Dalton v. Comm'r

• Citation: 682 F.3d 149,109 A.F.T.R.2d 2012
• Decision Date: 20 June 2012
• Docket Number: No. 11–2217.,11–2217.
• Parties: Arthur DALTON, Jr., and Beverly Dalton, Petitioners, Appellees, v. COMMISSIONER of INTERNAL REVENUE, Respondent, Appellant.
• Court: United States Courts of Appeals. United States Court of Appeals (1st Circuit)

682 F.3d 149

109 A.F.T.R.2d 2012-2687

Arthur DALTON, Jr., and Beverly Dalton, Petitioners, Appellees,

v.COMMISSIONER of INTERNAL REVENUE, Respondent, Appellant.

No. 11–2217.

United States Court of Appeals,

First Circuit.

Heard May 10, 2012.

Decided June 20, 2012.

Bethany B. Hauser, Attorney, Tax Division, with whom Tamara W. Ashford, Deputy Assistant Attorney General, and Thomas J. Clark, Attorney, Tax Division, U.S. Department of Justice, were on brief, for appellant.

John W. Geismar, with whom Daniel L. Cummings and Norman, Hanson & DeTroy, LLC were on brief, for appellees.

Before LYNCH, Chief Judge, SELYA and BOUDIN, Circuit Judges.

SELYA, Circuit Judge.

This appeal turns primarily on the standard of review that courts should apply when examining conclusions reached by the Internal Revenue Service (IRS) following a collection due process (CDP) hearing. See26 U.S.C. § 6330(b). While courts generally have agreed that review in this context is for abuse of discretion, no court has had the occasion to parse that standard and analyze how it plays out with respect to subsidiary factual and legal determinations made by the IRS during the CDP process. We grapple with that issue today.

The issue arises in a case in which the taxpayers offered to settle their tax liability for pennies on the dollar. The IRS determined that the taxpayers could afford to pay more because they owned valuable real estate and, therefore, rejected the offer in compromise. In a first-tier appeal, the Tax Court reviewed the IRS's underlying ownership determination de novo, found that the taxpayers were not the owners of the real estate in question, and directed the IRS to accept the offer in compromise. It later ordered the IRS to pay attorneys' fees to the taxpayers as prevailing parties.

We hold that the Tax Court employed an improper standard of review with respect to the IRS's subsidiary determinations. Applying a more deferential standard to these determinations consistent with the nature and purpose of the CDP process, we conclude that the IRS did not abuse its discretion when it rejected the taxpayers' offer in compromise. The IRS acted reasonably in determining that the taxpayers were the owners of the property and, thus, the equity in the property was appropriately considered when the IRS evaluated the compromise offer. Consequently, we reverse the Tax Court's judgment.

I. BACKGROUND

The taxpayers are a married couple: Arthur Dalton, Jr., and Beverly Dalton. In 1977 and 1980, respectively, they purchased two adjacent lots abutting Thompson Lake in Poland, Maine. In 1983, they deeded both lots, subject to an existing mortgage, to Arthur Dalton, Sr. (the father of Arthur Dalton, Jr.) for $1. Although the grantee agreed to assume the mortgage, the record contains no evidence that the mortgagee released the taxpayers from liability.

In 1984, Arthur Dalton, Sr., purchased an abutting lot. He then deeded all three lots (the Property) to a grantor trust of his creation. He appointed himself as the sole trustee, specified that the trust would expire upon the death of the last survivor of himself and the taxpayers, and designated the taxpayers' children as the trust's beneficiaries.

Notwithstanding these maneuvers, the record contains substantial evidence suggesting that the taxpayers continued to treat the Property as their own. For one thing, they continued to pay for the maintenance and upkeep of the Property. For another thing, long after the trust had taken title, Beverly Dalton co-signed a new mortgage on the Property and, in the mortgage papers, represented herself to be an owner of the Property.¹

The Property contains a large house, and the taxpayers moved into the house in 1997. The impetus for the move was the failure of their business and the consequent loss of their Massachusetts home. The Property has remained their principal residence since that time. The taxpayers have never had a written lease, but they insist that they entered into an oral lease with the trustee. They assert that under the terms of the oral lease, they agreed to care for the trustee's elderly wife, manage and maintain the Property, and pay “rent” roughly equal to the amount needed to defray mortgage payments and real estate taxes.

Arthur Dalton, Sr., passed away in 1999. The trust indenture gave Arthur Dalton, Jr., the power to name a successor trustee. He appointed Robert Pray (Beverly Dalton's brother). The widow of Arthur Dalton, Sr., entered an assisted-living facility a few years later. Since then, the taxpayers have been the sole inhabitants of the Property. They continue to maintain the premises and supply funds to the trust sufficient to cover the mortgage payments and real estate taxes. Beverly Dalton, who has the power to sign checks written on the trust's account, ensures that mortgage and tax payments are kept current.

