Standard of review

If the amount of the underlying liability is not in dispute, the trial court and the appellate court review the CDP determinations of the IRS Office of Appeals for abuse of discretion. Fargo v. Commissioner, 447 F.3d 706, 709 (9th Cir. 2006); Jones v. Commissioner, 338 F.3d 463, 466 (5th Cir. 2003). In providing for judicial review of CDP determinations on what is normally a scant record, Congress contemplated more deferential review than what is normally given to more formal agency decisions, viz., “review for a clear abuse of discretion in the sense of clear taxpayer abuse and unfairness by the IRS, lest the judiciary become involved on a daily basis with the tax enforcement details that Congress intended to leave to the IRS.” Robinette v. Commissioner, 439 F.3d 455, 459 (8th Cir. 2006). See also Fifty Below Sales & Mktg., Inc. v. United States, 497 F.3d 828, 830 (8th Cir. 2007); Murphy v. Commissioner, 469 F.3d 27, 32 (1st Cir. 2006); Christopher Cross, Inc. v. United States, 461 F.3d 610, 612 (5th Cir. 2006); Olsen v. United States, 414 F.3d 144, 150–51 (1st Cir. 2005); Orum v. Commissioner, 412 F.3d 819, 820–21 (7th Cir. 2005); Living Care Alternatives of Utica v. United States, 411 F.3d 621, 624–25, 629 (6th Cir. 2005).

A. Introduction to collection due process proceedings

When a taxpayer neglects or refuses to pay a federal tax liability after assessment, notice, and demand (see I.R.C. §§ 6201(a), 6303), a lien arises in favor of the United States and attaches to all of the taxpayer’s property and property rights (see I.R.C. §§ 6321–6323). The IRS may also collect the tax by levy under § 6331(a), after first giving the taxpayer 30-days’ notice of intent to do so. I.R.C. § 6331(d). Sections 6320 and 6330 of the Code provide certain procedural safeguards for taxpayers in connection with tax collection activity by means of liens and levies.

Under §§ 6320(a) and 6330(a), respectively, after filing a notice of federal tax lien or before making a levy, the IRS must notify a taxpayer of his right, upon making a timely request, to a collection due process (CDP) hearing before the IRS Office of Appeals. I.R.C. §§ 6320(b)(1), (2), 6330(b)(1), (2); Treas. Reg. § 301.6330-1(b), (d) (2006).³ At the hearing, the Appeals officer is to “obtain verification from the Secretary that the requirements of any applicable law or administrative procedure have been met,” including verifying that taxes have been properly assessed. I.R.C. § 6330(c)(1). A taxpayer may raise “any relevant issue relating to the unpaid tax or the proposed levy.” I.R.C. § 6330(c)(2)(A). Those issues include spousal defenses (i.e., the I.R.C. § 6015 “innocent spouse” defense), challenges to the appropriateness of collection activities, and offers of collection alternatives (e.g., posting a bond, substitution of other assets, an installment agreement, or an offer in compromise). I.R.C. § 6330(c)(2)(A). The taxpayer may also challenge the existence or amount of his underlying tax liability, but only if he did not receive a statutory notice of deficiency or did not otherwise have a chance to dispute the liability. I.R.C. § 6330(c)(2)(B). A taxpayer may not raise an issue at a CDP hearing if the issue was considered in a prior administrative or judicial proceeding in which the taxpayer meaningfully participated. I.R.C. § 6330(c)(4).

³ Both lien and levy hearings follow the essentially the same procedures. See I.R.C. § 6320(c); Treas. Reg. § 301.6320-1. The Regulations governing CDP hearings were amended effective for hearing requests made on or after November 16, 2006. See Treas. Reg. §§ 301.6320-1(j), 301.6330–1(j). References herein are to the older Regulations.

After the hearing, the Appeals officer issues a notice setting forth her determinations, including whether the proposed action balances collection efficiency with the taxpayer’s legitimate concern that any collection action be no more intrusive than necessary. I.R.C. § 6330(c)(3)(C); see Treas. Reg. §§ 301.6330-1(e)(3) (Q&A E8), (f)(1). The determinations in the notice are subject to judicial review, but a taxpayer can only raise issues that he raised in the CDP hearing.

I.R.C. § 6330(d)(1) (2005); Treas. Reg. § 301.6330-1(f)(2) (Q&A F5).

Taxes are “the life-blood of government, and their prompt and certain availability an imperious need.” Bull v. United States, 295 U.S. 247, 259 (1935). Taxpayers play a vital role in our tax system because “our tax structure is based on a system of self reporting.” United States v. Bisceglia, 420 U.S. 141, 145 (1975). “There is legal compulsion, to be sure, but basically the Government depends upon the good faith and integrity of each potential taxpayer to disclose honestly all information relevant to tax liability.” Ibid. Because “it would be naive to ignore the reality that some persons attempt to outwit the system, and tax evaders are not readily identifiable” (ibid.), the tax system, of necessity, must be one in which “[b]ad things happen if you fail to pay your federal income taxes when due.” Hinck v. United States, __ U.S. __, 127 S. Ct. 2011, 2013 (2007).

Over the years, Congress has enacted and revised a system of statutory additions to tax in an ongoing effort to balance revenue protection with fairness. “There are few statutory schemes more complex, comprehensive, or subject to greater congressional scrutiny than the Internal Revenue Code . . . .” Adams v. Johnson, 355 F.3d 1179, 1185–86 (9th Cir. 2004). For example, the civil penalty for fraud is not a punishment, but rather a remedial “safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer’s fraud.” Helvering v. Mitchell, 303 U.S. 391, 401 (1938).

The IRS has day-to-day responsibility for administering and enforcing the tax laws, which it does primarily through post-filing audits and investigations. See I.R.C. § 7601. The IRS, however, lacks the resources to audit more than a small fraction of the tax returns filed each year, and it does not require promoters to submit their tax-reduction schemes for preapproval.⁴ The tax system, therefore, makes

⁴ In fiscal year 2007, the IRS audited only 1.0% of individualincome tax returns. IRS, Data Book 2007 (Enforcement), at table 9 (2007). Cf. U.S. Food and Drug Admin., Approvals of FDA-Regulated

(continued...)

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taxpayers the first line of defense against abusive tax shelters. Although that might seem to be a heavy burden, “the alternatives could well involve far less agreeable invasions, of house, business, and records.” Bisceglia, 420 U.S. at 146.

C. Taxpayers’ standard offer in compromise did not conform to the IRS’s settlement guidelines, and accepting it would not foster effective tax administration but instead would undermine voluntary compliance

1. The guidelines in Treasury Regulation§ 301.7122-1 for evaluating offers in compromise were promulgated by the IRS under the specific authority granted by I.R.C. § 7122(d) and are controlling

The instant appeals involve offers in compromise under § 7122, which is the exclusive method of compromising with the IRS. See, e.g., Botany Worsted Mills v. United States, 278 U.S. 282, 288–89 (1929) (applying § 3299 of the Revised Statutes); Laurins v. Commissioner, 889 F.2d 910, 912 (9th Cir. 1989). In 1998, Congress amended § 7122 by adding subsections (c) and (d) (now (d) and (e)), instructing the IRS:

(1) to prescribe guidelines for IRS employees to use in evaluating compromise offers; (2) to develop schedules of national and local

⁴ (...continued)Products at http://www.fda.gov/opacom/7approvl.html (April 26, 2008)(new drugs, complex medical devices, and food additives must beapproved before placement on market).

allowances sufficient to allow taxpayers adequate means to provide for basic living expenses; and (3) to establish procedures for the administrative review of rejections of compromise offers. Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, § 3462, 112 Stat. 685, 764–66. As part of the statute, Congress enacted “special rules” requiring the IRS to establish guidelines to provide that: (1) an offer from a low-income taxpayer shall not be rejected solely on the basis of its amount; and (2) an offer based only on doubt as to liability shall not be rejected solely because the IRS cannot locate the taxpayer’s file, and need not be accompanied by a financial statement. I.R.C. § 7122(d)(3).

The legislative history indicates that Congress also anticipated that the IRS would permit the consideration, in certain circumstances, of factors beyond doubt as to liability and doubt as to collectibility, such as “equity, hardship, and public policy” where a compromise “would promote effective tax administration.” H.R. Conf. Rep. No. 105-599, at 288–89 (1998), reprinted in 1998-3 C.B. 747, 1043. Congress thus exercised its legislative authority while delegating to the IRS the task of using its experience in administering and enforcing the tax laws to fill in the gaps. See United States v. Correll, 389 U.S. 299, 307 (1967) (“Congress has delegated to the [IRS], not to the courts, the task of prescribing all needful rules and regulations for the enforcement of the Internal Revenue Code.”); Beecher v. Commissioner, 481 F.3d 717, 723 (9th Cir. 2007).

The IRS responded to Congress’s instructions by issuing Treasury Decision 9007 promulgating Treasury Regulation § 301.7122-1.⁵ The IRS gave further explanation and guidance in the introductory text of the Treasury Decision, in Revenue Procedure 2003-71, and in the Internal Revenue Manual (I.R.M.).⁶ Taken together, those authorities provide a comprehensive system for evaluating offers in compromise that gives due regard to Congress and also reflects the IRS’s expertise in tax administration. Because Congress expressly instructed the IRS to promulgate guidelines, the Treasury Regulation issued pursuant to that specific authority, Treas. Reg. § 301.7122-1, is controlling unless it is procedurally defective, arbitrary, capricious, or manifestly contrary to the statute. United States v. Mead Corp., 533 U.S. 218, 227 (2001);

⁵ The final regulation is substantially similar to the temporary regulation that preceded it. T.D. 9007, 2002-2 C.B. 349, 349.

⁶ The I.R.M. lacks the force of law, and it does not confer rights on taxpayers. Fargo, 447 F.3d at 713.

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Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 843–44 (1984); Beecher, 481 F.3d at 720, 722.

Treasury Decision 9007 states that, consistent with the IRS’s mission of applying the tax laws with integrity and fairness, it generally expects taxpayers to pay the total amount due and that “the IRS will presume that the correct application of the tax laws produces a fair and equitable result, absent exceptional circumstances.” T.D. 9007, 2002-2 C.B. at 349–50. The I.R.M. echoes that sentiment, stating: “Where a taxpayer is clearly liable for taxes, penalties, or interest due to operation of law, a finding that the law is unfair would undermine the will of Congress in imposing liability under those circumstances.”

I.R.M. § 5.8.11.2.2(3).

