Friday, July 31, 2009

[ Code Sec. 7122] Offer in compromise (OIC): Bankruptcy distribution. -- The IRS Appeals office acted within its discretion in rejecting a married couple's offer-in-compromise (OIC). Appeals had a legitimate concern that it could forfeit its right to the couple's bankruptcy distribution.

Claude E. Salazar, Dana L. Salazar, Petitioners-Appellants v. Commissioner of Internal Revenue, Respondent-Appellee.

U.S. Court of Appeals, 2nd Circuit; 08-2670-ag(L), 08-3842-ag(CON), July 23, 2009.

Unpublished opinion affirming the Tax Court, 95 TCM 1149, Dec. 57,342(M), TC Memo. 2008-38, and 91 TCM 659, Dec. 56,410(M), TC Memo. 2006-7.

[ Code Sec. 6404]

Before: Calabresi and Katzmann, Circuit Judges, and Eaton, Judge.



UPON DUE CONSIDERATION of the appeals from the United States Tax Court (Goeke, J.), it is hereby ORDERED, ADJUDGED and DECREED that the decisions of the Tax Court are AFFIRMED.

Appellants Claude E. Salazar and Dana L. Salazar (collectively, "Taxpayers") appeal pro se from the Tax Court's decisions entered on February 25, 2008 and June 2, 2008, sustaining the collection by levy of unpaid employment taxes for the calendar quarters ending December 31, 1998, through June 30, 2001, and unpaid personal income taxes for the years 1997, 1998, and 1999. We assume the parties' familiarity with the underlying facts, the procedural history, and the issues on appeal.

Taxpayers jointly operated an art gallery in Nevada that was organized in Mr. Salazar's name as a sole proprietorship. Certain of the gallery's employment taxes were not paid from 1998 to 2001, and the Taxpayers failed to pay their personal income taxes for the years 1997, 1998, and 1999. In January 2001, Taxpayers filed for Chapter 13 protection, which was later converted to a Chapter 7 proceeding. The Internal Revenue Service ("IRS") filed a proof of claim, later amended, in the bankruptcy proceeding covering these tax liabilities, to which Taxpayers did not object. Taxpayers received a discharge in July 2002, however, their tax liabilities were non-dischargeable. See 11 U.S.C. § 523(a)(1)(A). In August 2005, the bankruptcy trustee disbursed some funds to the IRS, which it applied solely to the employment tax liability.

On October 27, 2003, during the course of the bankruptcy proceeding, the IRS issued a notice of intent to levy for Taxpayers' unpaid income taxes. This notice informed Taxpayers that they had the right to a collection due process ("CDP") hearing with the IRS Appeals Office. Taxpayers asked for a hearing, during which they submitted an offer-in-compromise ("OIC") to the Appeals Office seeking to resolve all outstanding income tax liabilities. Thereafter, having reviewed the IRS Internal Revenue Manual ("IRM"), the Appeals Office rejected Taxpayers' OIC, explaining that accepting it could jeopardize the IRS's ability to collect an additional $20,000 from the Taxpayers' bankruptcy distribution, and noting that Taxpayers had declined to increase their offer by that amount.

On February 22, 2006, the IRS issued an additional notice of intent to levy Mr. Salazar's assets to satisfy the employment tax liability. He likewise asked for a CDP hearing, during which he indicated that he wished the Appeals Office to reconsider its decision not to accept the first OIC. He further objected to the accrual of post-petition interest and to the IRS's decision to apply Taxpayers' joint bankruptcy distribution solely to the employment tax liability. Mr. Salazar then submitted a second OIC in an effort to settle all of Taxpayers' liabilities. After a hearing, the Appeals Office rejected the second OIC, finding that the IRS's reasonable collection potential far exceeded the amount offered. The Appeals Office then issued a notice of determination sustaining the levy.

Taxpayers filed separate petitions in the Tax Court, 2 which were consolidated. The Tax Court then issued a single Memorandum Findings of Fact and Opinion, although it later entered separate decisions on each petition. In doing so, the Tax Court sustained both levies.

Three primary arguments 3 are raised on appeal: (1) that the Appeals Office erred in rejecting Taxpayers' first OIC; (2) that post-petition interest should not have accrued on tax liabilities that were paid by the distribution of funds from the bankruptcy; and (3) that the Tax Court erred in permitting the IRS to apply the August 2005 bankruptcy distribution solely to the employment tax liability.

We review the Tax Court's decisions de novo, and therefore we stand in the shoes of the Tax Court and review the Appeals Office's determinations for abuse of discretion where the underlying liability is not at issue and de novo when it is. See Robinette v. Comm'r, 439 F.3d 455, 462 (8th Cir. 2006); see also Living Care Alternatives of Utica, Inc. v. United States, 411 F.3d 621, 625, 628-31 (6th Cir. 2005).

