The Tax Court in Brief

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

The Week of August 2 – August 6, 2021

Belair v. Comm’r, Bench Opinion| August 2, 2021 | Weiler, J. | Dkt. No. 22133-19L

• Opinion

Short Summary: On February 28, 2019, Respondent issued a Notice of Federal Tax Lien (“NFTL”) to Petitioner Mary Belair with respect to her income tax liabilities for tax years 2013, 2014, and 2015. Ms. Belair timely mailed her Request for Collection Due Process Hearing on April 3, 2019. Respondent notified Ms. Belair that it could not consider her request for an installment agreement until she filed her delinquent personal income tax returns for 2016 and 2017.

The IRS Appeals officer notified Ms. Belair that the CDP conference would be held on October 16, 2019, and also requested a completed Form 433-A, as well as her tax returns for tax years 2016, 2017, and 2018. Ms. Belair requested a continuance of the CDP hearing, which was denied. During the conference, the IRS Appeals officer advised Ms. Belair that she did not qualify for alternative relief because of the delinquent tax returns. On October 17, 2019, the IRS Appeals officer closed the case, and on November 15, 2019, he issued to Ms. Belair a notice of determination upholding the NFTL. On December 16, 2019, the Court received and filed Ms. Belair’s petition. Respondent filed a motion for summary judgment.

Key Issues:

• (1) Whether IRS Appeals’ denial of Petitioner’s request for an installment agreement was an abuse of discretion.

Primary Holdings:

• (1) Based on the administrative record, IRS Appeals’ denial of Petitioner’s request for an installment agreement was not an abuse of discretion.

Key Points of Law:

• Where the validity of the underlying tax liability is not properly at issue, the Tax Court will review the Commissioner’s administrative determination for abuse of discretion. See Goza v. Comm’r, 114 T.C. 176, 182 (2000).

• In reviewing for abuse of discretion, the Court must uphold the administrative determination unless it is arbitrary, capricious, or without sound basis in fact or law. See, e.g., Keller v. Comm’r, 568 F.3d 710, 716 (9th Cir. 2009).

• It is not an abuse of discretion for Appeals to move ahead with its final determination after an Appeals officer gives a taxpayer an adequate timeframe to submit requested items and the taxpayer fails to submit those items. See Pough v. Comm’r, 135 T.C. 344, 351 (2010).
• Before issuance of a notice of determination, IRS Appeals must verify that all requirements of applicable law and administrative procedure have been met. I.R.C. § 6330(c)(1), (3)(A).

Insight: Tax filing compliance should be viewed by taxpayers as a minimum threshold to pursue collection alternatives. A taxpayer’s additional arguments are more or less irrelevant until tax compliance can be proven. Furthermore, Belair highlights the evaluation of an IRS appeals officer, balancing the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary.

Rogers v. Commissioner, 157 T.C. No. 3 | Aug. 02, 2021 | Toro, J. | Dkt. No. 17985-19W.

Short Summary:

Petitioner submitted nine claims (collectively, the claim) for a whistleblower award under I.R.C. § 7623 to the IRS Whistleblower Office (WBO). The claim had asserted that Petitioner’s extended family members had conspired to commit “grand theft through conversion” of the assets of Petitioner’s mother. Petitioner attached suppo rting documents to his claim, which then became part of an investigation report.

This report was received by the WBO Initial Claims Evaluation team, who then routed the Petitioner’s claim to a classifier in the IRS Small Business Self-Employed (SBSE) operating division. The SBSE classified reviewed the claim and completed a recommendation on each sheet to reject the claim for lack of specificity and credibility. Particularly, the classifier noted that the Petitioner did not “provide documentation to show how much money was embezzled and when money was embezzled.” Generally, the classifier stated the Petitioner failed to provide substantive information to support the allegation, and thus rejected the Petitioner’s claim as permitted under Treasury Regulation 301.7623-1(c)(1) for failure to include specific and credible information to support the allegation, as well as failure to supply documentation to support the claim.

