As tax professionals, assisting clients with tax collection issues is a critical part of our practice. A recent Tax Court Memorandum decision, Palli v. Commissioner, T.C. Memo. 2025-54, offers valuable insights into the Internal Revenue Service’s Collection Due Process (CDP) framework, particularly concerning Offers in Compromise (OICs) based on doubt as to collectibility. This case highlights the importance of timely communication, providing comprehensive and updated financial information, and understanding the IRS’s procedural guidelines (including the Internal Revenue Manual (IRM)) as interpreted by the Tax Court.

Case Background and Initial Collection Efforts

The case involves petitioner, Daniel Palli, and his unpaid federal income tax liability for the 2016 tax year. Mr. Palli timely filed his 2016 return, reporting a tax liability of $401,279. He made an initial payment of $15,000, leaving a significant balance unpaid. The IRS assessed the reported tax liability, along with additions to tax for failure to make estimated tax payments ($9,592) and failure to timely pay ($16,051), plus interest, on November 20, 2017. A small abatement of the failure to timely pay penalty ($75) occurred shortly after.

An installment agreement for the 2016 liability was requested and subsequently granted on August 8, 2018. Payments totaling $84,686 were made, and a credit of $105,673 was applied in 2018. However, the installment agreement terminated on March 15, 2021.

Initiation of CDP and Offer in Compromise Submission

On August 16, 2021, the IRS issued Notice LT11, indicating a proposed levy for the 2016 tax year and notifying Mr. Palli of his right to a CDP hearing. In response, Mr. Palli timely filed Form 12153, Request for a Collection Due Process or Equivalent Hearing, on September 14, 2021. He checked boxes indicating interest in an Installment Agreement, an Offer in Compromise, and I Cannot Pay Balance. The form noted that he had a prior installment agreement but could no longer make payments and was interested in an OIC. Notably, the Form 12153 did not dispute the underlying tax liability.

On October 5, 2021, Mr. Palli mailed Form 656, Offer in Compromise, to the IRS’s Centralized Offer in Compromise (COIC) Unit. The Offer was submitted on the grounds of doubt as to collectibility and proposed a total payment of $177,348, payable in five installments. The initial installment was included with the Offer, and subsequent payments were made in December 2021 and January 2022, all credited towards the 2016 balance.

The Offer submission included Form 433–A, Collection Information Statement, which detailed petitioner’s assets, including two checking accounts, an IRA, two vehicles, a note receivable, and an interest in a business entity that was a source of income.

COIC Unit Analysis and Preliminary Rejection

The COIC Unit assigned the Offer to a revenue officer (RO) who first contacted petitioner’s representative on April 19, 2022. The representative provided additional requested information in May 2022 and further documentation in July and August 2022, including tax documents, business profit and loss statements, bank statements (personal and business), IRA statements, and proof of living expenses. This information included documentation regarding insurance proceeds deposited into a business bank account in June 2022 and payroll information through July 1, 2022, showing a recent wage increase for petitioner.

Using this information, the RO calculated petitioner’s reasonable collection potential (RCP). This calculation involved determining monthly gross income ($3,200 based on most recent wages) and applying it over 77 months, resulting in $80,184 from future income. Adding this to a determined net equity in assets of $166,578, the RO calculated that Mr. Palli could pay $246,762. The RO compared this amount to an assumed outstanding liability of $229,895 and concluded that petitioner’s ability to pay ($246,762) exceeded the liability, leading to a preliminary decision to reject the Offer.

Petitioner’s representative disputed aspects of this calculation, arguing that a $43,560 cash balance in a business account consisted of insurance proceeds for property damage and should not be included in assets until repairs were completed. The representative also argued that petitioner’s recent wage increase to $20/hour was temporary, as he had ceased taking wages due to cash flow issues, and proposed averaging his year-to-date wages instead of using the most recent $3,200 figure. The RO maintained her calculations, deciding not to exclude the insurance proceeds until repairs were complete and declining to average wages, suggesting proof of lower wages could be provided to Appeals.

Initial CDP Hearing and Notice of Determination (NOD)

Meanwhile, the CDP request was assigned to a First Appeals Officer (First AO). After an initial attempt to conference was missed by the petitioner and representative, communication indicated petitioner still wanted the Offer considered but was no longer pursuing the CDP hearing, although no withdrawal form was returned. Subsequent faxes from the representative indicated no additional information while the Offer was pending but interest in discussing collection alternatives and penalty relief if the Offer was rejected.

The First AO, having received the Offer file and recommendation from the COIC Unit, attempted contact regarding the Offer rejection and an installment agreement. Receiving no response, the First AO sustained the levy on January 20, 2023. The Initial NOD, issued March 7, 2023, reflected the rejection of the Offer because the IRS determined petitioner could pay in full and sustained the proposed levy as no more intrusive than necessary, given the failure to propose an acceptable alternative. The Appeals Case Memorandum noted that petitioner had not presented information to dispute the collection action.