Compromises are normally based upon the traditional reasons of doubt as to liability and doubt as to collectibility. Treas. Reg. § 301.7122-1(b)(1), (2); Rev. Proc. 2003-71, 2003-2 C.B. 517, 517–19. If settlement is not possible for those reasons, the taxpayer can seek a compromise based upon the promotion of effective tax administration. Treas. Reg. § 301.7122-1(b)(3). Moreover, in a settlement based upon doubt as to collectibility, the IRS can accept less than the taxpayer’s “reasonable collection potential”⁷ if “special circumstances” (identical to the effective-tax-administration factors) are present. Rev. Proc. 2003-71, 2003-2 C.B. at 517; I.R.M. § 5.8.11.2. The instant appeals involve both effective-tax-administration and special-circumstances offers. We will use the term “effective tax administration” for both, and the term “normal amount” to refer to the collection of the lesser of the taxpayer’s full liability or his reasonable collection potential.

The IRS can accept an effective-tax-administration compromise when collection of the normal amount would cause the taxpayer economic hardship by leaving him unable to afford his basic living expenses. Treas. Reg. § 301.7122-1(b)(3)(i); see also Treas. Reg. § 301.6343-1(b)(4). The factors and examples in § 301.7122-1(c)(3)(i) and (iii), involve taxpayers who have income and assets that would normally be subject to collection, but who need those resources for their basic living expenses because of illness, age, disability, dependents, or similar circumstances. For example, the IRS could accept an economic-hardship offer from a disabled, low-income taxpayer rather than seize

⁷ To calculate a taxpayer’s reasonable collection potential, the IRS considers the taxpayer’s net realizable equity, his expected future income less an allowance for necessary living expenses, his foreign andother assets beyond the Government’s reach, and the amounts collectible from third parties (e.g., transferees). I.R.M. § 5.8.4.4.1.

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the taxpayer’s modest house, which is specially equipped for his disability. Treas. Reg. § 301.7122-1(c)(3)(iii)(Ex. 3).

If collection will not cause economic hardship, then the taxpayer must demonstrate “exceptional circumstances,” viz., compelling public-policy or equity considerations under which collection of the normal amount “would undermine public confidence that the tax laws are being administered in a fair and equitable manner” and under which compromise would be justified even though similarly situated taxpayers may have paid in full. Treas. Reg. § 301.7122-1(b)(3)(ii). Such compromises are limited to “those rare cases where collection of the full liability would adversely affect the overall tax system” and where public-policy and equity concerns are compelling enough to justify the “inherent inequity” of allowing similarly situated taxpayers pay different portions of their respective liabilities. T.D. 9007, 2002-2

C.B. at 350. See also I.R.M. § 5.8.11.2.2(2). The Treasury Regulation offers as examples: (1) a taxpayer who fell behind on his tax filings because of a serious illness resulting in almost continuous hospitalization for a number of years, during which time the IRS assessed taxes, plus interest and penalties that increased the liability by over 300%; and (2) a taxpayer who relied on erroneous written advice from the IRS. Treas. Reg. § 301.7122-1(c)(3)(iv); see also I.R.M. § 5.8.11.2.2(8) (liability directly caused by IRS error in completing paperwork). Compromise in those instances (and in the economic hardship situations noted above) will not harm tax compliance because they involve: (1) the IRS assisting taxpayers in situations into which few would voluntarily enter to avoid paying their taxes; or (2) the IRS not holding a taxpayer responsible for the IRS’s own easily avoidable errors in dealing directly with that taxpayer.

Finally, “[n]o compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws.” Treas. Reg. § 301.7122-1(b)(3)(iii). In general, a compromise undermines compliance when it places the taxpayer in a better position than if he had timely and fully met his obligations, and other taxpayers conclude that the taxpayer benefitted from his failure to obey the tax laws.

I.R.M. § 5.8.11.2.2(11). “Such cases present the danger that other taxpayers may consider it beneficial to take the chance of not complying with the tax laws or litigating an issue they would otherwise concede or settle, and relying on compromise at some later date as a safety net.” Ibid. The determination whether a compromise will undermine compliance also involves consideration of whether the taxpayer has a history of noncompliance, whether he has taken deliberate actions to avoid payment, and whether he has encouraged others to disobey the tax laws. Treas. Reg. § 301.7122-1(c)(3)(ii). A compromise that would undermine compliance is illustrated by an example in the I.R.M. regarding tax-shelter partnerships (I.R.M. § 5.8.11.2.2(3)):

In 1983, the taxpayer invested in a nationally marketed partnership which promised the taxpayer tax benefits far exceeding the amount of the investment. Immediately upon investing, the taxpayer claimed investment tax credits that significantly reduced or eliminated the tax liabilities for the years 1981 through1983. In 1984, the IRS opened an audit of the partnership under the provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). After issuance of the Final Partnership Administrative Adjustment (FPAA), but prior to any proceedings in Tax Court, the IRS made a global settlement offer in which it offered to concede a substantial portion of the interest and penalties that could be expected to be assessed if the IRS’s determinations were upheld by the court. The taxpayer rejected the settlement offer. After several years of litigation, the partnership level proceeding eventually ended in Tax Court decisions upholding the vast majority of the deficiencies asserted in the FPAA on the grounds that the partnership’s activities lacked economic substance. The taxpayer has now offered to compromise all the penalties and interest on terms more favorable than those contained in the prior settlement offer, arguing that TEFRA is unfair and that the liabilities accrued in large part due to the actions of the Tax Matters Partner (TMP) during the audit and litigation. Neither the operation of the TEFRA rules nor the TMP’s actions on behalf of the taxpayer provide grounds to compromise under the equity provision of paragraph (b)(4)(i)(B) of this section. Compromise on those grounds would undermine the purpose of both the penalty and interest provisions at issue and the consistent settlement principles of TEFRA. Depending on the taxpayers particular facts and circumstances, however, compromise may be authorized on the grounds of Doubt as to Collectibility (DATC), or because collection of the full liability would cause an economic hardship within the meaning of paragraph (b)(4)(i)(A) of this section.

The IRS’s guidelines for evaluating compromise offers give proper consideration to the concerns expressed in the legislative history of § 7122, in light of the regard that the IRS must give to the tax laws that Congress has enacted and amended over the years. The IRS rightly refused to allow taxpayers to use compromise offers to challenge perceived unfairness in the Code because the IRS’s “compromise authority under Section 7122 is not so broad as to allow the Service to disregard or override the judgments of Congress.” I.R.M. § 5.8.11.2.2(3). For example, proper regard for the judgments of Congress in enacting and amending Code sections regarding interest and penalties necessarily means that the IRS will rarely compromise those items in extra-statutory situations. T.D. 9007, 2002-2 C.B. at 351; see I.R.M. § 5.8.11.2.2(4). Similarly, the IRS sensibly determined that tax compliance would be harmed if it became an insurer of tax liabilities caused by tax-shelter promoters and other third parties.

Thus, the IRS will not accept public-policy or equity compromises based solely on the acts of third parties, but it will consider the actions of third parties in deciding whether a taxpayer’s situation is sufficiently compelling to justify compromise even though similarly situated taxpayers have fully paid. T.D. 9007, 2002-2 C.B. at 351; see I.R.M. § 5.8.11.2.2(10).

2. Taxpayers’ arguments about “longstanding”cases lack merit

Taxpayers argue (Br. 41, 48–49) that the IRS ignored statements in the legislative history that making compromises more available would enhance taxpayer compliance and keep taxpayers in the tax system. H.R. Conf. Rep. No. 105-599, at 288–89, 1998-3 C.B. at 1042–43. They particularly rely on a sentence in the legislative history in which the conferees “anticipate[d] that, among other situations, 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.” H.R. Conf. Rep. No. 105-599, at 289, 1998-3 C.B. at 1043. Congress may have urged the IRS to be “flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations and remain in the tax system” (ibid.), but it did not require the IRS to settle at all costs.

As explained by this Court in Fargo, Congress left settlement decisions within the discretion of the IRS. 447 F.3d at 711–12. The language of a statute ordinarily controls, and “the authorization provided by [§ 7122] is discretionary on its face.” Ibid. Section 7122(a) states that the IRS “may” compromise tax cases, and § 7122(d)(1) leaves it to the IRS to prescribe the guidelines “to determine whether” an offer is adequate. Id. at 712; see also Christopher Cross, 461 F.3d at 612; Olsen, 414 F.3d at 153, 157. This Court further stated that the legislative history (to the extent it was relevant) was “substantially discretionary as well.” Fargo, 447 F.3d at 712. Congress “anticipated” that the IRS “may utilize” its new authority to compromise longstanding cases, and it stated that the IRS “should” be flexible and “should” make settlements easier. Ibid.

Moreover, when Congress amended § 7122, it enacted certain requirements as part of the statute, but it placed other concerns in the legislative history for the IRS to consider. Had Congress wanted those concerns incorporated in the IRS’s guidelines, it would have included them in the list of “special rules” currently found at § 7122(d)(3) instead of delegating to the IRS the task of using its experience in tax administration. Congress made some policy choices, but it intentionally left the remainder “to be resolved by the agency charged with the administration of the statute in light of everyday realities.” Chevron, 467 U.S. at 844, 865–66.

The IRS did not ignore the legislative history of § 7122. In T.D. 9007, it stated that it was mindful of Congress’s concerns about longstanding cases, but that its “experience in applying the temporary regulations is that these regulations have given effect to the intent of Congress . . . since cases involving substantial interest and penalties often can be compromised under the standards of doubt as to collectibility and economic hardship.” T.D. 9007, 2002-2 C.B. at 351. Thus, third-party misdeeds may be considered when determining whether to accept collectibility and hardship settlements. Ibid. In that way, the IRS can enter into settlements that effectively involve the concession of interest and penalties without ignoring the reality that “a taxpayer is in the best position to anticipate, and protect himself or herself from, the risks of business associations and transactions.” Ibid.

In sum, the guidelines for compromises reflected in Treas. Reg. § 301.7122-1 give due regard to § 7122 and to the other Code sections enacted by Congress, and due consideration to the concerns expressed by Congress in the legislative history. Taxpayers may believe (see Br.

42, 50–51) that the guidelines are insufficiently generous to taxpayers who have invested in failed tax shelters, but “[s]uch policy arguments are more properly addressed to legislators or administrators, not to judges.” Chevron, 467 U.S. at 864.

3. Taxpayers’ standard offer did not conform to the IRS’s guidelines

Taxpayers’ standard offer provided for the payment of all Hoyt tax deficiencies for all years (not just the CDP years) plus regular interest up to April 15, 1993, but no other interest or penalties.⁸ (ER2 at 147–149, 200–205; Br. 25.) Taxpayers contended that ten years should be sufficient for the IRS to shut down a tax shelter, that after ten years a shelter audit should be considered a “longstanding case” where interest and penalty abatement is warranted, and that April 15, 1993, was their estimate of the tenth anniversary of the IRS’s audit of the Hoyt organization. (ER2 at 147, 228; Br. 25–26.) As will be discussed in part D, infra, the amounts offered by taxpayers were less than the amounts that taxpayers could afford to pay without

⁸ To the extent that a taxpayer has potential Hoyt liabilities foryears not at issue here, he will be entitled to a CDP hearing for thoseyears once the assessments are made and collection action begins.

