Originally published on Forbes.com Oct 21st, 2014

If you want to contemplate a real IRS scandal, you might take a look at a recent TIGTA report .  The report indicated that in fiscal 2013, the IRS wrote off $16.1 billion in tax debts, which is five times as much as field agents collected.  (The overwhelming bulk of tax collections are from compliant taxpayers just paying.  There are also automated collections.  Field collections is more of a backstop.  Still you would think that they would collect more than they write off.) The steps that TIGTA recommended to address the situation strike me as rearranging the deck chairs on the Titanic.  They mainly concern figuring out how to better pick the cases to pursue.

With a significant growth in delinquent accounts and a reduction in the number of employees, it is essential that the field inventory selection process identifies the cases that have the highest risk and potential for collection. This requires IRS officials to make decisions about how to ensure that the cases in the queue with the best collection potential are identified, selected, and assigned to be worked.

Passing The Buck Is As Good As Collecting It

On top of that reforms in the nineties prevent the IRS from using how much they collect in evaluating job performance of agents.

Several ROs interviewed advised us that closing a case for which all case actions complied with procedures was considered a productive case, regardless of the outcome (full paid, abatement of the balance due, CNC, installment agreement, or offer in compromise). A few of the ROs advised us that transferring a case from their inventory to the queue or to another RO was considered a successful case resolution even though taxpayers may not have made any payments towards their delinquent liabilities.

Although managers interviewed were inconsistent about how they interpreted desired outcomes in working cases, six of them believed a productive case is a case for which proper steps were taken to appropriately close the case, without consideration to revenue collected.

An Example of How Long It Can Take

What got me thinking about that report was the recent Tax Court decision in the case of Bruce Hauptman.  It illustrates how long the process can be stretched out, before serious collection action can be taken.  It makes it clear that if you can stand a lot of annoying mail and take advantage of existing procedures, it can take a very long time before the IRS guys can take your stuff to satisfy your tax liabilities.  The case concerns individual income taxes for the years 1992-1996.

At this point there does not appear to be any controversy about the amount of the liabilities which according to the Tax Court approximate $13,000,000.  What is in controversy is how much Mr. Hauptman has to pay.  I need to remind you here that I’m just a tax blogger, not an investigative reporter.  The Tax Court pretty much bought the IRS version of the story.  Mr. Hauptman might still see things differently.  So here is the story.

Mr. Hauptman did not get around to filing his returns for the years in question, so the IRS filed them for him.  He then filed his own returns.  I’m guessing that he came out with a lower tax.  Regardless, he did not send in enough money to cover the balance due.  The IRS assessed tax and penalties on all five years in 1997. What a lot of people do not understand is there are two almost entirely separate due process systems with respect to the federal income tax.  One is about determining the correct tax.  In Mr. Hauptman’s case that part was complete in 1997.

The other system, which most of us never get involved with, is whether you actually have to pay that amount.  (There is a third area which concerns whether you might have to forfeit your liberty, but we don’t need to get into that here.)  I mention this because it is likely that I will get comments to the effect that if we had a simpler system, we would not have problems like this protracted litigation.  Well, that’s probably not the case.  The simplest tax system conceivable would still have people not paying and action being taken to collect from them.

How You Can Get Behind

At any rate, it appears that Mr. Hauptman got into this situation from a meteoric rise and rapid collapse of his investment business:

In 1989 BHA formed Juniper Capital Management, Inc., later renamed Genesis Capital Fund, LP (Genesis or the fund), a limited partnership. Genesis employed various hedged investment strategies in managing client funds. Genesis  was formed to be the general partner of Genesis. Petitioner, through his 100% ownership of Georgica Pond, Ltd., an S corporation (Georgica Pond), owned 60% of Genesis Management.
Genesis began operations on December 6, 1989, with $5.1 million under management by 1993 the amount under management grew to, and peaked at, $179 million. From that point onward the fund sustained a decline in the amount under management, which affected the earnings of Genesis Management. Genesis ceased operations at the end of 1999. From 1997 through 2002 BHA sustained a dramatic decline in revenues to the point where it began to experience losses, forcing petitioner to personally fund the operations of BHA. By 2006 the number of BHA’s full-time employees had declined from 14 to 1.

This reminds me just a bit of the recent Trip Hawkins case.  Mr.Hawkins had participated in one of the bogus tax shelters dreamed up by KPMG.  That would have been bad enough, but he then poured his money into a losing venture.