Taxpayers insist that the Appeals Office's rejection of their OIC, (1) based on Taxpayers' refusal to increase their offer to account for the IRS's possible recovery in bankruptcy; and (2) based on the IRS's reliance on the IRM, was unlawful. These contentions are without merit. As the Tax Court observed, the record reveals that the Appeals Office had a legitimate concern about forfeiting the IRS's right to Taxpayers' bankruptcy distribution and there was nothing improper about it consulting the IRM. See Salazar v. Comm'r, T.C. Memo 2008-38, 2008 WL 495313, at *9 ("[The Appeal's Office] was simply applying respondent's guidelines on evaluating offers-in-compromise, including the reasonable collection potential, to the specifics of petitioners' offer."). Further, Taxpayers have made no serious argument as to why the Appeals Office should not consult the IRM. See Christopher Cross, Inc. v. United States, 461 F.3d 610, 613 (5th Cir. 2006) ("Taxpayer has offered no viable support for its contention that the Officer cannot utilize the guidelines set forth in the Manual when making the discretionary decision to return a submitted offer in compromise."). Thus, because the Appeals Office acted within its discretion and, in fact, consistent with the relevant Treasury regulation, the Tax Court's decision must be affirmed. See 26 C.F.R. § 301.7122-1(c)(1) ("[T]he decision to accept or reject an offer to compromise ... is left to the discretion of the Secretary."); see also 26 U.S.C. § 7122(a) ("The Secretary may compromise any civil or criminal case arising under the internal revenue laws ....") (emphasis added)); Murphy v. Comm'r, 469 F.3d 27, 32 (1st Cir. 2006) ("We will only disturb the rejection of [an] offer-in-compromise if it represents a clear abuse of discretion in the sense of clear taxpayer abuse and unfairness by the IRS.") (internal quotation marks omitted)).

Taxpayers next argue for abatement of interest on their tax liabilities because of an alleged delay in distribution of funds by the bankruptcy trustee. As to this claim, the Tax Court noted that the IRS "was no more in control over the distribution of the bankruptcy proceeds than were [Taxpayers]" and held that the IRS was not prohibited from seeking interest for the time period that Taxpayers' bankruptcy proceeding was pending. See Salazar, T.C. Memo 2008-38, 2008 WL 495313, at *12 (citations omitted). In reaching its conclusion, the Tax Court relied in part upon Woodward v. United States, 113 B.R. 680, 684 (Bankr. D. Or. 1990), in which the court explained that most courts that have considered the issue of whether a debtor remains liable for post-petition interest have found the Supreme Court's decision in Bruning v. United States, 376 U.S. 358 (1964), controlling.

We, too, believe that Bruning v. United States, whatever its full scope may be, precludes these Taxpayers from arguing that post-petition interest could not accrue on non-dischargeable tax liability. See 376 U.S. at 360 (explaining that "logic and reason indicate that post-petition interest on a tax claim excepted from discharge ... should be recoverable in a later action against the debtor personally"); see also In re Johnson Elec. Corp., 442 F.2d 281, 284 (2d Cir. 1971). Moreover, Taxpayers would have remained liable on their non-dischargeable liability --including interest --even had the IRS not filed a proof of claim in their bankruptcy proceeding. See 11 U.S.C. § 523(a)(1)(A). Therefore, we find Taxpayers' claim that the IRS is not entitled to collect post-petition interest to be without merit.

Finally, Taxpayers argue that the Tax Court erred in permitting the IRS to apply Taxpayers' bankruptcy distribution to the employment tax liability. Here, we review the Tax Court's conclusion of law de novo. See Sunik v. Comm'r, 321 F.3d 335, 337 (2d Cir. 2003); 26 U.S.C. § 7482(c)(1). Taxpayers claim that the application of the distribution to what they insist is Mr. Salazar's liability alone is unfair. Notwithstanding Taxpayers' fairness concerns, this claim must fail. The payments from Taxpayers' bankruptcy estate were involuntary, and, therefore, Taxpayers had no entitlement to designate where those payments were to be applied. See United States v. Pepperman, 976 F.2d 123, 127 (3d Cir. 1992) ("Under ... long-standing IRS policy, taxpayers may designate the application of tax payments that are voluntarily made, but may not designate the application of involuntary payments."); In re Kaplan, 104 F.3d 589, 596 n.16 (3d Cir. 1997) ("[A] tax payment has been considered 'involuntary' when it is made to agents of the United States as a result of ... levy or from a legal proceeding in which the Government is seeking to collect its delinquent taxes or file a claim therefor.") (internal quotation marks omitted)). Accordingly, the IRS was free to allocate the funds to Taxpayers' tax liabilities as it saw fit, and it cannot be said to have acted improperly given that the Taxpayers operated the art gallery jointly. See Davis v. United States, 961 F.2d 867, 879 (9th Cir. 1992) ("Involuntary payments, like undesignated [voluntary] payments, may be credited as the IRS desires."); see also Rev. Proc. 2002-26, 2002-1 C.B. 746, at § 3.02 (stating that IRS will apply non-designated payments in a manner that will "serve its best interest").

