                        T.C. Memo. 2010-22



                     UNITED STATES TAX COURT



              REMINGTON P. FAIRLAMB, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19122-07L.                 Filed February 4, 2010.



     Tony Mankus, for petitioner.

     Derek W. Kaczmarek, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:   Pursuant to section 6330(d), petitioner

seeks judicial review of respondent’s determination to proceed

with a proposed levy to collect petitioner’s unpaid Federal

income tax liabilities for 2002, 2003, and 2004.1    The issue for


     1
      Unless otherwise indicated, all section references are to
                                                   (continued...)
                               - 2 -

decision is whether respondent abused his discretion in rejecting

petitioner’s proposed offer-in-compromise.

                        FINDINGS OF FACT

     The parties have stipulated some facts, which we so find.

When he petitioned the Court, petitioner resided in Illinois.

     Petitioner, born in 1942, has worked for many years as an

independent sales representative in the paint industry.   In March

2005 he incorporated his business activities, forming Phoenix

Sales & Service, L.L.C. (the LLC), in which he and his wife each

owned a 50-percent interest.

     Petitioner did not timely file Federal income tax returns

for taxable years 1998 through 2004.   After making substitutes

for returns, on September 13, 2004, respondent assessed

petitioner’s income taxes for 1998 through 2001.   On April 9,

2005, respondent sent petitioner notices of intent to levy with

respect to his tax years 1998, 1999, 2000, and 2001.   Insofar as

the record shows, petitioner submitted no request for a

collection due process hearing with respect to these notices.

     On or about April 29, 2005, petitioner filed amended Federal

income tax returns for the years 1998 through 2002 and original

Federal income tax returns for 2003 and 2004.   He did not pay the



     1
      (...continued)
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure. All dollar amounts are
rounded to the nearest dollar.
                              - 3 -

taxes reported on these returns.   On October 6, 2005, respondent

sent petitioner a Letter 1058, Final Notice--Notice of Intent to

Levy and Notice of Your Right to a Hearing, with regard to

petitioner’s 2002, 2003, and 2004 income taxes, showing an unpaid

balance of $108,486 for these years.2    On October 14, 2005,

petitioner submitted a timely Form 12153, Request for a

Collection Due Process Hearing, on which he indicated that

enforcement action would create a hardship on him and that he

intended to submit an offer-in-compromise.

Petitioner’s First Offer-in-Compromise

     On December 29, 2005, respondent received from petitioner

Form 656, Offer in Compromise (the first offer), offering to pay

$150,000 to compromise his Federal income tax liabilities for

taxable years 1998 through 2004, which exceeded $400,000.

Petitioner proposed to pay $1,389 per month for 108 months.     This

offer indicated that it was based on doubt as to collectibility;

i.e., petitioner represented that he had insufficient assets to

pay the full amount of his tax liability.    As required,

petitioner submitted with the first offer Form 433-A, Collection

Information Statement for Wage Earners and Self-Employed



     2
      In addition to proposing the levy, on Oct. 24, 2005,
respondent filed a notice of Federal tax lien with respect to
petitioner’s tax years 2002, 2003, and 2004. Petitioner did not
file a Form 12153, Request for a Collection Due Process Hearing,
in response to this notice of Federal tax lien, and it is not at
issue in this proceeding.
                               - 4 -

Individuals, and Form 433-B, Collection Information Statement for

Businesses, with respect to the LLC.

     Respondent accepted petitioner’s offer-in-compromise for

processing.   By letter dated April 25, 2006, however,

respondent’s offer-in-compromise specialist (the first OIC

specialist) rejected the proposed terms of the first offer,

determining that any acceptable offer should be at least

$372,949, calculated as the sum of $18,755 of total net equity in

assets and $354,194 of total future income.

     By letter dated May 5, 2006, petitioner’s counsel took

exception to the determinations made by the first OIC specialist.

Petitioner’s counsel asserted, among other things, that

petitioner was elderly and in poor health and planned to retire

by age 70 if his health permitted him to work that long.

Petitioner’s counsel contended that petitioner’s future income

should be measured by reference to the 59 months that he said

remained until petitioner reached age 70.

     By letter dated May 11, 2006, the first OIC specialist

agreed that petitioner’s future income should be measured by the

months remaining until he reached age 70 but asserted that the

correct number of these remaining months was 69 rather than 59,

as petitioner asserted.   Using 69 months of future income, the

first OIC specialist lowered the minimum acceptable offer to

$149,286, an amount that was slightly less than petitioner’s
                               - 5 -

original $150,000 offer.   In a phone call with the first OIC

specialist, petitioner’s counsel indicated that he agreed with

most of the recalculations, except he contended that petitioner’s

future income should be calculated using 67 months instead of 69

months, because it would take about 2 months to have the offer

accepted, and that this adjustment would reduce the offer by

about $4,000.

