance of their offers. Further, the IRS employee and the taxpayers' accountant testified that the IRS employee never orally agreed to accept the taxpayers' proposals. Since the husband had a history of dishonest, criminal behavior, his testimony with respect to the alleged oral agreement lacked credibility. Thus, the taxpayers failed to establish that a binding agreement existed.-- CCH .

Debra L. Streck and Donald W. Streck, pro sese. Joseph P. Grant, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

RUWE, Judge:

Respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows:

                                              Additions to Tax

                                  ---------------------------------------

                                        Sec.                         Sec.

Year                     Deficiency  6653(b)(1)   Sec. 6653(b)(2)    6661

1983 ..................  $  142,520 $    71,260   50 percent of    $ 35,630

                                                  the interest due

                                                  on $142,520

1984 ..................     369,494     184,747   50 percent of      92,374

                                                  the interest due

                                                  on $191,310

1985 ..................     543,404     271,702   50 percent of     135,086

                                                  the interest due

                                                  on $412,774

                                           Additions to Tax

                                    ---------------------------------------

                                        Sec.            Sec.

Year                     Deficiency 6653(a)(1)(A)  6653(a)(1)(B)

1986 ..................  $  111,494 $     5,575   50 percent of

                                                  the interest due

                                                  on $111,494

 

Respondent's determination was based on the following items: Unreported gross income; ¹ disallowance of a net operating loss carryover; ² allowance of a deduction for two-earner married couples; ³ an increase in capital gains; ⁴ and disallowances of various deductions for business losses and expenses. ⁵ Petitioners concede the adjustments made by respondent for unreported gross income, the allowance of the two-earner deduction, and the increase to capital gains. Petitioners also concede that Mr. Streck is liable for the additions to tax under section 6653(b)(1) ⁶ and (2) for the taxable years 1983, 1984, and 1985, and agree with respondent that the addition to tax under section 6653(b)(2) is applicable only to the tax attributable to unreported income. Respondent concedes that Mrs. Streck is not liable for the additions to tax under section 6653(b)(1) and (2) for any of the years at issue.

The issues remaining for decision are: (1) Whether respondent is bound by an alleged settlement agreement for the years at issue; (2) whether petitioners are entitled to deductions for losses they claimed were sustained by Double D Ranch, Inc., an S corporation; (3) whether Mrs. Streck is entitled to innocent spouse relief pursuant to section 6013(e); (4) whether petitioners are liable for the addition to tax pursuant to section 6653(a)(1)(A) and (B) for negligence or intentional disregard of rules or regulations for the year 1986; and (5) whether petitioners are liable for the addition to tax pursuant to section 6661 for substantial understatement of income tax liabilities for the years 1983, 1984, and 1985. ⁷

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts is incorporated herein by this reference. At the time the petition was filed, Mr. Streck was incarcerated at FMC Lexington, Lexington , Kentucky , and Mrs. Streck resided in Cincinnati , Ohio . Petitioners were married in 1981 and remained married at the time of trial. Petitioners filed joint returns for the years in issue.

During the early 1980's, Mr. Streck owned and operated P.G.D., Inc. (P.G.D.), a company which provided trucking services. P.G.D. incurred substantial operating losses and, in early 1983, ceased operations.

During the years 1983 through 1985, Mr. Streck served as a consultant to a group of companies known as the Walsh Cos. (Walsh), which were headquartered in New Jersey . These companies provided trucking services. As a consultant for Walsh, Mr. Streck was paid $500 per day for his services.

While serving as a consultant, Mr. Streck diverted funds from Walsh. Respondent has determined, and petitioners concede, that Mr. Streck received gross income of $384,750 in 1983, $382,620 in 1984, and $825,548 in 1985 that petitioners failed to report on their joint income tax returns for those years.

On June 23, 1988 , Mr. Streck was indicted in the U.S. District Court of New Jersey for violations of sections 1341 , 1343, 1961, 1962, 1963, and 2314 of title 18 of the United States Code in connection with his diversion of funds from Walsh. On February 27, 1991 , Mr. Streck pleaded guilty to fraud under count 11 of the indictment. On November 3, 1988 , Mr. Streck was indicted in the U.S. District Court, Southern District of Ohio, for tax evasion under section 7201 for the years 1983, 1984, and 1985 and bankruptcy fraud under section 152 of title 18 of the United States Code. In November 1989, Mr. Streck was convicted on all tax evasion counts and acquitted on all counts of bankruptcy fraud. As a result of these convictions, Mr. Streck was incarcerated from December 8, 1989 , to April 15, 1991 . ⁸

As a result of being liable for much of the debt of P.G.D., Mr. Streck filed a debtor's petition in the U.S. Bankruptcy Court under chapter 7 of title 11 of the United States Code on October 14, 1983 . On March 30, 1984 , the Bankruptcy Court discharged Mr. Streck from all dischargeable debts.

During 1984, petitioners, acting through Double D Ranch, Inc., constructed a log cabin at an approximate cost of $494,000. Petitioners used the log cabin as their residence. During 1984 and 1985, petitioners also purchased two new 1985 Mercedes Benz automobiles, a $92,000 boat, and four Honda motorcycles. Also, in 1985, petitioners purchased two condominiums in Florida , one in Marco Island for $265,000 and upon its sale, another in Naples for approximately $675,000.

During the years in issue, Mrs. Streck was the sole shareholder of American Carriers, Inc. ( ACI ), and Mr. Streck was ACI 's president. Mrs. Streck was a signatory on ACI 's bank account, and she signed checks as an officer on behalf of ACI . She also participated in voting on resolutions adopted by ACI 's board of directors. Mrs. Streck was also an officer of P.G.D.

On August 1, 1993 , in connection with an ongoing audit by respondent, petitioners submitted an Offer in Compromise (Form 656) to respondent's Appeals Officer Frank Sower with respect to their individual Federal income tax liabilities for the years 1983 through 1992 and their liability for withholding taxes attributable to Jamie Enterprises, Inc. (JEI), a corporation owned by Mrs. Streck. This offer was in the amount of $2,000. ⁹

On February 10, 1994 , the original offer in compromise, dated August 1, 1993 , was withdrawn by petitioners and two revised offers were executed and submitted on Forms 656. The first Form 656 related to petitioners' individual income tax liabilities for 1983 through 1992. Petitioners offered to settle these liabilities for $19,000. The second Form 656 was submitted by Mr. Streck on behalf of JEI to compromise its employment taxes for 1991 and 1992 for $1,000.

OPINION

Petitioners' primary position is that they have previously entered into a binding settlement agreement with respondent regarding the years in issue. They allege that the agreement was entered into when respondent's Appeals Officer Mr. Sower accepted their offer in compromise prior to the issuance of the notice of deficiency. It is not clear which of the two Forms 656 relating to their individual income taxes petitioners rely on.

The settlement of disputed tax liabilities is governed by sections 7121 and 7122 , which authorize the Secretary or an authorized delegate to settle any tax disputes and compromise any civil or criminal case arising under the internal revenue laws. Klein v. Commissioner [90-1 USTC ¶50,251 ], 899 F.2d 1149, 1152 (11th Cir. 1990). Regulations under section 7122 clarify the procedure required with respect to an offer in compromise and how an offer may be accepted. Section 301.7122-1(d)(1) , Proced. & Admin. Regs., requires that offers in compromise shall be submitted on forms prescribed by the Internal Revenue Service. Section 301.7122-l(d)(3), Proced. & Admin. Regs., states that "An offer in compromise shall be considered accepted only when the proponent thereof is so notified in writing."