A few days after the SBSE classifier completed his review, a Tax Examining Technician for the WBO drafted an Award Recommendation Memorandum (ARM). The ARM included a notation recommending that the WBO reject Petitioner’s claim, stating the same rationale as the classifier as the basis for rejection.

After the ARM’s preparation, the WBO did not forward Petitioner’s claim to an IRS examiner for possible action with respect to the target taxpayers, but instead, the Initial Claims Evaluation team immediately issued Petitioner a letter (“Letter”) which stated: “The claim has been rejected because the IRS decided not to pursue the information you provided.” Petitioner timely appealed to the Tax Court for review of the WBO’s award determination under I.R.C. § 7623(b)(4). The Commissioner filed an answer that did not address certain monetary thresholds under I.R.C. § 7623(b)(5). The Commissioner then filed a motion for summary judgment, seeking a determination that the WBO did not abuse its discretion in its determination that the Petitioner was not entitled to an award.

Key Issue:

• Did the WBO abuse its discretion in determining that Petitioner was not entitled to an award?

Primary Holdings:

• The monetary threshold set out in I.R.C. § 7623(b)(5)(A) is not a jurisdictional requirement, but rather creates an affirmative defense that must be pleaded in the Respondent Commissioner’s answer.
• The WBO abused its discretion when it found Petitioner was not entitled to a whistleblower award under § 7623, as:
  • (1) the WBO was ambiguous in terms of whether it based its determination on a rejection or a denial-based rationale, and
  • (2) the WBO’s determination was not supported by the administrative record.
• Consequently, the Commissioner’s motion for summary judgment is denied as he could not prove that the WBO’s determination was supported by the administrative record and was not arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.

Key Points of Law:

• Summary Judgment
  • Final agency actions are reviewed under the Administrative Procedure Act (APA).
  • A summary judgment determination such as this serves as a mechanism for deciding, as a matter of law, whether the agency action is supported by the administrative record and is not arbitrary, capricious, abuse of discretion, or otherwise not in accordance with the law.

• Whistleblower Statute—I.R.C. § 7623
  • Section 7623 of the Internal Revenue Code allows for awards to individuals (known as whistleblowers) who submit information to the Government about third parties who either underpaid their taxes or otherwise violated the internal revenue laws.
    • 7623(a) allows for discretionary payments in certain circumstances, while § 7623(b) proves for mandatory (nondiscretionary) awards.
    • Prior to payment of an award, the IRS generally must proceed with an administrative or judicial action and collect proceeds from the target taxpayer. I.R.C. § 7623(b)(1); see alsoR.C. § 7623(a).
  • Under § 7623(b), the WBO first determines whether a whistleblower is entitled to a mandatory award.
    • If an award is due, then the WBO also determines the amount of the award. See I.R.C. § 7623(b)(1), (2), and (3).
    • The Tax Court has jurisdiction to review the WBO’s determinations under section 7623(b), including determinations that no award is due, but it does not have the authority to:
      • order the IRS to commence an administrative or judicial action, or
      • to review its determination of the alleged tax liability to which a whistleblower’s claim pertains.
    • The Tax Court generally does not review award determinations that have been properly made under § 7623(a) as opposed to § 7623(b).
      • 7623(a) applies if certain monetary thresholds under § 7623(b) are not met. Those thresholds provide that § 7623(b), rather than section 7623(a), applies with respect to any action if:
        • the proceeds in dispute exceed $2 million (I.R.C. § 7623(b)(5)(B)), and,
        • for an action against an individual, if the individual’s gross income exceeds $200,000 for any taxable year subject to the action (I.R.C. § 7623(b)(5)(A)).
      • However, the $2 million threshold set out in section 7623(b)(5)(B) is not jurisdictional bar, but rather, is an affirmative defense that the Commissioner must raise in his answer must prove.
      • This Court applies the same rationale regarding the $200,000 threshold, holding that this threshold too is not a jurisdictional bar, but rather an affirmative defense that the Commissioner must allege in his answer and must prove.
      • If the Commissioner fails to plead the monetary thresholds as an affirmative defense, then the Court proceeds to decide the case on its merits.

