When you drop a large rock into a pool of calm water, ripples appear and spread and eventually they will touch the entire surface of that pond, drastically changing its appearance. And the case of Gallagher v. Commissioner was a very big one indeed.

Gallagher v. Commissioner is a great example of how things work when the IRS is trying to collect taxes and you are behind on your payments. While the case does not establish new precedent, it highlights some interesting collection issues, which makes it all the more interesting. It raises questions – and to some extent answers them – about CDP reach and how you figure out what a taxpayer could pay in back taxes. It also touches on jurisdictional issues and even the indomitable Graev question.

Let’s begin with a basic primer on IRS collections. When you get behind on your taxes, the IRS will try to collect. There is a thing called Collection Due Process, and it was created in 1998 to give taxpayers some rights or to at least give them some ground to stand on. Under this system, the IRS must notify a taxpayer in writing before a Notice of Tax Lien is filed. Basically, it gives taxpayers the right to have a hearing before the IRS seizes their property through the lien. You may request a Collection Due Process Hearing, and it is a chance for you to get things settled with the “tax man” before your case goes to court. You have three options when this happens: (1) pay the debt in full, (2) request a CDP hearing, or (3) make the IRS an offer.

The purpose behind collection due process is to allow taxpayers an opportunity for administrative review of the IRS’s collection actions by the IRS Appeals Division before the IRS seizes their property or assets. Very simply, CDP gives taxpayers due process, or their “day in court” before actually having to go to court. After the Appeals Officer renders his or her decision in the form of a notice of determination, the taxpayer has the right to appeal an adverse determination to the United States Tax Court.

If you get a notice of lien or levy, you should promptly request a CDP hearing. This means the IRS is taking you to court, so requesting a hearing will put the brakes on to give you enough time to respond. You have 30 days after the IRS notice was filed to request your CDP hearing but the sooner the better.

A tax lien is a procedure that allows the government to seize your property in an effort to collect back taxes. The CDP is your tool to help you work with the IRS to get your account paid up. As hard as it is to believe, the IRS does not really want to take your property; they would rather you just pay the taxes. Negotiating with the IRS is possible, but it is important to request a CDP hearing in a timely manner.

Keep in mind that you always have the option of paying your bill in full, and that will close the case once and for all. However, if you are unable to do so, it is important to work with the IRS to get it settled. Putting it off just makes an already bad situation that much worse.

The hearing itself is conducted by an impartial appeals officer, who is referred to as the Settlement Officer (SO). If you dispute the amount owed, you may present your evidence and cause. Hearings may be conducted in an office or over the telephone. No witnesses are called or questioned.

The details of the case are fleshed out, and the seminal issue is whether the IRS followed proper procedures. If you can find something they did wrong, that can help your case. It is also at this stage that you can create a plan to pay your taxes. The point of the hearing is to make sure you were treated fairly.

This is why the Gallagher v. Commissioner case is interesting because it hits on all of these cylinders.

In Gallagher, the taxpayer was the sole shareholder of a business involved in construction. The business was delinquent on six quarters of employment taxes between 2010 and 2011. The IRS claimed he owed $800,000. The IRS filed its intent to lien and the businessman filed a request for CDP.

The businessman submitted a compromise for $56,000 and offered to pay that off over two years. An offer specialist initially raised the amount to $847,000 but was convinced to lower it to $231,000 after taking into consideration the spouse’s interest in the business’s assets and the impact of the spouse on the taxpayer’s appropriate share of household income. The businessman then submitted a counteroffer of $105,000, which was rejected because it fell below Reasonable Collection Potential (RCP).

There is a lot of back and forth negotiating at this stage as well, as the two sides try to settle the tax issue.

Unfortunately, negotiations fell apart and the IRS issued the taxpayer a notice of determination sustaining the proposed levies. The taxpayer petitioned the U.S. Tax Court arguing that the IRS abused its discretion in rejecting his offer and sustaining the proposed levies.

The U.S. Tax Court held that it is inappropriate for it to determine the reasonableness of an offer to settle taxes. Instead, the Tax Court is limited to determining whether the Settlement Officer’s ruling to reject the offer was unfair.

There were also questions pertaining to whether the taxpayer made a good faith effort to correctly estimate his assets.

The taxpayer also included some bills from other years in his offer, which the court considered. This raised a jurisdictional issue as to whether financial actions from another time should have been included in the calculation.

The offer in compromise was central to the case. This is the offer a taxpayer makes after requesting the CDP hearing. When a lien is about to be filed, the taxpayer may offer a compromise solution. There are two basic types: (1) doubt as to collectability and (2) doubt as to liability. Doubt as to collectability means that the taxpayer simply does not have the assets to make payment, and doubt as to liability means that the taxpayer is trying to prove that he or she does not owe the money.

A third type is effective tax administration. In this situation, the taxpayer agrees with the IRS but argues that it would create an economic hardship to require the taxes to be paid all at once. Instead, a plan to pay the amount over a set amount of time is proposed.

This case grew more complicated by the second because the property the taxpayer owned with his wife became entangled. It turned out she had some interest in his business that owed taxes as well. This raised the question of whether the wife’s property should be considered, in addition to the business that the taxpayer owned.

This led the IRS to grossly overstate the amount that was due. But the taxpayer did not come to the bargaining table with “clean hands” either. His own errors as to whether to include his wife’s property only added to the confusion and made him equally at fault.

The taxpayer strenuously argued that the IRS overstated the Reasonable Collection Potential (RCP), resulting in a much higher amount than he could afford.

An offer in compromise is a plan to pay what the IRS claims is owed. IRS procedures require an offer in compromise to reflect the RCP, which is the standard used by the IRS to determine what the taxpayer can pay and thus, whether an offer based on doubt as to collectability should be accepted. The offer amount must exceed the sum of (1) the taxpayer’s net equity and (2) the taxpayer’s future income determined over a four or five-year period, depending upon the terms of the offer. For example, if the taxpayer owes $ 80,000 and the reasonable collection potential is $ 30,000 but he only offers $ 20,000, the taxpayer may have to increase his offer by $ 10,000.

The taxpayer argued that his spouse’s income should never have been counted in his RCP, and that was the basis of his case.

The court ruling spoke of the limited role that the SO had in the case. The tax court held that it is not up to the SO to determine the reasonableness of the offer, but only whether the proper procedures were followed.

Also, there were rental properties primarily owned by the taxpayer’s wife. The question of whether this should be included in the assets was raised because it could generate future income from which the taxpayer could pay the IRS. The court ruled there was no violation as the property did not generate income.

There was also a Graev issue, which deals with whether the IRS obtained necessary signatures before imposing penalties and determining debt. Courts have gone back and forth on this. Here, the court ruled that signatures were not necessary on certain documents.

The final issue was the jurisdictional issue. Since the taxpayer included some tax bills from a different time period, the tax court had to decide whether it had jurisdiction. During this same time, the IRS proposed additional measures to take. This was because liens had not been filed on those assets. These additions were from 2012 and 2014, and the court ruled that it did not have jurisdiction to decide those cases.

Even so, the court held that it could implicitly consider these years. The court felt that it could decide whether the SO abused his discretion in rejecting the taxpayer’s original offer. In other words, although the court did not have jurisdiction to rule on years that were not included in the original IRS lien, those figures could nonetheless be considered in the overall picture and in determining the RCP for the years it was considering.