Chi Wai v. Comm'r ( 2006 )

T.C. Memo. 2006-179
UNITED STATES TAX COURT
CHI WAI, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket No. 19316-04L. Filed August 29, 2006.
P incurred alternative minimum tax liability as a
result of her exercise of incentive stock options in
2000. The stock declined precipitously in value after
the date of exercise. P partially paid her year 2000
tax liability through withholding, estimated tax
payments and application of a small credit, and
submitted an offer-in-compromise for the unpaid
balance. The IRS rejected the offer-in-compromise and
notified P of its intent to levy on P’s property.
Held: it was not an abuse of discretion to reject P’s
offer. IRS may proceed with the levy. Speltz v.
Commissioner, 124 T.C. 165 (2005), affd. 454 F.3d 782
(8th Cir. 2006), followed.
John S. Harper, for petitioner.
Cleve Lisecki, for respondent.
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MEMORANDUM OPINION
NIMS, Judge: Petitioner petitioned the Court under section
6330(d)1 to review the determination of the Internal Revenue
Service’s Office of Appeals sustaining a proposed levy on
petitioner’s property related to petitioner’s year 2000 Federal
income tax liability. Unless otherwise indicated, all section
references are to sections of the Internal Revenue Code in effect
at relevant times. Petitioner resided in Virginia at the time
she filed her petition.
Background
This case was submitted fully stipulated. The facts as
stipulated are so found.
Petitioner filed her Federal income tax return for 2000 on
the basis of married filing separate. Petitioner’s reported tax
liability included an alternative minimum tax liability (AMT) of
$776,447, and “regular” tax in the amount of $10,100, bringing
her total tax liability to $786,547. Her return reported Federal
income tax withheld of $11,080, and estimated tax payments of
$450,000, leaving a balance of tax due in the amount of $325,467.
1
The petition refers initially to sec. 6330(c); however,
this appears to be an inadvertence, since sec. 6330(d) is the
statutory provision that provides for judicial review of a
determination by the Internal Revenue Service Office of Appeals.
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Petitioner made no remittance with the return, and except for a
$300 credit on December 3, 2001, petitioner made no additional
payments.
Respondent accepted petitioner’s return as filed and in due
course assessed the $786,547 tax due shown on the return. In
addition, respondent assessed a $174,480.07 late filing penalty
under section 6651(a)(1), and a $31,018.68 late payment penalty
under section 6651(a)(2). Subsequently, respondent abated
$101,250 of the late filing penalty, and $13,122.50 of the late
payment penalty.
Petitioner was employed as an engineer by PMC-Sierra (PMCS)
during 2000. During the year, petitioner exercised several
incentive stock options (ISOs) covering PMCS shares having a
value of $2,910,251 on the exercise date. Petitioner’s total
exercise price under all the ISOs was $183,263, so that the value
of the shares on the date of exercise exceeded the exercise price
by $2,726,988.
Petitioner’s exercise of the ISOs encompassed an attendant
“ISO spread”, described below, within the purview of the AMT
system. See sec. 56(b)(3). The beneficial provisions of
sections 421(a) and 83(e) are superseded for purposes of
computing income adjustments in the AMT regime. As a result, the
pertinent AMT income recognition event for incentive stock option
transactions occurs upon the holder’s exercise of the option.
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The aforementioned ISO spread represents the differential between
the exercise price and the fair market value of the underlying
stock as of the date an option is exercised.
The above-described gain, although excludable from
petitioner’s year 2000 taxable income pursuant to section 421(a),
was includable in her alternative minimum taxable income (AMTI)
pursuant to section 56(b)(3). Petitioner did not sell any of the
shares in 2000 and properly reported the $2,726,988 gain on her
return for that year.
The value of petitioner’s PMCS stock purchased under the
ISOs fell dramatically after the ISOs were exercised in 2000 but
before the stock was sold in 2001, so that the actual selling
price over petitioner’s exercise price under the ISOs produced
for regular tax purposes a gain that was only a small fraction of
the AMT gain required to be reported on petitioner’s 2000 Federal
income tax return, and a tax that was also substantially less
than the $786,547 tax which petitioner reported on her 2000
return. Cf. Merlo v. Commissioner, 126 T.C. 205, 209-210 (2006).
On December 20, 2001, petitioner submitted a Form 656, Offer
in Compromise (OIC), which stated as the reasons Doubt as to
Liability, Doubt as to Collectibility, and Effective Tax
Administration. The amount of the offer was left blank, to which
respondent’s “offer unit” inserted $1 to permit the Internal
Revenue Service (IRS) to begin review of the OIC. Petitioner’s
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offer was temporarily put on hold “pending a review of the ISO
rulings by National Office.” Petitioner was later advised by
respondent’s offer specialist that “the Effective Tax
Administration offer is not feasible as it is used [only] when
the net realizable equity [in the taxpayer’s assets] exceeds the
tax amount”, which was not the case here.
