Fargo v. Commissioner of Internal Revenue ( 2006 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
CHARLES G. FARGO; ELIZABETH A. 
FARGO, No. 04-72190
Petitioners-Appellants, D.C. No.
v.  Tax Ct. No.
COMMISSIONER OF INTERNAL 9492-02L
REVENUE, OPINION
Respondent-Appellee.

Appeal from a Decision of the
United States Tax Court
Argued and Submitted
December 5, 2005—Pasadena, California
Filed May 8, 2006
Before: Robert R. Beezer, Cynthia Holcomb Hall, and
Kim McLane Wardlaw, Circuit Judges.
Opinion by Judge Hall
5139
FARGO v. COMMISSIONER OF INTERNAL REVENUE 5143
COUNSEL
Dennis N. Brager, Law Offices of Dennis N. Brager, Los
Angeles, California, for the appellants.
Randolph L. Hutter, Tax Division, United States Department
of Justice, Washington, D.C., for the appellee.
Terri A. Merriam, Pearson Merriam, Seattle, Washington, for
the amici.
OPINION
HALL, Senior Circuit Judge:
Charles and Elizabeth Fargo (Taxpayers) appeal the deci-
sion of the Tax Court holding that the Commissioner of Inter-
nal Revenue did not abuse his discretion by rejecting their
offer to pay $7,500 in compromise of the approximately
$104,000 interest owed on their 1983 and 1984 federal
income tax liabilities. We affirm.
I. Facts
More than twenty years ago, Taxpayers bought interests in
two partnerships: the Jackson & Associates Partnership (Jack-
son), and the Smith & Asher Associates Partnership (Smith &
5144 FARGO v. COMMISSIONER OF INTERNAL REVENUE
Asher). In 1983, Taxpayers claimed a loss of $30,767 attribut-
able to their interest in Jackson; in 1984, they claimed a
$2,749 loss from Jackson and a $28,996 loss from Smith &
Asher. These partnerships were themselves partners in yet
other partnerships (Wilshire West Associates and Redwood
Associates, respectively), which in turn were associated with
a series of tax shelters called the Swanton Coal Programs.1 All
of the partnerships were subject to the Tax Equity and Fiscal
Responsibility Act (TEFRA) provisions of 26 U.S.C.
§§ 6221-6234.
The Swanton Coal Programs were exposed as purely tax-
motivated transactions in Kelley v. Commissioner of Internal
Revenue, 66 T.C.M. 1132 (1993), with the Tax Court
opining that the Programs were “nothing more than an elabo-
rate scam to provide highly leveraged deductions for nonexis-
tent expenses.” The Tax Court’s 1993 ruling in Kelley had an
effect on Taxpayers’ liabilities for 1983 and 1984, but the
final liability amount would not be determined until six years
later, in 1999. This delay stemmed from the tiered partnership
system: before the effect of the decision in Kelley could be
determined, the Commissioner had to negotiate with the Tax
Matter Partners (TMPs) for Jackson and Smith & Asher. The
delay led to an accumulation of penalties and interest that
increased Taxpayers’ total liability to over $127,000. After
the assessment was finalized in 1999, Taxpayers were
informed of their liability—and while they quickly paid their
back taxes (in the amount of $23,977), they refused to pay the
remaining interest ($104,287.91). The Commissioner sent
notice of intent to levy, and Taxpayers requested a Collection
Due Process hearing before the Office of Appeals.
Taxpayers timely submitted to the Appeals Officer an
offer-in-compromise for $7,500 (about seven percent of their
1
For a more detailed description of the relevant partnerships and of the
Swanton Coal Tax Shelters, see Fargo v. Comm’r, 87 T.C.M. 815
(2004), and Kelley v. Comm’r, 66 T.C.M. 1132 (1993).
FARGO v. COMMISSIONER OF INTERNAL REVENUE 5145
outstanding liability). At the time of the offer, temporary
Treasury Regulations issued pursuant to 26 U.S.C. § 7122
governed the acceptance of offers-in-compromise.2 Tempo-
rary Treasury Regulation § 301.7122-1T(b)(4) indicated that
a compromise may be entered into to promote effec-
tive tax administration when—
(i) Collection of the full liability will create
economic hardship within the meaning of
§ 301.6343-1; or
(ii) Regardless of the taxpayer’s financial
circumstances, exceptional circumstances
exist such that collection of the full liability
will be detrimental to voluntary compliance
by taxpayers; and
(iii) Compromise of the liability will not
undermine compliance by taxpayers with
the tax laws.