I.R.C. § 6330(b)(2). At that hearing, he can ask the Appeals officer totake into consideration the money being applied to the instant Hoytliabilities.

economic hardship. In other words, taxpayers’ standard offer was a policy offer based upon their contention that the tax system was unfair and in need of liberalization.

Taxpayers’ ten-year rule finds no support in I.R.C. § 7122, its history, the Treasury Regulation, or any other administrative guidance. Congress has repeatedly adjusted the interest and penalty provisions of the Code to balance consequences and fairness. For example, Congress enacted § 6404(e) to allow the abatement of interest attributable to errors or delays by the IRS in performing nondiscretionary “ministerial” acts, and it later amended § 6404(e) to allow abatement for “managerial” acts that require some discretion but to restrict abatement to “unreasonable” errors or delays.⁹ Proper regard for the judgments of Congress necessarily means that the IRS will rarely compromise interest in other situations, such as IRS actions not listed in § 6404(e) or delays caused by third parties. T.D. 9007, 2002-2 C.B.

⁹ Tax Reform Act of 1986, Pub. L. No. 99-514, § 1563, 100 Stat.2085, 2762; S. Rep. No. 99-313, at 208–09 (1986), reprinted in 1986-3

C.B. (vol. 3) v, 208–09 (interest abatement not to be routine, but rather“in instances where failure to abate interest would be widely perceivedas grossly unfair”); Taxpayer Bill of Rights 2, Pub. L. No. 104-168,§§ 301–302, 110 Stat. 1452, 1457–58; H.R. Rep. No. 104-506, at 27–28(1996), reprinted in 1996-3 C.B. 49, 75–76.

at 351; I.R.M. § 5.8.11.2.2(4). Congress responded to the tax-shelter problems of the early 1980s by toughening the Code’s penalty regime to encourage taxpayers to exercise appropriate care in reporting their tax items and to resolve their tax disputes promptly, and Congress later consolidated and reformed the accuracy-related penalties in an effort to improve fairness and administrability and to make it easier for taxpayers to understand the conduct required of them.¹⁰ But Congress has nowhere enacted a law stating that interest must stop and penalties must be forgiven once a tax-shelter audit reaches its tenth anniversary. The adoption of taxpayers’ ten-year rule would represent a fundamental change in tax-enforcement policy for which taxpayers must look to Congress, not the IRS, the courts, or individual Appeals officers.

Further, it was the responsibility of the IRS as an agency — not the courts, not individual Appeals officers, and certainly not taxpayers — to promulgate guidelines for evaluating compromise

¹⁰ Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, § 722, 95Stat. 172, 341–43; H.R. Rep. No. 97-201, at 243–45 (1981), reprinted in1981-2 C.B. 352, 398–99; H.R. Conf. Rep. No. 98-861, at 984–86 (1984),reprinted in 1984-3 C.B. (vol. 2) 1, 238–40 (urging IRS to assert thenegligence and fraud penalties more often); Omnibus BudgetReconciliation Act of 1989, Pub. L. No. 101-239, § 7721, 103 Stat. 2106,2395–2400; H.R. Rep. No. 101-247, at 1387–94 (1989), reprinted in 1989

U.S.C.C.A.N. 1906, 2857–64.

offers. The IRS correctly declined to use its settlement authority to disregard or override the judgments of Congress. See I.R.M. § 5.8.11.2.2(3). A fortiori, the Appeals officers did not abuse their discretion when they rejected taxpayers’ bid to create a new tax settlement policy (Br. 50–53), but instead evaluated each taxpayer’s offer under the settlement guidelines established by the IRS.

Under those guidelines, taxpayers are expected to pay the amount they legally owe (or at least the amount that they can pay without incurring economic hardship), except in rare circumstances where differential collection from similarly situated taxpayers can be justified, and full collection would undermine public confidence that the tax laws are being fairly enforced. Treas. Reg. § 301.7122-1(b). A settlement “must alleviate potential present nonpayment while discouraging future nonpayment by others.” Fargo, 447 F.3d at 713. Consequently, the guideline examples of those rare circumstances involve situations that few would endure just to avoid taxes, or situations with easily avoidable IRS errors in dealing directly with a particular taxpayer. Treas. Reg. § 301.7122-1(c).

Because taxpayers’ offers fell outside the guidelines, the Appeals officers did not abuse their discretion in rejecting them. “[W]here the IRS followed the statutes and regulations governing grants of relief” and the Appeals officer satisfied the other CDP requirements, a court “may not reverse simply because [the court] would have weighed the equities differently than the appeals officer did.” Fifty Below, 497 F.3d at 830. See Orum, 412 F.3d at 821 (“the Judicial Branch does not instruct the Executive Branch how to make executive decisions”).

b. Factual insufficiency

Taxpayers voluntarily joined a tax shelter that promised large tax write-offs in exchange for a small investment of a taxpayer’s after-tax income. As noted at page 42, supra, many other taxpayers joined many other shelters, causing an audit and litigation backlog serious enough to lead to Congressional action. See also Staff of the Senate Comm. on Finance, Explanation of the Provisions Approved by the Committee on March 21, 1984, S. Prt. 98-169, vol. I at 436–37 (1984). Now taxpayers here want settlements far more generous than any that have been offered in the history of the Hoyt program. This case, therefore, is like the example in I.R.M. § 5.8.11.2.2(3) of a tax-shelter situation in which settlement is not warranted. Taxpayers quibble (Br. 51–53) about differences between the example and the Hoyt shelters, but as noted by the Tax Court (ER1 at 15–17), it is unrealistic to expect a general example to match the specifics of each individual case. The rejection of taxpayers’ offers was not an abuse of discretion, but instead was a reasonable exercise of the Appeals officers’ authority to apply the IRS settlement guidelines in the course of the routine administration of the tax laws.

Accepting taxpayers’ offers would also undermine effective tax administration and voluntary compliance with the tax laws. As pointed out by the Tax Court, adopting taxpayers’ ten-year rule would reduce the risks of investing in tax shelters, thereby encouraging more people to make tax-shelter investments. (ER1 at 20.) If the IRS did not end a shelter quickly, the Government (i.e., other taxpayers) would lose both the time value of the participants’ tax underpayments (which money the participants could invest at a profit in the interim) and the penalty revenue that serves in part to reimburse the Government for the expense of investigation. Either way, the Government would effectively assume “the unenviable role of an insurer against poor business decisions by taxpayers.” (ER1 at 20.)

Shelter promoters and participants would be given a powerful incentive to delay audits until their tenth anniversary, at which time interest would stop and penalties would be forgiven. Future promoters could echo Hoyt’s statement in The 1,000 lb. Tax Shelter that “no matter what happens, you are always better off than if you had paid the money in taxes.” (ER2 at 338.) That risk is not merely theoretical. In 1974 Congress raised the interest rate on tax underpayments out of concern that taxpayers were seeking to profit from higher commercial rates by delaying payment of their tax liabilities and by taking aggressive positions on their returns (the cost of which, if disallowed, would be less than the interest earned on the tax savings). Act of January 3, 1975, Pub. L. No. 93-625, § 7, 88 Stat. 2108, 2114–16; S. Rep. No. 93-1357, at 19 (1974), reprinted in 1975-1 C.B. 517, 528.

Because taxpayers’ offers did not fall within the IRS’s settlement guidelines, the Appeals officers did not abuse their discretion in rejecting them.

Taxpayers argue (Br. 11–17, 20–21, 42–44, 50–64) that Hoyt’s fraud, the Commissioner’s audit decisions, and the delay they caused were exceptional circumstances such that it was an abuse of discretion for the Appeals officers to reject their offers. They further argue (Br. 53–54) that this Court in Fargo established a four-factor test for relief based on effective tax administration. See Fargo, 447 F.3d at 714. When the last paragraph of the Fargo opinion is read in full, however, it is apparent that the Court was not attempting to formulate a definitive legal test. It was instead stating facts about the Fargos that cut against granting them relief in that case. Those facts were as follows: (1) the Fargos invested in tax shelters, and the Code frowns upon purely tax-motivated transactions; (2) there was no evidence to suggest that the Fargos were victims of fraud or deception; (3) the delay in Fargo was due to established TEFRA procedures and the inability of the TMP 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 contact with financial agents (such as TMPs).” In any event, comparing the facts of this case to the facts noted in Fargo does not help taxpayers.

First, taxpayers argue (Br. 54–56) that they had motives other than tax avoidance and that they thought that they were investing in a legitimate business. But taxpayers joined a program that marketed itself as The 1,000 lb. Tax Shelter. (ER2 at 323–424.) In that brochure, Hoyt stated that each partner would be given sufficient partnership items on his Hoyt-prepared returns to reduce dramatically or eliminate his taxes year after year, and that the partnerships could operate on partner payments equal to 75% of the tax savings generated from the Hoyt tax items. (ER2 at 336–338, 399–402.) The partner would then retain the remaining 25% of the tax savings as a 20% to 30% return on his investment (compared to a 6% to 8% return from the cattle operations). (ER2 at 336–338.) If it was not yet clear that tax reduction played a major role in the Hoyt program, the brochure also stated, e.g., “Again, You only considered making an investment in the cattle business AFTER you heard about the tax benefits. Tax benefits were your incentive. They encouraged you to make a high risk and financially questionable investment.” (ER2 at 337 (emphasis in original).) See also Hansen v. Commissioner, 471 F.3d 1021, 1026, 1031 (9th Cir. 2006) (Hansens (parties here) had disproportionately large tax savings in comparison to their investment); Van Scoten, 439 F.3d at 1257 n.9. Even if the Hoyt program was not a “pure” tax shelter, it was sufficiently tax motivated that taxpayers lose this point.

Second, as the Tax Court stated, considerations of Hoyt’s fraud were insufficient to preclude the Tax Court from finding Hoyt taxpayers liable for the accuracy-related penalty for negligence, nor to prevent this Court and two other Circuits from affirming the Tax Court. (ER1 at 806 n.11.) Hansen, 471 F.3d at 1029–33; Mortensen v. Commissioner, 440 F.3d 375, 387–93 (6th Cir. 2006); Van Scoten v. Commissioner, 439 F.3d 1243, 1251–60 (10th Cir. 2006). In other words, generic arguments (Br. 12–15, 20–21, 52, 56–61) about Hoyt, his program, and the history of the Hoyt audit were insufficient to allow Hoyt taxpayers to avoid the negligence penalty as enacted by Congress and applied by the courts after full trials on the merits. It would be anomalous, disrespectful to Congress and the above-cited courts, and discouraging to Hoyt taxpayers who sincerely cooperated with the IRS to get out of the Hoyt program to allow the instant taxpayers to escape penalties based on the same generic arguments simply because they switched from a direct attack on the penalties to a collateral attack using the CDP procedures and offers in compromise. ¹¹ See Kindred v. Commissioner, 454 F.3d 688, 698 (7th Cir. 2006) (offer in compromise cannot be used as collateral attack on underlying liability).