• Rejections and Denials under I.R.C. § 7623
  • The Department of the Treasury and the IRS adopted regulations supplementing I.R.C. § 7623. These regulations establish minimum criteria that apply to all whistleblower claims.
    • 301. 76233-1(b) of the Procedural & Administrative Regulations describes which individuals are eligible to file a claim.
    • 301.7623-1(c) of the Procedural & Administrative Regulations describes the information each claim must include.
      • Generally, a claim must:
        • (1) include specific, credible, and nonspeculative information that the whistleblower believes will lead to collected proceeds, (2) report a failure to comply with the internal revenue laws and identify the person(s) believed to have failed to comply with the internal revenue laws, and
        • (3) provide substantive information in support of the whistleblower’s allegations, including all available documentation. See Proced. & Admin. Regs. § 301.7623-1(c)(1), (4).
      • A claim is purely speculative if it lacks any basis or support for its allegations.
    • Additionally, these regulations provide for two distinct types of determinations that result in no award: (1) rejections and (2) denials.
    • Rejections
      • A rejection is a determination based on the face of the whistleblower’s claim based on the information contained therein. See & Admin. Regs. § 301.7623-3(c)(7).
      • A rejection is appropriate when a whistleblower’s claim fails to comply with the threshold requirements as to who may submit a claim or what information the claim must include. See & Admin. Regs. § 301.7623- 1(b), (c)(4),; see also Proced. & Admin. Regs. § 301.7623-3(b)(3).
      • If a claim fails to meet the threshold criteria, depending on the circumstances, the WBO has discretion on whether to notify the whistleblower of any deficiencies and give him an opportunity to perfect the claim before the WBO takes further action. See & Admin. Regs. § 301.7623-1(c)(4).
      • “Once the WBO determines that it will reject a claim, what happens next turns on whether the claim is subject to section 7623(a) or section 7623(b).”
        • If the claim is subject to § 7623(a), the WBO provides written notice to the whistleblower stating the basis for the rejection without sending a preliminary rejection letter. Proced. & Admin. Regs. § 301.7623-3(b)(3).
        • If instead, the WBO determines that it will reject a claim under section 7623(b), it commences a “whistleblower administrative proceeding” by sending the whistleblower a preliminary rejection letter that: (1) states the basis for the rejection and (2) invites the whistleblower to submit comments. Proced. & Admin. Regs. § 301.7623-3(c)(7). The WBO reviews all comments timely submitted by the whistleblower and, if it still believes that a rejection is appropriate, the WBO then provides written notice of the rejection to the whistleblower, again with an explanation.
      • When a claim (whether under § 7623(a) or § 7623(b)) is rejected for failure to meet threshold criteria other than those relating to the eligibility of the whistleblower under § 301.7623-1(b) of the Procedural & Administrative Regs., the whistleblower has a post-rejection opportunity to “perfect and resubmit the claim.” See & Admin. Regs. § 301.7623-1(c)(4).
    • Denials
      • A “denial” is fundamentally different from a “rejection.”
      • “A denial is a determination that relates to or implicates taxpayer information.” Proced. & Admin. Regs. § 301.7623-3(c)(8); see alsoR.M. pt. 25.2.1.1.3(3).
      • The WBO’s denial of a claim indicates that “the IRS either did not proceed based on the information provided by the whistleblower …or did not collect proceeds” as a result of proceeding against the taxpayer on the basis of the whistleblower’s information. Proced. & Admin. Regs. § 301.7623-3(c)(8);see also & Admin. Regs. § 301.7623-3(b)(3).
      • Thus, the WBO cannot make a denial until it engages in some substantive consideration beyond the face of a claim.
      • The WBO handles a denial of a claim similarly to a rejection.
        • In the case of a denial under § 7623(a), the WBO provides written notice of the denial to the whistleblower but does not state the basis for the denial. See & Admin. Regs. § 301.7623-3(b)(3).
        • In the case of a denial under § 7623(b), the WBO sends the whistleblower a preliminary denial letter that states the basis for the denial and invites the whistleblower to submit comments, which starts the whistleblower administrative proceeding to which the whistleblower is entitled. Proced. & Admin. Regs. § 301.7623-3(c)(8).
        • The WBO considers any timely response from the whistleblower and, if it still believes a denial is appropriate, provides written notice to the whistleblower so stating, including the basis for its determination.
        • Unlike with rejections, because a denial is based on factors beyond deficiencies on the face of the whistleblower’s claim, the whistleblower is NOT provided an opportunity to perfect his claim after a denial. Compare id. at (b)(3), (c)(8), with & Admin. Regs. § 301.7623-1(c)(4).