Petitioner’s Second Offer-in-Compromise

     This position was memorialized in petitioner’s amended

offer-in-compromise (the second offer), which respondent received

on May 22, 2006.   Petitioner offered to pay $145,433 to

compromise his Federal income tax liabilities for taxable years

1998 through 2004.   He proposed to pay $16,332 within 30 days of

the second offer’s acceptance and $1,927 per month for the next

67 months, until he reached age 70.    In a report dated May 24,

2006, the first OIC specialist recommended to her group manager

that petitioner’s second offer be accepted because it represented

“the most that can be expected to be paid by this taxpayer”

taking into account “Special circumstance[s] due to the taxpayers

[sic] age and health”.3



     3
      The report indicates that petitioner had provided
verification from two physicians regarding his health and states
that petitioner “has coronary artery disease, hypertension,
hyperlipidemia and problems with recurring sinusitis and
pneumonia.”
                               - 6 -

     On June 22, 2006, a different offer-in-compromise specialist

(the second OIC specialist) reviewed the second offer and

determined that it should be rejected.   By letter dated June 28,

2006, the second OIC specialist informed petitioner that,

notwithstanding the contrary recommendation of the first OIC

specialist, he would recommend that the second offer not be

accepted because “it is not in the best interests of the

government”.   As grounds for this conclusion, the second OIC

specialist asserted that petitioner had a long history of not

filing and not paying income taxes and had formed the LLC in 2005

to reduce his self-employment taxes.   The letter stated that

petitioner should make any response within 2 days because the

second OIC specialist would be retiring then.   By letter dated

August 21, 2006, respondent’s territory manager formally notified

petitioner that the second offer had been rejected because it was

determined not to be in the Government’s best interests.

     In a letter dated September 13, 2006, petitioner’s counsel

disputed the rejection of the second offer and requested that the

case be transferred to respondent’s Appeals Office.

Petitioner’s Third Offer-in-Compromise

     Petitioner’s case was assigned to a settlement officer in

respondent’s Appeals Office.   After discussions with petitioner’s

counsel, the settlement officer indicated by letter dated May 14,

2007, that she had determined petitioner’s reasonable collection
                                - 7 -

potential to be $241,356.    She indicated that she had calculated

petitioner’s future income assuming that he would work for 60

more months and retire at age 70.    The letter stated that “there

are still no guarantees of acceptance since we need the approval

of my Territory Manager and Counsel approval.”

     Petitioner accepted most of the settlement officer’s

calculations.   On June 12, 2007, respondent received a second

amended offer-in-compromise (the third offer) from petitioner

that was based on doubt as to collectibility and that proposed to

pay $241,356 to compromise his income tax liabilities for taxable

years 1998 through 2004.    He proposed to pay $4,023 within 30

days of the third offer’s acceptance and $4,023 per month for the

next 59 months.

     The third time was not a charm.    By letter dated June 20,

2007, the settlement officer informed petitioner that his third

offer had not been approved.    Citing provisions of the Internal

Revenue Manual (IRM), the letter indicated that petitioner’s

reasonable collection potential had been recalculated to be

$523,958, by projecting his future income over the 107 months

asserted to remain in the collection period.    The letter proposed

that petitioner’s liabilities could be resolved in one of two

ways:   (1) By a long-term deferred offer-in-compromise to pay

$4,897 for 107 months; or (2) by a part-payment installment

agreement, which would require petitioner to liquidate certain
                               - 8 -

assets and to make monthly payments of $4,053, apparently for 167

months (the 107 months alleged to remain in the collection period

plus 5 years), with the possibility that the monthly amount

“could be adjusted to a lesser amount when you retire if your

income is reduced.”

     By letter dated July 2, 2007, petitioner’s counsel disagreed

with the settlement officer’s application of the IRM provisions

and requested that the settlement officer and her manager

reconsider the third offer.

Notice of Determination

     On August 6, 2007, respondent issued a Notice of

Determination Concerning Collection Action(s) Under Section 6320

and/or 6330, with respect to petitioner’s tax years 2002, 2003,

and 2004, sustaining the proposed levies for those years (the

notice).   The notice states in part:

     [T]he Appeals Team Manager confirmed that the offer
     could not be accepted because the offer was a deferred
     payment offer which is to be paid over the life of the
     collection statute. Your offer stipulated a payment
     term of 59 months (your remaining projected work life
     until retirement) rather than the 107 months remaining
     on the collection statute. Consequently, your offer is
     considered a deferred payment offer with special
     circumstances.

