A Fair Decision: IRS Refusal of Hardship Waiver for Rollover Contributions is Overturned

IRA RolloverA retired New York City policeman who missed the deadline to roll over retirement plan distributions into an IRA sought a hardship waiver and asked the IRS for “a fair decision” based on his personal difficulties. He received it from the Tax Court in a precedential opinion. Trimmer v. Comm’r, Docket No. 27238-14, 2017 U.S. Tax Ct. LEXIS 15 (Apr. 20, 2017).

Mr. Trimmer worked as a New York City police officer for twenty years until he retired in April of 2011. His wife worked as a school teacher. 2017 U.S. Tax Ct. LEXIS 15 at *3. Mr. Trimmer had planned to work as a security guard with the New York Stock Exchange after retirement, but that job was not offered to him. Shortly thereafter, he began to display symptoms of a major depressive disorder. Id. at *4.

In late May and early June of 2010, Mr. Trimmer received two retirement account distribution checks totaling over $100,000, which he left sitting on his dresser for over a month before depositing them into the couple’s joint bank account. Id. at *5. The money remained in the account untouched until April of 2012, when Mr. Trimmer moved the funds to an IRA account at the urging of the couple’s tax preparer. Id. at *6. The couple’s return reported the distributions as non-taxable, but the 1099-Rs indicated that the distributions were early and no exception applied. Id.

Over time, Mr. Trimmer’s condition improved, and his symptoms were in remission by the summer. Id. at *7. Thereafter, in December of 2013, the IRS wrote to the Trimmers, outlining proposed changes to their return, which included $39,963 in additional tax based primarily on the retirement plan distributions and the associated penalty. Id. at *7. The notice told them that they should respond to the IRS if they disagreed with the proposed changes, and, after an extension, they did so. Id. at *7-*8.

Specifically, Mr. Trimmer wrote back, explaining that he had simply made a mistake because he “went through a rough time upon separation from my job.” Noting that none of the money had been spent and the hardship the additional tax would impose on his family, Mr. Trimmer asked the IRS to “come to a fair decision.” Id. at *10. The letter was acknowledged by the operations manager at the IRS Andover campus, who indicated that the Trimmers would hear from the IRS in sixty days. Three days later, the operations manager sent the Trimmers a letter indicating simply that distributions become taxable if not rolled over within sixty days; the letter contained no reference to the procedure for requesting a hardship waiver. Id. A notice of deficiency followed, and the Trimmers filed a petition with the Tax Court.

In the Tax Court, the Trimmers acknowledged that Mr. Trimmer failed to meet the rollover deadline, but asserted that he qualified for a hardship waiver under section 402(c)(3)(B) of the Code, which authorizes a waiver of the deadline “where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirement.” I.R.C. § 402(c)(3)(B). In response, the IRS asserted multiple technical defenses:

  • First, it asserted that Mr. Trimmer could not qualify for a waiver because he did not apply in accordance with the governing revenue procedure, Rev. Proc 2003-16, 2003-1 C. B. 359, which called for a request for a private letter ruling.
  • Second, it asserted that there was no final administrative determination denying relief to the Trimmers, despite the fact that it issued a deficiency determination that they owed almost $40,000 in additional tax.
  • Third, the IRS argued that if there was a final administrative determination denying relief it was unreviewable.
  • And for good measure, it asserted that there was no abuse of discretion because there was no showing that Mr. Trimmer was unable to complete the rollovers in the required sixty days.

After the IRS rebuffed the court’s suggestion that it give further consideration to a hardship waiver, the Tax Court rejected each and every one of the government’s arguments.

The court rejected the argument that a hardship waiver could only be obtained through a request for a private letter ruling, the method prescribed by Rev. Proc. 2003-16. In the Tax Court’s view, this argument failed to consider the independent authority that the IRS examination unit had to consider a waiver request in the course of examining a return. 2017 U.S. Tax Ct. LEXIS 15 at *14-*17. Specifically, the court noted that the Internal Revenue Manual indicated that examiners have “authority to recommend the proper disposition of all identified issues.” Id. at *16 (quoting IRM ¶ 4.10.7.4(2) (Jan. 1, 2006)). It also observed that subsequent modifications to Rev. Proc. 2003-16 were consistent with this pre-existing discretion. Id. at *17-*18. The court also noted that the examiner reviewing the Trimmers’ return had requested their comments on the proposal to treat the distributions as taxable; it further observed that the examiner had not refused to consider Mr. Trimmer’s submission and had never indicated that he needed to seek a private letter ruling. Id. at *18-*19.