Petitioners submitted a Form 656 to Mr. Sower on August 1, 1993 . In the Form 656, petitioners offered $2,000 to settle their income tax liabilities for the years in issue plus certain withholding tax liabilities. Petitioners withdrew the original Form 656 on February 10, 1994 , and submitted two separate offers on Forms 656 in place of the first. Each Form 656 referred to above contains a statement whereby the taxpayer-proponent agrees to waive and suspend the statutory period of limitations for assessment and collection. The Forms 656 also contain a signature line for an authorized Internal Revenue Service official to acknowledge that "I accept the waiver of statutory period of limitations for the Internal Revenue Service." Mr. Sower's signature appears under this preprinted statement on each form. By signing the Forms 656, Mr. Sower accepted petitioners' waiver of the statutory period of limitations. By signing the Forms 656 in this manner, Mr. Sower did not accept petitioners' offers.

Form 656 makes it clear that Mr. Sower's signature was not an acceptance of petitioners' offer in compromise. Clause (8) of Form 656 states:

The taxpayer-proponents agree to the waiver and suspension of any statutory periods of limitations for assessment and collection of the tax liability described in paragraph (1) while the offer is pending, during the time any amount offered remains unpaid and for one (1) year after the satisfaction of the terms of the offer. The offer shall be deemed pending from the date an authorized official of the Internal Revenue Service accepts taxpayer-proponents' waiver of the statutory periods of limitation and shall remain pending until an authorized official of the Internal Revenue Service formally, in writing, accepts, rejects or withdraws the offer. ***

Clause (10) of Form 656 states that "It is understood that this offer will be considered and acted upon in due course and that it does not relieve the taxpayers from the liability sought to be compromised unless and until the offer is accepted in writing by the Commissioner or a delegated official, and there has been full compliance with the terms of the offer." (Emphasis added.) Petitioners signed the Forms 656 agreeing to these terms. ¹⁰

Petitioners next argue their offer was accepted orally by Mr. Sower. While it is not clear which offer petitioners refer to, they have failed to prove that Mr. Sower said or did anything that would constitute acceptance of any offer they made.

Both parties offered testimony regarding the alleged oral agreement. Mr. Streck testified that Mr. Sower orally represented that he would accept petitioners' signed offer in compromise. Petitioners' accountant, Mr. Mancini, who was present during meetings between Mr. Streck and Mr. Sower did not recall any oral acceptance by Mr. Sower. Mr. Sower testified that he never told Mr. Streck that he would accept an offer in compromise relating to the years in issue. Mr. Sower testified that he "did not have the authority to accept or reject offers in compromises." ¹¹ We believe Mr. Sower's testimony. It is consistent with the plain language on the Form 656. The testimony of petitioners' accountant is consistent with that of Mr. Sower's. Mr. Streck, on the other hand, has a long history of dishonest, criminal behavior and lacks credibility. We find that Mr. Sower never made, or purported to make, an oral acceptance of any offer to compromise petitioners' tax liabilities for the years in issue and that no settlement agreement with respect to the tax years 1983 through 1986 ever existed. ¹²

Petitioners next argue that respondent improperly disallowed losses that they claimed from Double D Ranch, Inc., an S corporation. Petitioners deducted $277,582, $330,385, and $274,483 as their share of the purported losses of Double D Ranch, Inc., in 1984, 1985, and 1986, respectively. Respondent disallowed $200,331, $255,302, and $229,232 of those loss deductions in 1984, 1985, and 1986, respectively. These losses were disallowed because it had not been established to respondent's satisfaction that deductions taken by Double D Ranch, Inc., were ordinary and necessary business expenses or expenses incurred in an activity engaged in for the production of income. ¹³

Respondent's determinations are presumed correct, and petitioners bear the burden of proving otherwise. Rule 142(a); Welch v. Helvering [3 USTC ¶1164 ], 290 U.S. 111, 115 (1993). Deductions are a matter of legislative grace, and taxpayers bear the burden of proving that they are entitled to any deduction claimed. New Colonial Ice Co. v. Helvering [4 USTC ¶1292 ], 292 U.S. 435, 440 (1934). Taxpayers must substantiate the amount of any deductions claimed. Hradesky v. Commissioner [Dec. 33,461 ], 65 T.C. 87, 89-90 (1975), affd. per curiam [76-2 USTC ¶9703 ] 540 F.2d 821 (5th Cir. 1976). Taxpayers are required to keep sufficient records to enable respondent to determine their correct tax liability. Sec. 6001 .

Section 162 allows the deduction of ordinary and necessary expenses incurred in carrying on any trade or business. Section 212 allows the deduction of ordinary and necessary expenses for the production or collection of income or for the maintenance of property held for the production of income. Petitioners failed to substantiate their entitlement to deductions in an amount in excess of that already allowed by respondent. They did not produce records of Double D Ranch, Inc., such as journals, ledgers, invoices, or canceled checks. Petitioners did not prove that the Double D Ranch, Inc., incurred any expenses which could be classified as ordinary and necessary.

A taxpayer claiming a deduction under sections 162 or 212 for an expense, or under section 165 for a loss, must have an "actual and honest profit objective" in order to avoid the disallowance of such deductions. See sec. 183 ; Dreicer v. Commissioner [Dec. 38,948 ], 78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983). Mr. Streck testified that petitioners initially purchased a ranch located in Kentucky as "a getaway because I was working in New York and traveling all the time and we wanted to get out in the country." The ranch was later incorporated under the name Double D Ranch, Inc. Although petitioners apparently engaged in some farming, Mr. Streck testified that the farming activity was a "total disaster". Throughout the time petitioners owned Double D Ranch, Inc., they continued to use the log cabin constructed on corporate property as a personal residence and use the boat dock located on corporate property for pleasure. Petitioners failed to provide evidence of an actual and honest objective to make a profit. We sustain respondent's disallowance of deductions that petitioners claimed with respect to Double D Ranch, Inc.

The next issue is whether Mrs. Streck qualifies as an innocent spouse pursuant to section 6013(e). Generally, a husband and wife are jointly and severally liable for the total tax due on their joint Federal income tax returns. Sec. 6013(d) . In limited circumstances, however, a spouse may qualify as an "innocent spouse" and be relieved of joint and several liability. Sec. 6013(e) . The spouse seeking relief under section 6013(e) bears the burden of proof. Rule 142(a); Bokum v. Commissioner [Dec. 46,408 ], 94 T.C. 126, 138 (1990), affd. [93-2 USTC ¶50,374 ] 992 F.2d 1132 (11th Cir. 1993).

