When a taxpayer receives a notice of intent to levy, the taxpayer can pay the amount due and file a claim for refund, request an audit reconsideration, file for an offer in compromise or request a collection due process hearing.

The CDP hearing was part of the 1998 IRS Restructuring and Reform Act. Prior to then, the IRS could reach a delinquent taxpayer’s assets by lien or levy without providing any sort of pre-attachment process.

The First Circuit has recently shed some light on what practitioners and taxpayers can expect from a CDP hearing. Taxpayers in the case had offered to settle their tax liability for less than the full amount they owed. The IRS rejected the offer, saying that the taxpayers could afford to pay more because they owned valuable real estate. The Tax Court, reviewing the IRS CDP process, found that the taxpayers were not the owners of the real estate in question, and directed the IRS to accept the offer in compromise. It later ordered the IRS to pay attorneys’ fees to the taxpayers as prevailing parties.

The First Circuit reversed the Tax Court, finding that the IRS did not abuse its discretion when it rejected the taxpayers’ offer in compromise. The case was Dalton v. Commissioner, decided June 20, 2012.

“The decision can be distilled to say the findings were reasonable, not that they were correct,” said Barbara Kaplan, a tax partner at Greenberg Traurig LLP. “That’s the interesting part—the IRS might have been incorrect, but as long as it was reasonable, that’s all the reviewing court has to look at.”

“If you look at the facts, two things stand out,” she said. “There was a transfer of property to a parent and then to a trust, but from the facts demonstrating that the taxpayers continued to use the property, it was not unreasonable to conclude that there was a transfer that should be respected for tax purposes in light of the offer in compromise.”

According to the record, the taxpayers lived in and owned the house for years, then transferred the property to the father, who transferred it to a trust. “They claimed to be renting but continued to be listed on the mortgage. The facts were not really good facts for the taxpayer,” Kaplan said. “When you look at all the facts and circumstances, it was not unreasonable to include the value of the house as an asset for the taxpayers.”

The second factor was the effort made by the IRS to ascertain whether the transfer should be respected or not, Kaplan indicated. “It’s not like they just said, ‘Based on these facts, we won’t look at the law.’ They did look at the law. They may have reached a different conclusion than the court would, but they did do due diligence, and this was an important factor for the court to decide that they didn’t abuse their discretion.”

“The impact is that the court can look at the facts and find that the IRS analysis was wrong—that the trust is the true owner of the property—but because the IRS made an effort to determine whether the transfer would be respected, that’s all they have to do,” said Kaplan.  “The OIC process is itself an exercise of IRS discretion. At the end of the day, the IRS is entitled to exercise its discretion. That’s all the CDP process is intended to look at is if the IRS is being reasonable. Here, the IRS was not unreasonable.”

But it’s not as if this is the end of the line for the taxpayer, although it is costly to continue to undertake litigation, Kaplan noted. As the court observed, the taxpayers will have the opportunity to challenge the substantive correctness of the IRS ownership determination in subsequent judicial proceedings such as a motion to dissolve a wrongful attachment. “If the trust prevails that it’s the owner, there’s nothing to preclude the taxpayers from going back and seeking an offer in compromise,” Kaplan said.

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