     IRM 5.8.11.2(2) states taxpayers can have an offer
     accepted under Doubt as to Collectibility with special
     circumstances when their reasonable collection
     potential is less than their liability, but there are
     economic hardship factors that would justify accepting
     the offer for an amount less than the reasonable
     collection potential. Economic hardship is further
     defined in IRM 5.8.11.2.(2) as unable to pay reasonable
                               - 9 -

     basic living expenses. Since you are able to meet your
     basic living expenses, economic hardship does not apply
     to your situation. Therefore, your offer could not be
     accepted.

                     *    *    *     *    *    *    *

     Offer Discussion and Analysis

     Based on the financial data you provided, you are
     currently unable to pay the entire liability.
     Therefore an offer-in-compromise based on doubt as to
     collectibility would initially appear to be a more
     appropriate and less intrusive means of collection.
     However, your offer amount does not equal or exceed
     your Reasonable Collection Potential (RCP) of
     $523,988.00. Calculation of your RCP in the amount of
     $523,958.00 was based on Net Realizable Equity (NRE) in
     assets totaling $90,287.00 and Future Income Potential
     (FIP) of 433,671.00. For a long term deferred offer,
     future income is projected over the life of the
     collection statute.

                              OPINION

A.   Collection Procedures

     Section 6330 requires the Secretary to furnish a person

notice and opportunity for a hearing before making a levy on the

person’s property.   At the hearing, the person may raise any

relevant issue relating to the unpaid tax or proposed levy,

including spousal defenses, challenges to the appropriateness of

the collection action, and offers of collection alternatives.

The person may challenge the existence or amount of the

underlying tax liability for any period only if the person did

not receive a notice of deficiency or did not otherwise have an

opportunity to dispute the liability.    Sec. 6330(c)(2)(B); Sego

v. Commissioner, 114 T.C. 604, 609 (2000).    Once the
                               - 10 -

Commissioner’s Appeals Office issues a notice of determination,

the person may seek judicial review in this Court.   Sec.

6330(d)(1).

     Because petitioner has not challenged his underlying

liability, our review is for abuse of discretion.    Sego v.

Commissioner, supra at 610.    Under this standard of review, the

question is whether respondent’s rejection of petitioner’s

offers-in-compromise was arbitrary, capricious, or without sound

basis in fact or law.   See, e.g., Murphy v. Commissioner, 125

T.C. 301, 320 (2005), affd. 469 F.3d 27 (1st Cir. 2006).       On

brief the parties focus primarily on respondent’s rejection of

the third and final offer as the precipitating event for the

notice.   We shall do the same.

B.   Offers-in-Compromise

     Section 7122(a) authorizes the Secretary to compromise any

civil or criminal case arising under the internal revenue laws.4

The regulations set forth three grounds for compromising a

liability:    (1) Doubt as to liability; (2) doubt as to

collectibility; and (3) promotion of effective tax

administration.    Sec. 301.7122-1(b), Proced. & Admin. Regs.




     4
      Sec. 6331(k) generally prohibits the IRS from making a levy
on a taxpayer’s property while an offer-in-compromise is pending
with the IRS. An offer-in-compromise becomes pending when it is
accepted for processing. Rev. Proc. 2003-71, sec. 5.01, 2003-2
C.B. 517, 518.
                              - 11 -

Petitioner based each of his three offers-in-compromise on doubt

as to collectibility.

     For purposes of evaluating an offer-in-compromise, doubt as

to collectibility exists “where the taxpayer’s assets and income

are less than the full amount of the liability.”    Sec. 301.7122-

1(b)(2), Proced. & Admin. Regs.   An offer-in-compromise based on

doubt as to collectibility “will be considered acceptable if it

is unlikely that the tax can be collected in full and the offer

reasonably reflects the amount the Service could collect through

other means * * * This amount is the reasonable collection

potential of a case.”   Rev. Proc. 2003-71, sec. 4.02(2), 2003-2

C.B. 517, 517.   In some cases, the Commissioner will accept an

offer-in-compromise of less than the reasonable collection

potential if there are “special circumstances.”    Id.

     The IRM describes procedures for analyzing a taxpayer’s

financial condition to determine reasonable collection potential.

See IRM pt. 5.8.5 (Sept. 1, 2005).5    The IRM defines reasonable

collection potential as net equity plus future income.    IRM pt.

5.8.11.2 (Sept. 1, 2005).   “Future income” is defined as “an

estimate of the taxpayers [sic] ability to pay based on an

analysis of gross income, less necessary living expenses, for a

specific number of months into the future.”    IRM pt. 5.8.5.5(1).



