Acceptance of an Offer in Compromise May Preclude Further Relief

By Bruce M. Bird

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Dutton

In 1999, the taxpayer in Joseph Dutton v. Comm’r [122 T.C. 7 (2004)] submitted Form 8857, Request for Innocent Spouse Relief, for the taxable years 1984, 1985, and 1986. On April 24, 2001, the taxpayer submitted an amended Form 656, Offer in Compromise (OIC), in which he offered to compromise all income tax liabilities for 1986, 1987, and 1993–1999. The taxpayer submitted his offer on the basis of doubt as to the liabilities’ collectability. The taxpayer offered to pay $6,000 at a rate of $250 per month.

Form 656 provides that the taxpayer will not dispute the amount of the liability once the IRS accepts the offer in writing. It also provides that the OIC may be withdrawn by the taxpayer or by his representative at any time before the Commissioner accepts it.

In a letter dated May 7, 2001, an IRS manager informed the taxpayer of possible partial relief for 1986 and 1987 from joint and several liability under IRC section 6015(c), but that relief under other provisions would be denied in full. In the letter, the IRS manager also stated that no additional payments would be due, and that, to the best of his knowledge, after the recommended relief was granted, the petitioner would be entitled to refunds for 1986 and 1987.

On July 9, 2001, the taxpayer’s counsel sent a letter to the IRS manager regarding the taxpayer’s relief from joint and several liability. The letter stated that an IRS employee, in reviewing the taxpayer’s claim, had referenced IRC section 6015(c) and indicated that there would be no refund of the disputed debt. In another letter to the IRS manager, dated July 23, 2001, the taxpayer’s counsel indicated that he had recently discussed the taxpayer’s claim for relief with an “innocent spouse coordinator.” The coordinator indicated that no refund procedure existed when a claim is approved under section 6015(c).

On July 25, 2001, the IRS sent a letter accepting the OIC in the amount of $6,000, subject to the conditions and provisions stated on Form 656. The letter listed the taxpayer’s total account balance, as of April 30, 2001, for 1986, 1987, and 1993–1999, as $185,962. Balances of $37,162 and $84,124 related to 1986 and 1987, respectively. The taxpayer ultimately completed the payment plan for his OIC.

At trial, the Tax Court addressed whether the taxpayer is barred from seeking relief from joint and several liability because the OIC was accepted or whether the offer can be rescinded on the basis of a mutual mistake or a misrepresentation.

The Tax Court first examined IRC section 6015, which provides three avenues of relief from joint and several liability. Section 6015(b) provides relief similar to that available under former section 6013(e), and also allows a spouse to be relieved from a portion of an understatement of tax. Section 6015(c) generally provides for an allocation of liability for deficiencies as if the spouses had filed separate returns. Section 6015(f) allows for equitable relief in situations where relief is unavailable under 6015(b) or (c).

The Tax Court next examined IRC section 7122, which governs OICs. The court noted that an OIC may be withdrawn by the taxpayer or his representative at any time prior to its acceptance. The offer is considered withdrawn when the Commissioner receives such written notification by personal delivery or certified mail, or when the Commissioner issues a letter confirming the taxpayer’s intent to withdraw the offer.

Absent fraud or mutual mistake, an OIC, once accepted, will conclusively settle the liability of the taxpayer as specified in the offer itself [Estate of Jones v. Commissioner, 795 F.2d 566 (6th Cir. 1986), aff’g T.C. Memo 1984-53]. In order to reopen the case, the mistake must be mutual and “of material fact sufficient to cause the offer agreement to be reformed or set aside” [Temporary Procedural and Administrative Regulations section 301.7122-1T(d)(5)].

In its analysis, the Tax Court examined the OIC within the context of generally established principles of contract law. A mutual mistake exists where there has been a meeting of the minds of the parties, and an agreement actually entered into, but the agreement in its written form does not express the actual intention of the parties [Woods v. Commissioner, 92 T.C. 776, at 782 (1989)]. Black’s Law Dictionary (7th ed., 1999) defines a material fact as one “that is significant or essential to the issue or matter at hand.”