Taxpayers’ offer-in-compromise was based on sections (i)
and (ii) of this regulation; they claimed both economic hard-
ship and exceptional circumstances. They argued that eco-
nomic hardship would ensue because Mr. Fargo’s medical
expenses would soon balloon to $90,000 per year, and the
large interest payout of $104,000 would both cut into their
overall resources and eventually serve to bankrupt them. Tax-
payers additionally claimed exceptional circumstances, argu-
ing that the IRS dragged its feet in determining their liability,
and thus the delay was not Taxpayers’ fault and should not be
held against them. Also under the “exceptional circum-
2
The applicable temporary regulation, § 301.7122-1T(b)(4), can be
found at 64 Fed. Reg. 39,020 (July 21, 1999). The final regulation, codi-
fied at 26 C.F.R. § 301.7122-1, is substantially identical, but does not
apply here. See Fargo, 87 T.C.M. 815 at n.2.
5146 FARGO v. COMMISSIONER OF INTERNAL REVENUE
stances” rubric, Taxpayers contended that Congress specifi-
cally contemplated longstanding cases such as theirs when it
enacted 26 U.S.C. § 7122, and all but required that such cases
be compromised.
The Commissioner rejected their offer. The Tax Court,
reviewing for abuse of discretion, affirmed. Fargo v. Comm’r,
87 T.C.M. 815 (2004). Taxpayers appeal, again argu-
ing economic hardship and exceptional circumstances.
II. Standard of Review
We review the Tax Court’s decision under the same stan-
dard as civil bench trials in district court, see Milenbach v.
Comm’r, 318 F.3d 924, 930 (9th Cir. 2003), and thus review
de novo. Boyd Gaming Corp. v. Comm’r, 177 F.3d 1096,
1098 (9th Cir. 1999). In this instance, de novo review
amounts to a fresh analysis of whether the Commissioner
abused his discretion. Abuse of discretion occurs when a deci-
sion is based “on an erroneous view of the law or a clearly
erroneous assessment of the facts.” United States v. Morales,
108 F.3d 1031, 1035 (9th Cir. 1997) (en banc) (citing Cooter
& Gell v. Hartmarx Corp., 496 U.S. 384, 405 (1990)).
III. Discussion
A. Economic Hardship
The Tax Court held that the Commissioner did not abuse
his discretion in determining that the Taxpayers would not
experience economic hardship if their offer-in-compromise
was rejected. We agree.
[1] The operative statutory and regulatory framework in
this case focuses on basic expenses. The regulation in effect
at the time of the offer-in-compromise, Temporary Treasury
Regulation § 301.7122-1T(b), provides that a compromise
“may be entered into to promote effective tax administration
FARGO v. COMMISSIONER OF INTERNAL REVENUE 5147
when . . . [c]ollection of the full liability will create economic
hardship within the meaning of § 301.6343-1.” Economic
hardship is defined as the inability of the taxpayer “to pay his
or her reasonable basic living expenses.” 26 C.F.R.
§ 301.6343-1(b)(4)(i). The regulation goes on to specify that:
The determination of a reasonable amount for basic
living expense will be made by the director and will
vary according to the unique circumstances of the
individual taxpayer. Unique circumstances, however,
do not include the maintenance of an affluent or lux-
urious standard of living.
Id. These regulations are consistent with provisions of their
authorizing statute, 26 U.S.C. § 7122, which provides explic-
itly for a case-by-case analysis “designed to provide that tax-
payers entering into a compromise have an adequate means to
provide for basic living expenses.” 26 U.S.C. § 7122(c)(2).
