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IRS Not Bound by Offer in Compromise with Modified Terms Even Though It Cashed Taxpayer's Check

(Parker Tax Publishing June 2017)

The Tax Court held that the statute of limitations had not expired with respect to assessing tax on a married couple's income from three S corporations because the relevant return was the couple's individual return, not the returns of the S corporations. The Tax Court also held that no valid settlement with the IRS arose when the couple sent a check for payment of their liabilities along with a Form 656-L, Offer in Compromise (Doubt as to Liability), which the couple heavily modified, even though the IRS deposited (but later refunded) the check that accompanied the Form 656-L. Whitesell v. Comm'r, T.C. Memo. 2017-84 (2017).


Neil and Tracy Whitesell filed their 2011 and 2012 Forms 1040 on October 12, 2012, and October 15, 2013, respectively. The IRS issued a notice of deficiency relating to both returns on July 27, 2015. The adjustments included amounts that flowed through from Mr. Whitesell's three wholly owned S corporations, Whitesell International Corp. (WIC), NLW Holdings, LLC (NLW), and Whitesell Corp. WIC and NLW filed their Forms 1120S for 2011 on September 17, 2012. NLW filed its Form 1120S for 2012 on September 16, 2013. The IRS did not issue a notice of deficiency to any of the S corporations.

With respect to the deficiency notices, the Whitesells filed a petition with the Tax Court in December 2015. Around that time, the couple sent to the IRS a modified Form 656-L, Offer in Compromise (Doubt as to Liability), (OIC) for their tax liabilities for 2006 through 2012, which included liabilities resulting from the pass-through of income from their S corporations. The Whitesells substantially modified the Form 656-L by crossing out sentences in some subsections as well as crossing out other entire subsections. The Whitesells sent a check for $3 million along with their OIC as satisfaction of their 2006 through 2012 tax liabilities. The Whitesells did not request from the IRS an amount to pay off their outstanding tax liabilities.

The IRS received the OIC and deposited the $3 million check. In January 2016, the IRS sent a letter informing the Whitesells that it was returning their OIC. In February, another IRS letter confirmed that the Whitesells' OIC file had been closed and that the IRS was in the process of refunding the $3 million because of the modified terms and conditions. The Whitesells deposited the refund in April 2016.

Taxpayer and IRS Arguments

The IRS filed a motion for summary judgment on two issues: (1) whether the expiration of the statute of limitation for assessing deficiencies attributable to the S corporations' income barred the IRS from assessing deficiencies relating to the flow-through income for Mr. Whitesell from his S corporations, and (2) whether the Whitesells and the IRS entered into a contract to settle the Whitesells' income tax liabilities as a result of the IRS depositing the $3 million check.

Regarding the statute of limitations, the Whitesells argued that the relevant returns were not the Whitesells' individual returns but rather the returns of the S corporations from which the flowthrough income was allocated to Mr. Whitesell. The Whitesells' argument was based on a split among the circuit courts that arose in the 1990s and relied on a Ninth Circuit decision holding that the filing of the passthrough entity's return controlled. On the issue of the purported settlement with the IRS, the Whitesells argued that under the Uniform Commercial Code (UCC), their OIC was accepted when the IRS deposited their check and did not reject the OIC within 90 days of receipt. The IRS's response was that negotiation of a check does not constitute accord and satisfaction, and that the UCC does not govern the IRS's power to administer the federal income tax system.

The Tax Court held that under Code Sec. 6501(a), the relevant return for determining whether the statute of limitations has expired is the return of the taxpayer to whom the IRS is seeking to determine a deficiency. The court noted that Code Sec. 6501 was amended in 1997 with the specific purpose of clarifying this issue with respect to S corporations. According to the Tax Court, the legislative intent behind the amendment was to clarify that the relevant return is the return of the taxpayer, not the return of another person from whom the taxpayer received an item of income, gain, loss, deduction or credit. Therefore, the controlling returns in this case were the Whitesells' Forms 1040. The notice of deficiency, issued on July 27, 2015, was within the three year statute of limitations period for the Whitesells' 2011 and 2012 returns, which were filed on October 12, 2012 and October 15, 2013, respectively. Therefore, the statute of limitations had not expired.

On the issue of whether a valid settlement was executed, the Tax Court held that no document memorializing settlement of the issues was filed, nor did the parties manifest mutual assent through offer and acceptance. The Tax Court rejected the Whitesells' argument that their submission of a check and the IRS's negotiation of it constituted accord and satisfaction under the UCC. First, the Tax Court reasoned that the U.S. government is not bound by state statutes. Further, the Whitesells' submission of the OIC did not mean that the IRS had assented. The IRS notified the Whitesells by letter in January 2016 that their OIC would be returned along with their $3 million deposit. A second letter stated that the reason the OIC was rejected was that the Whitesells had modified the terms and conditions. The Tax Court found that the IRS had rejected the Whitesells' offer and there was no therefore no settlement.

The Tax Court was also not persuaded that by cashing the Whitesells' check, the IRS accepted their OIC. In the court's view, cashing the check did not necessarily mean that the IRS had accepted the offer. Further, the Whitesells understood at the time they submitted their OIC that their payment could be returned because that possibility was expressly stated on the Form 656-L. The Tax Court also looked to IRS guidelines for OICs, which state that OIC payments or deposits are placed in a non-interest bearing account, stamped nonnegotiable and returned, or posted to a taxpayer's account. The payment is either applied against the taxpayer's liability or returned only after a determination has been made on the OIC. The Tax Court found that the IRS had rejected the OIC and subsequently returned their check in accordance with these guidelines.

The Tax also rejected the Whitesells' argument that under the UCC, the IRS accepted their offer by not rejecting it within 90 days. In the court's view, the facts surrounding the OIC and the IRS's response clearly showed that the IRS had timely rejected the OIC and returned the couple's $3 million deposit.

For a discussion of the statute of limitations, see Parker Tax ¶260,130. For a discussion of offers in compromise, see Parker Tax ¶263,165.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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