The taxpayer argued that the OIC should be set aside because the IRS manager mistakenly stated that refunds would be allowed for any relief granted under section 6015(c). The taxpayer contended that the projected refund allowance would have eliminated his 1986 and 1987 liabilities, fully paid his outstanding balance for 1993–1999, and given him a refund of approximately $81,000. The taxpayer contended that he would not have agreed to an OIC had he known he was waiving his right to any refunds.

The Tax Court noted that the mistake in question—the incorrect statement by the IRS manager—occurred approximately two weeks after the taxpayer had submitted Form 656, under which the taxpayer would no longer be able to contest his tax liability for those tax years. The taxpayer did not put forth any evidence that, at the time of making the offer, the IRS manager had given him the impression that, if the offer had been approved, the IRS would have issued him a refund for tax years 1986 and 1987 under the innocent spouse rules under IRC sections 6015(b), (c), or (f).

Moreover, both the mistake in question, and the actions of the taxpayer’s counsel clarifying the existence of a mistake, occurred between the time the taxpayer made the offer and the time the IRS accepted it. While no evidence existed that the taxpayer’s offer was originally based on his erroneous assumption of the possible refund windfall in the first instance, had the taxpayer later wished to withdraw the offer, he had time to do so.

Accordingly, the Tax Court held that no sufficient mistake existed at the time the taxpayer submitted his offer or when the IRS accepted it. Stated alternatively, based on the facts presented, the taxpayer, in making his OIC, did not rely on any misrepresentations made by the IRS manager regarding the taxpayer’s right to receive a refund under IRC section 6015(c).

The Tax Court also noted that IRC section 6015(g)(1) refers to IRC section 7122, which governs offers. Thus, even if the taxpayer were granted relief under section 6015(b) or (f), the taxpayer would not be entitled to receive a refund under the terms of the OIC.

Johnston

In a letter dated January 31, 2003, the taxpayers in Thomas E. Johnston and Thomas E. Johnston, Successor in Interest to Shirley L. Johnston, Deceased [122 T.C. 6 (2004)] made a qualified offer, pursuant to IRC section 7430, to resolve the taxpayers’ tax liabilities relating to their docketed cases before the Tax Court for 1989, 1991, and 1992. In a letter dated February 10, 2003, the IRS accepted the taxpayers’ qualified offer without negotiation. The taxpayers then sought to reduce the amounts stated in the qualified offer by the amount of net operating losses (NOL) sustained in 1988, 1990, 1993, and 1995.

The IRS refused to allow such a reduction, claiming that its acceptance of the taxpayers’ qualified offer prevented the taxpayers from reducing the agreed-upon amounts. In response to the taxpayers’ amended petition claiming deductions for the NOLs in question, the IRS filed a motion for summary judgment.

The taxpayers contended that their qualified offer included only items in dispute in the cases before the Tax Court at the time the offer was made. Furthermore, because the issue of the NOLs was not in dispute at that time, their qualified offer was exclusive of the amounts related to the NOLs. As such, the taxpayers contended the NOLs could be used to reduce the agreed-upon amounts for the years in question.

In its analysis, the Tax Court first noted that all parties to the controversy agreed that the taxpayers made a qualified offer within the meaning of IRC section 7430(g). IRC section 7430 provides for the award of administrative and litigation costs to a taxpayer under circumstances where the taxpayer is the “prevailing party”; has exhausted available administrative remedies (in the case of litigation costs); did not unreasonably protract the administrative or judicial proceeding; and claimed reasonable costs. The court noted with emphasis [122 T.C. 6 (2004)], “One way for a taxpayer to establish that the taxpayer is the prevailing party is by a comparison of the amount of the last qualified offer with the portion of the judgment attributable to the adjustments at issue when that qualified offer was made.”