[2] Taxpayers claim that they will suffer economic hardship
if they are required to pay their full $104,000 liability. They
argue that Mr. Fargo’s medical expenses, owing to his pro-
gressive dementia, will soon reach $90,000 per year and
bankrupt them in about a decade. The evidence to support
their claim is thin. First, the only medical evidence Taxpayers
present is a diagnosis performed by a clinical neuropsy-
chologist that indicates that Mr. Fargo suffers from Frontal
Lobe Dementia, contributing to a number of impairments of
his mental abilities. This diagnosis, however, mentions noth-
ing of the necessity for long-term around-the-clock nursing
care, nor of medical expenses.
[3] Second, the Taxpayers’ current monthly medical
expenses, as reported in the Monthly Income and Expense
Analysis section of their offer-in-compromise, total $288.
Their claimed future expenses of $90,000 per year seems pre-
dominantly hypothesized from publicly-available information
5148 FARGO v. COMMISSIONER OF INTERNAL REVENUE
that is not particularized to Mr. Fargo. Thus, their future med-
ical expenses are almost wholly speculative.
[4] Third and perhaps most importantly, Taxpayers have
considerable assets, and it is highly unlikely that their ability
to pay “basic living expenses” would be impaired even were
Mr. Fargo to require around-the-clock nursing care. Taxpay-
ers have an annual adjusted gross income of $144,378; bank
accounts and individual retirement accounts worth $126,179;
securities worth $594,628; and equity in real property
amounting to $309,000. Their non-income assets are worth
more than a million dollars combined. Furthermore, their cur-
rent reported expenses are $5,888 per month, against a
monthly gross income of $8,859. In other words, Taxpayers
can afford significantly greater health care expenses than they
currently pay, even without liquidating any assets. Accord-
ingly, their contention that their medical expenses will outrun
their net worth in ten years seems to assume a number of
premises unsupported by the record, and indeed feels like
nothing more than back-of-the-napkin multiplication.
[5] Taxpayers’ hardship claim is particularly weak given
that the relevant inquiry is only whether the Commissioner
abused his discretion. Although one might find some ground
upon which to quibble with the Commissioner’s decision, it
is impossible to hold that the Commissioner employed an
erroneous view of the law or a clearly erroneous assessment
of the facts. Given the speculative nature of Taxpayers’
expenses, their considerable accumulation of wealth, and the
statutory focus on basic expenses, it stretches reason to con-
tend that the Commissioner abused his discretion in rejecting
the Taxpayers’ claim of hardship.
B. Exceptional Circumstances
Taxpayers’ claim of exceptional circumstances is also
unavailing. Taxpayers argue that the Commissioner either
waited too long after the Tax Court’s decision in Kelley to
FARGO v. COMMISSIONER OF INTERNAL REVENUE 5149
contact them with the amount of their liability, or simply took
too long to determine their liability in the first place. The
Commissioner responds that any delay is due to the length of
time it took to negotiate a closing agreement with the TMPs
of the partnerships in which Taxpayers had an interest. The
delay, argues the Commissioner, was part and parcel of the
legally-required procedures under TEFRA. Taxpayers rejoin
that the legislative history of 26 U.S.C. § 7122 supports their
position and in fact mandates the compromise of longstanding
cases such as theirs. We hold that the Tax Court did not err
in determining that the Commissioner did not abuse his dis-
cretion in rejecting Taxpayers’ offer-in-compromise on the
basis of exceptional circumstances.
Taxpayers raise three arguments based on exceptional cir-
cumstances. First, they claim that the Commissioner abused
his discretion by applying the Treasury Regulations incor-
rectly in light of their authorizing statute, 26 U.S.C. § 7122.3
Second, they claim that the Commissioner abused his discre-
tion by flouting internal IRS guidelines with regard to offers-
in-compromise. And third, they claim that the Commissioner
abused his discretion by ignoring certain equity and public
policy considerations. We reject each of these arguments.
1. Incorrect application of the Treasury Regulations in
light of their authorizing statute, 26 U.S.C. § 7122
[6] The bulk of Taxpayers’ arguments with regard to
exceptional circumstances concern whether the Commissioner
misapplied the temporary Treasury Regulations issued pursu-
ant to 26 U.S.C. § 7122. Specifically, Taxpayers contest the
3
This claim could be construed as an argument that the Treasury Regu-
lations themselves are in contradiction of their authorizing statute. How-
ever, Taxpayers explicitly disavow that interpretation, stating that “[i]t is
the IRS application of the regulations to preclude abatement of interest
which is an abuse of discretion.” Opening Brief of Petitioner-Appellant at
21 n.8, Fargo v. Comm’r, No. 04-72190 (9th Cir. Jul. 13, 2004).