We have considered Taxpayers' remaining arguments and find them to be without merit. Accordingly, the decisions of the Tax Court are hereby AFFIRMED.

1 The Honorable Richard K. Eaton of the United States Court of International Trade, sitting by designation.

2 Taxpayers originally filed a single joint petition in the Tax Court challenging the Appeals Office's rejection of their first OIC. However, because the employment tax liability was not part of the initial levy, that portion of the petition was dismissed for lack of jurisdiction.

3 An additional argument, concerning the IRS's ability to assess statutory penalties during the pendency of Taxpayers' bankruptcy case, has been resolved by the parties.

Bankruptcy. --Compromises: Bankruptcy

The IRS did not violate 11 U.S.C. §525 when it returned a corporation's offer in compromise (OIC) as nonprocessable during the pendency of its chapter 11 bankruptcy proceeding. IRS policy and procedures provided that, because the corporation was in bankruptcy, processing its OIC was not in the government's best interest. Moreover, mandamus relief was not available to the corporation as an alternative means to compel the government to consider its OIC. The IRS owed no clear duty to the corporation to act as required for mandamus relief. Its discretion to compromise carried with it the discretion not to exercise that discretion.

1900 M Restaurant Associates, Inc., 2007-1 USTC ¶50,116; aff'g, BC-DC D.C., 2005-1 USTC ¶50,313, 319 BR 302.

The IRS was not required to process an offer-in-compromise submitted by debtors in bankruptcy. That type of requirement would be a remedy in the nature of mandamus and that remedy was not appropriate. The IRS owed no clear duty to the debtors and its decision to not process offers-in-compromise submitted by debtors in bankruptcy was solely within its discretion. The plan confirmation process was an adequate alternative remedy to obtain a compromised tax liability from the IRS. Requiring the IRS to negotiate with the debtors outside of the plan confirmation process would not further the provisions of the Internal Revenue Code nor would it foster the ultimate goal of achieving a confirmed plan. The reasoning of 1900 M Restaurant Associates, Inc., BC-DC D.C., 2005-1 USTC ¶50,313, was adopted.

W. Uzialko, BC-DC Pa., 2006-1 USTC ¶50,297.

The District Court affirmed a Bankruptcy Court order requiring the IRS to consider an offer in compromise made by an individual in bankruptcy. The Bankruptcy Court had jurisdiction to make such an order under 11 U.S.C. §105, which states that a bankruptcy court can issue any order necessary to carry out the provisions of the Bankruptcy Code.

W.K. Holmes, DC Ga., 2005-1 USTC ¶50,230.

The IRS was ordered to process and consider an offer in compromise submitted by a debtor despite the agency's published policy of not considering offers in compromise from taxpayers who have filed for bankruptcy. The IRS position of not accepting less than what is required to be paid by a Chapter 13 reorganization plan, as set forth in Rev. Proc. 2003-71, was not required by the Tax Code or Treasury Regulations and did not carry the force and effect of law. Also, the IRS determination not to entertain offers in compromise from those in bankruptcy was not exempt from judicial review as an "agency action."

C. Peterson, BC-DC Neb., 2005-1 USTC ¶50,142, 317 BR 532.

A federal district court upheld a bankruptcy court order compelling the IRS to consider an individual debtor's offer in compromise. The bankruptcy court properly reasoned that the IRS could not dismiss the debtor's offer without processing and considering it, as the IRS does with non-debtor offers. The court reasoned that the offer was not submitted as a request for a discharge of taxes, but rather as a reflection of what the debtor was able to pay. The IRS's policy of mechanically disregarding the debtor's offer in compromise did not allow a "fresh start", as generally promoted by the Bankruptcy laws. Moreover, the rejection of such offers contradicted the IRS's general practice of being flexible in negotiating with debtors. The court rejected the government's claim that the order exceeded the bankruptcy court's jurisdiction pursuant to Bankruptcy Code sections 1129(a)(9) and 1129(a)(7). It was determined that Congress only intended to bar consideration of offers during Chapter 11 proceedings where a debtor did not agree to different treatment of his claim. Finally, the court was not persuaded that the order violated the Anti-Injunction Act.

R.H. Macher, DC Va., 2004-1 USTC ¶50,114, aff'g BC-DC Va., 2003-2 USTC ¶50,537.

