IRS Addition of Payroll Tax Liability That Was Subject of OIC to Going Concern Value of Business Was Not Reasonable

In the case of W. Zintl Construction, Inc. v. Commissioner, TC Memo 2017-119 the taxpayer in question was a corporation with a rather significant unpaid payroll tax liability ($6,563,263 to be exact).  The corporation was seeking an offer in compromise with regard to these taxes.  The IRS settlement officer (SO) determined that the offer was not to be accepted.  In doing so he considered the going concern value of the business as a whole and then added back the underlying payroll tax liability.

The taxpayer took its case to the Tax Court, arguing that a going concern value should not be used against the business itself, as opposed to that of the owner of the business.  The Tax Court disagreed with this view, but also determined the settlement officer had improperly computed the going concern value when he added back to that value the payroll tax liability.

The taxpayer had originally made an offer of $1 million to settle the case, with its justification explained as follows:

On a Form 656, Offer in Compromise, submitted on August 27, 2013, petitioner made an OIC of $1 million. In support thereof petitioner provided a profit and loss statement and a balance sheet ending June 30, 2013, and a Summary Appraisal Report by Hoff Appraisal Associates dated February 12, 2013, indicating a “Forced Liquidation Value” for petitioner’s machinery and equipment of $1,155,000. In an accompanying letter to Settlement Officer (SO) Albright, petitioner indicated an accounts receivable balance of $3,359,920 as of August 9, 2013. After quoting the Internal Revenue Manual (IRM) regarding the proper treatment of accounts receivable, the letter explained that “Zintl is profitable and its receivables are part of the income stream required for the production of income. The company must pay for materials and labor to continue operating. Without the income flow from these receivables the business could not operate.” Petitioner also explained that “[t]he liquidation of Zintl’s inventory, machinery, and equipment would end its ability to operate. Zintl recently sold all of the assets it could spare to satisfy an obligation to Citizens State Bank that was secured by its inventory and equipment.”

The SO requested additional documents including a valuation of the business as a going concern. 

Petitioner sent the documents requested, including a going-concern appraisal prepared by Shenehon Co. dated April 16, 2014. The going-concern appraisal estimated a going-concern fair market value of $2,100,000, using three valuation methods, each of which subtracted accrued payroll tax liability and interest of $4,190,290. The largest [*5] single asset reflected in the appraisal was the accounts receivable (in excess of $7 million at the end of petitioner’s fiscal year ending January 20143), and the largest single liability was the payroll tax liability. The appraisal did not include the accumulated penalties on the tax liability (estimated to be $2,101,723). The appraisal assigned no value to goodwill. The appraisal also estimated a liquidation value for the company of negative $3,720,000.

As an offer in compromise must be for at the reasonable collection potential, the SO made a determination of that reasonable collection potential.  He communicated that information to the taxpayer in a letter which stated:

[The] appraisal estimated the value of the business to be $2,100,000 after allowing for the IRS debt of $4,190,980. In other words the value of the business for purposes of the OIC is estimated to be $6,290,980. In determining the reasonable collection potential in an OIC, the IRS would generally reduce the asset values by 20%. As a result, in this case the reasonable collection potential is computed to be $5,032,784 ($6,290,890 x.8).

The SO indicated that the taxpayer needed to submit an amended offer at least equal to the computed reasonable collection potential and that, if it did not do so, he would likely reject the $1 million offer.  The taxapayer’s response was to protest that the going concern value should not be considered and kept its offer at $1 million.  The SO rejected the offer as being too low.

The Tax Court noted that consideration of the going concern value is provided for in the Internal Revenue Manual and found that the use of the method itself was not a problem.  But the Court had an issue with the agent adding to that value the payroll tax liability that was used to compute the value.

The Court understand why the SO felt the need to add back the payroll tax liability, but found it was not justified:

This modification to the value at first blush seems logical. Reducing petitioner’s going-concern value by its tax liability when determining how much of this tax liability petitioner can pay would seem to double count the tax liability and provide a boon to a business taxpayer whose tax debt is part of the business being valued. It is this tax liability that will be satisfied with the OIC, after all. The problem is that the going-concern value is intended to give some indication of [*12] the value of petitioner as a continuing business, that is, what a third party might pay to buy petitioner as a whole, including all of its assets and liabilities. No third party would buy petitioner without taking into account the unpaid tax liability. And the record shows that petitioner could not obtain financing for the modified amount either. This highlights the logical difficulty of using going-concern value — which presumes that a taxpayer can sell itself — to determine RCP. Nonetheless, we cannot conclude that consideration of the going-concern value and the information in the appraisal is irrelevant or that the settlement officer may not consider this information, including the specific assets and liabilities, including the tax liability, on remand. We also do not hold that petitioner’s offer was reasonable. We hold only that SO Albright’s rejection of petitioner’s OIC solely on the basis of his calculation of RCP that used petitioner’s going-concern valuation but disregarded completely its tax liability was not reasonable on this record.