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Confronted with Federal tax debts you can't pay or believe you don't owe? If so, you may be a candidate for an IRS Offer in Compromise. These guidelines and observations are designed to assist you in
evaluating your tax situation and pursuing an IRS Offer in Compromise.
In March 1999, the IRS released a then new Offer in Compromise Form 656 and
instructions that significantly changed several aspects of Offers in Compromise. In May 2001, with little fanfare, the IRS again changed the way it
processes Offers in Compromise. It
is public knowledge that the number of Offers pending has ballooned since 1999.
Both the 1999 and 2001 changes affect both the payment method as well as the
amount some Taxpayers may need to pay. For
example, now, the IRS will allow some Offers in Compromise to be paid in
installments and the amount due to be discounted (reduced). In instances where much of the 10-year statute of limitations period (the
collection period within which taxes must be obtained by the IRS) has passed,
there can be reductions in the amount offered the IRS.
Section 7122 of the Internal Revenue Code authorizes any tax matter to be
settled. It states:
The Secretary may compromise any civil or criminal case arising under the
internal revenue laws prior to reference to the Department of Justice for
prosecution or defense; and the Attorney General or his delegate may compromise
any such case after reference to the Department of Justice for prosecution or
defense.
This old Code Section allows the IRS great latitude to accept Offers in
Compromise and develop regulations concerning them.
Few understand that, generally, the IRS (and other government agencies) are often not bound by what they say or do because of a legal concept called "sovereign immunity." This means they can reverse their decisions after a matter has been settled or can renege on a promise to follow a course of action even if that promise has been made in writing. There are, however, exceptions to this doctrine.
The Offer in Compromise section, quoted above, is one of the few areas in
which the IRS is legally bound by its decision, permanently - in other words,
"sovereign immunity" does not apply - providing, of course, the Offer is
accepted and the Taxpayer complies with the conditions (i.e., the Taxpayer files
tax returns for five years and remits full payments). Item 8(i) of the Offer Form 656 succinctly states:
The IRS will not collect more than the amount offered.
Many believe, or hope, that obtaining relief using an Offer in Compromise is
merely a matter of "asking." Not
true. As with most benefits
provided by the Government, there are procedures, instructions, and officials to
deal with. The purpose of the
following materials is to explore when an Offer should be considered and how
Offers can be utilized.
Periodically, tax publications disclose national percentage averages for
Offers in Compromise accepted by the IRS. For
example, the national average for the amount accepted for Offers as a percentage
of the tax debt was about 15 to 16 percent at some point in 1997 or 1998.
Keep in mind that national percentage averages for Offers are no more
relevant than the statistics of the average amount of tax paid by the average
Taxpayer. While some may eventually settle their case for the national average,
the settlement amount is not based on such averages. Advertisements, used by
some alleged tax professionals, stating that your case can be resolved for
"pennies on the dollar" are misleading at best. Even worse, lump sum
payments made to such professionals often do not result in a resolution of the
tax problems.
The acceptance of an Offer is based upon:
(1) doubt as to the liability of the Taxpayer; OR
(2) doubt as to the Taxpayer's ability to pay the full
tax due; OR
(3) a combination of these two factors, in some cases.
These concepts are more fully explained below.
"DOUBT AS TO LIABILITY" means you don't owe all or a
portion of the tax debt the IRS has on its records and is trying to collect. The IRS Form 656 (May 2001) simply states this concept as, "Doubt exists that the
assessed tax is correct."
Observation
Improper or incorrect IRS assessments (tax debts) can arise in many ways:
-
Invalid or incorrectly computed IRS determination of
the tax;
-
Improperly prepared tax returns;
-
Failure to respond to notices about payroll taxes
(usually trust fund penalties [formerly called the "100% Penalty"]);
-
The Dog, Parrot, or ________ ate, destroyed, or
otherwise trashed my records,
then I guessed, incorrectly, what the tax should have been; and
-
Other ways too numerous to list here.
The cornerstone of an Offer based on DOUBT AS TO LIABILITY
is to explain to the IRS why a Taxpayer does not owe the assessed tax reflected
on the IRS records and offer an amount the IRS will accept. Obtaining the IRS's acceptance of an offer based on doubt as to
liability is difficult, even for a tax professional. Offers based on doubt as to liability are subject to some special rules
and procedures which will not be discussed here. As a practical matter, the successful submission of an Offer based on
doubt as to liability will almost always require the assistance of a
knowledgeable tax professional.