5150 FARGO v. COMMISSIONER OF INTERNAL REVENUE
application of Temporary Treasury Regulation § 301.7122-
1T(b)(4), which provides that the Commissioner may accept
an offer-in-compromise if “exceptional circumstances exist
such that collection of the full liability will be detrimental to
voluntary compliance by taxpayers; and . . . [c]ompromise of
the liability will not undermine compliance by taxpayers with
the tax laws.” Taxpayers contend that, following the Tax
Court’s opinion in Kelley, the delay in determining their lia-
bility constitutes exceptional circumstances.
[7] Taxpayers cite repeatedly to the legislative history of 26
U.S.C. § 7122, claiming that whatever regulations it autho-
rizes should be used to accommodate compromise in long-
standing cases where large amounts of interest have accrued,
even though no such specification occurs in the statutory text.4
However, as the Supreme Court has previously noted in the
taxation context, “[l]egislative history can be a legitimate
guide to a statutory purpose obscured by ambiguity, but [i]n
the absence of a clearly expressed legislative intention to the
contrary, the language of the statute itself must ordinarily be
regarded as conclusive.” Burlington N. R.R. Co. v. Okla. Tax
Comm’n, 481 U.S. 454, 461 (1987) (internal quotation marks
omitted) (citing United States v. James, 478 U.S. 597, 606
(1986)). The Tax Court has also recognized the primary value
of statutory text, indicating that “[i]f the language of the stat-
ute is plain, clear, and unambiguous, we generally apply it
according to its terms.” Montgomery v. Comm’r, 122 T.C. 1
(2004) (citing, inter alia, United States v. Ron Pair Enters.,
Inc., 489 U.S. 235, 241 (1989)). Here, the authorization pro-
4
Although this case is about compromise, not interest abatement, Tax-
payers claim that the Tax Court incorrectly adopted the standards utilized
in the interest abatement statute (26 U.S.C. § 6404) as controlling whether
to accept an offer-in-compromise. However, the Tax Court does not so
much as mention § 6404, let alone apply it. Instead, it merely mentions
(and distinguishes) the interest abatement case Beagles v. Commissioner,
85 T.C.M. 995 (2003). Taxpayers’ erroneous line of reasoning
seems to stem from certain background information to the final Treasury
Regulations, which is analyzed infra Subsection 3.
FARGO v. COMMISSIONER OF INTERNAL REVENUE 5151
vided by the statute is discretionary on its face, stating that
“the Secretary may compromise any civil or criminal case
arising under the internal revenue laws.” 26 U.S.C. § 7122(a)
(emphasis added). Discretion is also given to the Secretary of
the Treasury to determine what standards will govern evalua-
tion of an offer-in-compromise: “The Secretary shall pre-
scribe guidelines for officers and employees of the Internal
Revenue Service to determine whether an offer-in-
compromise is adequate and should be accepted to resolve a
dispute.” 26 U.S.C. § 7122 (c)(1) (emphasis added).
Taxpayers contend that these authorizations of discretion
are tempered by the statute’s legislative history, which they
say specifically contemplates compromise of longstanding
cases where large amounts of fines and interest accrue. The
House Conference Report, for instance, indicates that:
[t]he conferees anticipate that, among other situa-
tions, the IRS may utilize this new authority to
resolve longstanding cases by forgoing penalties and
interest which have accumulated as a result of delay
in determining the taxpayer’s liability. The conferees
believe that the ability to compromise tax liability
and to make payments of tax liability by installment
enhances taxpayer compliance. In addition, the con-
ferees believe that the IRS should be flexible in find-
ing ways to work with taxpayers who are sincerely
trying to meet their obligations and remain in the tax
system. Accordingly, the conferees believe that the
IRS should make it easier for taxpayers to enter into
offer-in-compromise agreements, and should do
more to educate the taxpaying public about the avail-
ability of such agreements.