Offers In Compromise

If you don’t pay your tax, IRS collections can, ultimately, take your stuff (levy) or tell other people who owe you money to pay them instead of you – or else.  As you can see from this case, it is possible to keep that wolf from the door for a really long time.  Mr. Hauptman presented offers in compromise in August 1997 and March 1998, which were both rejected as inadequate.  A third offer was made in July 2005 which was deemed to be made “solely to delay collection activity”.  A fourth offer was submitted on February 10, 2010.  It was for $500,000.

The IRS “Offer Specialist” tasked with examining the case noted that much of Mr. Hauptman’s personal expenses and the 20% deposit on the offer had come from a limited partnership called Georgica Ponds.  The specialist also noted that Mr. Hauptman had:

realized millions of dollars in gains from stock transactions but had chosen to reinvest the assets and make substantial charitable contributions rather than paying his outstanding tax liabilities

Mr. Hauptman had apparently explained this to IRS settlement officer Curtis Megyesi in a fax dated August 18, 2011

When you are down 12 runs in the ninth inning bunting is not a realistic option if you want to finally resolve the issue. It was hoped and expected that such investments would provide the means to pay all the taxes due. *** If taxes and penalties equaled in excess of $10 million and I had $3 million in assets then the IRS would take all of the funds and I would still be left with a huge tax problem and have no means to invest in hopes of paying the balance due.

There is quite a bit of interplay between Mr. Hauptman and Mr. Megyesi:

Petitioner was asked how he was able to pay his living expenses. Petitioner replied that he supported himself with proceeds of bank loans and money borrowed from individuals.

Settlement Officer Megyesi asked petitioner why he donated $400,000 to the Maharishis of Iowa when his offer-in-compromise was pending. Petitioner replied he was confident that an investment he then was concluding would permit him to pay his taxes in full.

Settlement Officer Megyesi raised concerns as to discrepancies between the stated values of assets set forth in financial information petitioner provided the IRS and the stated values of the same assets set forth in petitioner’s loan application with Central State Bank. See supra note 4. Petitioner replied that the figures submitted on the loan application were “puffed up.” Settlement Officer Megyesi, however, believed the asset values set forth in the loan application were accurate and that petitioner had understated the value of his assets as set forth in the IRS forms.

The IRS determined that the minimum acceptable offer was $2,900,000.  Mr. Hauptman’s offer was rejected.  He appealed to the Tax Court.

Petitioner first argues that the IRS erred by rejecting his offer-in-compromise on the premise that because he is not or has not been in compliance with his filing and payment obligations, it would not be in the best interest of the Government to accept the offer-in-compromise. Petitioner maintains (1) such a determination is contrary to regulations and published IRS policy statements, and (2) the record does not support the conclusion that petitioner is not in compliance or has in the past been so. Second, petitioner asserts the IRS erred in adding dissipated assets to the calculation of his reasonable collection potential. Third, [*17] petitioner asserts the IRS erred by using asset valuations that have no basis in fact and are unsupported by the record. And, fourth, petitioner asserts the IRS erred by failing to use applicable public guidance to calculate the value of his potential future income.

The Decision

The Tax Court went with the IRS.

Petitioner argues that the record does not support respondent’s conclusion that he is not or has not been in compliance in the past with his return filing and tax payment obligations. Petitioner points out that the supplemental notices acknowledged that he timely filed Federal income tax returns for years after the years involved in these cases. Moreover, as petitioner points out, the IRS has not audited or adjusted any of his claimed losses.

Petitioner’s argument, however, ignores the fact that he failed to comply with his tax return filing and payment obligations throughout the years involved, a failure due to his desire to use the money for other purposes, rather than an inability to make any tax payments. Moreover, respondent’s rejection of petitioner’s offer-in-compromise is based in part on a determination that petitioner did not give the IRS complete and accurate information regarding his taxable income. Petitioner’s own documentation raises questions as to the intercompany structure of his businesses, payments by those businesses of his personal expenses, and loans ostensibly made to him by his businesses and by others. Indeed,  petitioner’s own representative agreed that certain transactions were “a bad deal” for the other parties. Petitioner failed to provide clarification of these transactions despite IRS requests to do so. And it is not an abuse of discretion to reject a collection alternative and sustain the proposed collection action (i.e., levy) on the basis of a taxpayer’s failure to submit requested financial information.

So there might be some levy action taken on tax liabilities that would be old enough to start college if they were kids.  Of course, Mr. Hauptman may still appeal the Tax Court decision.