The record also indicates that the trustees and the taxpayers have been less than scrupulous in observing certain formalities. To cite one example, the trust did not file any tax returns until 2001 (after the present controversy with the IRS was under way). To cite another example, the mortgagee, Key Bank, has since 2000 forwarded paperwork to Arthur Dalton, Jr., indicating that he is the payor of the mortgage and, thus, the person eligible to take the concomitant interest deduction for tax purposes.

In 2001, the taxpayers refinanced the mortgage. The bank's records anent the new mortgage list the taxpayers as the owners of the Property.

The current trustee, Pray, lives in Texas but insists that he controls the trust corpus. He claims that he speaks to the taxpayers three to four times per year regarding the Property and that he visits annually to ensure its condition. He has kept no records (or even notes) commemorating any of these meetings or discussions.

The taxpayers' troubles with the IRS began just before their business went bankrupt. The taxpayers owned and operated Challenger Construction Corp., which in 1996 withheld payroll taxes but never paid the retained amounts to the United States. The IRS determined that the taxpayers were personally liable for those amounts. See26 U.S.C. § 6672(a); Jean v. United States, 396 F.3d 449, 453–54 (1st Cir.2005). With accrued interest, the taxpayers' alleged indebtedness now exceeds $400,000.

In 2004—perhaps eyeing the taxpayers' equity in the Property—the IRS gave notice of its intent to levy. See26 U.S.C. § 6330(a). The taxpayers did not dispute the amount of taxes owed but, rather, requested a pre-attachment CDP hearing and offered to settle their debt for a total of $10,000. See id. § 6330(b), (c)(2)(A)(iii). They denied that they had any ownership interest in the Property and asserted that, based on their assets and income, they could never come close to satisfying their total tax liability.

After gathering information from the taxpayers and hearing their arguments, the IRS rejected the offer in compromise.² In reaching this decision, the IRS applied principles gleaned from federal case law and found that the taxpayers were the real owners of the Property; that is, that the trust was merely a nominee for the taxpayers and held naked legal title purely for their convenience. Relying on this finding, the IRS concluded that the offer in compromise was insufficient because the taxpayers' ownership interest in the Property could be liquidated to generate substantially more funds. ³

The taxpayers appealed, and the Tax Court directed the IRS to reconsider the nominee issue in light of Maine law. See Dalton v. Comm'r, 96 T.C.M. (CCH) 3 (2008). On remand, the IRS concluded that a Maine court likely would borrow nominee principles from federal law and reiterated its finding that the trust was a mere nominee. Accordingly, the IRS stood by its rejection of the offer in compromise.

The taxpayers again repaired to the Tax Court. Reviewing the IRS's ownership finding de novo, the court determined that the trust was not a nominee of the taxpayers under Maine law. Dalton v. Comm'r, 135 T.C. 393, 407–15 (2010). The court added that federal law would dictate the same result. Id. at 415–23. Accordingly, the IRS had abused its discretion in rejecting the taxpayers' offer because the IRS had premised that rejection on an erroneous view of the law. Id. at 423–24. To add insult to injury, the court thereafter awarded attorneys' fees to the taxpayers on the ground that the IRS was not substantially justified in rejecting the offer. Dalton v. Comm'r, 101 T.C.M. (CCH) 1653 (2011) (citing 26 U.S.C. § 7430). This timely second-tier appeal ensued.

II. ANALYSIS

We begin our analysis by identifying the applicable standards of review. We then proceed to discuss the merits of the Tax Court's rulings.

A. Standards of Review.

Where, as here, the amount of the underlying tax liability is not in dispute, we review the IRS's disposition of an offer in compromise following a CDP hearing for abuse of discretion, ceding no special deference to the Tax Court's intermediate review. See Murphy v. Comm'r, 469 F.3d 27, 32 (1st Cir.2006); Olsen v. United States, 414 F.3d 144, 150 (1st Cir.2005); see also H.R.Rep. No. 105–599, at 266 (1998), 1998 U.S.C.C.A.N. 288. The parties agree with this paradigm. They disagree, however, as to how a court should review the preludial findings on which the IRS bases its rejection of an offer in compromise.

The taxpayers argue that any finding predicated on a material error of law is a per se abuse of discretion. See, e.g., United States v. Walker, 665 F.3d 212, 223 (1st Cir.2011). This means, they say, that any abstract legal question that formed a part of the IRS's decisional calculus must be accorded de novo review. The IRS argues for a more deferential standard.

In the exercise of powers of judicial review, one size does not fit all. The taxpayers' construct—that questions of law engender de novo review even when a matter is committed to a lower court's (or an agency's) disc...