Journal of Accountancy

Tax

Tax Notes

TAX NOTES

The Treasury Department and the IRS in May issued a revenue procedure providing guidance on using statistical sampling to assess the deductibility of business meal and entertainment (M&E) expenses ( www.irs.gov/pub/irs-drop/rp-04-29.pdf ). Although generally no more than 50% of each such expense can be deducted, certain ones may be fully deductible. To quickly establish which items in a large M&E account are entirely deductible, taxpayers can use the guidance’s sampling methodology.

The GAO in April provided the IRS with findings and recommendations relating to its audit of the service’s financial statements and internal controls ( www.gao.gov/new.items/d04553r.pdf ). The GAO report, which was based on the watchdog agency’s 2002 and 2003 audits of the service’s financial statements and assessment of the effectiveness of its internal controls, said the IRS should improve its controls on budgeting, operating costs, financial reporting and the safeguarding of taxpayer receipts. The IRS agreed with all but one of the report’s 15 recommendations and said it would reassess risks in that area—the composition of courier teams responsible for transporting taxpayer remittances to depository institutions—and advise the GAO of any related changes it makes. In its fiscal year 2004 audit, the GAO will examine the IRS’s conclusions in this respect and evaluate whatever corrective actions the service may have taken in response to any of the report’s recommendations.

The IRS issued a reminder—as it has done in recent presidential election years—that charities, educational institutions, religious and other federal-income-tax-exempt organizations described in IRC section 501(c) are prohibited from participating or intervening in any political campaign for or against any candidate for public office ( www.irs.gov/newsroom/article/0,,id=122887,00.html ). Such entities cannot, for example, make donations, raise funds or distribute literature. Tax-exempt organizations the IRS finds involved in such undertakings risk losing their favored status and being subject to an excise tax on their politically related expenditures.

Tax

Offers in Compromise

By Edward J. Schnee

July 2004

Taxpayers unable to pay their income tax liability may make an offer in compromise under IRC section 7122 to settle the tax bill. Such an offer can, however, have a negative impact on other rights available to taxpayers, as the Tax Court recently demonstrated.

On September 3, 1999, Joseph Dutton filed a request for innocent spouse relief for tax years 1984 to 1986. On April 24, 2001, he filed Form 656, Offer in Compromise, for tax years 1986, 1987 and 1993 to 1999. On May 7, 2001, the IRS sent Dutton a letter granting partial relief from joint and several liability under IRC section 6015(c) for 1986 and 1987. The letter said he could receive a refund of taxes he had paid for those years. Dutton’s attorney received a second letter from the IRS dated July 23, 2001, stating no refund was permitted if the IRS granted relief under section 6015(c)—contrary to the implication in the first letter.

On July 25, 2001, the IRS accepted Dutton’s offer in compromise. On August 12, 2002, it notified Dutton he was not entitled to relief from joint and several liability under sections 6013(c), 6015(b), (c) and (f) for 1986 and 1987. Dutton filed suit in Tax Court requesting that relief and asking for the previously accepted offer in compromise to be set aside so he could receive a refund. The IRS said the court should not set aside the offer and Dutton was not entitled to relief from liability.

Result. For the IRS. The court immediately dismissed the taxpayer’s request for relief under section 6013. Since the petition listed only section 6015, the court could not grant relief under section 6013. The court next turned to the issue of setting aside the offer in compromise.

Section 6015(g) says a taxpayer will receive a refund—where appropriate—if the IRS grants relief from joint and several liability under section 6015 unless IRC sections 6511, 6512(b), 7121 and 7122 apply. It also says no refund is permitted if relief has been granted under section 6015(c). Section 7122 says an accepted offer in compromise settles the taxpayer’s liability unless the request is withdrawn before accepted. The only exception is in cases of fraud or a mistake.

Since an offer in compromise is a contract, the court said it should be analyzed under general contract law, which provides a contract can be set aside if both parties have made a mistake as to a basic assumption and the mistake has had a material effect. The regulations under section 7122 provide for reopening an offer if there is a mutual mistake as to a material fact.

The taxpayer argued he was mistaken as to the availability of a refund because of the letter he had received from the IRS in 2001. The court rejected this argument because the IRS had notified Dutton that no refund was permitted before he accepted the offer. He should have withdrawn his offer if he wanted to pursue a refund claim.

The court’s conclusion appears to be very clear. An accepted offer in compromise terminates tax disputes absent a mutual, material mistake as to the basic facts of the case. In addition, new final regulations say no refund is permitted under section 6015 if a taxpayer enters into an accepted offer in compromise. Future taxpayers must be prepared to live with any deal they make.

Joseph Dutton v. Commissioner, 122 TC no. 7.

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