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Tuesday, June 27, 2006

CONTRACTUAL ALLOCATION OF TAX LIABILITIES MAY HAVE MORE VALUE THAN PREVIOUSLY SUSPECTED

Oftentimes, parties to a contract allocate who will be responsible for paying present or future taxes. Such agreements can occur in regard to the purchase, sale, or division of a business, a divorce scenario, or in other business and personal situations. Legal advisors to the parties generally advise them that the IRS will not be bound by their allocation of the tax liability - that is, the IRS can pursue whoever it determines is the appropriate party to collect against. Nonetheless, such agreements are still valuable since if the IRS pursues the party who does not have the contractual liability, that party has a contractual claim against the responsible party to recover the tax.

A recent case provides another benefit of such agreements.

Collen and Donald Crawford divorced. Donald agreed to assume an entire debt owed to to the IRS and to indemnify Colleen should the IRS collect the tax from her. As a result, he was awarded sole ownership of a family business, as well as certain real property, which he agreed to sell and apply the proceeds to the IRS debt. However, he didn't satisfy it and in September 2004, IRS issued a Notice of Intent to Levy and a Notice of Federal Tax lien to Colleen regarding the tax debt.

Colleen filed a request for a Collection Due Process Hearing under Internal Revenue Code Sec. 6330(b). As part of that request, she suggested an alternative proposal for collecting the debt. She proposed that IRS first attempt to recover the debt from Donald and, in addition, she would attempt to work out an installment agreement to pay off any of the debt that could not be collected. After holding a due process hearing regarding the collection process, the IRS upheld its determination that it should collect the taxes from Colleen. IRS determined that her proposal was not viable because it was not authorized by law in that it did not attempt to satisfy the outstanding debt from her assets but instead required IRS to seek the assets of another party.

Collen went to district court arguing that the IRS appeals officer abused his discretion by basing his ruling on an improper understanding of the law. Specifically, Colleen challenged his decision that collection of the outstanding taxes from her ex-husband was not a viable collection alternative that the IRS was required to consider under Code Sec. 6330.

The court noted that although the IRS was not bound by Colleen and Donald's divorce decree, they had split their assets in a manner that would facilitate payment of the tax liability by Donald through the sale of property he received in the divorce. The court stated that Colleen's collection alternative was a proposal to withhold collection from her until it was determined whether it would facilitate the tax collection and provide a less intrusive means of collection to go after the assets earmarked for payment of the tax liability as defined in the divorce decree. It concluded that her request fell within the alternative contemplated by Reg. § 301.6630-1(e)(3) and should have been considered. The court stressed that it was not saying that her proposed collection alternative had to be accepted by IRS. The error was not that it was rejected, but that it was rejected without the proper consideration required by the statute.

The net effect of the ruling is that tax liability allocation agreements may have more value than previously suspected. While they still cannot bind the IRS as to who to pursue for collection, in the right circumstances they can at least require the IRS to consider the collection mechanisms agreed to by the parties.

Crawford v. U.S., 97 AFTR 2d 2006-1875 (DC NV 3/24/2006)



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