"Doubt as to Collectibility," as described on Form 656, means, "Doubt exists that you
could ever pay the full amount of tax owed."
Observation
Left to their own devices, probably nearly everyone, except, perhaps, Bill
Gates, would assert that they had "insufficient assets and income" to pay
their taxes. Determining how much
a Taxpayer can pay within a "reasonable period of time" (a criteria not
quoted above, but an important factor), and convincing the IRS of the
correctness of the position, is the "nub" of the art of getting an Offer
processed and accepted.
As in all real life tragedies, players are needed. In addition to the Taxpayer-Offeror, there is often another person,
perhaps a relative or friend (a/k/a a "Saint"), who is paying the amount
offered on behalf of the Taxpayer-Offeror.
On the opposite side of the stage (and the world, it sometimes seems) is the
IRS. Between 1999 and 2001,
there were regional or state IRS Supervisors of Offers. Now,
depending upon where you live, all Offers are to be sent to one of two IRS
Service Centers, Memphis Tennessee or Holtsville New York. How this centralization will effect the processing of Offers remains to
be seen. Since the number of
pending Offers has swollen, it is probably safe to assume that the new
centralized approach will make it more difficult to get Offer's processed. Stated differently, rejections, for procedural reasons will probably
increase.
An Offer in Compromise deemed to be "processable" by the IRS is usually
assigned to an Offer Specialist. Since the designation of Offer Specialist did not exist until quite
recently, many of the Offer Specialists are "recycled" IRS Revenue
Officers. These Revenue
Officers have (had) the unenviable job of collecting unpaid taxes and unfiled
returns. Consequently, quite a few
IRS Collection employees, Revenue Officers, have become known for toughness and
tenacity in tax collection matters.
Since many of the relatively new Offer Specialists are former Revenue
Officers, it should be assumed that many of the IRS "retread-employees" are
not ideally suited for these new positions. Providing a "Fresh Start" to Taxpayers (one of the stated goals of
the 1999 Offer in Compromise procedures) is not an objective viewed with favor
by many of the Offer Specialists; hence the Taxpayer's need for a
professional's help.
Before an Offer in Compromise can be accepted, the IRS must decide to process
it. Staff at the two national IRS
Offer in Compromise offices will initially examine Offers in Compromise to
determine if they are "processable."
These processing units seem to diligently look for reasons why an Offer in
Compromise cannot be processed. Stated differently, Offers are often mailed back with
rejection forms full of checkmarks, sometimes pointing out why the Offer is
unacceptable as submitted. These
reasons may include:
- The form is outdated, not the newest version;
- Insufficient (or no) amount was offered; or
- Signatures of the Taxpayer(s) are missing.
If the Offer in Compromise is deemed to be "processable," it is assigned
to an Offer Specialist. Under the
new system put into effect in May 2001, Offer Specialists may go to the
Taxpayer's home or place of business. More likely than not there will be requests for additional data by correspondence or phone. If a Power of Attorney, IRS Form 2848, has been filed, then the Offer
Specialist must deal with the Taxpayer's Representative.
The objectives of the Offer Specialist are to verify the data and, in
general, make a determination of whether the amount offered is adequate. As
indicated above, finding the correct amount to offer and convincing an Offer
Specialist (and Appeals Officer, if there is an appeal) that the Offer should be
accepted often require much patience.
Throughout the period an Offer in Compromise is being considered by the IRS, as various employees become involved, there will be
requests for updated or additional materials. For example, an Offer Specialist or Appeals Officer may ask
for new pay stubs to see if the Taxpayer is earning more income now.
If an Offer in Compromise is rejected by an Offer Specialist, the rejection
can be appealed by filing a Written Protest with an IRS Appeals
Officer, a type of administrative judge. Appeals Officers are more inclined to reach an accord with the Taxpayer
on a disputed Offer in Compromise, since, by definition, if Appeals Officers
never varied from the Offer Specialist's position, there would be no need for
Appeals Officers, right? Do not
expect, however, that every appealed Offer will be successfully negotiated at
the Appeals level. Some Appeals
Officers can be quite dogmatic, but, in many cases, an accord can be reached.
It should always be remembered that the IRS players in the Offer- Tragedy
play are employees of the IRS and are inevitably bound by the dictates of the
Agency. For example, if all the
Taxpayer's returns are not filed, an Offer in Compromise will NOT be accepted
no matter what the Taxpayer does.