In order for Mrs. Streck to qualify for innocent spouse status, she must prove that: (1) Petitioners filed a joint tax return; (2) on that joint tax return, there was a substantial understatement of tax attributable to grossly erroneous items of the other spouse; (3) in signing the joint tax return, she did not know, nor have reason to know of the substantial understatement; and (4) taking into account all the facts and circumstances, it is inequitable to hold her liable for any deficiency attributable to the substantial understatement. Sec. 6013(e)(1)(A)-(D). Failure to prove any one of these requirements will prevent Mrs. Streck from qualifying as an innocent spouse. Bokum v. Commissioner, supra at 138. The parties agree that petitioners filed joint tax returns for 1983, 1984, 1985, and 1986. Respondent also concedes that there are substantial understatements on petitioners' tax returns for those years and that the unreported income for the years 1983 through 1985 constitutes grossly erroneous items of Mr. Streck. ¹⁴

Under section 6013(e)(1)(C), Mrs. Streck must establish that in signing the tax returns for the years in issue, she did not know, and had no reason to know, there was a substantial understatement. The standard to be applied in determining whether a taxpayer "had reason to know" is whether a reasonably prudent person with knowledge of the facts possessed by the person claiming innocent spouse status should have been alerted to the possibility of a substantial understatement. Shea v. Commissioner [86-1 USTC ¶9150 ], 780 F.2d 561, 566 (6th Cir. 1986), affg. in part and revg. in part [Dec. 41,283(M) ] T.C. Memo. 1984-310; Flynn v. Commissioner [Dec. 46,030 ], 93 T.C. 355, 365 (1989). Three factors are significant in determining whether a spouse had reason to know of an understatement of tax: (1) Participation in business affairs or bookkeeping by the alleged innocent spouse, Quinn v. Commissioner [Dec. 32,597 ], 62 T.C. 223, 229-230 (1974), affd. [75-2 USTC ¶9764 ] 524 F.2d 617 (7th Cir. 1975), (2) the culpable spouse's refusal to be forthright concerning the couple's income, Adams v. Commissioner [Dec. 31,989 ], 60 T.C. 300, 303 (1973), and (3) the presence of unusual or lavish expenditures, Mysse v. Commissioner [Dec. 31,273 ], 57 T.C. 680, 699 (1972). Another factor the courts have focused on is whether the couple's standard of living improved significantly during the years in issue. Id. at 698-699.

Mrs. Streck participated in the business affairs and bookkeeping of petitioners' businesses. During the years in issue, Mrs. Streck was the sole shareholder of ACI . Mrs. Streck was a signatory on ACI 's bank account, and she signed checks as an officer on behalf of ACI . She also participated in voting on resolutions adopted by the board of directors of ACI . Mrs. Streck was an officer of P.G.D., a corporation wholly owned by Mr. Streck. Mrs. Streck testified that she wrote and signed checks for all of petitioners' businesses including ACI . She also testified she made deposits to corporate bank accounts and paid invoices from corporate accounts. We find that Mrs. Streck substantially participated in petitioners' combined business affairs.

Mrs. Streck provided absolutely no evidence or argument that Mr. Streck refused to disclose information or was not forthright with her regarding their financial affairs.

Family expenditures during the years in issue appear to be lavish within the meaning of Mysse v. Commissioner, supra at 699. During 1984, through Double D Ranch, Inc., petitioners constructed a log cabin at an approximate cost of $494,000, which they used as their residence. Petitioners purchased other luxury items during 1984 and 1985, including two 1985 new Mercedes Benz automobiles, a $92,000 boat, and four Honda motorcycles. Also, in 1985, petitioners purchased two condominiums in Florida , one in Marco Island for $265,000 and upon its sale, another in Naples for approximately $675,000. Some of these purchases occurred during or shortly after the time Mr. Streck had filed for relief in bankruptcy in October 1983. ¹⁵ Their 1986 financial statement indicates that petitioners owned valuable furs and jewelry.

These expenditures appear inconsistent with the amounts petitioners reported on their tax returns and would have alerted Mrs. Streck to the fact that there were understatements of income on petitioners' returns. ¹⁶ We find that Mrs. Streck knew or should have known that there were understatements of tax on the returns in issue.

Mrs. Streck has also failed to show that it would be inequitable to hold her jointly and severally liable for the disputed taxes. An important factor in determining whether it is inequitable to hold a spouse liable is whether that spouse significantly benefited, either directly or indirectly, from the understatement of taxes. Belk v. Commissioner [Dec. 46,070 ], 93 T.C. 434, 440 (1989); Purcell v. Commissioner [Dec. 42,894 ], 86 T.C. 228, 242 (1986), affd. [87-2 USTC ¶9479 ] 826 F.2d 470 (6th Cir. 1987); sec. 1.6013-5(b) , Income Tax Regs. Normal support is not considered a significant benefit. Terzian v. Commissioner [Dec. 36,348 ], 72 T.C. 1164, 1172 (1979). Mrs. Streck bears the burden of proving that she received no significant benefit from the unreported income other than normal support, and this burden must be supported with specific evidence of lifestyle expenditures, as well as asset acquisitions. Bokum v. Commissioner [Dec. 46,408 ], 94 T.C. at 157; Estate of Krock v. Commissioner [Dec. 46,194 ], 93 T.C. 672, 681 (1989).

Mrs. Streck failed to provide any specific evidence that her lifestyle and asset acquisitions were normal support. There is no evidence of petitioners' lifestyle prior to 1983. Petitioners purchased numerous luxury items during the years in issue, including new Mercedes Benz automobiles, an expensive boat, and various residences. Petitioners' 1986 financial statement indicates that their joint net worth increased since Mr. Streck's bankruptcy. ¹⁷ The financial statement indicates that petitioners owned valuable furs and jewelry. We find that Mrs. Streck failed to show she did not significantly benefit from the understatement of taxes.

The next issue concerns petitioners' liability for additions to tax under sections 6653(a) and 6661 . Respondent determined that petitioners are liable for additions to tax for negligence or intentional disregard of rules or regulations under section 6653(a)(1)(A) and (B) for the taxable year 1986. As in effect during 1986, section 6653(a)(1)(A) imposed an addition to tax equal to 5 percent of the underpayment of tax where any part of the underpayment was due to negligence or disregard of rules or regulations. Section 6653(a)(1)(B) imposed an addition to tax in an amount equal to 50 percent of the interest payable under section 6601 with respect to the portion of the underpayment which was attributable to negligence.

Respondent also determined that petitioners are liable for the addition to tax for substantial understatement of income tax pursuant to section 6661 with respect to their 1983, 1984, and 1985 income tax returns. As in effect during 1983, 1984, and 1985, section 6661(a) imposed an addition to tax equal to 10 percent of the amount of any underpayment attributable to a substantial understatement of income tax. An understatement is defined in section 6661(b)(2)(A) as the excess of the amount of tax required to be shown on the return over the amount of tax imposed which is shown on the return. There is a substantial understatement under section 6661(b)(1)(A) if the amount of the understatement for the taxable year exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. All of petitioners' tax returns for the years in issue have understatements of tax in excess of the threshold.

Petitioners bear the burden of proving that the additions to tax do not apply. Rule 142(a); Luman v. Commissioner [Dec. 39,500 ], 79 T.C. 846, 861-862 (1982). Petitioners failed to introduce convincing evidence that they were not negligent or that respondent's determination is erroneous. Accordingly, we sustain respondent's determination that petitioners are liable for the additions to tax pursuant to section 6653(a)(1)(A) and (B) in 1986 and section 6661 with respect to their returns in 1983, 1984, and 1985.

Decision will be entered under Rule 155.

¹ Respondent determined that petitioners had unreported gross income of $384,750, $382,620, and $825,548 in 1983, 1984, and 1985, respectively.