Third, taxpayers’ argument (Br. 15–17, 61–64) about longstanding cases not only should be rejected as a matter of law for the reasons stated above, but also is, as the Tax Court stated, “essentially the

¹¹ If a particular taxpayer believes that his actions were sufficient for him to avoid a penalty (see Br. 21–25, 55–58), he can challenge the penalty on that basis.

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same” as the argument “considered and rejected” by this Court in Fargo, 447 F.3d at 709–12. (ER1 at 14–15.) The Hoyt cases are comparable to Fargo in both timing and the reasons for delays. Fargo involved: (1) the Fargos’ 1983 and 1984 taxable years; (2) a 1993 IRS victory in which the Tax Court found the Fargos’ shelter be “‘nothing more than an elaborate scam to provide highly leveraged deductions for nonexistent expenses’”; (3) a six-year delay until 1999 in determining the Fargos’ liability due to the tiered nature of the shelter and the need to negotiate with the TMP; and (4) the accumulation of $104,288 in penalties and interest on an underlying liability of $23,977. Fargo, 447 F.3d at 708.¹²

In the Hoyt cases, the IRS began its audits in approximately 1980, and it issued notices of deficiency allowing taxpayers to file Tax Court cases (concerning mostly years in the late 1970s) beginning in 1982. RCR#1, 85 T.C.M. at 1371; Bales, 58 T.C.M. at 431 (listing docket numbers beginning with 12479-82). The Tax Court tried Bales in 1986, but it did not issue an opinion until October 1989. Bales, 85

T.C.M. at 431. In contrast to Fargo, where the IRS scored a first-round

¹² The Fargos paid their back taxes, but refused to pay thepenalties and interest. Fargo, 447 F.3d at 708. Taxpayers’ counsel participated in Fargo as counsel for the amici curiae. Id. at 707, 714. (ER1 at 14.)

knockout of the shelter involved, Bales “set back considerably” the IRS’s enforcement efforts against Hoyt with its finding that the cattle partnerships were not shams and that their transactions had economic substance. RCR#1, 85 T.C.M. at 1371. In response to Bales, the IRS decided to conduct a professional count of the Hoyt livestock, but Hoyt’s lack of cooperation and the resulting need to bring a summons-enforcement action delayed the count until late 1992. RCR#1, 85 TCM

at 1372. The count was far enough along by May 1993 for the IRS and Hoyt to enter into a global settlement for tax years 1980 through 1986, and also for the IRS to issue FPAAs for later tax years in time to allow the filing of partnership-level Tax Court cases in 1994. (ER2 at 206–214.) Durham Farms, 79 T.C.M. at 2009, 2034–42; RCR#4, 77 T.C.M. at 2245, 2267–69 (docket number 9551-94). In 1996, the Tax Court issued opinions resolving the disagreements between the IRS and Hoyt over the allocation of the 1980 through 1986 settlement items to the individual partners. E.g., Shorthorn Genetic Eng’g 1982-2 v. Commissioner, T.C. Memo. 1996-515, 72 T.C.M. (CCH) 1306. In 1996 and 1997, respectively, the Tax Court held trials in the Durham Farms and RCR#4 test cases for tax years 1987 and later, but it did not issue opinions until 1999 for RCR#4 and 2000 for Durham Farms. Durham

Farms, 79 T.C.M. at 2010; RCR#4, 77 T.C.M. at 2245. As taxpayers acknowledge, the Hoyt organization’s loss in RCR#4 was the first Tax Court ruling on the merits of the Hoyt program since the Bales opinion in 1989. (ER2 at 183.)

As demonstrated both by Fargo and by the Hoyt proceedings, it takes time to end a major tax-shelter partnership program under TEFRA, especially when dealing with a difficult TMP. Taxpayers, moreover, have not identified any errors or delays in performing nondiscretionary, ministerial acts that would justify interest abatement under § 6404(e). See Mekulsia v. Commissioner, 389 F.3d 601 (6th Cir. 2004) (Hoyt case holding that decision whether to remove TMP is discretionary and thus not a proper subject for interest abatement under § 6404).¹³ (ER1 at 797, 809.) Taxpayers who can now afford to pay at least part of the interest and underpayment-based penalties without suffering economic hardship presumably could have reduced or avoided those charges by posting bonds, making payments, or filing returns without shelter items and seeking refunds conditional upon the allowance of the shelter. See Hinck, 127 S. Ct. at 2017; Mekulsia, 389

¹³ After Mekulsia, the Hoyt taxpayers with similar interest-abatement cases dismissed their cases. (E.g., ER4 at 104.) Taxpayers who can identify ministerial errors and delays in the processing of their individual cases might still be able to seek interest abatement.

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F.3d at 603. But, as was the case with the penalties, taxpayers cannot use the CDP process as a means to get around Code sections governing interest that they believe to be insufficiently generous.

Fourth, the instant appeals aptly demonstrate the point that taxpayers are the first line of defense against abusive tax schemes. The 1,000 lb. Tax Shelter contained numerous, explicit warnings about the tax aspects of the Hoyt program. For example, it acknowledged that “‘[t]his deal looks too good to be true!’” and that investors might “think there’s no way this deal can be legal, and all those guys are going to end up in jail.” (ER2 at 329.) It warned that tax-shelter partnerships structured like the Hoyt partnerships would be “branded as a potential ‘abuse’” by the IRS and subjected “to automatic audit.” (ER2 at 403.) On a page entitled “The Risks,” it noted the possibility that “[a] change in the tax laws or an audit and disallowance by the IRS could take away all or part of the tax benefits, plus the possibility of having to pay the tax along with penalties and interest.” (ER2 at 362.) It described “[t]he prospect of having to pay the taxes when you have put your tax money in to a tax shelter, and it’s gone” with terms like “decapitated” and “financial wreck.” (ER2 at 395–396.) It advised that “[i]f you must have a tax man give you specific personal advice as to whether or not you belong in the cattle business, stay out.” (ER2 at 380 (emphasis in original).) And it contained a cartoon of a Native American on a bluff with “IRS” on his quiver preparing to ambush the “HS ‘Circle of Wagons’” below. (ER2 at 402.) In Hansen, this Court described those warnings and stated: “We have consistently held that given similar warning signals, investors must undertake adequate investigations at the time of investment to avoid the negligence penalty.” 471 F.3d at 1025, 1029–30; see also Mortensen, 440 F.3d at 380–81, 390.

The Hoyt investors received other “warning signals” over the years. For example, the individual partners generally received Notices of Beginning of Administrative Proceeding (NBAPs) informing them that their partnerships had been selected for audit, and Notices of Final Partnership Administrative Adjustments (FPAAs) informing them of the IRS’s adjustments to their partnerships’ tax items. I.R.C. § 6223(a). (ER2 at 179, 230–231.) Hoyt mailings over the years described the organization’s battles with the IRS and solicited partner payments into a legal defense fund. (E.g., ER2 at 436–437, 450–457, 730, 783, 796–798, 825–827, 835–854.) Letters to the partners from Hoyt and the IRS in late 1991 and early 1992 took contradictory positions on the “material participation” under I.R.C. § 469 that the partners needed to claim Hoyt tax benefits. (ER2 at 812–822.) Van Scoten, 439 F.3d at 1249–50. In early 1993, the IRS began sending prefiling notices to the partners stating that, starting with tax year 1992, it would freeze the portions of partner refunds attributable to Hoyt deductions. Van Scoten, 439 F.3d at 1246. And in late December 1993, after the completion of the cattle count, the IRS sent letters to all of the partners warning them that fictitious animals had been sold to the partnerships and that Hoyt and his organization had overstated the number and value of the animals purportedly owned by the partnerships. RCR#1, 85 T.C.M. at 1385–86. As aptly observed by the Sixth Circuit, “when the predators are circling, no reasonable ostrich sticks its head in the sand.” Mortensen, 440 F.3d at 385.

The Bales opinion (Br. 58–61) may have been a major setback for the IRS’s institutional enforcement efforts, but parts of it should have been cause for caution among the individual Hoyt taxpayers. After Bales, the IRS felt constrained to work with Hoyt and to treat his organization as a legitimate business needing only to be reduced to “demonstrable economic reality.” (ER2 at 259, 277.) In a 1994 letter to Senator Gorton, the IRS responded to concerns by the Senator’s constituents “that the IRS let the Hoyt partnerships continue” by stating: “Since Hoyt has been recognized by the courts as a legitimate business, the IRS has no authority to intervene with the promotion of the partnership.”¹⁴ (ER2 at 794–795; see also ER2 at 244, 247–248 (May 1993 hearing on global settlement where judge describes Hoyt partnerships as “legitimate business enterprises”).) Many of the Bales taxpayers wound up owing taxes, however, because of concessions stated in the opinion that (contrary to Hoyt’s claim in The 1,000 lb. Tax Shelter (ER2 at 256–257, 402)) partnership deductions could not be retroactively adjusted after the close of a taxable year to meet an individual partner’s tax needs, and that partners could only claim Hoyt deductions up to the limit of their cash investments. Bales, 58 T.C.M. at 435, 449. (ER2 at 182.) See Hansen, 471 F.3d at 1026, 1031 (claiming Hoyt losses far in excess of investment); Mortensen, 440 F.3d at 393 (same); Van Scoten, 439 F.3d at 1249–50 (same).

The record further shows that many Hoyt partners heeded the warning signals, accepted the settlements offered by the IRS over the years, and left the Hoyt partnerships. For example, Hoyt organization mailings complain about departing partners. (ER2 at 450, 454

¹⁴ Interestingly, other Hoyt partners complained to Senator Gorton that the IRS was “harassing the Hoyt partnerships.” (ER2 at 795.) At a minimum, that shows that the partners were aware of the IRS’s enforcement efforts but chose to remain loyal to Hoyt.

835–843.) Other partners were organized enough to obtain independent counsel, to form committees, and to take other actions against the Hoyt organization. (ER2 at 277–278, 435, 797, 844, 1000–1025.) In fact, in 1993 the Hoyt organization began to experience financial difficulties because partner defections (due in part to the refund freeze) greatly reduced its cash flow. RCR#1, 85 T.C.M. at 1372. The instant taxpayers cannot use the CDP process to obtain a better outcome simply because they “act[ed] like a prairie rabbit in a hailstorm and just hunker[ed] down until it pass[ed].” Mortensen, 440 F.3d at 389.

