It is very difficult to run a business and to do so in full compliance with all of our laws. Having worked with thousands of business owners, the message is the same. Something always seems to give.
If the business focuses on the operational side of the business to comply with industry regulations or to keep customers happy, the administrative compliance side may fall behind. If the business focuses on the administrative compliance side, the business operations may fall behind.
This is the nature of many tax debts. The taxpayer focuses on managing and growing their businesses, only to neglect their tax compliance. The idea is that all resources need to be put into growing the business and, as a result, the business will produce revenues that pay someone eventually to clean up the past tax compliance problems. And in many cases, this is exactly what happens. The business makes money and it hires a tax attorney to help it come into compliance.
But in the cases where the business either isn’t as profitable as envisioned or other unexpected liabilities or obstacles arise, the tax compliance problems linger. They add up over time. Then they are such that catching up with the IRS back taxes is near impossible.
This is the back story for the “dissipated asset.” The “dissipated asset” is sold one year and then, shortly thereafter, the taxpayer tries to settle their back taxes with the IRS. The “dissipated asset” is usually the interest in the business itself or some asset belonging to the business. The IRS often factors this “dissipated asset” into its calculations for determining whether to settle back taxes and for how much.
The recent Siebert v. Commissioner, T.C. Memo. 2021-34, provides an opportunity to consider the “dissipated asset” type of cases and how to plan for dissipated assets.
Facts & Procedural History
The taxpayers filed their 2013 tax return, but did not fully pay the tax due.
The IRS attempted to collect the tax debt, which the taxpayers filed a collection due process hearing request to appeal.
The appeals office sent the case back to the IRS revenue officer, but retained jurisdiction over the case.
The taxpayers submitted an offer in compromise to the revenue officer. The revenue officer sent the offer to the OIC Specialist. The OIC Specialist eventually disallowed the proposed settlement.
The disallowance was based, in part, on the taxpayer having taken a 401K distribution and sold a partnership interest a year prior to the time the offer was submitted. The IRS counted these assets as “dissipated assets.”
The denial ended up in the U.S. Tax Court.
Settling a Tax Debt With the IRS
The IRS is authorized to settle back taxes. The primary way the IRS does this is its offer in compromise program.
The offer in compromise program has changed over time, but generally, it involves submitting information to the IRS, the IRS reviewing the information and applying IRS policies and collection standards to determine the amount of an acceptable settlement (if any), and then informing the taxpayer of its decision. This process can take anywhere from three to twelve months–or more.
During this process, taxpayers often disagree with how the IRS applies its policies. As relevant here, one such policy relates to dissipated assets. The IRS is authorized to add in so-called “dissipated assets” in calculating the settlement amount in some circumstances.
About “Dissipated Assets”
A dissipated asset is thus defined as any asset (liquid or non-liquid) that has been sold, transferred, or spent on non-priority items or debts and that is no longer available to pay the tax liability.
The concept of a “dissipated asset” is needed to prevent taxpayers from disposing of assets and then, shortly thereafter, settling their back taxes with the IRS by arguing that they have no assets.
The IRS generally looks back three years prior to the time an offer is submitted to see whether there are dissipated assets.
The IRS’s IRM (its policy manual) says that:
Inclusion of dissipated assets in the calculation of the reasonable collection potential (RCP) is no longer applicable, except in situations where it can be shown the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary, or other income) for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed * * *
Thus, even if there are so-called “dissipated assets,” these assets still may not count if the taxpayer used the assets or proceeds for necessary expenses.
Evidence of Necessary Expenses
It is not clear what evidence is required to show that the “dissipated assets” were spent on necessary items or expenses. How does one make this showing?
For example in Johnson v. Commissioner, 136 T.C. 475 (2011), the taxpayer argued that he contributed the proceeds from the dissipated assets to his failing business and the business used the funds to pay him a salary. The IRS does look to income and assets in determining how much a taxpayer can pay. So it would seem that the IRS was double-counting by adding in the asset and also counting the income from that asset. Thus, the argument went that if he could show that the salary was used for necessary expenses, the dissipated asset should not be considered. The court did not explain what evidence was needed to support this. It merely noted that no evidence was presented for this argument.
In Samuel v. Commissioner, T.C. Memo. 2007-312, the court sustained the IRS’s determination that refinancing a house a year prior to submitting his offer and he only remitted a small portion of the proceeds to the IRS. The small portion was remitted to the IRS in the form of estimated tax payments. The IRS counted all but the estimated payment portion as dissipated assets.
In Tucker v. Commissioner, T. C. Memo. 2011-67, the IRS had determined that a stock day trader had dissipated assets from the sale of stocks. The IRS appeals office reduced this amount prior to the court hearing presumably because the assets were actually inventory needed to operate the day trading business.
The courts that have considered this issue have not provided a bright-line rule as to what evidence is sufficient for a necessary expense. The court cases do suggest that there have to be some necessary expenses incurred on or around the time the asset is dissipated.
Those who want to settle their tax debts should consider the timing of when they submit their offers. This is where some advance tax planning can help.
If the taxpayer can wait three years from the time a significant asset was sold, they should consider doing so.
If the taxpayer cannot wait three years, they should take care to document their necessary expenses. They might start with a list of the necessary expenses owing just before and those paid after the time the asset was sold or used. This might include living expenses, business expenses, and taxes.
Then they might evaluate the available records showing how those expenses were paid. Tracing might be used if possible. If not, then even the records might be organized and summarized to show the timing and nature of the expenses.
Ideally, this type of evaluation and record-keeping exercise should be performed before the offer is submitted to the IRS.