H. Conf. Rep. 105-599, at 289 (1998), reprinted in 1998
U.S.C.C.A.N. 288 (emphasis added). The Senate Report, also
seeming to indicate that Congress hoped the IRS would be
reasonably generous in accepting compromise, states that “[i]t
5152 FARGO v. COMMISSIONER OF INTERNAL REVENUE
is anticipated that the IRS will adopt a liberal acceptance pol-
icy for offers-in-compromise to provide an incentive for tax-
payers to continue to file tax returns and continue to pay their
taxes.” S. Rep. 105-174, at 90 (1998).
[8] These expressions of legislative intent, though relevant
in support of Taxpayers’ position, do not meet the threshold
for proving the Commissioner’s abuse of discretion. First, the
authorizing statute remains explicitly discretionary, and in
performing statutory interpretation the text must come first.
Second, the legislative history at issue is, as the emphasis
above shows, substantially discretionary as well. Congressio-
nal intent here is probative, but it does not show that the Com-
missioner made a decision “on an erroneous view of the law
or a clearly erroneous assessment of the facts.” Morales, 108
F.3d at 1035. Indeed, at least one court has held that not only
is § 7122 discretionary, but it does not even confer the right
to have one’s offer considered. See Christopher Cross, Inc. v.
United States, 363 F. Supp. 2d 855, 858 (E.D. La. 2004). In
this case, however, we need not address the exact scope of
§ 7122 in such a manner; we hold only that the Commissioner
did not abuse his discretion.
2. Flouting of internal regulations with regard to
compromise
Taxpayers suggest that even if the IRS Appeals Officer was
correct to determine that $7,500 was an inadequate offer, he
was duty-bound by the Internal Revenue Manual to negotiate
a better deal rather than reject the offer outright. The portion
of the Manual to which Taxpayers cite does not exist under
the current revisions, and they provide no date for reference.
But even taking Taxpayers at their word that the Manual
exhorts Appeals Officers to negotiate before rejecting an
offer-in-compromise, their contention that they were owed a
duty of negotiation is incorrect.
[9] The Internal Revenue Manual does not have the force
of law and does not confer rights on taxpayers. This view is
FARGO v. COMMISSIONER OF INTERNAL REVENUE 5153
shared among many of our sister circuits. See, e.g., Carlson
v. United States, 126 F.3d 915, 922 (7th Cir. 1997); Marks v.
Comm’r, 947 F.2d 983, 986 n.1 (D.C. Cir. 1991) (holding that
“[i]t is well-settled . . . that the provisions of the [Internal
Revenue M]anual are directory rather than mandatory, are
not codified regulations, and clearly do not have the force and
effect of law” (emphasis added)); see also Valen Mfg. Co. v.
United States, 90 F.3d 1190, 1194 (6th Cir. 1996); United
States v. Horne, 714 F.2d 206, 207 (1st Cir. 1983); Einhorn
v. DeWitt, 618 F.2d 347, 349-50 (5th Cir. 1980).
[10] Further, even if the Manual does recommend negotia-
tion, it contains numerous provisions that vest Appeals Offi-
cers with the discretion to accept or reject offers-in-
compromise. See, e.g., I.R.M. §§ 5.1.9.3.7.1 (Mar. 24, 2005),
8.1.1.2 (Feb. 1, 2003), 8.13.2.11 (Mar. 2, 2006). Each of these
sections confers considerable discretion, militating against the
existence of any duty to negotiate rather than reject. Even if
some duty existed attendant to the Internal Revenue Manual,
Taxpayers’ argument does not show that the Commissioner
abused his discretion.
3. Public policy and equity
[11] Taxpayers’ final claim under the exceptional circum-
stances rubric is that a decision ruling against them will dis-
courage future individuals from paying their taxes, because
the delay in this case was outside of their control and thus
unfairly punitive. The effective tax administration ground for
compromise in Temporary Treasury Regulation § 301.7122-
1T(b)(4) indicates that two conditions must be met: first, col-
lection of the full liability must endanger “voluntary compli-
ance by taxpayers,” and second, compromise must “not
undermine compliance . . . with the tax laws.” In other words,
compromise based on exceptional circumstances must allevi-
ate potential present nonpayment while discouraging future
nonpayment by others. Taxpayers and amici claim that the
delay in this case, because it rested outside of the control of
5154 FARGO v. COMMISSIONER OF INTERNAL REVENUE
Taxpayers, should not be held against them. Amici in particu-
lar are worried about the long-reaching effects of our decision
in this case, fearing that individuals will be hoodwinked into
tax shelters and then stung for the interest on their massive tax
liabilities.5 But this theory, even if plausible, simply does not
fit into the regulatory scheme. In this case, a decision to col-
lect the full liability will not discourage voluntary tax pay-
ment in the future, and a compromise could undermine the tax
laws.
