Campbell, TC Memo 2019-4
The Tax Court has concluded that IRS’s determination to sustain the proposed levy action regarding the taxpayer’s unpaid tax liability was an abuse of discretion. In rejecting the taxpayer’s offer-in-compromise (OIC), the IRS Appeals officer improperly determined his reasonable collection potential.
Background. In connection with a collection due process (CDP) hearing, an Appeals officer must verify that the requirements of applicable law and administrative procedure have been met, consider issues properly raised by the taxpayer, and consider whether any proposed collection action balances the need for the efficient collection of taxes with the taxpayer’s legitimate concern that any collection action be no more intrusive than necessary. (Code Sec. 6330(c)(3))
Code Sec. 6320(a)(1) and Code Sec. 6330(a)(1) require IRS to give a taxpayer written notice when a Federal tax lien is filed upon the taxpayer’s property or IRS intends to levy upon the taxpayer’s property. Code Sec. 6331(a)generally authorizes IRS to collect tax liabilities by levy against all property and property rights of the taxpayer. A levy is meant to reach every interest in property that a taxpayer might have, including property held by a third party if that third party is holding the property as a nominee or alter ego of the taxpayer. (G.M. Leasing Corp. v. U.S., (S Ct 1977) 429 U.S. 338)
An OIC is an offer made by the taxpayer to IRS to enter into a contract in which IRS agrees to accept an amount different from what the taxpayer owes in taxes. (Reg § 601.203) There are three grounds for such a compromise: (1) doubt as to liability; (2) doubt as to collectibility; and (3) promotion of effective tax administration. (Code Sec. 7122(a), Reg § 301.7122-1(b))
IRS may compromise a tax liability on doubt as to collectibility where the taxpayer’s assets and income render full collection unlikely. When a taxpayer submits an OIC based on doubt as to collectibility, the Appeals officer follows Internal Revenue Manual (IRM) guidelines to determine the taxpayer’s RCP. (IRM pt. 22.214.171.124 (Jan. 18, 2018)) Those guidelines consist of determining: (1) assets, including dissipated assets, (2) future income, (3) amounts collectible from third parties, and (4) assets available to the taxpayer but beyond the reach of the Government. (IRM pt. 126.96.36.199.1 (Apr. 30, 2015)) Under IRS procedures, IRS will not accept a compromise that is less than the RCP value of the case absent a showing of special circumstances. (Rev Proc 2003-71, sec. 4.02(2)) IRS has no duty to negotiate with a taxpayer before rejecting an OIC. (Fargo v. Comm., (CA9 2006) 97 AFTR 2d 2006-2381, affg (2004) TC Memo 2004-13)
According to the IRM, including dissipated assets in calculating the RCP is applicable only in situations where it can be shown the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or otherwise used the assets for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or during a period up to six months prior to the tax assessment. (IRM pt. 188.8.131.52(1) (Mar. 23, 2018)) The IRM instructs Appeals officers to use a three-year look-back period, from the date the offer is made, to determine whether it is appropriate to include dissipated assets in the RCP calculation. The look-back period includes the year that an OIC is submitted. (IRM pt. 184.108.40.206(2)) An Appeals officer is allowed to look beyond the three-year period of the offer submission if the transfer of the asset(s) occurred within six months before or after the assessment of the tax liability.
When a taxpayer submits an OIC based on doubt as to collectibility, the IRS’ calculation of the taxpayer’s RCP includes an analysis of assets available to the taxpayer but beyond the reach of the Government. (IRM pt. 220.127.116.11.1)
Facts. On Apr. 26, 2004, John Campbell (the taxpayer) established the First Aeolian Islands Trust (Trust), an irrevocable grantor trust for Federal tax purposes, in Nevis, West Indies. The duration of the Trust was 99 years unless terminated earlier by the trustee. The taxpayer and his family were named beneficiaries of the Trust, but he anticipated receiving no benefit from the Trust. He funded the Trust with a $5 million contribution. At the time of the contribution, his net worth was approximately $25 million. No contributions to the Trust have been made since his initial contribution in 2004.