     5
      The parties have stipulated the relevant provisions of the
Internal Revenue Manual (IRM) referenced in this opinion.
                              - 12 -

For a deferred payment offer, the general rule is that future

income should be projected for “the number of months remaining on

the statutory period for collection.”     Id.   The IRM also

instructs the offer-in-compromise examiner to “Consider the

taxpayers [sic] overall general situation including such facts as

age, health, marital status, number and age of dependents,

highest education or occupational training, and work experience.”

IRM pt. 5.8.5.5(3).   More specifically, the IRM states:       “Some

situations may warrant placing a different value on future income

than current or past income indicates”.    IRM pt. 5.8.5.5(5).      By

way of illustration, the IRM states that if “A taxpayer is

elderly, in poor health, or both and the ability to continue

working is questionable”, then the offer-in-compromise examiner

should “Adjust the amount or number of payments to the expected

earnings during the appropriate number of months.     Consider

special circumstance situations when making any adjustments”.

Id.

      The IRM also describes procedures for processing offers-in-

compromise in the Commissioner’s Appeals Office.     See IRM pt.

8.23.3 (Oct. 16, 2007).   It states:   “IRM 5.8 is the primary

authority for evaluating offers and should be followed when

evaluating an appealed rejection.   Appeals does not have the

authority to disregard established guidance.”     IRM pt.

8.23.3.3(1).
                               - 13 -

C.     Analysis of Respondent’s Determination

       Respondent’s settlement officer followed the just-cited IRM

directives in initially recommending that petitioner’s third

offer be accepted.    In determining petitioner’s reasonable

collection potential, she projected his future income for 60

months, which she noted was his “remaining working life until

70”.    She noted in her case activity report:

       Determination is made to recommend the offer for
       acceptance. Tp [taxpayer] owns no realty and only has
       minimal personal assets. His most important asset is
       his income as an independent paint sales manufacturing
       representative. This income is the source that will
       fund the offer of $241,356.00. Distraint action
       against this income could be a possibility but would
       not provide any more funds into the Treasury than is
       provided via monthly payments of $4,022.60 via the
       offer. Also continued levy could result in tp’s
       dismissal. If the taxpayer maintains the offer, he
       will liquidate the back taxes and remain compliant with
       current taxes as well. Tp is now 65 years old. The
       older he becomes, the less likely the Service is to
       collect the liability or enforce collection.

       Ultimately, the settlement officer was overruled by her

superiors, and petitioner’s third offer was rejected.    The

reasons articulated in the notice are somewhat cryptic.    The

notice cites IRM pt. 5.8.11.2(2) for the proposition that

“[t]axpayers can have an offer accepted under Doubt as to

Collectibility with special circumstances when their reasonable

collection potential is less than their liability, but there are

economic hardship factors that would justify accepting the offer

for an amount less than the reasonable collection potential.”
                                - 14 -

Applying this standard, the notice concludes that petitioner did

not qualify for an offer-in-compromise based on doubt as to

collectibility with special circumstances because “you are able

to meet your basic living expenses”.

     This rationale is deficient for at least two reasons.

First, the notice misstates IRM pt. 5.8.11.2(2), which states

that an offer-in-compromise based on doubt as to collectibility

with special circumstances may be accepted where there are

“economic hardship or public policy/equity factors that would

justify accepting the offer”.    (Emphasis added.)    More

fundamentally, according to the IRM an offer-in-compromise is to

be evaluated as based on doubt as to collectibility with special

circumstances (as opposed to plain-vanilla doubt as to

collectibility) only if it is “for an amount less than the

reasonable collection potential”.    Id.

     Petitioner’s third offer was for the exact amount that the

settlement officer had initially calculated to be his reasonable

collection potential.    Addressing this issue obliquely, the

notice states (without citation of authority):       “For a long term

deferred offer, future income is projected over the life of the

collection statute.”    The notice fails to take into account,

however, IRM pt. 5.8.5.5(5), which, as previously discussed,

directs that in computing a taxpayer’s future income, adjustments

should be made for a taxpayer who is elderly or in poor health
                               - 15 -

and whose ability to continue working is questionable.    Following

this directive, the settlement officer initially calculated

petitioner’s future income under the assumption that he would

work until age 70.    There is no indication in the record that any

determination was ever made that petitioner would be able to work

beyond age 70.    Rather, the record strongly suggests that the

determination in the notice was based on a misapplication of the

IRM directives.

     The Commissioner’s internal procedures, as reflected in the

IRM, do not have the force of law, and deviation from them does

not necessarily render the Commissioner’s action invalid.