Taxpayers argue that the IRS should have been more aggressive about revoking Hoyt’s enrolled agent status (Br. 62–63) and prosecuting him criminally (Br. 61–62). They also argue (Br. 63–64) that in May 1993 the IRS should have settled with a partner settlement committee instead of with Hoyt.¹⁵ All of those, however, are highly discretionary decisions for which Congress has not provided any

¹⁵ The TEFRA partnership provisions allow all partners to participate as parties in partnership-level litigation, and the partner settlement committee was represented by counsel. I.R.C. § 6226(c). (ER2 at 1000–1035.) Dissatisfied partners could have challenged the May 1993 global settlement in the then-pending Tax Court proceedings dealing with those partnerships and years. See SGE82-2, 72 T.C.M. at 1306 (listing docket numbers beginning with 22003-89).

mechanism for third-party review or relief. See Phillips v. Commissioner, 272 F.3d 1172, 1175–76 (9th Cir. 2002); Mekulsia, 389 F.3d at 603–06. Moreover, whatever titles Hoyt held, he promoted these shelters and his organization’s tax office prepared the individual partners’ tax returns and then required the partners to pay over 75% of the tax savings that the Hoyt organization claimed to have generated. (ER2 at 256–257, 338.) This Court and other courts of appeals have uniformly held in Hoyt cases that a taxpayer cannot negate the negligence penalty through reliance on a transaction’s promoters or on other advisors who lack independence because they are laboring under a conflict of interest. Hansen, 471 F.3d at 1031–32; Mortensen, 440 F.3d at 387–88; Van Scoten, 439 F.3d at 1252–53. Taxpayers should not be allowed to convert the CDP process from a shield against overzealous collection activity into a sword to be used for collateral attacks on the IRS’s discretionary decisions over the course of a long and difficult audit.

In the end, taxpayers have not shown why normal collection of their tax debts — in accordance with the laws enacted by Congress and applied to the Hoyt tax shelter by the courts — would undermine public confidence that the tax laws are being fairly and equitably enforced.

Taxpayers have also not shown why they deserve more favorable treatment than other Hoyt taxpayers who accepted the Commissioner’s settlement offers and left the Hoyt shelter. Giving more generous terms to taxpayers who continue, unsuccessfully, to dispute their liabilities would not only undermine the penalty and interest provisions enacted by Congress and the consistent settlement principles of TEFRA, but also would encourage future taxpayers to disregard IRS warnings and early settlement programs in the hopes that their intransigence will lead to a better deal at a later date.

D. Taxpayers have not shown that they would suffer economic hardship if they were to pay more than the amounts in their compromise offers

Taxpayers state (Br. 25) that Abelein, the Blondheims, the Freemans, the Hansens, and Keller are not advancing collectibility and hardship arguments on appeal. The taxpayers in the other eleven cases contend that the Appeals officers erred in evaluating their finances. Before addressing each taxpayer’s specific arguments, certain legal principles must be discussed.

At issue is whether the Appeals officer abused her discretion in rejecting taxpayers’ economic-hardship offers in compromise. Economic hardship is defined as the inability to meet reasonable basic living expenses. Treas. Reg. § 301.6343-1(b)(4)(i). The IRS can reject a hardship offer if the amount offered is less than the amount that can be collected without causing hardship. Murphy, 469 F.3d at 33; I.R.M. § 5.8.11.2.1(10), (11). The taxpayer has the burden of demonstrating hardship, and he should do so by thoroughly documenting his claims in the first instance. The Regulations do not require Appeals officers to fill the gaps in a taxpayer’s documentation by, e.g., personal visits to the taxpayer’s home to assess the need for repairs. (See ER1 at 440–441; ER9 at 124; Br. 33–34, 70–71.) Appeals officers also are not required to negotiate before rejecting an offer. Fargo, 447 F.3d at 712–13; Speltz v. Commissioner, 454 F.3d 782, 786 (8th Cir. 2006); Olsen, 414 F.3d at 157.

The examples of hardship in the IRS settlement guidelines direct attention towards whether the taxpayer will suffer current hardship, and Appeals officers need not credit a taxpayer’s speculation about the future. Treas. Reg. § 301.7122-1(c)(3). For example, the Fargos argued, based on “thin” evidence, that they would soon need to spend $90,000 per year on medical expenses related to Mr. Fargo’s progressive dementia. Fargo, 447 F.3d at 710. Their medical evidence consisted only of a diagnosis that did not mention a need for nursing care or other expenses, and their claimed future expenses seemed “predominantly hypothesized from publicly-available information that is not particularized to Mr. Fargo” and were “almost wholly speculative.” Ibid. “Although one might find some ground upon which to quibble with the [IRS’s] decision,” it was “impossible” to say that the IRS abused its discretion in rejecting the Fargos’ hardship claim. Ibid.

A CDP determination rejecting a hardship offer and upholding a levy means only that collection can proceed. It does not mean that the IRS will doggedly attempt to collect the amount calculated by the Appeals officer for purposes of evaluating the taxpayer’s offer. See Living Care, 411 F.3d at 628–29 (investigation into equity obtainable from asset not required at CDP hearing but only prior to actual levy). And as the Tax Court noted, the IRS cannot seize a taxpayer’s principal residence without approval from a district court. (ER1 at 158 n.11.)

I.R.C. § 6334(a)(13)(B), (e); Treas. Reg. § 301.6334-1(d). A taxpayer can always make a new offer, and in levy cases the Office of Appeals retains jurisdiction to consider post-CDP changes in circumstances. I.R.C. § 6330(d)(2); Treas. Reg. § 301.6330-1(h); Speltz, 454 F.3d at 786.

In the eleven appeals where the taxpayers make financial arguments, they challenge (Br. 64–66) the reasonable collection potential calculated by the Appeals officers, but they fail to prove that their offers are the most they could pay without suffering hardship. That is a fundamental error. Speltz, 454 F.3d at 786 (computation errors not material if corrected collection potential exceeds amount offered). In each case, we will show why the rejection of the taxpayer’s offer was not an abuse of discretion and will address the taxpayer’s arguments as necessary. See Christopher Cross, 461 F.3d at 613 (in deciding whether Appeals officer abused discretion, court considers whether officer “made a determination grounded in the discretion afforded to her by law and provided a reasonable basis for finding the Offer inadequate”). Any calculations based on a taxpayer’s arguments are done only to show no abuse of discretion and do not signify an acceptance of the taxpayer’s position. Likewise, our decision not to engage in unnecessary defenses of an Appeals officer’s computations should not be treated as a disavowal, nor should our decision not to refute all of a taxpayer’s arguments be treated as a concession.

The Andrewses offered $25,000 compared to an assessed liability of $248,108 and to their adjusted reasonable collection potential of $351,531 ($160,146 if the Andrewses’ financial statement had been taken at face value). (ER1 at 50, 58, 60; ER3 at 129, 186.) They argue (Br. 26–28, 66–67) that the Appeals officer failed to consider their medical expenses. The Appeals officer allowed in full the claimed $533 in monthly medical expenses even though that amount was higher than normal.¹⁶ (ER3 at 184–185.) She did not allow the “possible future expenses” because they were “general projections from the taxpayers’ representative and may never, in fact, be incurred.” (ER3 at 186.) The Tax Court agreed, stating that “it was not arbitrary or capricious for [the Appeals officer] to ignore these speculative future costs in making her final determination.” (ER1 at 60.)

The Barnses offered $32,000 compared to a liability of $342,012 and to their reasonable collection potential of $107,617 to $139,617, as computed by the Appeals officer under different scenarios. (ER4 at 77, 111–113.) They argue (Br. 28–29, 67–69) that the Appeals officer failed

¹⁶ The Appeals officer could not have considered the insurancestatement showing an out-of-pocket liability of $417,347 because it isdated almost one year after the notice of determination. (ER3 at 36; see also ER1 at 57 n.10; Br. 28, 67.)

to consider their medical expenses and to grant them an additional housing allowance to compensate for tax collections from the equity in their residence. The Appeals officer allowed the Barnses’ above-average claim of $1,087 in monthly medical expenses, and the $107,617 collectibility figure includes $500 in undocumented other expenses that the Appeals officer could have disallowed. (ER3 at 112–113; see also ER1 at 144–145, 156–157.) That $500 is greater than the $354 in extra housing expenses that the Barnses seek (Br. 68) in their brief. Moreover, an extra $354 per month over the 48-month collection period¹⁷ would still yield a reasonable collection potential of at least $90,625. (See ER4 at 112–113; ER1 at 158 (describing the Barnses’ housing hardship claims as “vague, speculative, undocumented, and unavailing”).) Further, the value of the Barnses’ cash, their retirement accounts, the cash value of their life insurance (adjusted for the loss of $106 per month in annuity income over the collection period), their non-residential real estate, and three of their four vehicles is $45,529. (ER4 at 77, 111.) The Tax Court correctly concluded that the Appeals

¹⁷ The amount collectible from a taxpayer’s future income iscalculated by multiplying the taxpayer’s expected monthly income (netof necessary living expenses) by 48 months for cash offers, 60 monthsfor short-term deferred offers, and the number of months left in the collection statute for deferred payment offers. I.R.M. § 5.8.4.4.1(1).

officer did not abuse her discretion in rejecting the Barnses’ offer. (ER1 at 143–145, 152–153, 155–159.)

The Carters offered $99,851 compared to a liability of $187,041 and to their adjusted reasonable collection potential of $304,782 ($173,406 if the Carters’ financial statement had been taken at face value). (ER1 at 284, 287–288; ER6 at 199, 283–287.) They contend (Br. 29–30, 74–75) that the Appeals officer made various errors, but even at their 80% quick-sale valuation, the Carters have at least $138,191 of equity in their house alone, not counting any other assets or income (ER1 at 275; ER6 at 283–284). Further, allowing $600 per month in extra health insurance costs over the 48-month collection period (ER1 at 284; Br. 75) would only reduce the Carters’ face-value collection potential to $144,606. The Tax Court correctly found that the Appeals officer did not abuse her discretion in rejecting the Carters’ offer. (ER1 at 272–278, 284–289.)

The Catlows offered $35,000 compared to a tax liability of $541,620 (plus unassessed amounts from later years) and to their reasonable collection potential of $193,438. (ER6 at 90, 118–121.) They contend (Br. 30–31) that the Appeals officer erroneously reduced their monthly expenses, but they do nothing to refute her reasons for those reductions (see ER7 at 119–120). Further, the Catlows reported $13,110 in cash, $36,000 in home equity, and $105,440 in retirement accounts from which at least $60,250 should be available after taxes on withdrawals. (ER7 at 118–119.) The Appeals officer did not abuse her discretion in rejecting the offer. (ER1 at 346.)

The Claytons offered $100,000 compared to a tax liability of $203,797 (plus unassessed amounts for later years) and to their reasonable collection potential of $431,417 to $546,417 as computed by the Appeals officer under different scenarios. (ER8 at 100, 137–140.) Even removing the $57,432 for dissipated assets and allowing the Claytons $1,000 per month for federal tax payments over the 48-month collection period would only reduce their collection potential to $325,985. (ER8 at 128, 139–140, Br. 31–32.) Moreover, the Claytons reported a retirement account with a value of $335,645 after adjusting for taxes on withdrawals. (ER8 at 137.) The Appeals officer did not abuse her discretion in rejecting the Claytons’ offer. (ER1 at 394–395.)