Peter Meara was appointed the Trust Protector. The Trust’s organizational documents allowed the trustee to make investments and to create companies for this purpose. John Campbell maintained no control over the trustee to make distributions or investments.
In November 2006, the taxpayer made a $27 million investment in the Gulf Coast region in the “GO-Zone Initiative,” which resulted in a $10,490,130 net operating loss (NOL). Under the Gulf Opportunity Zone Act (GO Zone), the taxpayer was able to deduct that NOL against income reported on previously filed Federal tax returns. At the time of his investment, the taxpayer estimated that his net worth was approximately $19 million, consisting of cash and liquid investments.
The Gulf Coast investments in residential and commercial real estate were structured through limited liability companies (LLCs) which purchased each asset. In addition to his personal cash investment, he personally guaranteed all of the loans the LLCs executed to purchase the assets. He expected a 7% return on his cash investment. After making his cash investment in the GO Zone, he had approximately $6.5 million remaining in liquid assets.
In the summer of 2009, the taxpayer learned that approximately half of the residential properties owned by one of the LLCs, Slidell Property Management, LLC (Slidell), contained contaminated Chinese drywall, making the properties uninhabitable. The lender for the Slidell properties foreclosed on the assets in 2011. At the time of foreclosure, the outstanding balance on the loan for the Slidell assets was approximately $4.5 million. The lender sold the properties in 2011 for approximately $1.35 million.
The taxpayer repurchase the foreclosed property under a State law provision for $1.5 million and sold Slidell’s assets for $1.5 million to Clairise Court, LLC (Clairise Court), another LLC of which he was the sole member. The funds for the purchase were borrowed from Antilles Offshore Investors, Ltd., an LLC wholly owned by Antilles Master Fund, which in turn had two investors: the taxpayer and Liberty Mountain Corp. (Liberty), a corporation wholly owned by the Trust.
IRS issued a statutory notice of deficiency for 2001 to the taxpayer. IRS and the taxpayer reached a settlement that entitled the taxpayer to deduct his NOL carryback from his GO Zone investment against his 2001 tax liability. The Court entered a decision determining that for tax year 2001 the taxpayer was liable for a deficiency of $1,135,192 and an accuracy-related penalty of $113,519. IRS assessed the additional tax and penalty, and subsequently issued a final notice of intent to levy (levy notice), informing the taxpayer of IRS’s intent to collect his 2001 unpaid tax liability and providing notice of his right to a CDP hearing.
The Appeals officer rejected the taxpayer’s OIC of $12,603 because she calculated that the taxpayer’s RCP as $19.5 million, which included dissipated assets, amounts collectible from third parties, and assets beyond the reach of the Government. The taxpayer contended that the Appeals officer abused her discretion by failing to consider relevant issues he raised during the CDP hearings.
Court’s conclusion. The Tax Court determined that it was an abuse of discretion for the Appeals officer to include the Trust assets and the taxpayer’s 2006 investments in the GO Zone as dissipated assets.
Under the IRM guidelines, the Appeals officer should have looked only to 2012 for any dissipated assets, although she could have looked back to the assessment date, Apr. 19, 2010, for any dissipated assets if there was a transfer of assets within the six months before or after the assessment date. However, in the RCP calculations, IRS included as dissipated assets the funds the taxpayer had transferred to the Trust on Apr. 26, 2004, 6 years before the assessment period look-back and 10 years before he made his OIC.
On May 10, 2004, after making the Trust contribution, the taxpayer was notified that his 2001 return was under examination. The taxpayer was not aware of a potential audit examination of his 2001 tax return or any increased income tax liability that might arise from the examination until after making his contribution to the Trust. But even if he were, the Court reasoned that his net worth after making the contribution to the Trust exceeded any potential tax liability arising from the examination of his 2001 Federal tax return. During the CDP proceedings, the taxpayer demonstrated that his net worth was $19 million in 2006, an amount that would have more than covered the deficiency for 2001.