• Standard of Review—Abuse of Discretion
  • The Tax Court reviews the WBO’s determinations regarding an award for abuse of discretion.
  • An agency’s failure to follow its own regulations typically constitutes an abuse of discretion.
  • In determining whether the WBO abused its discretion, the Court confines its review to the administrative record.
    • In the whistleblower context, the administrative record consists of “all information contained in the administrative claim file that is relevant to the award determination and not protected by…privileges.” Proced. & Admin. Regs. § 301.7623-3(e)(1).
  • The Court will review the agency’s (here, WBO’s) determinations solely on the grounds it actually relied on when making its determinations. In other words, the Court will judge WBO’s reasonableness in the grounds it actually used for its determination, and will not supplement any additional grounds upon which WBO may have derived its conclusions.
  • In its analysis, the Court may consider any “contemporaneous explanation of the agency decision” contained in the record.
    • As such, the Court may “uphold a decision of less than ideal clarity if the agency’s path may be reasonably discerned.”
  • If the Court determines that the WBO abused its discretion in rejecting or denying a whistleblower’s claim, then the case is remanded for further consideration.

• Analysis-2 Prong Approach
  • The reviewing Court judges an agency action by the standards which the agency itself invoked, looking first at the agency’s final determination, and then to the administrative record.
  • Prong 1: The Agency’s final determination letter (i.e., WBO’s Letter)
    • In order to claim that a whistleblower is not entitled to an award due to a rejection of the whistleblower’s claim, the WBO must set forth rationale for the rejection. See & Admin. Regs. § 301.7623-1(b)(2), (c)(4).
    • A whistleblower’s claim may be properly rejected if:
      • the whistleblower does not meet specified minimum criteria (see id.);
      • the IRS is unable to identify the taxpayer based on the claim; or
      • the claim: does not raise a tax issue, is purely speculative, or does not contain credible information (see I.R.M. pt. 25.2.1.1.3(7)).
    • A final determination that does not state the WBO’s rationale, but rather simply states “the IRS decided not to pursue the information” set forth in the whistleblower’s claim, does not properly explain a rejection, but may serve as the basis for a denial.
    • Where, as here,[1] there is ambiguity on whether the determination Letter rejected or denied the whistleblower’s claim, the Commissioner has the burden of proving that the WBO’s determination is not an abuse of discretion. Absent such show of proof, the Commissioner’s motion for summary judgment should be denied.
  • Prong 2: The Administrative Record
    • A determination letter that is either silent or ambiguous as to its rationale underlying its decision may still be sustained if other materials in the record clarify the agency’s reasoning.
      • These “other materials” cannot supply post-hoc rationale for the agency’s action, but they may be admissible to offer “contemporaneous explanation[s] of the agency decision.”
      • The Court will look beyond the four corners of the decision letter when evaluating under this second prong, specifically searching for information that would fill in the gaps left by the decision letter.
    • If, after analyzing the administrative record, the agency’s rationale behind its determination still seems ambiguous, the agency’s determination will be struck down for abuse of discretion and the case will be remanded to the agency for further consideration.

