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In IRS examinations, many practitioners encounter situations where the Internal Revenue Service seems to conjure up a set of facts that is divorced from reality. On the collection side, strange as it may sound, the IRS sometimes does this too, by treating the taxpayer as if he has assets he really doesn't.
When a taxpayer is unable to pay his tax in full, he is entitled to request a “collection alternative” from the IRS, usually an Installment Agreement but sometimes an Offer in Compromise. This process involves submitting a variety of financial statements to the IRS – most often a Collection Information Statement (A for individuals, B for Businesses) in which the taxpayer essentially has to “get naked” with his finances under penalties of perjury so that the IRS can compute his “reasonable collection potential.”In a recently reported Tax Court Opinion, Tucker v. Commissioner, TC Memo 2011-67, the Tax Court considered a situation in which a taxpayer was indebted to the IRS when he proceeded to lose money by doing “day trading”. The IRS took the position that instead of investing/gambling that money, the taxpayer should have paid off his taxes, so in terms of determining his reasonable collection potential for purposes of an Offer in Compromise, the IRS made its computations as if the money he lost was still available.
I am sorry to report that the Tax Court upheld the IRS position to the extent of Mr. Tucker’s losses. The Court noted “dissipation” of an asset occurs whenever an asset has been sold, transferred or spent on non-priority items or debts such that it is no longer available to pay the tax liability. Thus, even if the money was no longer available, it can be “dissipated”; in which case the IRS may include it in computing what is an acceptable Offer in Compromise.
The Court observed that the Internal Revenue Manual takes this position in order to deter delinquent taxpayers from wasting money which should be to pay taxes, as distinguished from the way conscientious taxpayers precede. The Court stressed that the losses suffered were not due to an unforeseeable event but were commonplace for a relatively inexperienced person in a highly volatile activity, and that he made the conscious decision to devote the money to a risky investment. For this, the Court concluded that the dissipation of assets justified the rejection of the Offer in Compromise.
While it is unlikely that this pattern would be repeated, this writer has anecdotal experience with debtors who pay all of their non-IRS debts, like credit cards and utilities, and then propose an Offer in Compromise to the IRS for what remains. This approach will likely be viewed as "dissipation" like day trading, so it is wise for anyone tempted to do this to speak to a knowledgeable tax practitioner before taking any action.
George Connelly is recognized as one of the leading federal tax litigators in the United States. His practice focuses on IRS audit, collection and criminal matters including civil and criminal tax litigation matters, for clients ...