On May 1, 2003, petitioner submitted an amended offer-in-
compromise (amended OIC), which contained only doubt as to
collectibility and effective tax administration (ETA) as reasons
for the offer, and again contained no dollar amount, which
respondent treated as $1, and again rejected. Petitioner then
filed a protest, and respondent’s settlement officer in general
appeals programs sustained the rejection of the amended OIC.
On May 20, 2004, respondent mailed to petitioner a Final
Notice - Notice of Intent to Levy and Notice of Your Right to a
Hearing, in response to which petitioner requested a hearing
(Appeals hearing). In the request, petitioner asserted that
respondent’s rejection of petitioner’s OIC was an abuse of
discretion.
On September 8, 2004, respondent advised petitioner that the
Appeals Office had sustained respondent’s Final Notice - Notice
of Intent to Levy and Notice of Your Right to a Hearing for the
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2000 year. Respondent’s Final Notice contained the following
“Summary of Determination” (Summary), quoted here in its
entirety:
Summary of Determination
Although we addressed each of your issues we could not
reach an agreement. Based on the case file the issuing
of the Final Notice - Notice of Intent to Levy and
Notice Of Your Right To A Hearing is sustained.
As is apparent, the Summary does not disclose the issues to
which it refers. However, on November 8, 2003, respondent’s
settlement officer had issued an Appeals Case Memorandum which
explained in detail respondent’s reasons for rejecting
petitioner’s OIC, as follows:
SUMMARY AND RECOMMENDATION
The taxpayer is seeking to compromise, under the
authority of Section 7122 of the Internal Revenue Code,
and as amended by the Restructuring and Reform Act of
1998 to include provisions under Effective Tax
Administration (ETA), the unpaid taxes plus all
statutory additions, relating to the Individual Income
Tax Return, Form 1040, filed Married filing Separate
for the calendar year ending December 31, 2000.
Mrs. Wai’s Offer was submitted solely on the premise of
the inequity and unfairness of the assessment of
Alternative Minimum Tax (AMT) that she was subject to
for tax year 2000 as a result of exercising stock
options. Her offer, based on ETA, focused on the fact
that had she filed jointly with her husband for this
year, the amount of her AMT tax would not only have
been significantly less, but it would have essentially
been paid in full. Her Power of Attorney, John S.
Harper, therefore reasoned that the provisions of IRC
6015(f) should be applied in consideration of the
Offer.
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The rejection of this Offer has been sustained by
Appeals for the following reasons:
1. It is the current position of Appeals that
Offers submitted based solely on the merits
of the ISO-AMT issue, do NOT qualify for
consideration under the principles of ETA.
Currently there is no provision in the law
that allows consideration of ETA-OIC’s due to
AMT on stock options. Our position remains
that Congress must enact a change in the law
with respect to the AMT on stock options
before we will give consideration to the
merits of an offer submitted under ETA based
solely on this issue. We will NOT set
precedent at this time with reviewing or
accepting ETA-OIC’s based on the ISO-AMT
issue until a change in the law has been
made. Appeals also has no authority at this
time to suspend any of these ETA-OIC’s
currently in inventory until such time, if
any, that a change in the law is made. And
secondly,
2. Mr. Harper’s request to have the ETA-OIC
viewed in light of the provisions of IRC
6015(f) is flawed. The fact that if the
taxpayer’s[sic] had filed jointly would
have significantly reduced the amount of
Mrs. Wai’s AMT tax does not negate the
fact that they voluntarily chose to file
separately for tax year 2000, thus
creating a larger tax burden for
themselves individually. As previously
discussed with Mr. Harper, the
Wai’s[sic] still have the ability to
amend their 2000 returns by filing a
joint return, and thus reducing the
amount of AMT tax that Mrs. Wai is
asking the IRS to compromise. In
addition, Mrs. Wai would then be in a
position to request relief under the
Innocent Spouse provisions, in which Mr.
Harper believes she would prevail.
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Appeals will not consider the
principles under IRC 6015(f) in
determining whether or not the ETA-
OIC should be accepted from Mrs.
Wai.
The offer is being rejected without further consideration by
Appeals at this time.
During the pendency of petitioner’s CDP matter before
respondent’s settlement officer, petitioner’s counsel was in
contact with other Government officials (of which he kept the
Settlement Officer and her superior informed) in an attempt to
obtain collateral relief for petitioner from her AMT liability.