Insight: When reviewing an agency’s decision for abuse of discretion, the Court will apply a two-prong approach: first, it will look to the rationale found within the wording of the decision letter; second, if the decision letter is ambiguous or silent, it will look to the administrative record.

[1] Recall that the WBO Letter here simply stated, among other things, that “the IRS decided not to pursue the information you provided.” In effect, the WBO Letter is saying “we reject your claim because we are denying your claim.” As such, the Letter is ambiguous in terms of whether it forms a basis in rejecting or in denying the Petitioner’s claims.

Today’s Health Care II LLC. v. Comm’r, 2021 T.C. Memo 2021-96| August 2, 2021 | Gustafson, J. | Dkt. No. 25541-18.

Short Summary: The case involved the analysis of the constitutionality of Section 280E.

Today’s Health Care (the “Company”) was engaged in the business of growing, producing, and selling marijuana products. On its 2014-2015 tax returns, it reduced its gross receipts to account costs of goods sold (“COGS”), deducted expenses incurred in its marijuana business and deducted Net Operating Losses (NOL) from his business activities from previous years.

The IRS allowed COGS, rejected the deduction for expenses and the NOLs. The Company challenged the determination and argued the unconstitutionality of Section 280E under the Eight and Sixteenth Amendments to the Constitution.

Key Issues: Whether Section 280E violates the Eight and Sixteenth Amendments to the Constitution.

Primary Holdings: Section 280E does not violate the Eight and Sixteenth Amendments to the Constitution.

Key Points of Law:

The taxpayer has the burden of proof to show that the IRS’ determination is incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111 , 115 , 54 S. Ct. 8 , 78 L. Ed. 212 , 1933-2 C.B. 112 (1933). In this case, the burden of proof did not affect the outcome of the case because the Company challenged the IRS’ determination on legal grounds and not on a factual basis.

Section 280E establishes that no deduction or credit is allowed for amounts paid or incurred in a trade or business if such business consists of trafficking in controlled substance. Marijuana is a controlled substance, and the Company acknowledged such fact. Under Tax Court’s precedent, disallowance of deductions under Section 280E does not violates Eight and Sixteenth Amendments to the Constitution. The Court confirmed that opinion.

Insight: Section 280E has been actively litigated in Tax Court, and the Court’s position has been to sustain its holding that 280E is constitutional. Further litigation is expected but no different outcome in the near future is visible.

Jerry R. Abraham and Debra J. Abraham. v. Comm’r, 2021 T.C. Memo 2021-97| August 3, 2021 | Urda, J. | Dkt. No. 760-20L

Short Summary: The case involved the determination of the lawfulness of the rejection of an Offer in Compromise (OIC) by the IRS, under the abuse of discretion standard.

Mr. Abraham, a partner at a law firm, and Mrs. Abraham, a teacher, (the “Abrahams” or the “Taxpayers”), filed tax returns for the 2012-2016 period, but failed to pay their tax liability. The IRS issued a Notice of Federal Tax Lien (“NFTL”), and the Taxpayers timely requested a Collection Due Process or Equivalent Hearing (“CDP”), and submitted an OIC.

The OIC was premised on Doubt as to Collectibility (“DATC”), based on special circumstances (“DATCSC”). The Taxpayers argued bias against large families and a prospective lower income as retirement. The IRS rejected the OIC because the Taxpayers’ returns showed “relatively steady” income, their adult children showed that they had sufficient income to support themselves, expenses such as food and clothing were reduced to the national and local standards, and religious education expenses were disallowed. The IRS also determined that the assets of the Taxpayers, including a personal residence, showed a reasonable collection potential in excess of their offer. No evidence of doubt as to Collectibility or special circumstances were found.