The Court also rejected IRS’s assertion that the funds the taxpayer used for the production of income between 2006 and 2010 should be included in the taxpayer’s RCP as dissipated assets. IRS contended that in 2006 the taxpayer knew the examination results for his 2001 tax return and asserted that if the taxpayer had conserved his assets he would have over $14 million available to pay his tax liability. In reaching this conclusion, IRS increased the taxpayer’s RCP to just over $19.5 million. IRS concluded that it was unreasonable for the taxpayer to make the investments he made between 2006 and 2010 because of the loss he suffered and because he had a “duty to preserve sufficient assets” to pay a tax obligation of which IRS had made him aware.
The Tax Court determined that the taxpayer did not waste his wealth in an effort to deprive the Government or to shirk his financial obligation to the public fisc. In 2006 the taxpayer made a substantial investment in the Gulf Coast region under the GO Zone legislation. After making the investment, he still had cash on hand of more than $6 million. He was unaware of the Chinese drywall issue that affected many of the properties he purchased through the LLCs and the looming financial crisis. IRS provided no consideration of these issues in its notice of determination and instead asserted that the taxpayer wasted his wealth in an effort to establish a loss. The Court found that there was no indication in the record, and that none was demonstrated at trial, that the taxpayer invested in the GO Zone in an attempt to avoid paying his 2001 tax liability.
Amounts collectible from third parties. The Court also rejected IRS’s determination that the Trust held assets as a transferee, nominee, or alter ego of the taxpayer. In response, the taxpayer contended that as a beneficiary of the Trust, he did not hold a property interest in the Trust asset.
The Tax Court noted that the Supreme Court has stated that the transferee, nominee, or alter ego theory requires a two-part analysis, which looks first to State law to determine what rights a taxpayer has in property and then turns to Federal law to determine whether a taxpayer’s rights in that property qualify as property or rights to property under Federal tax law. (Drye v. U.S., (S Ct 1999) 84 AFTR 2d 99-7160)
While IRS found that the Supreme Court of Connecticut (the applicable State) would adopt Federal principles of nominee theory, the Tax Court concluded that IRS failed to present any evidence that Connecticut courts have applied or adopted a nominee theory. The Tax Court determined that it was not in a position to say that the judicial branch of Connecticut would adopt such a theory.
In addition, the Trust document indicated that the taxpayer had no control over the trustee and couldn’t force the trustee to make distributions or investments. Because IRS failed to presented any evidence supporting the determination that the taxpayer had a property right in the Trust under State law, the Court found that IRS’s determination that the Trust was a nominee of petitioner was arbitrary, capricious, and without sound basis in fact or law. Accordingly, the Court found that the Appeals officer abused her discretion in making that determination.
Assets available to the taxpayer but beyond the Government’s reach. The Tax Court also rejected IRS’s alternative contention that, because the taxpayer appointed the Trust Protector, and because the Trust indirectly invested in the taxpayer’s GO Zone business ventures, the taxpayer maintains sufficient control over the Trust and thus had access to the Trust’s assets.
The Court noted that Trust’s organizational documents allowed the trustee to make investments and to create companies for the purpose of making investments. In the investment at issue — which the taxpayer proposed to funded Clairise Court’s repurchase of the properties previously owned by Slidell — the taxpayer described, in detail, his personal conflicts of interest in the investment. The trustee, in its sole discretion, directed a portion of the Trust’s assets to be invested in Antilles Offshore Investors, Ltd through Liberty, which the Trust created as an investment vehicle.
The Court concluded that the Trust’s assets were not considered assets available to the taxpayer but beyond the reach of the Government. Therefore, the Tax Court determined that the Appeals officer abused her discretion in determining that the taxpayer had control over the Trust’s assets.
References: For offers in compromise, see FTC 2d/FIN ¶T-9601; United States Tax Reporter ¶71,224.01. For balancing the need for efficient collection with legitimate taxpayer concerns relating to levies, see FTC 2d/FIN ¶V-5267.2; United States Tax Reporter ¶63,304.