² Respondent disallowed $88,236 of petitioners' 1983 net operating loss carryover deduction.

³ Respondent allowed a deduction for two-earner married couples of $120 for 1983 pursuant to sec. 221 .

⁴ Respondent determined an increase in petitioners' capital gains of $6,636 for 1983.

⁵ Respondent disallowed deductions claimed by petitioners for the following items: Business expenses in the amount of $42,500 for 1984; legal and professional fees in the amount of $16,014

for 1984; losses related to petitioners' ownership of Double D Ranch, Inc., an S corporation, in the amounts of $200,331, $255,302, and $229,232 for 1984, 1985, and 1986, respectively; and real estate taxes in the amount of $22,994 for 1985. Respondent allowed an increase in expenses related to legal and professional fees in the amount of $2,848 in 1985.

⁶ Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

⁷ Petitioners appear to have raised other issues at various times in this case. We need not address these issues since they are either frivolous or were not addressed at trial or on brief by petitioners.

⁸ Subsequent to Mr. Streck's release from prison, and while he remained on probation, petitioners moved to Knoxville , Tennessee . In connection with the refinancing of a house they purchased in Knoxville , Mr. Streck prepared a false document purporting to be a release of a Federal tax lien. On July 3, 1996 , in the Criminal/Circuit Court of Knox County Tennessee, Mr. Streck pleaded guilty to a theft in excess of $60,000 from his employer in Knoxville . On July 5, 1996 , based on violations of the terms and conditions of his probation in connection with the 1988 convictions, Mr. Streck was reincarcerated.

⁹ Petitioners had a case before this Court with respect to their 1987 tax year. On Oct. 19, 1993 , pursuant to an agreement by the parties, this Court entered its decision that there was no deficiency and no additions to tax with respect to the 1987 tax year.

¹⁰ We note that if petitioners believed that Mr. Sower's signature on the first Form 656 constituted an acceptance, it makes no sense that they withdrew the first offer in order to make an offer to pay more.

¹¹ Mr. Sower did not have the authority to accept such an offer. See Boulez v. Commissioner [Dec. 37,661 ], 76 T.C. 209, 213 (1981), affd. [87-1 USTC ¶9177 ] 810 F.2d 209 (D.C. Cir. 1987); Deleg. Order No. 11 (Rev. 23), 1994-1 C.B. 324; Deleg. Order No. 11 (Rev. 22), 1992-1 C.B. 488.

¹² Petitioners also argue that respondent should be estopped from rejecting their offer in compromise. The doctrine of equitable estoppel should be applied against the Government `with utmost caution and restraint.'" Kronish v. Commissioner [Dec. 44,694 ], 90 T.C. 684, 695 & n.10 (1988)(quoting Boulez v. Commissioner, supra at 214-215). In order for estoppel to apply, the proponent must show, among other things, the existence of a false representation and detrimental reliance on the representation. Id. Petitioners have failed to show any misrepresentations made by respondent.

¹³ The only deductions that respondent allowed to Double D Ranch, Inc., were those for real estate taxes and interest. The Double D Ranch, Inc., loss amounts that respondent allowed to petitioners were computed as follows:

                                                 1984      1985      1986

Total income reported by                          $1,500        $0   $18,817

   Double D Ranch, Inc.

Less:

   Total interest paid                          (71,644)  (69,590)  (58,228)

   Total real estate taxes paid                  (7,107)   (5,493)   (5,840)

                                               --------- --------- ---------

   Total loss allowed                          ($77,251) ($75,083) ($45,251)

 

¹⁴ Mrs. Streck claims that for purposes of sec. 6013(e), the deductions disallowed are attributable to grossly erroneous items of Mr. Streck. Sec. 6013(e)(2)(B) defines "grossly erroneous items" as "any claim of a deduction, credit, or basis * * * for which there is no basis in fact or law." Mrs. Streck must prove that the disallowed deductions have no basis in fact or law. Flynn v. Commissioner [Dec. 46,030 ], 93 T.C. 355, 360 (1989). Mrs. Streck failed to establish that the deductions disallowed by respondent were frivolous, fraudulent, or phony. Id. at 364. Both Mr. and Mrs. Streck argued that the deductions related to Double D Ranch, Inc., are valid business expenses. As previously indicated, petitioners failed to produce evidence of the amount and nature of the expenses of Double D Ranch, Inc., that were disallowed. We find that Mrs. Streck has not proven that any of the deductions were grossly erroneous items.

¹⁵ In his October debtor's petition filed in the U.S. Bankruptcy Court, Mr. Streck listed debts of $1,999,678 and assets of $548,994. A financial statement prepared by petitioners' accountant, a C.P.A., based on information received from petitioners, reflects petitioners' assets and liabilities as of Sept. 30, 1986 , as follows:

Assets

   Cash and cash equivalents                                      $   36,600

   Investments, nonmarketable equity securities                    1,408,000

   Residence                                                         770,000

   Automobile                                                         54,500

   Furs, jewelry, household items, etc.                              200,000

                                                                  ----------

                                                                  $2,469,100

Liabilities and Net Worth

   Income taxes, current year balance                             $  500,000

   Notes payable, financial institutions                             817,800

   Estimated income taxes, on the difference between the

      estimated current values of assets and the estimated

      current amounts of liabilities and their tax bases             215,000

Net worth                                                            936,300

                                                                  ----------

                                                                  $2,469,100

 

¹⁶ On their tax returns, petitioners reported taxable income of zero in 1983, $66,857 in 1984 (after amendments), $31,561 in 1985, and $103,836 in 1986.

¹⁷ There is nothing to indicate Mrs. Streck's separate financial status prior to petitioners' financial statement as of Sept. 30, 1986 .

 

 

93-2 USTC ¶50,480] Principal Mutual Life Insurance Company, Plaintiff v. The United States , Defendant

U.S. Court of Federal Claims, 486-87T, 8/26/93 , 29 FedCl 157. On motion to reconsider a Court of Federal Claims decision, 92-2 USTC ¶50,392 , 26 ClsCt 616

[Code Sec. 801 ]

Insurance: Deductibility of state-mandated reserves.--On the government's motion for reconsideration, the court upheld the test that it had employed to distinguish between life and accident and health insurance. While the life insurance contracts at issue provided for monthly insurance payments upon total and permanent disability, the payments did not transform them into life insurance contracts combined with health and accident insurance. Moreover, the insurance company could not package casualty coverages together with death benefits in order to change the overriding characteristic of the policy for tax purposes without violating state ( Iowa ) law. In addition, reserves established for casualty claims are accrued liabilities that did not come within the purview of Code Sec. 801(b)(1)(B) . Most importantly, since the deduction for interest to non-life insurance reserves was allowed on the same basis as interest credited to life insurance reserves, there was no tax incentive to package health and accident benefits with life insurance benefits.

[Code Sec. 804 ]

Insurance: Advertising expenses.--A mutual insurance corporation's deduction of advertising expenses was rendered moot by a settlement of the matter prior to the issuance of the opinion. Through written correspondence, an offer to settle the deduction issue was proposed by the corporation, but the government's acceptance contained variant terms. Because the corporation did not apprise the government of its erroneous understanding until after the opinion in the corporation's favor was issued, the acceptance was deemed valid.