Vallone v. Commissioner, 88 T.C. 794, 807-808 (1987).

Nevertheless, the determination in this case, which was based

wholly on misapplication of internal procedures, cannot be said

to have a sound basis in law or fact.

     On brief respondent argues that the offer-in-compromise was

properly rejected because of petitioner’s alleged “long history

of non-compliance and his affirmative tax avoidance actions”.6    In

making this argument, respondent cites section 301.7122-

1(b)(3)(iii), Proced. & Admin. Regs., which provides:    “No

compromise to promote effective tax administration may be entered

into if compromise of the liability would undermine compliance by



     6
      Petitioner contests these assertions as unfounded in the
record.
                                - 16 -

taxpayers with the tax laws.”    (Emphasis added.)   Because

petitioner’s various offers were all based on doubt as to

collectibility rather than effective tax administration, this

regulatory provision is not, by its terms, applicable.7      In any

event, we do not believe that respondent’s ultimate

determination, as explained in the notice, can fairly be

construed as predicated on this rationale.    In initially

recommending petitioner’s third offer, the settlement officer

expressed no concern about this issue, and there is no indication

in the record that this consideration played any role in the

decision to overturn the settlement officer’s initial

recommendation.

     In the light of the inadequacy of the reasons given in the

notice for rejecting petitioner’s third offer, which the

settlement officer, with seemingly more soundly reasoned

analysis, had initially recommended accepting, we are unable to

conclude whether it was an abuse of discretion for respondent to

determine to proceed with the proposed collection action for

petitioner’s 2002, 2003, and 2004 tax liabilities.     We will


     7
      In Oman v. Commissioner, T.C. Memo. 2006-231, this Court
found that IRS directives as contained in IRM pt. 5.8.7.6(5)
(Nov. 15, 2004) and policy statement P-5-100 (Jan. 30, 1992) were
inconsistent as to whether doubt as to future compliance is a
sufficient reason to reject an offer-in compromise. The Court
remanded for further consideration and clarification the
Commissioner’s determination rejecting on this ground the
taxpayer’s proposed offer-in-compromise based on doubt as to
collectibility.
                                   - 17 -

remand the case to respondent’s Appeals Office for further

consideration and clarification and to allow petitioner, if he

wishes, to propose a new collection alternative.

D.      Evidentiary Issues

        At trial the Court received into evidence a number of

petitioner’s exhibits over respondent’s objection that they are

outside the administrative record.          On similar grounds respondent

objected to petitioner’s testimony and, in a motion in limine, to

the testimony of petitioner’s witness, a business associate.         On

brief respondent has renewed his objections.

        Petitioner suggests that the disputed documents should be

considered part of the administrative record because most of them

are IRS documents and the others were sent to petitioner by the

IRS.8       Petitioner complains that respondent evinces a double

standard in that, while insisting that judicial review should be

limited to the administrative record, respondent seeks to raise

in these proceedings for the first time issues and arguments that




        8
      Evaluation of the parties’ competing claims in this regard
is complicated by the fact that respondent has not offered into
evidence a certified copy of the entire administrative record.
Although the parties have stipulated numerous documents that
might properly appear in an administrative record, they have not
filed with the Court the entire administrative record, stipulated
as to its genuineness. Cf. Rule 217 (describing procedures for
disposing of a declaratory judgment action on the administrative
record). From the absence of certain documents cross-referenced
in the stipulated exhibits, it is apparent that the entire
administrative record is not in evidence.
                                - 18 -

were never raised in the administrative hearings.9      Petitioner

states on brief:   “The Petitioner cannot help but further wonder

whether Respondent’s strenuous efforts to limit the judicial

review to the administrative file is not an effort to generally

hamstring the tax courts and the taxpayers in order to avoid

having its procedural missteps brought to light.”

     The Tax Court does not follow the administrative record

rule.    See Robinette v. Commissioner, 123 T.C. 85 (2004), revd.

439 F.3d 455 (8th Cir. 2006).    In any event, in reaching our

decision we have not relied upon any of the disputed documents or

their contents or any of the trial testimony.    The portions of

the record as to which respondent has raised no objection are

sufficient to sustain our decision.

     To reflect the foregoing,


                                           An appropriate order

                                      will be issued.




     9
      For instance, on brief respondent disputes whether
petitioner’s health would necessitate his retirement by age 70.
Insofar as the record shows, however, respondent’s officers who
examined petitioner’s offers-in-compromise were satisfied with
the documentary evidence petitioner submitted in this regard, and
the notice of determination does not suggest that this issue
played any role in the ultimate rejection of petitioner’s offer-
in-compromise.
