On June 8, 2020, the Tax Court issued a Memorandum Opinion in the case of Howe v. Commissioner (T.C. Memo. 2020-78). The issues before the court in Howe were (1) whether the notice of deficiency is valid and (2) whether respondent is equitably estopped from denying the executed settlement agreement in Form 870-AD (Offer to Waive Restrictions on Assessment and Collection of Tax Deficiency and to Accept Overassessment).
A Bit of Perspective
For the one tax year at issue, the accuracy-related penalty under IRC § 6662(a) was just shy of $2m. And Howe! That pun was coming eventually, so might as well just get it out of the way now.
The Long and Winding Road to Deficiency
Revenue Agent Lord (yes, that’s her real name) began an audit of the petitioner’s personal 2008 Form 1040 in February 2011. On petitioner’s 2008 Form 1040 the petitioner claimed at-risk loss deductions from the Schedule E entities. Critically, he explained that the deductions were from loans made to the entities. RA Lord issued a Notice of Proposed Adjustment (NOPA) and a Form 866-A (Explanation of Items) in May 2012.
RA Lord giveth, and RA Lord taketh away.
RA Lord closed the case and transferred it to Appeals. After a number of meetings and negotiations and concessions by both sides (mostly Appeals), the petitioner signed a Form 870-D (Offer to Waive Restrictions on Assessment and Collection of Tax Deficiency and to Accept Overassessment), which was accepted and signed properly by the IRS.
Form 870-AD reduced petitioner’s deficiency from $8.4m to $1.5m and the accuracy-related penalty from $2m to zero. Form 870-AD stated that the case would not be reopened by the IRS unless there were specific occurrences including fraud, malfeasance, concealment, or a misrepresentation of a material fact. This was a problem for petitioner, who had argued to Appeals that the transfers weren’t bona fide loans.
RA Lord caught wind of the boondoggle and went to her immediate supervisor with her concerns. This begs a lot of fundamental, epistemological questions regarding the identity of a supervisor of the (RA) Lord, but that’s for another day. Ultimately opting against a panoply of his go-to plague options, RA Lord filed a Dissent of Appeals Decision in response to the ACM, which explains, in a nutshell, that commandments were broken, lies were told, wives were coveted, all sorts of nasties, but mostly the lies, which RA Lord characterized as “misrepresentations of a material fact.”
Drawing on IRS Policy Statement 8-3 in IRM 22.214.171.124.3(2), because the disposition of an issue in the case involved misrepresentations of material facts by petitioner. The Appeals Director approved reopening petitioners’ case for tax year 2008, and Appeals notified the petitioner that because he had misrepresented material facts, the case would be reopened.
The writing was on the wall once the case was reopened, and in September 2014, the IRS issued the petitioner a notice of deficiency and attached a statement which explained that the petitioner had not established entitlement to the loss deductions he claimed from Schedule E. The petitioner timely filed a petition to redetermine the deficiency.
Why Contract Law is a Cute but Unavailing Argument with the Tax Court (Except with Closing Agreements)
IRC § 7121 and IRC § 7122 and their accompanying regulations establish procedures for closing agreements and compromises of tax liabilities, respectively. These procedures are exclusive and must be satisfied for there to be a compromise or settlement that is binding on both the taxpayer and the Government. Dormer v. Commissioner, T.C. Memo. 2004-167, *11-*12; Rohn v. Commissioner, T.C. Memo. 1994-244, *4. Critically, Form 870-AD is not a binding settlement agreement under IRC § 7121. Whitney v. United States, 826 F.2d 896, 98 (9th Cir. 1987); see also Botany Worsted Mills v. United States, 278 U.S. 282, 288-89 (1929).
The Hobbit – A Metaphor for an Equitable Estoppel Argument
If you are pinning your hopes on an equitable estoppel defense in Tax Court, it is likely that you have already lost. This may seem cynical, but read on, and then tell me I’m wrong.
Equitable estoppel precludes a party from denying his own acts or representations which induced another to act to his detriment. Hofstetter v. Commissioner, 98 T.C. 695, 700 (1992). Equitable estoppel is often used between private litigants as an alternative theory when a contract is held to be invalid. However, the same rules of “equity” do not apply to the U.S. Government, or so says the Supreme Court, which noted rather plainly that “equitable estoppel will not lie against the Government as it lies against private litigants.” Office of Pers. Mgmt. v. Richmond, 496 U.S. 414, 419 (1990).