[Code Sec. 804 ]

Insurance: General expenses.--On motion for reconsideration, the court upheld its determination that panels of the U.S. Court of Appeals for the Federal Circuit failed to follow New World Life Insurance Co. (39-1 USTC ¶9348 , 88 ClsCt 405) when they affirmed Ohio National Life Insurance Co. (807 F.2d 1577 (CA-FC 1986)) and Peoples Security Life Insurance Co. (833 F.2d 1001 (CA-FC 1987)). Because the government's interpretations of Ohio National and Peoples Security were inconsistent with New World , the court was barred from following those interpretations until the Federal Circuit issued an en banc decision overruling New World . Since this had not yet occurred, the court declined to apply a more stringent standard for evaluating general expenses than that established in New World .

[Code Sec. 7122 ]

Compromises: Acceptance of offer: Stipulation of dismissal.--Correspondence between a mutual insurance corporation and the government did not reflect an intention that the filing of a stipulation of dismissal would be a condition precedent to the completion of settlement negotiations. Because the parties entered into a valid settlement agreement, the government's acceptance letter merely stated that a stipulation of dismissal would "reflect" the agreement which had already been reached. As such, a stipulation was not essential to the validity of the parties' settlement agreement.

Bruce Graves, Brown, Winick, Graves , Donnelly, Baskerville and Schoenebaum, 601 Locust St. , Des Moines , Iowa 50309 , for plaintiff. James A. Bruton III , Acting Assistant Attorney General, Robert C. Markham, Mildred L. Seidman, Michael J. Dennis, Department of Justice, Washington, D.C. 20530, for defendant.

OPINION

SMITH, Chief Judge:

This case is before the court on defendant's Motion for Reconsideration pursuant to Rules 59(a) and 82.2(f) of the Rules of the United States Court of Federal Claims (RCFC). The court's earlier opinion in this case, Principal Mutual Life Insurance Company v. United States [92-2 USTC ¶50,392 ], 26 Cl. Ct. 616 (1992), granted plaintiff's cross-motion for summary judgment concerning the waiver of premium benefits, monthly payments from life insurance, advertising expenses, and state examination fees. ¹ The United States contends that this opinion was erroneous for three reasons. First, defendant contends that the portion of the opinion concerning plaintiff's advertising expenses should be stricken as that matter was allegedly settled prior to the issuance of the opinion. Second, defendant argues that the test employed in the court's opinion to distinguish between life and accident and health insurance is unworkable and conflicts with Internal Revenue Code Section 801(b)(1)(B) . Finally, the United States asks the court to reconsider its conclusion that panels of the United States Court of Appeals for the Federal Circuit failed to follow New World Life Insurance Co. v. United States [39-1 USTC ¶9348 ], 88 Ct. Cl. 405, 26 F.Supp. 444 (1939), aff'd [40-2 USTC ¶9832 ], 311 U.S. 620 (1940), when they affirmed Ohio National Life Insurance Co. v. United States [89-1 USTC ¶9298 ], 807 F.2d 1577 (Fed. Cir. 1986), and Peoples Security Life Insurance Co. v. United States , 833 F.2d 1001 (Fed. Cir. 1987).

Upon full consideration of defendant's arguments, and for the reasons set forth below, the court grants in part and denies in part defendant's motion for reconsideration.

FACTS

Because of the complexity of the issues involved, a brief recitation of the facts is warranted. A full statement of the facts and discussion of the insurance reserves structure is set forth in the court's earlier opinion. See Principal Mutual [92-2 USTC ¶50,392 ], 26 Cl. Ct. at 2-6.

Plaintiff, Principal Mutual Life Insurance Company (Principal), is a mutual insurance corporation organized and existing under the laws of the state of Iowa . Its primary business is writing various forms of life and health and accident insurance. During 1977 and 1978, Principal treated various state mandated reserves as deductible from its income. ² In addition, Principal deducted from its income the costs of various advertising expenses. As a result of these and other deductions, Principal's taxable income for 1977 and 1978 was reduced significantly. In August of 1981, the Internal Revenue Service assessed an income tax deficiency of $2,486,917.33 against plaintiff for tax year 1977 and $3,678,350.01 for tax year 1978.

During the years in question in this case, Principal provided group insurance policies which were typically issued to employers as the group policyholder. These policies obligated Principal to provide insurance coverage for renewable one year terms ³ for employees who were actively employed by the group policyholder. Employees covered by these policies were referred to as either "active employees" or "active lives." Employees who became "totally and permanently disabled" while insured under the contract typically received a waiver of the premium and a monthly income. Employees who could demonstrate total and permanent disability were referred to as "disabled employees" or "disabled lives." Once an employee became disabled, Principal was obligated to continue providing these benefits even if the group policyholder cancelled or failed to renew the group insurance contract.

Plaintiff established both an "active lives reserve" and a "disabled lives reserve" to keep sufficient funds to satisfy its obligations under the group policies. When an employee became totally and permanently disabled, the active lives reserve for that employee was eliminated and a disabled lives reserve was created. The basic purpose of the disabled lives reserve was to provide for the payment of a death benefit to disabled employees who died while disabled. However, there were three types of disabled lives reserves which provided three different benefits: (1) waiver of premium benefits; (2) pre-death monthly payments of the life insurance death benefit; and (3) monthly disability income pursuant to accident and health insurance. Only the monthly payments from the life insurance death benefit are at issue in defendant's motion for reconsideration.

Under some of the life insurance policies at issue in this case, disabled employees were entitled to receive the face value amount of their life insurance payable in sixty equal monthly installments so long as the employee remained disabled throughout the sixty-month period. Principal ceased payment after the sixtieth installment, the date of death, or the date of recovery from disability, whichever occurred first. If the disabled employee died before the final installment was paid, Principal paid the commuted value of the unpaid installments to the employee's beneficiary. Thus, the benefits paid to employees monthly from their life insurance policy's face amount during disability: (1) arose from a life insurance contract; (2) were measured by the amount of the employee's life insurance in force; (3) were paid out upon the contingency of death while disabled or pursuant to an acceleration option; and (4) were restored to life insurance upon the employee's recovery from the disability.

On June 30, 1992 , the court determined that the disabled lives reserves established by Principal to provide monthly payments from life insurance qualified as life insurance reserves under Section 801 of the Internal Revenue Code (IRC) and, therefore, were properly treated as deductions by plaintiff for the years in question. In so holding, the court recognized that while the contingency of disability triggers a payment obligation under plaintiff's life insurance policy, the "overriding contingency insured against under this policy is the occurrence of death." Principal Mutual [92-2 USTC ¶50,392 ], 26 Cl. Ct. at 628. In addition, the court found that plaintiff properly deducted investment related advertising expenses in 1977 and 1978. Prior to the court's decision, however, the parties had been actively engaged in settlement negotiations concerning the advertising expenses. Defendant maintains that the parties did, in fact, settle that issue and neglected to inform the court before the decision was issued. Plaintiff contends that there was never a settlement agreement reached between the parties.