Legislative history indicates that the purpose of IRC section 7430 is to encourage the settlement of tax cases whenever possible [S. Rept. 105-174, at 48 (1998), 1998-3 C.B. 537, 584]. In a related decision, Gladden v. Comm’r [120 T.C. 446, 450 (2003)], the Tax Court held that the qualified-offer provision encourages settlements by imposing litigation costs on the party not willing to settle. As a result, in Johnston, the Tax Court concluded that no persuasive reason exists why a settlement reached by reason of a qualified offer should be treated any differently from any other type of settlement agreement [122 T.C. 6 (2004)].

OIC in Settlements

As contracts, settlements are governed by general principles of contract law. No particular method or form is required [Dorchester Indus. Inc. v. Commissioner, 108 T.C. 320, at 330 (1997), aff’d. w/o published opinion, 208 F.3d 205 (3rd Cir., 2000)]. Thus, letters of offer and acceptance can be used to settle an issue. A settlement agreement is effective and binding once there has been an offer and an acceptance. To be effective and binding, it is not necessary that a settlement agreement be filed with the court.

In Johnston, the Tax Court held that the taxpayers’ letter dated January 31, 2003, constituted the definite and material terms of an offer to settle the docketed cases, and it held that the IRS’s letter dated February 10, 2003, constituted a valid acceptance of that offer. As a result, the taxpayers’ qualified offer resulted in an effective and binding contract.

The taxpayers further contended that the temporary regulations promulgated under IRC section 7430 supported their position that new issues may be raised after an agreement is reached if the agreement is reached by way of the qualified-offer provision. Temporary Procedural and Administrative Regulations section 301.7430-7T(c)(3) contains three requirements for the offered amount:

• It must specify the dollar amount for the liability;
• It must be with respect to all adjustments at issue and only those adjustments; and
• It must be an amount that will fully resolve the taxpayer’s liability for the types of tax and the tax years at issue.

The Tax Court held that the plain language of the third requirement, which provides that the offered amount be that amount which will fully resolve the taxpayer’s liability, prevents the taxpayer from raising new issues once a qualified offer is accepted. In order to comply with the third requirement, the taxpayers should have at least stated in their letter that such offered amount was subject to reduction by application of their NOLs.

Tax Planning Implications

The Dutton decision stands for the proposition that, in order for an accepted OIC to be set aside, the taxpayer must prove either a mutual mistake of a material fact or a misrepresentation. Note that, although the IRS manager made a mistaken statement, the taxpayer’s reliance upon it must be demonstrated in order for an OIC to be set aside.

Also notable is that the Tax Court in Dutton did not consider the taxpayer’s argument involving the doctrine of equitable estoppel. The taxpayer raised this argument for the first time in his answering brief [122 T.C. 7 (2004)]. The Tax Court makes it practice not to consider new issues raised at such time and in such manner.

In Dutton, the taxpayer, while pursuing an innocent spouse claim involving tax years 1986 and 1987, submitted an OIC involving a number of tax years that included 1986 and 1987. Pursuing dual claims involving overlapping tax years can be a recipe for confusion. The taxpayer should have waited until his innocent spouse claim had been resolved before submitting an OIC. Alternatively, the taxpayer (or counsel) should have rescinded the offer upon discovering the IRS manager’s statement.

In Johnston, the Tax Court mentioned that the taxpayers should have at least stated in their letter to the IRS—the qualified offer—that the amount was subject to reduction by application of NOLs. Stated alternatively, the fact the NOLs were not in dispute at the time the qualified offer was made was the result of the taxpayers’ own actions.

The Dutton and Johnston decisions serve as cautionary tales. Care must be taken both in drafting an OIC and in deciding when to submit it. Typically, absent fraud or mutual mistake, an accepted OIC will not be set aside, even if the taxpayer is unaware of or surprised by its collateral effects.