The court quickly rejected the IRS’s contention that the denial of the requested waiver was not a final administrative determination because it technically invited a further response from Mr. Trimmer in a clause that the Tax Court characterized as “boilerplate.” Id. at *21. Similarly, the court rejected the argument that it lacked jurisdiction to review the decision not to grant a waiver, noting that its jurisdiction from a notice of deficiency reached “administrative determinations that are necessary to determine the merits of deficiency determinations.” Id. at *22-*23. Given the general presumption that discretionary administrative acts are subject to judicial review, and the absence of any limitation on judicial review in the relevant provision of the Code or its legislative history, the Tax Court held that the procedures established to examine deficiencies “logically contemplate review of such a denial as one element of the deficiency determination.” Id. at *23-*24 (citations omitted).

Next, the Tax Court considered what standard of review it should apply, concluding that appropriate standard was to examine whether the IRS “abused [its] discretionary authority by exercising it arbitrarily, capriciously, or without sound basis in law or fact.” Id. at *27 (citations omitted). The court readily concluded that the IRS had abused its discretion, given the fact that the relevant agent had denied the request for a waiver while operating without a complete understanding of the statute and failed to address any of the facts and circumstances outlined by Mr. Trimmer. Id. at *28.

The IRS then sought to assert that there was no abuse of discretion because Mr. Trimmer had not offered any substantiation for his assertions. The Tax Court rejected this contention because the information was never requested. Noting also that the Trimmers had submitted expert evidence before it, the court concluded that the IRS had abused its discretion and had failed to offer a reasoned basis for its refusal to grant a waiver; consequently, the court concluded that it should review the denial on a de novo basis. Id. at *29.

After rejecting a hyper-technical motion in limine that sought to bar the testimony of the Trimmers’ expert, the Tax Court “finally” turned to the merits of the request for the hardship waiver. Id. at *49-*50. Focusing on the statutory language authorizing a waiver if strict enforcement “would be against equity or good conscience,” the Tax Court then observed that a prior memorandum decision had held that severe health problems excused a failure to make estimated tax payments under a provision authorizing the IRS to waive the estimated tax penalty if imposing it would be “against equity and good conscience.” Id. at *50-*51 (citing Meyer v. Comm’r, T.C. Memo. 2003-12, 2003 U.S. Tax Ct. Mem. LEXIS 12 (Jan. 13, 2003)). After surveying a variety of other federal statutes, the Tax Court concluded that it should construe the phrase “equity or good conscience” as embracing “a broad and flexible concept of fairness.” Id. at *52-*53.

The court then examined the factors governing a waiver determination under Rev. Proc. 2003-16. Three of these factors were relevant: The taxpayer’s inability to complete the roll over; any use the taxpayer made of the funds; and the amount of elapsed time. Id. at *53-*54. As the Trimmers had simply left the funds on deposit in their bank account and had acted promptly when alerted to the need to roll them over into an IRA, the court focused its attention on whether Mr. Trimmer’s depression was a sufficient disability to excuse his failure to make the roll over election. The court was satisfied that the standard was met, notwithstanding evidence that Mr. Trimmer had written checks at the prompting of his wife and had deposited the relevant distribution checks. Id. at *57-*58. The Tax Court finished its analysis of the refusal to grant Mr. Trimmer a waiver by reviewing two private letter rulings that had granted waivers in similar situations, leading the court to conclude that its construction of the waiver standard was similar to what the IRS had done in the past.

Trimmer is interesting on several levels. First, the court’s willingness to recognize the impact of depression on individuals is laudable. Second, the court’s opinion is a rare instance in which the Internal Revenue Manual is treated as persuasive authority. And the case reflects a sensitivity to the frustrations of individual taxpayers who have to interact with the IRS that is refreshing. Of course, the fact pattern was fairly extreme, as the IRS made no effort whatsoever to inform the taxpayer how to request a waiver. The outcome might have been different if Mr. Trimmer had been told that he needed to file a request for a private letter ruling or had been asked to substantiate his claim that he was impaired. The court’s opinion also suggests some degree of frustration with the lawyers representing the government, who seemed to contest every conceivable issue. For example, in asserting that the petitioners’ expert testimony should be barred, the government argued that the expert exceeded her authority under New York’s licensing law for social workers by offering opinion testimony that she was qualified to offer.

The case is noteworthy for another reason: It was handled by students at Fordham Law School’s federal tax clinic, operating under the supervision of Professor Elizabeth Maresca, who delivered a fair decision to a taxpayer who clearly deserved one.

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