DISCUSSION

I. THE ALLEGED SETTLEMENT OF THE ADVERTISING EXPENSE ISSUE

The government asserts that the portion of the court's earlier opinion addressing advertising expenses has been rendered moot by a settlement of that issue. Specifically, defendant contends that "[t]he parties have reached a settlement of the advertising expenses issue, encompassing both the printing and duplicating costs associated with the distribution of the plaintiff's annual report and financial statement, and the general institutional advertising costs (which includes its claimed promotion costs.)" ⁴ Plaintiff disputes this contention, arguing that: (A) there was never a mirror-image acceptance of plaintiff's offer, (B) that there was never stipulation for partial dismissal filed; and (C) plaintiff is not estopped from contending that the advertising expense issued was not settled. As the court finds that defendant validly accepted plaintiff's offer, and that the failure to file a stipulation is not fatal to the resulting agreement, there is no need to address the estoppel argument. The court's reasons for its conclusions are set forth below.

(A) Mirror-Image Acceptance

On January 29, 1991 , plaintiff's counsel sent a letter to defendant's counsel proposing:

that the advertising expenses which were directly related to investment during the taxable years, consisting of (1) the cost of duplicating and distributing the taxpayer's annual financial statements to mortgage loan brokers and investment bankers and (2) the cost of certain promotional items . . . distributed by the investment department, in the amounts of $35,303 in 1977 and $41,665 in 1978, be allowed as investment expenses under Section 804(c) of the Code in effect during these taxable years. ⁵

In addition, plaintiff proposed that the ratio of the taxpayer's gross investment income to its total income, for purposes of allocating the state income taxes to investment under Section 804(c), would be 23.19% for 1977 and 24.02% for 1978.

On February 5, 1991 , defendant replied to plaintiff's letter setting forth the government's understanding that:

[t]he claims for general advertising expenses as investment expenses . . . would be resolved by allowing as investment expenses costs of duplicating and distributing plaintiff's annual financial statement to loan brokers and investment bankers and the costs of certain promotional items distributed by the investment departrment. The total amounts to be allowed are $35,303 for 1977 and $41,665 for 1978.

* * *

We understand that your offer in compromise is made in full settlement of the issues aforementioned and, if accepted, will result in the filing of a stipulation for dismissal of the issues involved with prejudice, the parties to bear their respective costs, including any possible attorneys' fees or other expenses of litigation with respect to such litigation. ⁶

The government also acknowledged plaintiff's proposed ratios of gross investment income to total gross income for 1977 and 1978. Plaintiff was asked to advise defendant in writing whether the government's understanding of the offer was correct. Finally, the government stated that plaintiff's offer would "be processed in accordance with our usual procedure, including obtaining the view of the Chief Counsel, Internal Revenue Office. . . . We are sure you understand that unless you receive a formal notice of acceptance from this office, the Department is in no way committed to a settlement." ⁷

In the government's view, formal notice of acceptance of plaintiff's settlement offer was given in defendant's June 10, 1991 letter to Principal's counsel. In that letter, defendant restated its understanding of plaintiff's offer and advised plaintiff that "this offer has been accepted on behalf of the Attorney General." However, defendant added that "[i]t is our understanding that no refund will result from this action, pending resolution of other issues in this case." ⁸ Plaintiff argues that neither this letter nor the February 5, 1991 letter can be construed as acceptances because they contained variant terms from plaintiff's offer.

As plaintiff points out, it is an elementary principle of contract law that a purported acceptance must mirror the terms of the offer to result in the formation of a contract. A.L. Corbin, Corbin on Contracts §86 (1963) ("If the purported acceptance attempts to restate the terms of the offer, such restatement must be accurate in every material respect. . . . A variation in the substance of the offered terms is material, even though the variation is slight."). Plaintiff contends that the acknowledgement letter recharacterized plaintiff's offer by referring to "general advertising expenses" rather than those "directly related to investment." In addition, plaintiff challenges defendant's statement regarding costs and attorney fees as an unacceptable variation from plaintiff's offer. Finally, plaintiff argues that even if the acknowledgement letter did not constitute a counter offer extinguishing Principal's offer, defendant's June 10, 1991 letter cannot be considered an acceptance because of the refund terms.

Defendant responds that the acknowledgement letter does not amount to a counter-offer as it merely stated the government's understanding of Principal's offer and invited plaintiff to notify defendant if that understanding was erroneous. The court finds the government's position in this regard to be persuasive as plaintiff did not object to defendant's understanding until after the opinion in plaintiff's favor was issued. As the United States Court of Appeals for the First Circuit noted in the seminal case of Dickey v. Hurd, 33 F.2d 415, 418 (1st Cir.), cert. denied, 280 U.S. 601 (1929):

When Mr. Hurd received these communications, he was fully apprised of how Mr. Dickey understood the language of his offer, and, if that was not the meaning which he intended to give to it, it was his duty to have at once informed him. . . . It was not open to him to lie quietly until after the time of acceptance had expired and then say . . . you have not met the requirements.

The court also rejects plaintiff's contention that the refund terms in defendant's June 10, 1991 letter were an unacceptable variance from Principal's offer. Indeed, the court finds this assertion dubious in light of plaintiff's counsel's January 21, 1992 letter to defendant's counsel which offered to settle the advertising expense issue for the 1979 through 1981 taxable years "on the same basis as was done in Plaintiff's case for the 1977-1978 taxable years." ⁹ Thus, the court finds that Principal's January 29, 1991 offer to settle the advertising expense issue for the 1977 and 1978 taxable years was validly accepted by the government's June 10, 1991 letter.

B. The Failure to File a Stipulation for Partial Dismissal

Plaintiff contends that the correspondence between the parties clearly reflects an intention that a stipulation of dismissal would be executed and filed to complete the settlement negotiations. Plaintiff's January 29, 1991 letter specifically provided that, if the proposal was acceptable to the government, the parties would "proceed with the usual stipulation of dismissal concerning these issues." In addition, in the government's June 10, 1991 acceptance letter, defendant advised plaintiff that counsel for the government would "be in touch . . . regarding the filing of an appropriate stipulation to reflect the settlement of these two matters." Thus, plaintiff argues that even if the terms of its offer were validly accepted by defendant, the failure to file a stipulation renders the resulting agreement merely tentative in nature.

In support of that contention, plaintiff relies upon Coopers & Lybrand v. Livesay, 437 U.S. 464 (1978). However, that reliance is misplaced. In a footnote to that case, the Court rejected a mootness claim based upon a settlement agreement where the agreement was tentative and a stipulation of dismissal was not executed. The Court did not, however, as plaintiff implies, find that the lack of a stipulation of dismissal rendered the agreement tentative. In fact, the court described the agreement itself as tentative before addressing the stipulation issue: "[t]he parties entered into a tentative settlement agreement. Respondents and petitioners in [a related case] agreed to dismiss that petition; petitioner in this case, however, did not stipulate to dismissal of its petition." Id. at 465 n.3. Thus, the failure of the parties to stipulate to dismissal in that case was merely further evidence of what was already a tentative agreement.

This approach is in keeping with the well established rule that a binding contract is created at the time the parties reach a final agreement through offer and acceptance, rather than later when the agreement is formally executed by both sides. United States v. Purcell Envelope Co., 249 U.S. 313, 319 (1919); see also Dale Construction Co. v. United States, 168 Ct. Cl. 692, 709 n.8 (1964) (where the parties have reached a binding settlement agreement "it is immaterial that the parties may have contemplated a later, more formal instrument."). In the instant case, as found above, the parties entered into a valid settlement agreement. The correspondence relied upon by plaintiff does not suggest that the filing of a stipulation of dismissal was a condition precedent. Indeed, the government's acceptance letter expressly stated that a stipulation would "reflect" the agreement which had already been reached. As such, a stipulation was not essential to the validity of the parties' settlement agreement. Cheyenne-Arapaho Tribes, et al. v. United States , 229 Ct. Cl. 434 (1982). As the court has found the parties in this case entered into a binding settlement agreement concerning the advertising expenses claimed as investment expenses by plaintiff in this case, that issue is hereby declared moot.