Ertz offered $157,824 compared to a tax liability of $318,116 (plus unassessed amounts for later years) and to his reasonable collection potential of $503,834. (ER9 at 122, 175.) Ertz argues (Br. 32–34, 69–72; ER9 at 122–124, 147, 173) that the net equity in his house was $102,855, that the tax-adjusted amount in his retirement account was $178,483, that $51,120 in net income would not be available after he paid off his mortgage, that his normal monthly expenses exceeded his income by $227 ($10,896 using Ertz’s figures and a 48-month collection period for a cash offer), that he needed $44,000 for home repairs (already accounted for in the house value above) and other major expenses, and that there would be future increases in his medical expenses. But even with all of the enumerated adjustments (some of which include double counting), Ertz’s collection potential is still $242,467. The Appeals officer allowed in full Ertz’s claimed $511 monthly medical expense, and she did not abuse her discretion when she did not allow as future expenses the “general projections from the taxpayers’ representative [that] may never, in fact be incurred.” (ER1 at 437–439; ER9 at 173, 175.)

The Hubbarts offered $60,400 compared to a currently assessed tax liability of $345,145 and to their adjusted reasonable collection potential of $329,068 ($178,656 if the Hubbarts’ financial statement had been taken at face value). (ER1 at 596, 599; ER12 at 129, 208.) Their case is different from the other cases in that it involves a lien, not a levy. (ER12 at 198–199.) See I.R.C. § 6320. The Hubbarts argue (Br.

34–35, 72–73; ER12 at 62, 98) that the Appeals officer overvalued their home, which they describe as “specially equipped” due to its wider doors and lack of stairs. The Appeals officer used the $214,141 value given the property by the county assessor, which “figure must be considered to be a conservative figure.” (ER12 at 204–205; ER1 at 598–599 (use of county assessor’s valuation not arbitrary or capricious).) The Hubbarts themselves value the house at $165,713, and they cite only to post-CDP-hearing trial transcripts for the proposition that their house was specially equipped. (ER12 at 62, 96–98, 158.) An Appeals officer cannot abuse her discretion by not considering information not given to her. Moreover, the Hubbarts will be entitled to another CDP hearing if the IRS seeks to collect by levy.

I.R.C. §§ 6320(b)(2), 6330(b)(2).

Johnson offered $120,500 compared to a tax liability of $569,654 and to his adjusted reasonable collection potential of $442,338 ($238,892 if Johnson’s financial statement had been taken at face value). (ER1 at 642, 599; ER13 at 139, 189.) Other than speculative future medical expenses, all of the adjustments that Johnson disputes (Br. 36–37, 71 n.9, 73–74) would not have been made in computing the $238,592 face-value figure ($225,132 if Johnson and his wife keep two cars (ER13 at 186)). The Appeals officer did not abuse her discretion “by rejecting an offer-in-compromise that bore no relationship to [Johnson’s] ability to pay based on his own calculations.” (ER1 at 645.)

The Lindleys made an effective-tax-administration offer of $40,413, and a later offer of $150,000 with respect to which they abandoned “their special circumstances arguments related to retirement, medical conditions, and the fact that they are victims of a convicted felon.” (ER15 at 170, 202, 209; ER1 at 709–710, 718–719.) The Lindleys’ tax liability was at least $162,005 (and possibly up to $420,000), and they had a reasonable collection potential of $175,535 as adjusted by the Tax Court. (ER1 at 710–715, 721–727; ER15 at 174, 206, 208.) The Lindleys broadly argue (Br. 37–39) that the Appeals officer and the Tax Court “failed to consider the Lindleys’ health and financial issues.” But they abandoned their medical issues in making the $150,000 offer, and they do not specify what “financial issues” the Tax Court failed to consider in recalculating their collection potential. The Lindleys have not shown an abuse of discretion regarding the rejection of their $150,000 offer, which fell below their $175,535 collection potential. Moreover, both the Appeals officer and the Tax Court allowed the Lindleys’ claimed $250 in monthly medical expenses ($152 of which was a health insurance premium), and the Lindleys offered only speculation about future increases in their unreimbursed medical expenses. (ER1 at 724; ER15 at 127–130, 171, 173, 175–176, 187, 191, 201, 211.) They have thus not shown an abuse of discretion in rejecting their $40,413 offer.

McDonough offered $102,000 compared to a tax liability of $98,881 (plus unassessed amounts for 1987 through 1996) and to his adjusted reasonable collection potential of $448,762. (ER1 at 762–763; ER16 at 130, 221.) Over the 48-month collection period using McDonough’s monthly average wages as computed by the Appeals officer (based on McDonough’s documentation) and allowing all of McDonough’s claimed expenses (including the $1,747 monthly medical expense claimed by McDonough and allowed by the officer), McDonough could pay $72,096 out of his future income. (ER16 at 198, 219–220; ER1 at 762–763.) Moreover, using McDonough’s figures and adjusting for taxes and quick-sale values, he had $52,251 in cash, $20,323 in stocks, $34,800 in real property other than his home, and at least $32,672 in various vehicles (leaving McDonough and his wife with two vehicles), for a total of $140,046 in only some of McDonough’s assets. (ER16 at 129, 194–196, 204, 217–218.) McDonough has not demonstrated (Br. 39–40) any abuse of discretion in rejecting his offer.

The Smiths offered $11,552 compared to an assessed tax liability of $79,641 (the Smiths estimated a total liability of $265,023) and to their reasonable collection potential of $161,844. (ER1 at 788; ER17 at 35, 100–101.) They initially reported assets with a net value of $124,038, but they omitted from their financial forms a retirement account with a tax-adjusted value of $38,823 and three parcels of nonresidential real property, which the Appeals officer valued at a total of $1,500 (compared to a total assessed value of $2,800 for purposes of local property taxes). (ER17 at 48–50, 92–93, 98; ER1 at 792–795.) Thus, the value of the Smiths’ omitted assets alone is over three times the amount of their offer. They complain (Br. 40–41) that the Appeals officer did not adequately consider their medical expenses, but the officer allowed their claimed $262 monthly expense, and as stated by the Tax Court, she “was not required on her own initiative to increase arbitrarily the amount of those reported medical expenses to reflect the possibility that [the Smiths] would incur additional medical costs in the future.” (ER17 at 52; ER1 at 793–794, 804–805.)

The Tax Court had jurisdiction to review the record of prior, partnership-level cases to determine if factual findings relevant to tax-motivated interest under former I.R.C. § 6621(c) were manifest

Standard of review

Both the Tax Court’s interpretation of the relevant statutes and its holding that it lacked subject-matter jurisdiction are legal conclusions reviewable de novo. RCR#1, 401 F.3d at 1143.

In twelve of the instant appeals, the IRS’s computational adjustments included determinations that the taxpayers are liable for interest at the increased rate prescribed by former § 6621(c) (120% of the normal rate).¹⁸ This issue affects the taxpayers in twelve of the instant appeals (i.e., all taxpayers except the Hansens, Keller, the Lindleys, and McDonough). (Br. 77 n.11.) The affected taxpayers

¹⁸ In 1984, Congress enacted I.R.C. § 6621(d) applicable to interest accruing after December 31, 1984, even on pre-enactment transactions. In 1986, Congress amended I.R.C. § 6621(d) and redesignated it I.R.C.§ 6621(c). In 1989, Congress repealed I.R.C. § 6621(c) effective for returns due after December 31, 1989. Despite the repeal, interest at the increased rate continues to accrue on earlier liabilities. See Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 144, 98 Stat. 494, 682–84;Tax Reform Act of 1986, Pub. L. No. 99-514, §§ 1511(c)(1), 1535, 100Stat. 2085, 2744, 2750; Omnibus Budget Reconciliation Act of 1989Pub. L. No. 101-239, § 7721(b), (d), 103 Stat. 2106, 2399–2400.

entered into stipulations to be bound by the Tax Court’s decision on the § 6621(c) issue in the Ertz case. (ER2 at 132–134.)

Section 6621(c) interest is applicable to underpayments in excess of $1,000 attributable to tax-motivated transactions. I.R.C. § 6621(c). In Ertz, the Tax Court held that it lacked jurisdiction to consider whether the taxpayers’ partnerships’ transactions were tax motivated. (ER1 at 453–460.) It therefore dismissed the taxpayers’ challenges to § 6621(c) interest for lack of jurisdiction. We agree with taxpayers (Br. 44–45, 75–82) that the Tax Court erred in holding that it lacked jurisdiction, but we disagree with them that the necessary partnership-level findings were not made.

Partnerships do not pay federal income tax, but instead file annual information returns reporting their tax items and each partner’s distributive share thereof. I.R.C. §§ 701, 6031. Each partner must then report his share of his partnership’s items on his individual income tax return, treat the items consistently with partnership’s treatment, and account for them when determining his income tax.

I.R.C. §§ 701, 702, 6221, 6222.

Congress enacted the TEFRA partnership provisions (I.R.C. §§ 6221–6234) to achieve consistent treatment of all partners in the same partnership and to remove the substantial administrative burden occasioned by duplicative audits and litigation. See H.R. Conf. Rep. No. 97-760, at 599–600 (1982), reprinted in 1982-2 C.B. 600, 662–63. TEFRA gives the Tax Court jurisdiction in partnership-level proceedings to rule on “partnership items.” I.R.C. § 6226(f). A “partnership item” is any item more appropriately determined at the partnership level as prescribed by Treasury Regulations. I.R.C. § 6231(a)(3); Treas. Reg. § 301.6231(a)(3)-1(b). After a partnership-level proceeding ends, the IRS makes computational adjustments to the returns of the individual partners, and the partners are personally liable for any resulting increase in their income tax liability. I.R.C. §§ 6225, 6230, 6231(a)(6). Section 6621(c) interest is an “affected item,” i.e., a partner-level item that is affected by partnership items. I.R.C. § 6231(a)(5); Field v. United States, 328 F.3d 58, 59–60 (2d Cir. 2003).

As already explained, the May 20, 1993 global settlement treated the Hoyt cattle partnerships as legitimate businesses, but sought to reduce their 1980 through 1986 tax years to demonstrable economic reality. (ER2 at 259, 277.) The IRS and Hoyt, however, could not agree on a formula for allocating tax items among the individual partners. The Tax Court agreed with the Commissioner on the allocation issues. E.g., SGE82-2, 72 T.C.M. (CCH) 1306. All of the instant taxpayers affected by this issue were in partnerships governed by the global settlement and by the SGE82-2 opinion. (ER2 at 123; Br. 77.) In the decisions following SGE82-2, the Tax Court stated that § 6621(c) interest was an affected item requiring factual determinations at the partner level “and [is] not within the Court’s jurisdiction in this case.” (ER9 at 222–237.)