The IRS issued a notice of determination sustaining the NFTL and the rejection of the OIC. The Taxpayers petitioned the Tax Court. On summary judgment, the Tax Court reviewed the rejection under the abuse of discretion standard and sustained the IRS’ determination.

Key Issues: Whether a prospective reduction of income by reason of advanced age supports special circumstances for a OIC premised under DATCSC.

Primary Holdings: Prospective reduction of income because of age, considering the level of education and nature of work, does not arise to a special circumstance for purposes of an OIC.

Key Points of Law:

The Tax Court has jurisdiction to review a determination made by the IRS in regard to a NFTL under Section 6320(c) and Section 6330(d)(1). The Court’s analysis is made under the “abuse of discretion” standard when the underlying tax liability is not challenged. Sego v. Commissioner, 114 T.C. 604 , 610 (2000); Goza v. Commissioner, 114 T.C. 176 , 182 (2000). Abuse of discretion is found if the IRS’ determination was arbitrary, capricious or without sound basis in fact or law.

In this case, the Court reviewed three issues: whether the IRS verified that the requirements of applicable law had been met, whether the IRS considered relevant issues raised by the Taxpayers and whether the proposed collection action balanced the need for efficient collection with the Taxpayers’ concern that the action was more intrusive than necessary.

• As for the first element, the verification that requirements under applicable law have been met, the Court determined that the IRS’ conducted a thorough review of the account transcripts and verified all applicable requirements were met.
• As for the issues raised by the Taxpayers, the Court determined that even if the arguments of the Taxpayers (related to the disallowance of their religious education expenses, the inclusions of certain amount of money for taxes and IRA contributions and the computation of the reasonable collection potential (“RCP”) which was multiplied income by 33 months rather than 12 months) were correct, the decision of the IRS should be sustained.

This is because even if there are errors in the calculation of the RCP, the decision is sustained when the taxpayer’s offer is far less than the correct RCP. Alphson v. Commissioner, T.C. Memo. 2016-84 , at *25; see also Gustashaw v. Commissioner, T.C. Memo. 2018-215 , at *24. In this case, the RCP of the Abrahams was approximately $294k, and their offer was $50k. Thus, the Court sustained the rejection.

• Additionally, the Court determined that special circumstances were not found here. Special circumstances include facts that demonstrate economic hardship and compelling public policy or equity considerations that provide sufficient basis for compromise. Murphy v. Commissioner, 125 T.C. at 309 ; McClanahan v. Commissioner, T.C. Memo. 2008-161 , 2008 WL 2550665 , at *3 ; sec. 301.7122-1(b)(3), Proced. & Admin. Regs.; IRM pt. 5.8.4.2(4)(May 10, 2013).
• No special circumstances exist because Mr. Abraham had income “relatively steady”, the Taxpayers failed to explain why his age (63 years old) would suggest a significant diminution of his income. Consequently, no economic hardship was found, and no compelling public policy exist to justify the compromise of the tax liability.
• As for the balancing test between the need for the efficient collection of taxes with the legitimate concern of the person that the collection action be no more intrusive than necessary, the Court ruled that the Taxpayers conceded this issue by no raising it on their petition under Rule 331(b)(4).

Insight: OIC is a great tool to reduce tax liabilities. In an OIC submitted under DATCSC, it is relevant to emphasize the special circumstances that surround the taxpayer to allow the IRS to compromise the liabilities. As seen in this case, advanced age is not enough to show the existence of a special circumstance. Moreover, the OIC analysis made by the IRS would almost be always sustained if the offer is low compared to the RCP. In this case, an RCP that is six times the offer submitted allowed the Court to sustain the IRS analysis. Careful analysis of the amount of the offer must be made, to prevent unfavorable results such as this case.

[View source.]