At various times, counsel was in contact with the National
Taxpayer Advocate’s Office, and with the Assistant Secretary of
Treasury for Tax Policy.
By letter dated October 28, 2004, Commissioner of Internal
Revenue Mark W. Everson advised Senators Grassley and Baucus
that, as of that date, no formal guidance had been issued by the
IRS to its employees specifically pertaining to the compromise of
liabilities attributable to the AMT arising from the exercise of
ISOs.
Discussion
The facts in this case giving rise to the AMT almost exactly
parallel those of Speltz v. Commissioner, 124 T.C. 165 (2005),
affd. 454 F.3d 782 (8th Cir. 2006). In each case, the taxpayer
exercised ISOs during the year 2000, and reported on the
respective Federal tax returns, for purposes of the AMT, an
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excess of AMT income over “regular tax income” of very
substantial amounts. The value of the taxpayer’s stock in each
case dropped precipitously after the exercise, and the amount
realized on the later sale of the stock after year 2000 was a
small fraction of the AMTI reported on the respective year 2000
returns, and also a small fraction of the AMT in each case. The
taxpayers in each case thus suffered substantial economic losses
as a result of what might be called phantom income which they
were required to report in 2000 but never in the usual sense
actually received.
Section 7122(c)(1) and (2) provides:
SEC. 7122(c). Standards for Evaluation of Offers.--
(1) In general.--The Secretary shall prescribe
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.
(2) Allowances for basic living expenses.--
(A) In general.--In prescribing
guidelines under paragraph (1), the Secretary
shall develop and publish schedules of
national and local allowances designed to
provide that taxpayers entering into a
compromise have an adequate means to provide
for basic living expenses.
(B) Use of schedules.--The guidelines
shall provide that officers and employees of
the Internal Revenue Service shall determine,
on the basis of the facts and circumstances
of each taxpayer, whether the use of the
schedules published under subparagraph (A) is
appropriate and shall not use the schedules
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to the extent such use would result in the
taxpayer not having adequate means to provide
for basic living expenses.
Regulations adopted pursuant to section 7122 set forth three
grounds for the compromise of a liability: (1) Doubt as to
liability; (2) doubt as to collectibility; or (3) promotion of
effective tax administration. Speltz v. Commissioner, supra at
172; sec. 301.7122-1, Proced. & Admin. Regs. In her petition,
petitioner asserts that there was an abuse of discretion as to
all three grounds, although she pursued only promotion of ETA at
the CDP hearing.
Generally, we may consider only those issues that the
taxpayer raised during a section 6330 hearing. Sapp v.
Commissioner, T.C. Memo. 2006-104; sec. 301.6330-1(f)(2), Q&A-F5,
Proced. & Admin. Regs.; see also Magana v. Commissioner, 118 T.C.
488, 493 (2002). Respondent asserts that petitioner did not
raise the issue of doubt as to liability at her Appeals hearing,
which petitioner disputes. In any event, petitioner has failed
to aver facts or legal argument sufficient to show error in
respondent’s assessment. See Poindexter v. Commissioner, 122
T.C. 280, 284-285 (2004), affd. 132 Fed. Appx. 919 (2d Cir.
2005). Petitioner has not argued that the computation of the AMT
on her year 2000 return is incorrect, but she argues instead that
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she is entitled to the benefit of section 59(g), even in the
absence of the regulation permitted thereunder. Section 59(g)
provides:
SEC. 59(g). Tax Benefit Rule.--The Secretary may
prescribe regulations under which differently treated
items shall be properly adjusted where the tax
treatment giving rise to such items will not result in
the reduction of the taxpayer’s regular tax for the
taxable year for which the item is taken into account
or for any other taxable year.
On brief, petitioner maintains that
The “differently treated” item in the AMT system
(that is, the ISO Spread that cannot be offset against
capital loss, as otherwise permitted by section
422(c)(2) or as occurs naturally on a sale that is not
a disqualifying disposition on a decline in value of
the ISO stock) is precisely the type of situation that
ought to be remedied under section 59(g). Otherwise,
the imposition of AMT in this situation can produce
results that are inequitable and unfair, by imposing a
tax on “phantom income” that is not true economic
income, and accordingly that will never be subject to
tax in the regular tax system.
In the absence of the regulations that respondent is
authorized, but not mandated, to promulgate under section 59(g),
petitioner urges us, in effect, to do so. Petitioner cites
Hillman v. IRS, 250 F.3d 228, 233 (4th Cir. 2001), revg. 114 T.C.