Both the Tax Court and this Court addressed the issue of I.R.C. § 6621(c) interest in River City Ranches #1. The Tax Court held that it lacked jurisdiction in partnership-level cases to rule on an affected item like § 6621(c) interest. RCR#1, 85 T.C.M. at 1396. This Court reversed and remanded, holding that the Tax Court had jurisdiction to rule on the character of the partnerships’ transactions for purposes of § 6621(c) interest. RCR#1, 401 F.3d at 1143–44.

After this Court’s opinion in RCR#1, there is no dispute that the issue of the character of a partnership’s transactions is a partnership item, but that the issue whether any individual partner is liable for § 6621(c) interest requires the additional determination at the partner level whether there is an underpayment exceeding $1,000 attributable to tax-motivated partnership transactions. At issue here is the Tax Court’s jurisdiction in a partner-level proceeding to review the record of a prior, partnership-level proceeding to determine whether findings relevant to § 6621(c) interest had been made.

After the conclusion of partnership-level proceedings, the IRS made computational adjustments to taxpayers’ returns, including imposing interest at the § 6621(c) rate where applicable. Because interest is a computational adjustment, Ertz and the others did not have an opportunity to challenge the § 6621(c) interest in a deficiency proceeding. (ER1 at 454.) N.C.F. Energy Partners v. Commissioner, 89

T.C. 741, 743–45 (1987). Instead, they challenged it in the instant CDP proceedings.

There is no dispute that the Tax Court had CDP jurisdiction to consider the issue of the taxpayers’ liability for § 6621(c) interest, which liability they had not yet had an opportunity to contest. I.R.C. § 6330(c)(2)(B), (d)(1)(A). (ER1 at 454.) The Tax Court, however, framed the issue as whether it could rule in a partner-level CDP case on whether the partnership-level transactions of Hoyt partnerships were tax motivated. (ER1 at 455, 459.) The Tax Court, citing this Court’s opinion in RCR#1, concluded that it lacked jurisdiction to do so. (ER1 at 457–459.) It therefore dismissed taxpayers’ challenges to § 6621(c) interest for lack of jurisdiction. (ER1 at 418, 459–460.) Under the dismissals, taxpayers will owe § 6621(c) interest without a court ever having specifically ruled on any aspect of that interest.

As stated above, Congress enacted the TEFRA partnership provisions to achieve the consistent treatment of all partners in the same partnership and to remove the substantial administrative burden occasioned by duplicative audits and litigation. That purpose defines the parameters of the Tax Court’s jurisdiction in partner-level cases. If a court in a partnership-level proceeding issues a decision, opinion, or similar dispositive document in which it explicitly makes factual findings or legal determinations relevant to § 6621(c) interest (even if it does not label them as such), a court in a later partner-level proceeding would be bound by those findings. See I.R.C. §§ 6221, 6222. On the other hand, if the partnership-level court did not make any findings or determinations relevant to § 6621(c), a court in a later partner-level proceeding would lack jurisdiction to review the evidence presented in the partnership-level case in order to make those findings or determinations for the first time. The first situation involves no duplication or risk of inconsistency, the second situation involves both.

The instant CDP cases fall between those two examples. We maintain that the Tax Court had jurisdiction in these partner-level proceedings to review the dispositive documents issued by the Tax Court in the prior partnership-level cases (along with any documents adopted by the dispositive documents or necessary to the ultimate findings therein) in order to determine whether partnership-level issues relevant to § 6621(c) interest have been resolved or can be resolved based on already-found subsidiary facts without the need to exercise discretion or judgment at the partner level. See Botany Worsted Mills, 278 U.S. at 290 (when trial court makes findings on subsidiary facts but not on ultimate facts, subsidiary facts will not support a judgment unless they are such that the ultimate facts follow from them as a necessary inference and may be held to result as a conclusion of law); Nault v. United States, 517 F.3d 2, 3–4, 8 (1st Cir. 2008) (when Tax Court decision based on parties’ settlement says tax shelter lacked economic substance, appellate court cannot decide substance but can determine meaning of words in decision). That standard is consistent with TEFRA because it keeps the determination of partnership items in partnership-level proceedings, removes artificial barriers to the consideration in partner-level proceedings of facts definitively determined in partnership-level proceedings, but still minimizes the risk of duplication or inconsistency.

In the stipulations to be bound by the result in the Ertz case, the parties agreed that the taxpayers would be treated as if they had been partners in Ertz’s partnership, Durham Genetic Engineering 1985-5 (DGE85-5). (ER2 at 132–134.) In its opinion in SGE82-2 and in the resulting decisions, the Tax Court did not explicitly rule on any partnership-level items relevant to § 6621(c) interest. (ER1 at 459.) The court did, however, state: “Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits received into evidence are incorporated by this reference.” 72 T.C.M. at 1308. The parties in Ertz included in evidence dispositive documents and incorporated stipulations from SGE82-2, DGE85-5’s 1985 and 1986 partnership tax return (from which the “As Reported” amounts in the Tax Court’s decisions for DGE85-5 presumably were taken), and a cattle inventory used by the IRS to apply the terms of the May 1993 global settlement to the partnerships. (ER9 at 216–220.)

In the May 20, 1993 settlement (exhibit 1-A to the SGE82-2 stipulation of facts (SER 32–33)), the IRS and Hoyt agreed to reduce the Hoyt partnerships to demonstrable economic reality by agreeing to a per-head value for each class of cattle ($4,000 head in the case of breeding cows like those owned by DGE85-5) and by allocating the extant animals among the partnerships according to a formula that multiplied the number of cattle claimed by a partnership by a fraction in which the numerator was the total extant animals for a year and the denominator was the total claimed animals for that year. (ER2 at 207–208.) The settlement allowed depreciation and interest deductions and investment tax credits based on the number of extant cattle in a partnership’s first year times $4,000 per head. (ER2 at 208–209.)

The global settlement had the following effect on DGE85-5’s tax items that are based on the number and the value of the cattle in DGE85-5’s herd. On its 1985 partnership tax return, DGE85-5 claimed a $669,910 depreciation deduction for a breeding herd with a basis of $4,701,120, and it reported that the entire $4,701,120 basis in the herd qualified for the investment credit. (SER 2–3, 8, 10–13.) The decision entered pursuant to the global settlement reduced the depreciation deduction to $68,400, and it reduced the value of the qualified investment property to $480,000. (ER9 at 235–236.) On its 1986 partnership tax return, DGE85-5 claimed a $982,534 depreciation deduction and a $524,183 interest deduction. (SER 15–17, 23, 25.) The decision entered pursuant to the global settlement reduced the depreciation deduction to $161,040 and the interest deduction to $33,600. (ER9 at 251.)

According to the IRS’s cattle inventory, DGE85-5 claimed to have a herd of 520 cattle in both 1985 and 1986. (SER 29.) Dividing DGE85-5’s $4,701,120 claimed basis by its 520 claimed animals yields a value of $9,041 per animal. Dividing the $480,000 adjusted basis by the agreed value of $4,000 per animal yields a herd of 120 cattle. (See also SER 31 (DGE85-5 had 120 animals in 1985 and 189 animals in 1986).) In other words, DGE85-5 claimed a herd of 520 animals worth $9,041 each, but it only had a herd of 120 animals worth $4,000 each.

Tax-motivated transactions under § 6621(c) includes “any valuation overstatement (within the meaning of section 6659(c))” and “any sham or fraudulent transaction.” Former § 6659(c) stated that there was a valuation overstatement if the value or basis claimed on any return was 150% or more of the correct amount.¹⁹ A transaction is

¹⁹ Contrary to taxpayers’ argument (Br. 77), § 6621(c) does not (continued...)

3121444.3

a factual sham if it did not occur, did not occur as reported, or violated some background assumption of commercial dealing. Rogers v. United States, 281 F.3d 1108, 1113 n.2 (10th Cir. 2002); Horn v. Commissioner, 968 F.2d 1229, 1236 n.8 (D.C. Cir. 1992); see also Cook v. Commissioner, 941 F.2d 734, 735 (9th Cir. 1991).

Because DGE85-5’s claimed $9,041 value per animal was more than 150% of the $4,000 actual value per animal, any tax benefits derived from the overvaluation of the extant animals were the result of a tax-motivated transaction subject to § 6621(c) interest. DGE85-5 also claimed tax benefits based upon 400 animals that it never actually acquired. Those tax benefits are the result of transactions that fit within the definition of factual sham to the extent (but only to the extent) that they overstated the number of animals acquired. The above conclusions inexorably follow as a matter of simple arithmetic from established subsidiary facts in documents that the Tax Court had

¹⁹ (...continued) have a partner-level, good-faith defense to tax-motivated interest. Section 6621(c) defines a valuation overstatement by reference to the mathematical formula provided by § 6659(c). Section 6621(c) does not mention § 6659(e), which by its own terms, applies only to the penalty imposed by § 6659 itself. Once the mathematical test for overvaluation is met at the partnership level, a partner’s liability for tax-motivated interest turns on the computational question whether the underpayment attributable to that and to other tax-motivated transactions exceeds $1,000.

jurisdiction to consider here. Therefore, to the extent that the instant taxpayers have substantial underpayments attributable to the depreciation and interest deductions and the investment tax credit, the underpayments are subject to tax-motivated interest under former I.R.C. § 6621(c).²⁰

Our position on the application of § 6621(c) is consistent with our positions in the remainder of this brief and in Keller v. Commissioner (9th Cir. – No. 06-75441) and McDonough v. Commissioner (9th Cir. – No. 07-73610), overvaluation-penalty appeals currently pending before this Court. The Hoyt organization deteriorated over time, going from a prominent breeding operation in the 1960s, to a legitimate business

²⁰ For 1985, DGE85-5 also claimed a boarding expense of $149,398that was reduced to zero in the Tax Court’s decision for 1985. (ER9 at 235–236; SER 2, 8.) For 1986, DGE85-5 also reported $106,434 in farm income, claimed a $89,064 deduction for other farm expenses, and reported $26,000 in partner payments for their individual retirement accounts. (SER 15, 17, 20–22.) All of those items were reduced to zero by the Tax Court’s decision for 1986. (ER9 at 251.) There is nothing in the record stating the basis of the reductions of the farm income and expenses. Moreover, the global settlement stated that deductions for contributions to retirement accounts were limited to cash actually and timely paid to the custodial bank. (ER2 at 207.) The disallowances of those deductions cannot be tied on this record to the reduction in the number and value of DGE85-5’s cattle. Accordingly, the IRS has informed us that it will administratively recompute taxpayers’ liabilities, subjecting the portions of taxpayers’ underpayments attributable to the disallowances of those deductions only to regular (and not enhanced) interest.

with some questionable tax practices in the late-1970s Bales years. Durham Farms, 79 T.C.M. at 2012–13; Bales, 58 T.C.M. 431–51 (pp. 435, 449 for tax problems). In the early 1980s, the partnerships started to deteriorate. Durham Farms, 79 T.C.M. at 2013. They were still legitimate partnerships, but their transactions had to be reduced to economic reality. (ER2 at 259, 277.) The distortions in need of correction fit within various categories of tax-motivated transactions under § 6621(c). By the middle of the 1980s, however, it could fairly be said that the Hoyt partnerships had become mere parts of the larger scheme of the Hoyt organization (which actually owned thousands of real cattle and thus was not itself a factual sham) to generate tax benefits through transactions lacking in economic substance. See Hansen, 471 F.3d at 1025 n.4 (describing the Hoyt sheep- and cattle-breeding tax shelters as “in reality, largely economic shams” because of overvaluation, phantom animals, and the indiscriminate shuffling of animals among partnerships); RCR#1, 94 T.C.M. at 9 (describing Hoyt sheep partnerships as shams lacking in economic substance); Durham Farms, 79 T.C.M. at 2013–15, 2017–30.