Petition, Remand, and Supplemental CDP Hearing

Mr. Palli petitioned the Tax Court, arguing the IRS should have accepted the Offer. The Petition alleged delay in processing, ignored information (income imputation, insurance proceeds), and suggested the representative’s lack of response to the First AO was reasonable as the voicemail mentioned only a "payment plan," not the Offer appeal.

Respondent filed a Motion to Remand, acknowledging an error in the COIC RO’s analysis underlying the Initial NOD. The RO had compared petitioner’s RCP to his liability after Offer payments, rather than his liability at the time the Offer was submitted. Respondent stated that petitioner’s RCP as determined by the RO was, in fact, less than his liability when the Offer was submitted, making "ability to pay" an incorrect basis for rejection at that stage. Respondent requested remand for Appeals to reconsider the Offer, which the Court granted.

A Second Appeals Officer (Second AO) was assigned the case. She reviewed the case and determined the unpaid balance when the Offer was submitted was $230,958.80 (higher than the RO’s initial comparison figure, though the RO’s RCP of $246,762 was still higher than this liability and the Offer).

During the supplemental CDP hearing process, the Second AO conveyed that petitioner could submit a new OIC with updated financial information, as the prior information was outdated. However, the representative maintained that the original Offer should be considered. The Second AO explained her role was not to recalculate using the old, outdated information but would consider a new OIC. The representative requested and was granted a 60-day extension to submit a new OIC by May 10, 2024.

As of May 15, 2024, no further communication or a new OIC was received.

Supplemental NOD

The Supplemental NOD, issued June 10, 2024, concluded that all legal and procedural requirements for the levy had been met. It noted that petitioner’s RCP was determined to be $246,763. It reiterated that the prior determination that the Offer should be rejected because petitioner could fully pay his liability was correct. It also explicitly noted that petitioner was offered an opportunity to submit a new OIC with new financial information but did not do so.

Tax Court Analysis

The case came before the Tax Court on Respondent’s Motion for Summary Judgment. Mr. Palli argued against summary judgment, claiming disputes of material fact regarding the RCP calculation, specifically the use of 77 months for future income, inclusion of insurance proceeds, and the wage calculation basis.

The Court determined the case was appropriate for summary adjudication, finding no genuine dispute about the underlying facts used in the IRS’s computations and evaluations, only disputes about the application of those facts.

Since the underlying tax liability was not disputed, the Court reviewed Appeals’ determination for abuse of discretion. This standard requires the Court to determine if the decision was arbitrary, capricious, or without sound basis in fact or law, without substituting its own judgment. The Court’s review was based primarily on the Supplemental NOD and the administrative record.

The Court evaluated Appeals’ actions under the framework of Section 6330(c), considering verification, issues raised by the taxpayer, and the balancing of collection needs against intrusiveness.

