First Circuit Speaks on Estoppel Against the IRS (2/14/13)

In Shafmaster v. United States, 707 F.3d 130 (1st Cir. 2013), here, the taxpayers urged, inter alia, that the the IRS was estopped from collecting the failure to pay penalty the IRS asserted under § 6651(a)(3).  The Shafmasters claimed that the IRS, in its various dealings with them and various documents, had agreed not to assert the penalty.  The problem was that there was certainly not a closing agreement that said that.  Nor was there even a Form 870-AD that said that.  Nor did the other dealings really establish the claim.  The Court disposed of the argument as follows and expressed skepticism, but declined to hold, that estoppel could apply against the IRS.  The key part of the holding is as follows (footnote omitted):

The Shafmasters argue that the IRS was equitably estopped from assessing the failure-to-pay penalty because the agency had, through Hamilton and through the various documents that the Shafmasters signed, agreed not to assess such a penalty, and the Shafmasters had relied on that promise. The argument fails, for a number of reasons. We need not reach the question of whether equitable estoppel can ever bind the IRS in informal settlements reached apart from the §§ 7121-7122 procedures. 

In Botany Worsted Mills v. United States, 278 U.S. 282 (1929), the Supreme Court interpreted the predecessor of 26 U.S.C. §§ 7121-7122 as providing the "exclusive method" for compromising tax liability, holding that Congress "did not intend to in trust the final settlement of such matters to the informal action of subordinate officials in the [IRS]." Id. at 288-89. As a result, the Court concluded, informal settlements are not binding on either the taxpayer or the government. Id. at 288. However, the Court went on to note that it was not "determining whether such an agreement, though not binding in itself, may when executed become, under some circumstances, binding on the parties by estoppel." Id. at 289. The Court thus left the door open for the argument that some informal agreements between taxpayers and the IRS might give rise to claims of estoppel -- at least when, as in Botany Worsted, the government asserts estoppel against a taxpayer.

In the years since Botany Worsted, a number of courts of appeals have determined that informal settlements such as the Form 870-AD can in fact trigger estoppel against taxpayers, although there is disagreement as to when, if ever, estoppel may apply. See Whitney v. United States, 826 F.2d 896, 897-98 (9th Cir. 1987) (collecting cases). It does not appear that any circuit has used an informal tax settlement to bind the government under estoppel principles, although it also appears that the question simply may never have been addressed.\ 

The First Circuit has not decided whether informal tax settlements can be binding by estoppel even on taxpayers, and we need not do so now in order to resolve this case. Nor do we need to determine the relationship between claims of estoppel and the statutory closing mechanisms of 26 U.S.C. §§ 7121-7122. Even assuming arguendo that an informal IRS settlement such as the Form 870-AD could ever have estoppel effects against the government -- a proposition of which we are skeptical -- the Shafmasters' argument would fail. There is no viable claim here in any event under general principles of equitable estoppel. 

Generally, in order to make out a claim for equitable estoppel, a party must show that "(1) the party to be estopped made a 'definite misrepresentation of fact to another person having reason to believe that the other [would] rely upon it'; (2) the party seeking estoppel relied on the misrepresentations to its detriment; and (3) the 'reliance [was] reasonable in that the party claiming the estoppel did not know nor should it have known that its adversary's conduct was misleading.'" Ramírez-Carlo v. United States, 496 F.3d 41, 49 (1st Cir. 2007) (alterations in original) (quoting Heckler v. Cmty. Health Servs., 467 U.S. 51, 59 (1984)).  [*14] Additionally, when a party seeks to equitably estop the government, it "must show that the government engaged in affirmative misconduct." Id. Although "there is no settled test for what constitutes" affirmative misconduct, it must at least include "an affirmative misrepresentation or affirmative concealment of a material fact by the government." Id. (quoting Watkins v. U.S. Army, 875 F.2d 699, 707 (9th Cir. 1989)). 

Here, the Shafmasters did not present a genuine issue of material fact as to whether a government actor engaged in affirmative misconduct. In fact, the Shafmasters do not even allege that Hamilton, Brown, or any other representative of the IRS did engage in misconduct during the Shafmasters' negotiations or when executing the various documents. Instead they argue, erroneously, that this circuit's case law should be read to excuse the misconduct requirement and instead to apply a "balancing approach" that would weigh the interests of the party asserting estoppel against the public interest represented by the underlying policy at issue. This is a misunderstanding of our precedent. Indeed, we recently reaffirmed the principle that the affirmative misconduct requirement applies in this context. See Dickow v. United States, 654 F.3d 144, 152 (1st Cir. 2011) ("The argument of estoppel by silence on the part of the busy IRS is, on these facts, simply a non-starter."). The Shafmasters also conflate affirmative misconduct with the separate element of misrepresentation of fact. 

Further, none of the documents on which the Shafmasters rely -- the Tax Court stipulation for 1994, the Form 870-AD, or the installment payment agreement -- mention the 1994 failure-to-pay penalty at all, let alone demonstrate that the penalty was waived. To the contrary, the installment plan specifically states that the taxpayer will pay the amount shown "plus penalties and interest provided by law" (emphasis omitted). Brown's letter to Jonathan Shafmaster in March 2005 reminded him that failure-to-pay penalties were accruing on the unpaid balance. Because none of the documents promised to waive the penalty -- and some explicitly warned of the penalty -- there was no definite misrepresentation of fact contained therein as to whether the penalty would be assessed. 

This disposes of any dispute over what Hamilton did or did not say. The written settlement documents made it unreasonable for the Shafmasters to continue to rely on any alleged oral promise from Hamilton.

The net effect is that estoppel may apply against the taxpayer but, rarely if at all, against the Government.  In the specific instance of the Form 870-AD, although it is not a closing agreement, critical mass in the cases suggest that, when the taxpayer and the IRS signed the Form, the taxpayer will likely be bound by it, by estoppel or some other theory.  But, the IRS may not be bound by it.  As I state in the Federal Tax Procedure text, however, it is doubtful that the IRS would not honor the terms of a Form 870-AD absent the express terms by which it is allowed to avoid the Form 870-AD (fraud or misrepresentation).  So, the fact that the IRS might have an argument to avoid the Form 870-AD because estoppel will rarely if ever apply to the Government, may be a moot point.  But, other types of actions which the taxpayer claims gives rise to estoppel may just be a non-starter for the taxpayer to argue for estoppel.