Trial court rulings regarding discovery, the ultimate admission of evidence, and reopening the record are reviewed for abuse of discretion. Pierce v. County of Orange, 519 F.3d 985, 994 (9th Cir. 2008) (also, de novo review of interpretation of evidentiary rules); Hallett v. Morgan, 296 F.3d 732, 751 (9th Cir. 2002); Devore v. Commissioner, 963 F.2d 280, 282 (9th Cir. 1992).

A. Judicial review of CDP determinations is limited to the administrative record

1. Judicial review of agency action is “ordinarily limited to consideration of the decision of the agency . . . and the evidence on which it was based.” United States v. Carlo Bianchi & Co., 373 U.S. 709, 714–15 (1963); Camp v. Pitts, 411 U.S. 138, 142 (1973); Love v. Thomas, 858 F.2d 1347, 1356 (9th Cir. 1988). The First and Eighth Circuits have applied that principle to CDP cases, holding that judicial review of the determinations of IRS Appeals officers is likewise limited to the administrative record. Murphy v. Commissioner, 469 F.3d 27, 30–31 (1st Cir. 2006), aff’g on other grounds 125 T.C. 301, 313 (2005); Robinette v. Commissioner, 439 F.3d 455, 458–62 (8th Cir. 2006), rev’g 21 123 T.C. 85 (2004) ; Olsen v. United States, 414 F.3d 144, 155–56 (1st Cir. 2005). Because the administrative-record rule is consistent with the principles of administrative law and with the nature of the CDP proceedings, this Court should join the First and Eighth Circuits in applying it to CDP cases.

When Congress provides for judicial review of agency action without setting forth procedures or standards, “consideration is to be confined to the administrative record” and “no de novo proceeding may be held.” Carlo Bianchi & Co., 373 U.S. at 715. “The task of the reviewing court is to apply the appropriate . . . standard of review, 5 U.S.C. § 706, to the agency decision based on the record the agency presents to the reviewing Court.” Florida Power & Light Co. v. Lorion, 470 U.S. 729, 743–44 (1985). As is relevant here, 5 U.S.C. § 706 empowers a reviewing court to set aside agency actions that are “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” Under that standard, judicial review should be “searching and careful,” but narrowly focused on “the relevant factors

²¹ In Robinette and Murphy, the Tax Court did not agree with the Commissioner’s position that judicial review in CDP proceedings islimited to the administrative record.

and whether there has been a clear error of judgment.” Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402, 416 (1971). A court may not substitute its judgment for that of the agency. Ibid. “[T]he focal point for judicial review should be the administrative record already in existence, not some new record made initially in the reviewing court” (Camp, 411 U.S. at 142), because “judicial consideration of evidence relevant to the substantive merits of the agency action but not included in the administrative record . . . inevitably leads the reviewing court to substitute its judgment for that of the agency.” Asarco, Inc. v. EPA, 616 F.2d 1153, 1159–60 (9th Cir. 1980).

Those same “basic administrative law principles” also apply to judicial review of discretionary rulings made in CDP hearings. Murphy, 469 F.3d at 31. As explained above, courts employ the already deferential abuse-of-discretion standard even more deferentially in the review of CDP determinations than in the review of more formal agency decisions. See, e.g., Robinette, 439 F.3d at 459 (review limited to clear taxpayer abuse and unfairness, “lest the judiciary become involved on a daily basis with tax enforcement details that Congress intended to leave with the IRS”). It follows that judicial review of CDP determinations should be limited to the administrative record compiled during the CDP hearing. As the Eighth Circuit explained, “[n]othing in the text or the history of the [1998 Reform Act creating the CDP process] clearly indicates an intent by Congress to permit trials de novo in the Tax Court when that court reviews decisions of IRS appeals officers under § 6330.” Robinette, 439 F.3d at 460. “[I]t would be incongruous to hold that review is limited to determining whether an appeals officer ‘abused his discretion,’ but also to conclude that the appeals officer committed such an ‘abuse’ by failing to weigh information that was never even presented to him.” Ibid.; see also Murphy, 469 F.3d at 31.

In CDP cases, the administrative record consists of all documents in the case file reviewed by the Appeals officer, along with all communications between the taxpayer and the officer between the time of the request for the hearing and the issuance of the notice of determination. See Treas. Reg. § 301.6330-1(d)(2)(Q&A D6), (f)(2)(Q&A F5); see also Portland Audubon Soc’y v. Endangered Species Comm., 984 F.2d 1534, 1548 (9th Cir. 1993) (administrative record “includes everything that was before the agency pertaining to the merits of its decision”). There are exceptions to the administrative-record rule (not applicable here) allowing a court to consider additional evidence when a failure to explain an administrative action is severe enough to frustrate judicial review, and when the taxpayer makes a strong showing of bad faith or improper behavior by an agency decision maker. Murphy, 469 F.3d at 31.

2. Even without the administrative-record rule, decisions regarding discovery and the admission of evidence will not be disturbed on appeal absent a showing of extraordinary circumstances or actual prejudice. Pierce, 519 F.3d at 994; Hallett, 296 F.3d at 751; Devore, 963 F.2d at 282. Prejudice requires more than a showing that the evidence was arguably meaningful, but instead requires a reasonable probability that the outcome would have been different had the evidence at issue been discovered or admitted. Pierce, 519 F.3d at 994; Laub v. Department of the Interior, 342 F.3d 1080, 1093 (9th Cir. 2003); Martel

v. County of Los Angeles, 56 F.3d 993, 995–97 (9th Cir. 1995) (en banc).

Taxpayers argue (Br. 17–20, 45–47, 82–94) that the Tax Court should have considered additional evidence that was not part of the administrative records. The evidence that taxpayers contend was improperly excluded can be divided into four categories: (1) oral testimony from taxpayers who relied on written submissions at their administrative CDP hearings (Br. 82, 91–92); (2) background documentary evidence in taxpayers’ possession but not provided to the Appeals officers because (according to taxpayers) the Appeals officers would have discovered the evidence had they granted taxpayers’ request to conduct an independent investigation of the Hoyt audit (Br. 82–85, 90–91); (3) documents discovered after the issuance of the notices of determination as a result of the discovery ordered by this Court in RCR#1 (Br. 82, 85–90); and (4) a sealed TIGTA case file containing the report of an internal investigation of the Hoyt audit neither admitted into evidence nor released to taxpayers after an in camera review by a Tax Court special trial judge specially assigned to conduct that review (Br. 92–94).

None of the above-listed evidence was provided to the Appeals officers. If a taxpayer does not submit evidence to an Appeals officer for inclusion in the CDP record, then the administrative-record rule prohibits the submission of that evidence to the Tax Court. The Treasury Regulations governing CDP hearings allow for face-to-face meetings, for telephone conferences, and for hearings based entirely on documentary submissions. Treas. Reg. § 301.6330-1(d)(2)(Q&A D6). A taxpayer can choose to rely only on documentary submissions, and he can decide which documents to submit. But the documentary record thus created at the administrative stage becomes the entire record in the reviewing court. It would be incongruous to find an abuse of discretion based on testimony or documents not provided to the Appeals officer but instead produced for the first time in court. Murphy, 469 F.3d at 31; Robinette, 439 F.3d at 460.

Taxpayers contend (Br. 82–85, 90–92) that, absent their new evidence, the administrative records are insufficient for judicial review. The Tax Court disagreed, finding that it “had more than sufficient information to review [the Commissioner’s] determination” (ER1 at 22). To the extent that taxpayers complain about the exclusion of evidence in the April 2006 cases but not the October 2005 cases (Br. 4–5, 82–85), they have not demonstrated prejudice because the outcome was the same in all of the cases. The underlying issue in these appeals is whether the Appeals officers abused their discretion in rejecting taxpayers’ offers in compromise. In each case, the Appeals officer did exactly what she was supposed to do. She evaluated the taxpayer’s offer in light of the IRS’s settlement guidelines, and she rejected the offer because it failed to meet the guideline criteria. Contrary to taxpayers’ argument (Br. 84, 90–91), nothing in the settlement guidelines requires Appeals officers to become free-ranging inspectors general sitting in judgment of the discretionary audit decisions made by other IRS officials years earlier. Instead, the guideline examples of IRS mistakes for which relief can be granted involve easily avoidable, almost ministerial errors of which the affected taxpayer will learn soon after their commission. Treas. Reg. § 301.7122-1(c)(3)(iv); I.R.M. § 5.8.11.2.2(8).

Nothing more needs to be said about the first two categories. Regarding the third category (documents discovered after the issuance of the notices of determination), the list of examples in taxpayers’ brief (Br. 87–90) involves discretionary decisions by the IRS and other matters that would support neither interest abatement under § 6404(e) nor acceptance of taxpayers’ settlement offers under the IRS’s guidelines. Taxpayers’ own list supports the Tax Court’s observation that taxpayers’ “new evidence” would not “add anything unique or different” to the already voluminous evidence on which taxpayers relied for their arguments about IRS and Hoyt delays, and thus was “unnecessarily cumulative and duplicative.” (ER1 at 25–26.)

Finally, Tax Court Judge Haines submitted the TIGTA case file under seal to Special Trial Judge Carluzzo for review, and he gave Special Trial Judge Carluzzo access to all of the court’s files on these cases. (ER1 at 33–34.) Special Trial Judge Carluzzo examined the entire 854-page TIGTA file and determined that the material therein was not arguably relevant to the instant proceedings. (ER1 at 32; ER2 at 1117.) Taxpayers challenge (Br. 92–94) the special trial judge’s conclusion by speculating about what the TIGTA file might contain and by repeating their already-refuted arguments for the acceptance of compromise offers that fall outside the IRS guidelines. Because nothing in taxpayers’ speculations could bring their offers within the guidelines, taxpayers have not demonstrated prejudice and are not entitled to a reversal of the Tax Court’s order. See Hallett, 296 F.3d at 751.