II. DISABLED LIVES RESERVES ESTABLISHED FOR MONTHLY PAYMENTS FROM LIFE INSURANCE

Under IRC 801(b), life insurance reserves are amounts which are computed on the basis of recognized morbidity tables and assumed rates of interest and

. . . are set aside to mature or liquidate, either by payment or reinsurance, future unaccrued claims arising from life insurance, annuity, and noncancellable health and accident insurance contracts (including life insurance or annuity contracts combined with noncancellable health and accident insurance) involving, at the time with respect to which the reserve is computed, life, health, or accident contingencies.

26 U.S.C. §801(b)(1)(B) . In addition to those requirements, life insurance reserves must be required by law in order to qualify as such under Section 801(b) . Id. In its earlier opinion, the court held that Principal's disabled lives reserve, established for monthly payments to employees from their life insurance benefits upon disability, is a life insurance reserve under Section 801(b) . The government now asserts that the reserve cannot qualify as a life insurance reserve because it is a disability benefit derived from a cancelable group contract. Because the life insurance policy in the instant case is combined with accident and health insurance, defendant argues that the disabled lives reserve fails to meet the statutory requirements under Section 801(b) .

The government reads the statute quoted as "expressly deal[ing] with the situation in which the policy insures against death and also provides benefits for sickness or injury resulting in death, designating such policies 'life insurance or annuity policies combined with noncancellable accident and health insurance.' " ¹⁰ In the government's view, the statute provides that in a case in which a policy contains a combination of benefits, the health and accident insurance must be noncancellable. Thus, defendant argues, the court erred in examining the overriding or predominant character of the policy at issue in this case. The court disagrees.

Section 801(b) defines life insurance reserves as amounts set aside for future claims arising from "life insurance, annuity and noncancellable health and accident insurance (including life insurance or annuity contracts combined with noncancellable health and accident insurance . . ." Hence, the statute refers to three types of contracts: life insurance, annuity, and noncancellable health and accident insurance. Combined types of contracts are merely a mixture of the three. The life insurance category clearly includes contracts, such as those involved in this case, which provide life insurance benefits only. The group policies issued by Principal provide for the payment of a sum based upon the amount of the employees' life insurance in force. If the insured became totally and permanently disabled, the monthly payment is $17.70 per $1000 of life insurance. If the employee dies while receiving monthly payments, his beneficiary receives the commuted value of the remaining installments. If the insured recovers, the face amount of his life insurance is reduced by the amount of the payments made to him while he was disabled. Thus, the only benefit provided by the group policies at issue is a death benefit which can be accelerated and paid out in monthly installments in the event of total and permanent disability.

While the life insurance contracts at issue provide for monthly insurance payments upon total and permanent disability, this does not transform them into life insurance contracts combined with health and accident insurance under Section 801(b)(1) . Unlike other policies which provide benefits upon death and separate benefits for health and accident contingencies, the benefits under the group life insurance contracts at issue here are interdependent. The maximum amount paid out by Principal during disability and upon death cannot exceed the amount of life insurance in force. Health and accident disability payments normally end upon the death of the insured and the insured's beneficiary does not receive the balance of any installment payments.

Defendant also contends that the distinction between the types of policies recognized in the court's earlier opinion amounts to a standard which would be impossible to apply in many instances. The government admits that there is a dollar-for-dollar reduction in the principal amount of death benefits payable to a disabled insured who dies while disabled and only one accident and health benefit at issue in this case. However, defendant asserts that in other cases, "a plethora of accident and health benefits, such as hospitalization, surgical expense, loss of time, maternity, and others, may be packaged together with a death benefit." ¹¹ The court's opinion, in the government's view, would allow any kind of insurance, even casualty insurance, to be treated as life insurance simply by packaging them with a death benefit in a policy with a ceiling on the amount of benefits payable.

There are several reasons why defendant's concerns are not persuasive. First, as plaintiff points out, an insurance company could not package casualty coverages together with death benefits in order to change the overriding characteristic of the policy for tax purposes without violating state law and its casualty charter. In addition, reserves established for casualty claims are accrued liabilities which do not come within the purview of Section 801(b)(1)(B) . Most importantly, however, under the Tax Reform Act of 1984, the deduction for interest credited to nonlife insurance reserves is allowed on the same basis as interest credited to life insurance reserves. Thus, there would be no tax incentive to package health and accident benefits with life insurance benefits.

Moreover, the government's arguments concerning the court's ruling on the disabled lives reserves established for monthly payments from life insurance present no "manifest error of law or mistake of fact." Weaver Bailey Contractors, Inc. v. United States , 20 Cl. Ct. 158 (1990). Instead, defendant "merely reasserts . . . arguments previously made . . . all of which were carefully considered by the court." Frito-Lay of Puerto Rico, Inc. v. United States , 92 F.R.D. 384, 391 (D.C. Puerto Rico 1981). Accordingly, there is no reason to grant the government's motion for reconsideration on the disabled lives reserve issue.

III . OHIO NATIONAL LIFE INSURANCE CO. v. U.S. AND NEW WORLD LIFE INSURANCE CO. v. U.S.

Finally, the government argues that the affirmances by the Federal Circuit of the Claims Court decisions in Ohio National and Peoples Security are not inconsistent with New World and, hence, represent binding precedent. In New World , the Court of Claims defined general expenses under §804(c)(1) as those "which are not definitely and entirely either investment or underwriting expenses." 88 Ct. Cl. 458 To be deductible under New World , a general expense must "with some degree of reasonableness, be said to have some direct relationship to the investment department and also to be reasonably susceptible of division and assignment" to the investment department. Id. at 435.

In its previous opinion in the instant case, the court found that Ohio National construed New World as setting forth a more stringent standard for evaluating general expenses. Principal Mutual [92-2 USTC ¶50,392 ], 26 Cl. Ct. at 633-34 (noting that the court in Ohio National found that New World offered "more particularized expressions of the general definition for investment expenses."). In addition, this court acknowledged that this interpretation of New World had been adopted by Peoples Security and that both the latter and Ohio National were affirmed Per Curiam by the Federal Circuit. Id. at 634-635. However, as the court expressed in the previous opinion, the government's interpretation of the decisions in Ohio National and Peoples Security are inconsistent with New World . Thus, the court is barred from following these interpretations until the Federal Circuit issues an en banc decision overruling New World . Id. at 635. As that has not yet occurred, the court again declines to apply a more stringent standard for evaluating general expenses than that established by the Court of Claims in New World .

CONCLUSION

For the foregoing reasons, the court declares the portion of its earlier opinion concerning advertising expenses moot as a result of the parties' settlement agreement but denies the remainder of defendant's motion for reconsideration. As established by the court's June 3, 1993 order, the parties shall have sixty days from the date of this opinion to submit a joint status report.

¹ The court also granted defendant's motion for summary judgment as it applied to agents' debit balances and to monthly income pursuant to accident and health insurance. Those portions of the opinion have not been challenged by plaintiff.