103 (2000), to support the proposition that in petitioner’s type
of situation an exception can be made to the literal application
of the statutory provision (here, the AMT) because the literal
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application of the AMT to petitioner’s facts produces an absurd
result. Presumably petitioner believes regulations could be
written to ameliorate such result.
It is not very clear what kind of regulation petitioner
would like to have written even if we were in position to do so.
Be that as it may, and to paraphrase the words of the Fourth
Circuit in Hillman v. IRS, supra at 234, if there is an inequity
in the AMT as applied to petitioner, only Congress or the
Secretary (as the holder of delegated authority from Congress to
modify the effects of the AMT in certain instances) has the
authority to ameliorate the inequity.
Since our Opinion in Speltz v. Commissioner, 124 T.C. 165
(2005), contains a detailed analysis of “promotion of effective
tax administration” as a ground for the compromise of a
liability, and the analysis is equally applicable to the facts in
this case, it is unnecessary for us to repeat this extensive
analysis here. Thus, this case is controlled by the result in
Speltz.
As did the taxpayers in Speltz, petitioner has devoted a
substantial part of her argument to the perceived unfairness of
the AMT as applied to her specific facts. The crux of
petitioner’s position, as in Speltz, appears to be that section
7122 trumps the literal application of the AMT statutes, and
that, therefore, it was an abuse of discretion by the Appeals
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Office not to accept her OIC. See id. at 175-176. As we pointed
out there, “The unfortunate consequences of the AMT in various
circumstances have been litigated since shortly after the
adoption of the AMT. In many different contexts, literal
application of the AMT has led to a perceived hardship, but
challenges based on equity have been uniformly rejected.” Id. at
176 (and cases cited therein).
Petitioner asserts “economic hardship” as a justification
for compromise and that it should be expansively construed by
respondent to constitute an available ground for accepting the
OIC. Pursuant to section 301.7122-1(c), Proced. & Admin. Regs.,
economic hardship constitutes a basis for compromise, although
the compromise is classified within the ETA rubric. ETA is
bifurcated into subcategories of enumerated justifications for
compromise in section 301.7122-1(c), Proced. & Admin. Regs.--the
aforementioned public policy and equity, and economic hardship.
The following three scenarios are depicted in section 301.7122-
1(c), Proced. & Admin. Regs., as supporting (but not conclusive
of) a determination of economic hardship: A taxpayer suffering
from a long-term illness, medical condition, or disability, which
is expected to exhaust the taxpayer’s financial resources; total
depletion of a taxpayer’s income resulting as a result of the
provision of dependent care; and an inability of a taxpayer to
exploit existing asset wealth in order to finance both basic
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living expenses and to satisfy the outstanding tax liability.
As we said in Speltz v. Commissioner, supra at 178, under
almost identical facts:
Unlike the examples set forth under section
301.7122-1(c), Proced. & Admin. Regs., petitioners do
not claim illness or a medical condition or disability;
they do not have income that is exhausted providing for
the care of dependents; and they have sufficient income
to meet “basic living expenses”. Petitioners’ hardship
argument is essentially that the tax liability is
disproportionate to the value that they received from
the ISOs and that they have already been forced to
change their lifestyle unreasonably. ***
Petitioner’s urgent plea in this case does not fall on deaf ears.
We sympathize with petitioner’s situation, but regrettably this
type of hardship is not unique in the AMT-ISO arena. Id. at 177.
It remains for Congress to address the issue if it chooses to do
so, but as the Court of Appeals for the Seventh Circuit said in
Kenseth v. Commissioner, 259 F.3d 881, 885 (7th Cir. 2001), affg.
114 T.C. 399 (2000): “it is not a feasible judicial undertaking
to achieve global equity in taxation”.
We have considered petitioner’s many other arguments, but we
find them to be without merit. We hold that petitioner failed to
establish that the IRS abused its discretion on the basis of the
promotion of effective tax administration when it refused
petitioner’s OIC.
At the hearing, petitioner moved orally to admit a “Third
Stipulation of Facts” relating to an OIC by her husband, Kenneth
Lee, who contemporaneously had a similar matter pending before
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the IRS, which petitioner maintains is relevant to respondent’s
exercise of discretion in this case “under the public policy
prong of the effective tax administration standard.” At the
hearing, we took the motion under advisement.
Petitioner’s motion appears to be in support of a convoluted
argument made on brief that respondent should settle petitioner’s
case on the basis of the result petitioner would have obtained
had she and her husband filed a joint return for the year 2000,
which, in fact, they did not do. We find this argument
irrelevant and unconvincing, and petitioner’s oral motion will be
denied.
Respondent may proceed with the proposed levy.
Order and Decision will be
entered for respondent.