On October 31, 1995, James Robinette and the IRS entered into an offer in compromise for tax years 1983 to 1991. Robinette agreed to pay $100,000 of the total $989,475 liability and to timely file his next five tax returns, which he did; however, the IRS never received his 1998 return. As a result it ruled Robinette breached the offer in compromise and it assessed the additional tax. The taxpayer protested this decision. At the administrative hearing, the IRS representative rejected the taxpayer’s evidence of timely mailing of his return on the grounds the only acceptable proof was a certified or registered mail receipt. Since Robinette did not have either, the IRS rejected his appeal. The taxpayer filed a petition with the Tax Court to reinstate the offer in compromise on the grounds the IRS abused its discretion.

Result. For the taxpayer. The issue before the court was the correct standard of review it should apply. Robinette wanted a de novo (to start anew) review on the grounds the tax liability was at issue. The court rejected this argument; instead it held the appropriate review was for abuse of discretion.

The court then had to decide whether to limit its inquiry to the administrative record as the IRS argued or allow additional evidence (alternate proof he had mailed his 1998 return) as the taxpayer requested. To answer this question, the court had to determine whether the Administrative Procedure Act applied and—consistent with prior decisions—concluded it did not. The court then said its review would be de novo and, therefore, the taxpayer could submit evidence not in the administrative record.

Having won this battle, the taxpayer then had to convince the court the evidence he wished to present regarding the mailing of his 1998 return was relevant to the issues raised. Robinette was successful again. However, in a concurring opinion, several of the judges cautioned future taxpayers not to interpret this case as allowing the introduction of evidence withheld from the administrative hearing. Only new evidence or evidence rejected by the administrator will be considered in addition to the administrative record. In this case the administrator had rejected Robinette’s attempt to present his evidence of timely filing.

Earlier this year the Tax Court, in Commissioner v. Ewing, held that taxpayers could introduce additional evidence the IRS had abused its discretion by failing to grant innocent spouse relief under IRC section 6015 (f). As in Ewing, there were dissenting opinions. Thus the apparent conclusion that all abuse of discretion cases will be decided on the total evidence and not just the administrative record remains in doubt.

Future taxpayers should try to submit all evidence at the administrative hearings. If the evidence is rejected or new evidence comes to light, a taxpayer should be able to convince a court to review all the evidence to determine whether the IRS had abused its discretion. It’s not certain the courts will consider evidence the taxpayer had but chose not to provide at the administrative hearing. With this limitation it appears the courts are willing to consider all evidence an IRS failure to grant a taxpayer relief was an abuse of its discretion.

James M. Robinette v. Commissioner, 123 TC no. 5.

Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.

In 1985 William Kidd filed a lawsuit against the state of California, its personnel board and its fish and game department, asserting the state’s affirmative action policy of “supplemental certification” violated his rights under the Equal Protection Clause of the 14th Amendment to the U. S. Constitution and the “merit” principle in the California constitution. Kidd had applied for positions with the fish and game department; it filled these positions, through a supplemental certification program, with individuals who had not performed as well as he had on competitive examinations. Kidd did not seek monetary damages; rather he sought to have the program stopped and employees hired under it dismissed.

While the lawsuit was pending in superior court, the state personnel board reexamined the supplemental certification program and concluded it was improper. The superior court dismissed Kidd’s lawsuit. The court of appeals reversed and remanded that decision with instructions to “fashion an equitable remedy to redress the violation of plaintiff’s constitutional and statutory rights.” In 2000 Kidd received a $132,000 settlement from the state of California. He did not include the sum on his 2000 federal income tax return. The IRS concluded he should have included the payment as income and filed a deficiency notice of $43,012.

Result. For the IRS. Kidd argued the state had awarded the payment to him for injuries unrelated to traditional work-related compensation, such as back pay or a lost job opportunity. He further asserted the $132,000 compensated him for the “abuse and mental distress” he had suffered as a result of the state’s treatment of him.

The Tax Court rejected these arguments. Since the settlement did not expressly state the reason for the payment, the court looked to the two-pronged test in IRC section 104(a)(2): (1) The underlying cause of action must be based upon tort or tort-type rights and (2) the payment must be on account of personal physical injuries or physical sickness. The court concluded the abuse and mental distress met neither the definition of personal physical injuries or physical sickness nor the emotional distress exception in section 104(a).

Kidd was one of a series of cases testing the definition of personal physical injuries or physical sickness. With the recently filed discrimination case against Wal-Mart, CPAs can expect such tests to continue.

William L. and Marsha G. Kidd v. Commissioner, TC Memo 2001-135.

Under Texas law interest began accruing at a 6% annual rate one year from the date the state issued testamentary letters to Turner. She funded the bequest on October 19, 1999, in the amount of $11,052,055, including interest. On September 13, 2000, Turner filed a refund claim seeking $450,108 based on an estate tax deduction of $1,052,055 in statutory interest. The IRS rejected the claim, arguing the estate should deduct the interest on its income tax return.

Note: The deduction was worth more on the estate tax return than on the income tax return since, in 2000, the top estate tax rate was 55% while the top individual tax rate was only 39.6%.

Result. For the taxpayer. For an administrative expense to be deductible under IRC section 2053, it must be (a) incurred in the administration of the decedent’s estate, (b) actually and necessarily incurred and (c) allowable by the laws of the jurisdiction under which the estate is being administered. The IRS challenged Turner’s assertion that the estate had met the second criteria. The IRS argued Turner had enough information (for example, church publications) from Fowler Homes to fund the bequest at an earlier point in time, and therefore, the interest paid was not “actually and necessarily incurred.”

The court disagreed, stating that given the size of the bequest and the explicit requirement in the decedent’s will that Fowler Homes be a charitable organization, Turner had “prudently determined” that the available information “was not reliable enough to permit funding of the bequest.”

This case illustrates that as long as an estate takes reasonable steps to fulfill and document a decedent’s instructions, IRS challenges should prove unsuccessful.

Estate of Sally C. Jackson v. United States, 306 FSupp2d 668, 93 AFTR2d 686.

Prepared by Michael H. Brown, CPA, PhD, assistant professor of accounting, Millikin University, Decatur, Illinois.