[12] The crux of Taxpayers’ concerns seem to flow from
the background information to the finalized Treasury Regula-
tion § 301.7122-1(b), in which it is stated that:
The IRS and Treasury Department do not believe
that it would promote effective tax administration to
authorize compromise solely on the basis of an
asserted delay by the IRS, particularly delay that
does not support relief under section 6404(e) . . . .
Compromise of Tax Liabilities, 67 Fed. Reg. 48,025, 48,027
(July 23, 2002) (codified at 26 C.F.R. pt. 301). From this
statement, as noted supra, Taxpayers and amici draw the idea
that the standard for offers-in-compromise is now the same as
that for interest abatement, and delay on the part of the IRS
can never constitute a valid ground for compromise. Thus,
goes the argument, this case and others like it are being
decided on a stricter standard than authorized by 26 U.S.C.
5
In an error shared with amici, Taxpayers also assume that the Tax
Court’s decision here affects all “similarly situated” parties equally. We
review the case before us, however, for abuse of discretion, which is
highly case-specific. The fact that the Commissioner chose to reject Tax-
payers’ offer-in-compromise here does not mean that he will reject all
similar offers in compromise in the future; indeed, that is the very defini-
tion of discretion. In addition, “exceptional circumstances” is not the only
acceptable ground for accepting an offer-in-compromise. This case does
not necessarily preclude other similarly-situated taxpayers from reaching
a compromise with the IRS.
FARGO v. COMMISSIONER OF INTERNAL REVENUE 5155
§ 7122, and that stricter standard also frustrates the policy
goals of Treasury Regulation § 301.7122-1(b). This argument
is undermined, however, by a quote later in the background
information, which states that
cases in which a taxpayer believes the liability was
caused, in whole or in part, by delay on the part of
the IRS or by the actions of third parties may be
appropriate for compromise under the public policy
and equity standard. Such cases, however, are
expected to be rare, as the taxpayer must identify
compelling public policy or equity concerns that sat-
isfy the standard set forth above.
Id. (emphasis added). While Taxpayers chose to focus on the
fact that such equity-based compromises will be “rare,” the
relevant question is merely whether the Commissioner has
relinquished his discretion to compromise longstanding cases.
He has not.
[13] Furthermore, in this instance the Commissioner has
not abused his discretion by not accepting Taxpayers’ offer-
in-compromise. There are a number of factors cutting against
Taxpayers which do not lend themselves towards relief on
effective tax administration grounds: 1) Taxpayers invested in
tax shelters, and purely tax-motivated transactions are
frowned upon by the Code;6 2) no evidence was presented to
suggest that Taxpayers were the subject of fraud or deception;
3) the delay that took place was due to well-established
TEFRA procedures and the inability of Taxpayers’ TMPs to
negotiate quickly; and 4) the primary incentives created by
requiring full payment are to encourage taxpayers to research
future investments more carefully and to keep in better con-
tact with financial agents (such as TMPs).7 At the very least,
6
See, e.g., 26 U.S.C. § 6621 (applying a higher interest rate to past lia-
bilities resulting from tax-motivated transactions).
7
We note that the Tax Court indicated that even in the absence of an
abuse of discretion by the Commissioner, Taxpayers may have a right of
action against their TMPs for unnecessary delay, perhaps on grounds of
breach of fiduciary duty. Fargo, 87 T.C.M. 815.
5156 FARGO v. COMMISSIONER OF INTERNAL REVENUE
the presence of these policy factors indicates that the Com-
missioner did not abuse his discretion in rejecting Taxpayers’
offer on grounds of exceptional circumstances.
AFFIRMED.