Verification: The Court found that Appeals conducted a thorough review and verified all applicable requirements were met, concluding there was no abuse of discretion regarding verification.
Issues Raised by Petitioner:
- Delay: Petitioner argued the delay in processing the Offer was inappropriate. The Court noted there’s no prescribed timeline for Appeals. While Section 7122(f) provides a 24-month limit for deemed acceptance, only about half a year passed before the COIC Unit and Appeals began considering the Offer. Given the IRS paper backlog from the COVID-19 pandemic during that time, the Court found the delay in commencing consideration was not an abuse of discretion. Consideration proceeded thereafter, pausing only while awaiting petitioner’s responses.
- COIC Unit’s Computation: The Court reviewed the COIC Unit’s initial ability-to-pay calculation. Compromise based on doubt as to collectibility is proper when assets and income are less than the liability. The determination includes ability to pay. OICs in CDP are considered under normal IRM guidelines for financial analysis, which involve an initial calculation based on asset equity and future income over the remaining collection period. Financial information over 6 months old, especially if significant changes occurred, warrants requesting updated information.
  - The Court found the RO’s actions consistent with the IRM. Requesting updated financial information when the original was over six months old was proper. Including cash in the business bank account, in the absence of evidence it had been spent, was consistent with IRM guidance on cash and liquid assets. Focusing on the most recent month’s wages ($3,200) rather than averaging year-to-date wages was consistent with IRM guidelines focusing on recent income (e.g., prior three months) to determine current ability to pay. The Court noted that a decrease in wages might appropriately be offset by considering amounts obtainable from petitioner’s business interest.
  - 77-Month Period: Petitioner first raised the objection to the 77-month period in his Response to the Motion for Summary Judgment. The Court stated that an issue must be properly raised during the CDP hearing to be considered by the Court. Therefore, this issue was not properly before the Court. Nevertheless, the Court observed that the 77 months used by the RO was consistent with IRM installment agreement guidance for determining amounts payable by the end of the collection period limitations period. The Court also noted that periods where levy is prohibited due to pending OICs or IAs suspend the collection period, and factoring in these suspensions could support a collection period around 77 months from the Offer submission date. The Court acknowledged petitioner’s dispute was likely based on IRM rules for computing RCP for OICs payable in 5 or fewer payments, which may use a 12-month period for future income.
- Appeals Consideration and Failure to Provide Information: Petitioner suggested Appeals (the First AO) improperly based the Initial NOD solely on the RO’s recommendation without giving him a proper opportunity to be heard. The Court countered that the initial Appeals letter stated the COIC determination was preliminary and petitioner would have an opportunity to comment. Petitioner failed to communicate or provide information despite this notice and the Offer remaining pending with Appeals. When the case was remanded, the Second AO gave petitioner a renewed opportunity to submit a new OIC with updated financial information. She even granted a 60-day extension for this submission. Petitioner refused to provide the requested updated information. The Court reaffirmed its consistent holdings that an Appeals officer does not abuse discretion by rejecting collection alternatives and sustaining the levy when the taxpayer fails to submit requested financial information. Refusing to provide updated information despite Appeals’ request and the opportunity on remand meant petitioner "squander[ed] his opportunity for a fresh look".
- Appeals Error in Comparing Liability Amount (Harmless Error): Respondent conceded that Appeals erred by comparing petitioner’s ability to pay ($246,763) to his outstanding liability after Offer payments ($229,895) rather than his liability at the time the Offer was submitted ($230,958.80 determined by the Second AO, or the approximately $329,678 liability including accrued interest as of August 2021 noted by Respondent). IRM guidelines require comparison to the liability, including accrued interest and penalties, due at the time of OIC submission.
  - However, the Court noted that IRM guidelines also provide for rejecting an OIC if it is less than the taxpayer’s RCP. The Court has consistently held that rejecting an OIC when the RCP exceeds the Offer amount is not an abuse of discretion. Respondent argued, and the Court agreed, that the error in the liability comparison was harmless error because petitioner’s Offer amount ($177,348) was less than his calculated ability to pay ($246,762/$246,763).
  - The Court itself examined the RCP calculation based on IRM guidelines for OICs payable in five or fewer payments, which suggest a 12-month period for future income computation, not 77 months. Using the $3,200 monthly income over 12 months ($12,496 future income) plus the $166,578 net equity in assets yields an RCP of $179,074. The Court highlighted that this recalculated RCP ($179,074) was still greater than petitioner’s $177,348 Offer.
  - Furthermore, IRM guidelines suggest including cash paid as a deposit for the OIC when computing RCP. Adding the $106,409 in Offer deposits to the $166,578 net asset equity would yield an RCP of $285,483 (as calculated in the source text). The Court found that even with this potential computation error in the RO’s analysis, the resulting RCP ($285,483) was still greater than the Offer amount ($177,348).
  - Therefore, the Court concluded that any error in the RCP computation was harmless, as the correct RCP (however calculated consistent with IRM) still exceeded the Offer amount, justifying rejection based on the IRM. Given petitioner’s failure to provide updated information in the supplemental hearing, Appeals did not abuse its discretion in rejecting the OIC.
Balancing Analysis: Petitioner did not allege that Appeals failed to consider the balancing requirement under Section 6330(c)(3)(C). Appeals determined the levy was balanced because petitioner provided no viable collection alternative. The Court found no abuse of discretion in this determination, noting that absent a viable alternative, a levy is not considered unduly intrusive.

Conclusion

The Tax Court granted Respondent’s Motion for Summary Judgment, sustaining Appeals’ determination to reject the OIC and sustain the proposed levy.

The Palli case serves as a strong reminder of several key points for practitioners navigating the CDP process and OICs:

Proactive Engagement is Crucial: Failure to communicate with Appeals officers or provide requested information can result in unfavorable determinations being sustained.
Updated Financials Are Essential: When financial information is outdated, Appeals will likely require updated statements to evaluate an OIC. Refusal to provide updates, even on remand, can be fatal to the collection alternative request.
Understanding RCP and IRM Guidelines: The IRS’s RCP calculation method is based on IRM guidelines, considering assets and future income. While errors can occur in calculation, the Court will review whether the overall determination (e.g., rejecting an OIC less than RCP) was an abuse of discretion, potentially finding errors harmless if the outcome would be the same.
Properly Raising Issues: Disputes regarding the IRS’s calculations or procedures must be raised during the CDP hearing with Appeals to preserve them for judicial review.

This case underscores the importance of diligent representation, ensuring timely responses, providing comprehensive documentation, and actively engaging with Appeals to present the most favorable case for a collection alternative.

Prepared with assistance from NotebookLM.