During tough times, taxpayers often make the mistake of "borrowing" from the IRS by deferring employment or other tax payments or withholdings, expecting to catch-up later as cash flow permits. Taxes, penalties and interest may become overwhelming, necessitating an offer-in-compromise through which a reduced payment is accepted by the IRS in recognition of a taxpayer’s lack of assets or sources of income to pay in full.
An offer will be rejected if assets or sources of income are sufficient to enable full payment within the foreseeable future. A taxpayer must submit a detailed financial statement as part of the offer evaluation process. The IRS has wide discretion in evaluating financial information, but may be forced to accept an offer if it abuses its discretion by rejecting an offer, as illustrated in the recent Tax Court ruling in In re Dalton.
In re Dalton involved an IRS attempt to collect trust fund recovery penalties from Arthur and Beverly Dalton arising from a failed business. The IRS rejected an offer-in-compromise because the Daltons excluded certain property held in a trust as part of their assets.
Eleven years before the IRS claims, the Daltons transferred three lots in Poland, Maine to Arthur's father, who transferred the property to a trust established for the benefit of the Daltons’ children. When their business failed, the Daltons lost their home. They moved in with Arthur’s parents, sharing a residence on the property held in the trust. Pursuant to an oral agreement with Arthur’s parents, the Daltons agreed to pay rent to cover overhead expenses, such as mortgage debt and property taxes, to manage and maintain the property, and to pay their direct costs of occupancy.
The Daltons claimed they had no retained interest in the trust property and were not required to include it as part of their assets in connection with their offer-in-compromise. They argued that the IRS abused its discretion in rejecting their offer-in-compromise.
The Tax Court advised the IRS to consider state and federal law in determining whether the Daltons had any interest in the trust property. The IRS concluded the Daltons had a retained interest to the property which should have been included as an asset in their financial statement based on the Daltons’ payment of the initial purchase price for the property, their continued payment of mortgage and property taxes against it, and their payment of maintenance costs pursuant to the oral agreement with Arthur’s parents.
The Tax Court rejected the IRS’ conclusion. It held that under Maine law the deeds to Arthur’s father and the trust extinguished all of the Daltons’ legal title and right to the transferred property. The deeds were publicly recorded. There was nothing to suggest that the transfers were made to hide assets from creditors. The Daltons took no action to conceal any other assets, were not insolvent at the time of the transfers, and did not become insolvent because of the transfers. There was nothing to suggest that the transfers were made with fraudulent intent, and the trust agreement gave the Daltons no rights to any of the property held in the trust.
The Tax Court held that, under federal law, which focuses on whether and to what degree a person generally exercises control over the nominal titleholder and trust assets, and whether a person engaged in a legal fiction by placing legal title to property in the hands of a third party, the same conclusion applied. The property was not transferred to Arthur’s father in anticipation of a specific suit or as a shield against any known liabilities. The close relationship between the parties suggested that the transfer of the property was simply a gift. The payment of mortgage and property taxes, and the payment of maintenance and occupancy expenses, were rental payments to the trust in exchange for their occupancy of the residence. The Tax Court concluded that it would be improper to impose a resulting trust on the property and concluded that IRS abused its discretion in rejecting the offer-in-compromise.
Any offer-in-compromise requires full and complete disclosure of all assets and sources of income. Indeed, an accepted offer-in-compromise may be set aside if the IRS discovers that assets or sources of income were concealed. If you find yourself cornered by tax liabilities, an offer-in-compromise may be an appropriate remedy, but professional guidance is warranted. Please contact us if we may be of any assistance.