“But why are there dwarves knocking at my door? No one knocks at my door,” the little hobbit murmurs to himself.
The doctrine of equitable estoppel is applied against the IRS “with utmost caution and restraint,” which essentially means not at all. (I’m paraphrasing that last part.) Schuster v. Commissioner, 312 F.2d 311, 317 (9th Cir. 1962), aff’g in part, rev’g in part 32 T.C. 998 (1959). The reason that equitable estoppel (in practice) never lies against the IRS is that to be successful, the invoking party must overcome the hurdle of “outweighing” the policy consideration in favor of “an efficient collection of the public revenue.” Id. Loosely translated, unless you can leap buildings in a single bound, this is a hurdle that is likely not surmounted.
“I am going to regret ever leaving my shire. Where’s my pipe? I feel as if I might need it.”
Assuming for a moment that the taxpayer overcomes this barrier, the taxpayer’s next step on his mythical quest to prove equitable estoppel should apply, is to make a tripartite showing of IRS-specific elements of equitable estoppel. The taxpayer must show (1) that the IRS engaged in affirmative misconduct that went beyond “mere negligence;” (2) that the IRS’s wrongful acts will (not could, might, or may perchance, but will) cause a serious injustice; and (3) that the public’s interest will not suffer undue damage by imposition of estoppel. Baccei, 632 F.3d at 1147.
I imagine that a taxpayer is by this point a bit like Bilbo Baggins, thinking that he’s almost made it, only for Gandalf to show up and say that his journey has only just begun, and better yet, there’s a dragon, his dwarfish retinue heartily laughing, and Bilbo cursing under his little hobbit breath.
Assuming that Bilbo (the taxpayer) manages to get over the first two hurdles, it will next have to satisfy the “traditional elements of equitable estoppel,” which include the following four elements. Purcell v. United States, 1 F.3d 932, 939 (9th Cir. 1993). First, the IRS must know all of the facts. Second, the IRS must intend that its conduct shall be acted on or must so act that the taxpayer has a right to believe the conduct is intended to be acted upon. Third, the taxpayer must be “ignorant of the true facts.” Fourth, the taxpayer must rely on the IRS’s conduct to his injury. See Baccei v. United States, 632 F.3d 1140, 1147 (9th Cir. 2011); Morgan v. Gonzales, 495 F.3d 1084, 1092 (9th Cir. 2007). If a single one of these elements is not present, the music has stopped and there are no chairs left for the petitioner to sit in, meaning that equitable estoppel is not appropriate. See Nolte v. Commissioner, T.C. Memo. 1995-57, *5, aff’d, 99 F.3d 1146 (9th Cir. 1996).
Then, Bilbo meets the dragon.
Affirmative misconduct by the IRS requires an “affirmative misrepresentation” or “affirmative concealment of a material fact” such as a “deliberate lie.” Baccei, 632 F.3d at 1147.
“Is that all,” the hobbit says sarcastically to himself.
Sadly, no; affirmative misconduct must involve “ongoing active misrepresentations” or a “pervasive pattern of false promises” as opposed to “an isolated act” of providing “misinformation.” Purcell, 1 F.3d at 940. Framed slightly differently, the IRS can straight-up-bald-faced lie to you, but it’s ok, so long as it only happens once (for equitable estoppel purposes only, of course).
If you thought you could avail yourself of procedural and administrative “rules” such as the IRM for support, you would be wrong – so terribly naïve and so fundamentally wrong. Procedural rules and IRM policies, the Tax Court tells us, are not so much “rules” as suggestions, which is to say that they are “are merely directory, not mandatory.” Collins v. Commissioner, 61 T.C. 693, 701 (1974); Luhring v. Glotzbach, 304 F.2d 560, 563 (4th Cir. 1962); Estate of Brocato v. Commissioner, T.C. Memo. 1999-424, *10.
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And that, dear reader, is why equitable estoppel sounds good, but, unless Lucifer himself is assigned as your Appeals officer – and even then, who knows – the argument is worth about as much as an ice cube to an Eskimo.