The IRS has announced its nonacquiescence with respect to In re Macher, in which a federal district court upheld a bankruptcy court's order compelling the IRS to consider an individual debtor's offer in compromise. The district court found that the IRS's policy of mechanically rejecting a debtor's offer in compromise did not allow the "fresh start," generally promoted by the bankruptcy laws. The district court also found that the IRS's rejection of such offers contradicted the IRS's general practice of being flexible in negotiating with debtors.

Nonacquiescence Announcement, I.R.B. 2004-32, August 9, 2004.

The Chief Counsel has recommended nonacquiescence with respect to In re Macher. In Macher a federal district court upheld a bankruptcy court's order compelling the IRS to consider an individual debtor's offer in compromise. The district court found that the IRS's policy of mechanically rejecting a debtor's offer in compromise did not allow the "fresh start," generally promoted by the bankruptcy laws. The district court also found that the IRS's rejection of such offers contradicted the IRS's general practice of being flexible in negotiating with debtors.

AOD 2004-03, August 5, 2004.

An individual failed to prove that he entered into a contract with the IRS to release a federal tax lien on his real property. Since an IRS agent lacked statutory authority to release the lien prior to the taxpayer's discharge in bankruptcy, he could not accept the taxpayer's offer to release the lien for payment and, thus, there was no mutual assent to a settlement agreement. Moreover, even if a contract had been formed, the existence of a material misrepresentation on the part of the taxpayer would have made the contract voidable.

G.J. Buesing, FedCl, 2000-2 USTC ¶50,724, 228 FSupp2d 908.

An IRS policy not to consider offers in compromise from taxpayers who had filed for bankruptcy was impermissibly discriminatory because it was based solely on the bankruptcy status of the taxpayer and not on the merits of the offer. Failure to consider offers in compromise made by bankruptcy debtors denied the debtors access to procedures set forth in Code Sec. 7122 that were available to all other taxpayers. Further, investigation of offers in compromise did not violate the automatic stay. It was also irrelevant that a bankruptcy filing might transfer the IRS's authority to accept a compromise offer to the Department of Justice. Therefore, married taxpayers who had filed for bankruptcy were entitled to have their offer in compromise considered by the IRS under the same standards as non-debtor taxpayers.

G.E. Chapman, BC-DC W.Va., 99-2 USTC ¶50,690.


D.A. Mills, BC-DC W.Va., 2000-1 USTC ¶50,103, 240 BR 689.

The IRS's rejection of married taxpayers' two offers-in-compromise with respect to both income and employment taxes was not an abuse of discretion. The taxpayers had already filed for bankruptcy when they submitted their first offer-in-compromise (OIC) and the Appeals officer rejected the offer because it was less than what the IRS expected to receive from the bankruptcy distribution and because accepting the offer would risk, if not extinguish, all claims the IRS had to the bankruptcy estate's assets. The IRS also did not abuse its discretion when rejecting the taxpayers' second OIC with respect to the husband's employment tax liabilities because the taxpayers' financial situation had improved by the time the second OIC was submitted and the IRS determined that the taxpayers could pay their liabilities in their entirety. In addition, the taxpayers did not present any argument or evidence to suggest that the rejection of the second OIC was an abuse of discretion.

C.E. Salazar, 95 TCM 1149, Dec. 57,342(M) , TC Memo. 2008-38.

The IRS did not abuse its discretion in rejecting a taxpayer's offer-in-compromise of his outstanding tax liabilities. In evaluating his reasonable collection potential, the taxpayer argued that the IRS failed to make an allowance for his basis living expenses greater than provided in published guidance and that the IRS failed to take into consideration his option to file for bankruptcy and potentially discharge some of the tax liabilities. However, the taxpayer had not disclosed any special circumstances that would warrant allowing him a standard of living more lavish that the standard for the area where he lived. The evidence also indicated that the IRS did consider the possibility that the taxpayer might file for bankruptcy; however, in light of the changes to the bankruptcy law, the IRS believed that the taxpayer would not be able to avoid paying the total tax liability by filing for bankruptcy.

C. Klein, 94 TCM 423, Dec. 57,156(M), TC Memo. 2007-325.

The IRS has issued the 2007 allowable living expense standards. Allowable living expense standards, also known as collection financial standards, are used to determine the ability of a taxpayer to pay a delinquent tax liability. The standards are effective October 1, 2007. For bankruptcy purposes, the effective date for the standards will be January 1, 2008.

IRS News Release, IR-2007-163, October 1, 2007.

An individual's offer-in-compromise, which was based on doubt as to collectibility, was properly rejected because the individual had a reasonable collection potential in excess of $1,000 and he was not in compliance with federal income tax laws. The individual's contention that he was protected under a state law (California) bankruptcy exemption was rejected because it was not properly raised before the IRS Appeals Office. Even if the issue had been properly raised, a federal tax lien would survive a subsequent bankruptcy filing, regardless of any state statute.

A.M. Kun, Dec. 57,513(M), TC Memo. 2008-192.

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