² Reserves are established by insurance companies to set aside sufficient funds to cover anticipated liabilities under their policies. States require the establishment of reserves to protect policyholders and to ensure the solvency of insurance companies.

³ Principal was not obligated to renew these policies and could discontinue them by giving 31 days' notice to the group policyholder.

⁴ Defendant's Motion at 2.

⁵ Appendix B to Defendant's Motion at 3.

⁶ Appendix B to Defendant's Motion at 5.

⁷ Appendix B to Defendant's Motion at 6.

⁸ Appendix B to Defendant's Motion at 7.

⁹ Appendix B to Defendant's Motion at 10 (emphasis added). Plaintiff's claims that its counsel lacked settlement authority are equally unavailing. Any lack of authority was cured by plaintiff's failure to object to the settlement agreement within a reasonable time. Smedley v. Temple Drilling Co., 782 F.2d 1357, 1361 (5th Cir. 1986) (A client's failure to object in a timely manner ratifies an unauthorized settlement).

¹⁰ Defendant's Motion for Reconsideration at 5.

¹¹ Defendant's Motion at 5-6.

 

[86-2 USTC ¶9548] William F. Brooks. Plaintiff v. Antone Construction Co., Inc. Anthony J. Frank, Fidelity and Deposit Company of Maryland, and United States of America, Defendants

U.S. District Court, So. Dist. W.Va., Huntington, 83-3528, 5/30/85

[Code Secs. 6321 , 6322 ]

Liens for taxes: Creation of lien.--The tax liens asserted against a construction company that was delinquent in paying employment taxes were established at the time the assessments were made.

[Code Sec. 6323 ]

Liens for taxes: Personalty.--A mechanic's lien, and the suit brought to enforce it, were a chose in action and thus personal property. The tax liens levied against this personal property were properly filed at the residence of the taxpayer, i.e. where the principal executive office was located.

[Code Sec. 6323 ]

Lien for taxes: Filing of Notice: Real vs. personal property.--Tax liens filed prior to an assignment of the property levied upon had priority over the assignment because they were filed at the principal executive office of the delinquent taxpayer before the assignment. The assignee did have priority over one of the tax liens because it was imposed after the assignment had been made.

[Code Sec. 7121 ]

Compromise agreements: Unauthorized agreements.--Tax liens were not extinguished by the IRS acceptance of a compromise offer because the deputy director who accepted did not have the authority to accept. Therefore, the IRS ' acceptance of the offer was not binding.

[Code Sec. 122 ]

Compromises: Acceptance of offer.--The IRS was not estopped from denying that it settled tax liabilities, even though it retained money offered as a settlement, because the procedures set forth for settling disputes were not followed. Since the statutory requirements were not followed, there could be no settlement, and thus no estoppel.

Lawrence J. Lewis, Vinson, Meek, Lewis & Pettit, Huntington , W.Va. , for plaintiff. Antone Construction Co., Inc., Anthony J. Frank, 120 Maple Dr., Heritage, Pa. 16148, pro se. John J. Petro, McNamara & McNamara, 88 East Broad St., Columbus, Ohio 43215-3558, for Fidelity & Deposit Co. of Md. Gary E. Pullin, Assistant United States Attorney, Huntington, W.Va. 25714, Michael J. Kearns, Department of Justice, Washington, D.C. 20530, for defendants.

MEMORANDUM OPINION AND ORDER

STAKER, District Judge:

Plaintiff brought this action seeking a declaratory judgment that his claim to a sum of money being held by the defendant Fidelity and Deposit Company of Maryland (hereinafter "Fidelity") had priority over any tax liens asserted by the defendant United States against that sum of money. In his complaint, plaintiff alleged that he had made certain loans to the defendants Anthony J. Frank and Antone Construction Company (hereinafter "Antone") and that Antone had assigned to him, as security for those loans, an interest in an action Antone had brought in the Circuit Court of Cabell County, West Virginia, to enforce a mechanic's lien against other, unrelated parties. While that state court action was pending the defendant United States , through its Internal Revenue Service, made assessments against Antone for delinquent taxes and caused notices of tax liens therefor to be filed in the Commonwealth of Pennsylvania . Thereafter, according to the plaintiff, the mechanic's lien action was settled with Fidelity for the sum of $310,000.00. The plaintiff, the United States and Fidelity agreed that Fidelity should withhold disbursal of $152,480.23 of that settlement fund pending a resolution of plaintiff's and the United States ' conflicting claims to the amount set aside. Plaintiff and the United States, it is alleged, each contended that he/it had a priority claim to this fund of money based upon the assignment of interest in the law suit and the tax liens, respectively. It is further alleged in the complaint that subsequently the United States compromised and settled its tax claims with Antone; thus extinguishing its asserted liens against the settlement fund. Plaintiff contends that he is, therefore, entitled to the sum of money being held by Fidelity in an amount equal to his assignment from Antone and asks the court to enter a judgment declaring the same.

Defendant Anthony F. Frank answered and admitted essentially all the material allegations in the complaint and disavowed any interest in the funds being held by Fidelity. Defendant Antone answered and likewise admitted the material allegations of the complaint and asserted a right to any surplus that might remain in the funds being held by Fidelity after the lien of either the plaintiff for the United States is satisfied. The United States ' answer pled lack of knowledge of the assignment by Antone to the plaintiff of an interest in the mechanic's lien action; admitted the assessment of tax delinquencies and filing of tax liens against Antone; but denied any settlement of its claims for such taxes or the extinguishment of the liens. Furthermore, the United States filed a cross-claim against Fidelity alleging that its claim to the funds being held by Fidelity had priority over any claim thereto by the plaintiff. It asked this court to determine the priority of the claims to monies held by Fidelity and to order the same to be paid over to the United States . Fidelity, in its answer to the complaint and the cross-claim, declared itself ready to pay over the monies in dispute to whomever this court should determine was entitled thereto.

Thereafter, the plaintiff filed a motion for summary judgment. This was opposed by the United States on the ground that there were genuine issues of material fact still unresolved based upon the evidence submitted in support of and in opposition to the motion. On October 19, 1984, counsel for the plaintiff and the United States appeared before this court to present oral arguments regarding the motion for summary judgment. At that time, it was agreed among counsel and the court that this action could be submitted for decision by the court based upon evidence submitted by the parties and without the necessity of a trial to present live testimony. Therefore, by an order entered October 26, 1984 , this court established a time frame within which the parties would submit their evidence and memoranda of law and also setting a date for oral arguments. This time frame was extended in order to allow the parties to complete discovery. On May 20, 1985 , the United States submitted the evidence it wished the court to consider, accompanied by its memorandum of law. The plaintiff filed a responding memorandum of law ¹ but did not submit any new evidence in addition to that already produced through discovery or in regard to the motion for summary judgment. Thereafter, at plaintiff's request, the court delayed rendering a decision while he sought, unsuccessfully, to intervene in a purportedly related action pending in the United States District Court for the Western District of Pennsylvania. All preliminary matters having been resolved and all evidence having been submitted that the parties wish the court to consider, this action is now ripe for decision. ² There follows the court's findings of fact and conclusions of law, as required by Fed.R.Civ.P. 52, based upon the affidavits, depositions and exhibits attached thereto, answers to interrogatories, materials produced through other discovery, and other exhibits submitted by the parties.