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IRS's Computation of Taxpayer's Reasonable Collection Potential Wasn't Reasonable

(Parker Tax Publishing July 2017)

The Tax Court held that an IRS settlement officer's rejection of a corporation's offer in compromise solely on the basis of his calculation of reasonable collection potential that used the corporation's going-concern valuation, but disregarded completely its tax liability, was not reasonable. According to the court, the going-concern value is intended to give some indication of what a third party might pay to buy a corporation, but no third party would buy a corporation without taking into account the corporation's unpaid tax liability. W. Zintl Construction, Inc. v. Comm'r, T.C. Memo. 2017-119.

W. Zintl Construction, Inc. (Zintl Inc.), a commercial construction subcontractor, is a C corporation. On May 28, 2013, the IRS sent a notice of intent to levy to Zintl Inc. with respect to its 2011 and 2012 employment tax liabilities. In response, Zintl Inc. submitted Form 12153, Request for a Collection Due Process or Equivalent Hearing. Several other notices of intent to levy were sent to Zintl Inc. and the company responded to each by filing Form 12153. On all Forms 12153, Zintl Inc. checked "offer in compromise" as a collection alternative.

On August 27, 2013, Zintl Inc. submitted Form 656, Offer in Compromise, and made an offer in compromise (OIC) of $1 million. In support thereof, Zintl Inc. provided a profit and loss statement and a balance sheet ending June 30, 2013, and a Summary Appraisal Report dated February 12, 2013, indicating a "Forced Liquidation Value" for the company's machinery and equipment of approximately $1.2 million. In an accompanying letter to IRS Settlement Officer (SO) Albright, Zintl Inc. indicated an accounts receivable balance of approximately $3.4 million as of August 9, 2013. After quoting the Internal Revenue Manual (IRM) regarding the proper treatment of accounts receivable, the letter explained that "Zintl is profitable and its receivables are part of the income stream required for the production of income. The company must pay for materials and labor to continue operating. Without the income flow from these receivables, the business could not operate." Zintl Inc. also explained that the liquidation of Zintl's inventory, machinery, and equipment would end its ability to operate and that it had recently sold all of the assets it could spare to satisfy a bank obligation that was secured by the company's inventory and equipment.

SO Albright requested additional documentation, including a valuation of the business as a going concern and a copy of the equipment appraisal listing the fair market value of Zintl Inc.'s physical assets. Zintl Inc. sent the documents requested, including a going-concern appraisal dated April 16, 2014. The going-concern appraisal estimated a going-concern fair market value of $2.1 million using three valuation methods, each of which subtracted accrued payroll tax liability and interest of approximately $4.2 million. The largest single asset reflected in the appraisal was the accounts receivable (in excess of $7 million), and the largest single liability was the payroll tax liability. The appraisal did not include the accumulated penalties on the tax liability (estimated to be $2.1 million). The appraisal assigned no value to goodwill. The appraisal also estimated a liquidation value for the company of negative $3.72 million.

In a letter dated April 24, 2014, SO Albright noted that, according to the appraisal, the value of Zintl Inc. was estimated to be $2.1 million after allowing for the IRS debt of $4.2 million. In other words, he said, the value of the business for purposes of the OIC was estimated to be approximately $6.3 million. Further, he noted that in determining the reasonable collection potential (RCP) in an OIC, the IRS generally reduces the asset values by 20 percent. As a result, in Zintl Inc.'s case, SO Albright found that the RCP was approximately $5 million.

SO Albright gave Zintl Inc. an opportunity to submit an amended OIC in an amount at least equal to the $5 million RCP and stated that he likely would reject the original $1 million offer if an amended offer were not received by May 8, 2014. By letter dated May 1, 2014, Zintl Inc. disagreed with the use of the going concern valuation of Zintl Inc. to calculate an acceptable OIC amount. The following month, SO Albright sent Zintl Inc. a letter stating that he had been unable to find anything to indicate that the going-concern value cannot be used in determining the RCP when the taxpayer is a business (as opposed to when the taxpayer is the shareholder of a business) and advised Zintl Inc. to submit an amended OIC to reflect the RCP he had previously calculated.

In a July 9, 2014 meeting and subsequent calls, Zintl Inc. advised SO Albright that it was unable to secure financing to fund a $5 million OIC but was continuing to work with banks on financing. On August 4, 2014, Zintl Inc.'s attorney notified SO Albright that Zintl Inc. anticipated receiving a loan of $3 million that, if approved, would allow the company to increase its OIC to $3.2 million. Because the deadline for increasing the OIC had lapsed and the loan had not yet been approved, the IRS rejected Zintl Inc.'s $1 million OIC offer because its RCP exceeded that amount and sustained the disputed collection actions. Zintl Inc. petitioned the Tax Court to review whether SO Albright abused his discretion by using the going-concern value as described in the Internal Revenue Manual 5.8.5.17 (Sept. 30, 2013) and, on that basis, rejecting Zintl Inc.'s OIC as substantially below its RCP.

The Tax Court held that SO Albright's calculation of Zintl Inc.'s RCP was not reasonable and remanded the case to the IRS Office of Appeals for the purpose redetermining Zintl Inc.'s RCP. The court noted that, in effect, Zintl Inc. was asking it to decide that use of the going-concern value of a business is never appropriate when the business being valued is the taxpayer. The court said that it could not so conclude, nor did it need to. According to the court, SO Albright's calculation of RCP was faulty for a different reason: In calculating Zintl Inc.'s RCP, SO Albright increased the corporation's going-concern value by the amount of the unpaid tax liability, which the appraisal took into account in its calculation of value, and based his determination of RCP solely on this modified value. This modification to the value at first blush seemed logical to the court. Reducing Zintl Inc.'s going-concern value by its tax liability when determining how much of this tax liability the corporation could pay would seem to double count the tax liability and provide a boon to a business taxpayer whose tax debt is part of the business being valued. After all, the court said, it is this tax liability that will be satisfied with the OIC.

However, the court observed, the problem with this is that the going-concern value is intended to give some indication of the value of Zintl Inc. as a continuing business; i.e., what a third party might pay to buy the corporation as a whole, including all of its assets and liabilities. No third party would buy Zintl Inc., the court noted, without taking into account the unpaid tax liability. And the record showed that Zintl Inc. could not obtain financing for the modified RCP amount either. According to the court, this highlights the logical difficulty of using going concern value - which presumes that a taxpayer can sell itself - to determine RCP.

The court also said that it could not conclude that consideration of the going-concern value and the information in the appraisal was irrelevant or that the settlement officer could not consider this information, including the specific assets and liabilities, such as the tax liability, on remand. The court also stated that it was not holding that Zintl Inc.'s offer was reasonable. It was only holding that SO Albright's rejection of Zintl Inc.'s OIC solely on the basis of his calculation of RCP that used the corporation's going-concern valuation but disregarded completely its tax liability was not reasonable.

For a discussion of the rules relating to OICs, 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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