If you owe back taxes but the Federal government owes you for some other matter, can the IRS offset the unpaid taxes with the amount the government owes you? The answer is more complex than one would think. The court addresses this in Tartt v. Commissioner, T.C. Memo. 2019-112.

Facts & Procedural History

The taxpayer filed a lawsuit against a hospital and medical clinic for employment discrimination. The trial court dismissed the claims.

On appeal to the Seventh Circuit, the taxpayer complained that the U.S. government had joined in a conspiracy to deprive him of employment benefits. 

The taxpayer filed his 2013-2015 tax returns, but did not pay the tax reported on the returns. The IRS eventually filed a tax lien notice.

The taxpayer responded by filing a collection due process (“CDP”) hearing with the IRS to contest the IRS lien notice filing.

During the CDP hearing, the taxpayer argued that:

It’s my position that the United States owes more than owed, therefore, [I] will not pay any debt to the United States until the debt owed is settle[d] through the courts or settlement.

The IRS appeals office did not address this argument. The taxpayer filed a petition with the U.S. Tax Court to have the decision reviewed.

The U.S. Tax Court’s Power to Setoff Non-Tax Debts the Government Owes

Unlike most other courts, the U.S. Tax Court was established by an act of Congress. And the judges can be removed by the U.S. President. This differs from other courts.

It raises serious questions about whether the U.S. Tax Court is impartial. Critics often assert that the U.S. Tax Court is not a legitimate court, but acknowledged that it functions similar to a legitimate court.

Given that the court was created by Congress, it’s authority to hear cases also comes from Congress. Congress specifically prescribes the types of cases the court can hear by passing a tax statute to give the court authority to consider different types of cases.

The court itself has always been wary of exceeding its authority given this odd grant of authority.

The U.S. Tax Court’s ability to consider disputes involving CDP hearings is an example. It is specifically authorized in the tax code. This law does not permit the U.S. Tax Court to consider other issues. This is why the U.S. Tax Court has taken the position that it cannot hear tax refunds, for example.

Given this limitation, the U.S. Tax Court has taken the position that it does not have the ability to hear setoff claims, like the one presented in this case, in the context of collection cases. The court has concluded that it an only hear the tax collection case. The court reiterated this position in Tartt.

But what about other courts? What about the IRS at the administrative level?

The Federal Courts Power to Setoff Non-Tax Debts the Government Owes

The Federal Court of Claims and District Courts have jurisdiction to hear most claims against the Federal government.

This jurisdiction is limited in tax cases, but it does include tax refund claims where the taxpayer asserts that some or all of their tax is not due. A taxpayer can bring a tax refund suit and another non-tax claim against the Federal government in the same court. If the taxpayer wins one and loses the other, the claims would be offset against each other.

It is more common for the taxpayer to file a refund suit and the government to file a counter claim to set-off some non-tax liability owed by the taxpayer.

The IRS’s Ability to Setoff Non-Tax Debts the Government Owes

Section 6402 authorizes the IRS to offset refunds owed to taxpayers for debts the taxpayer owes to the federal government. But what about the reverse? Can the IRS offset taxes owed by amounts the federal government owes the taxpayer?

Section 7122 authorizes the IRS to settle any tax balance. The IRS does this using its offer-in-compromise process. It also employs collateral agreements to have the taxpayer waive certain property or rights in compromise of their tax debts.

The IRS’s administrative materials do not address whether non-tax liabilities can be the offer submitted via the IRS’s offer-in-compromise process. However, one basis for an offer-in-compromise is the “effective administration offer.” This type of offer is available if collecting the tax would “undermine public confidence that the tax laws are being administered in a fair and equitable manner.”

This would seem to fit the situation where a taxpayer owes the IRS back taxes and the federal government owes the taxpayer for some other reason. The public would expect these to set each other off and, absent a setoff, it would seem that public confidence in our tax system would be in question.

Setting off Non-Tax Debts the Government Owes During CDP Hearings

This brings us back to the Tartt case. What if the taxpayer in Tartt or his tax attorney had submitted an offer-in-compromise based on effective tax administration? What if he had done so as part of his CDP hearing? Could the U.S. Tax Court, which couldn’t otherwise consider a setoff now consider whether the IRS erred in rejecting the offer?

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