Appeals to the U.S. Tax Court
In 1998, new Internal Revenue Code Sections 6320 and 6330 were adopted,
allowing appeals of rejected Offers to the U.S. Tax Court. Assuming an IRS Appeals Officer rejects an Offer in Compromise, a
petition to the U.S. Tax Court can be filed using an "abuse of discretion"
standard. The petition needs to be
filed within 30 days of the Appeals Officer's decision. There is, as yet, virtually no history of implementation, or reported
cases, under these new Code Sections, so it is impossible to predict how the Tax
Court will apply these rules.
In the past, some Offers took years to complete because of bureaucratic
delay, complexities, and appeals. It
seems some Offer Specialists routinely reject Offers, thus necessitating an
appeal. Will these types of delays
continue in the future? In many
cases, probably "yes," but, hopefully, the process may speed up.
Even if it appears that the Taxpayer owes nothing, should some amount be
offered? Yes! Here's why. Technically,
under the broad grant of authority given the IRS, an Offer in Compromise
offering nothing (zero) could be accepted. However, look at the situation from the IRS's perspective. If you offer nothing, what incentive is there for the IRS to process or
accept the Offer in Compromise? For
this reason, even if it is relatively clear that the Taxpayer owes nothing, some
amount should be offered.
Observation
If the Taxpayer owes nothing and is due a refund, consideration should be
given to filing a Claim for Refund
or Penalty Abatement (both covered
by Form 843) or an amended return (Form 1040X), rather than offering nothing. Sometimes, the IRS rejects an Offer in Compromise because it insists
that, for example, a Claim for Refund is more appropriate. Legally, the IRS could accept an Offer in Compromise and refund money,
but it probably will not. In the
1999 guidelines, there was no mention of change of policy in this regard.
Other alternatives, such as Claims for Refund, do not, however, prohibit the
IRS from later asserting additional tax or filing a suit to retrieve an
erroneous refund check, mistakenly mailed. Expressed differently, using these other methods allows the IRS to still
say, "Oops, we made a mistake; please return the refunded amount." As previously stated, an Offer in Compromise, if accepted and paid, is
not reversible and DOES bind the IRS.
Doubt as to Collectibility - How Much to Offer?
With an Offer based on doubt as to the ability to pay, "Collectibility,"
a Taxpayer must submit a completed IRS "Collection Information Statement"
(Financial Statement), Form 433-A (individuals) or Form 433-B (businesses). If the Taxpayer owns or controls a business, usually both IRS forms (A
and B) are required. (If an Offer
in Compromise is submitted based solely on doubt as to liability, financial
statements are not required.)
Observation
The Forms 433-A and B provide the Offer Specialist with massive amounts of
data about the Taxpayer. Due to
the length of these forms, complexity
and interrelationship of the data, many Taxpayers need professional help in
completing them. For instance, if
local real estate taxes are claimed as a deduction in computing available cash
flow, the deduction may be disallowed unless the asset portion of the Form
433-A reflects the Taxpayer as the owner of real estate or there is some other
reason the Taxpayer is committed to pay real estate taxes (e.g. a lease
requiring the tenant to pay real estate taxes).
The prior IRS regime approached much of the information gathering and
computational approaches in essentially the same manner as the new guidelines. The major difference is that Offers can now be paid in installments and
the amount due can be discounted if the 10-year statute of limitations on
collection is soon to expire.
Note: if
there is less than five years left in the collection period, the amount due
may be reduced, even for so called "Cash Offers." In other words, a Taxpayer may owe less than the combination
of the three classes of assets (Liquid Assets, Quick Sale Value, and Future
Income) if there is less than five years remaining for the IRS to collect the
tax debt.
In order to make the determination of the amount to offer (for an Offer based
on Doubt as to Collectability or the Taxpayer's inability to pay the
liability), let's first look at the basics. Remember, Offers will be returned as unprocessable if the amount offered
is inadequate. The IRS will want a total dollar amount representing the
following three areas:
- Available
Liquid Assets;
- Quick
Sale Value of Assets; and
- Some
portion of future income.
Each of these is discussed below.
Available Liquid Assets
AVAILABLE LIQUID ASSETS include bank accounts, securities, and similar
assets. Also included in this
category are Individual Retirement Accounts (IRAs), 401(k)s, etc., minus all
taxes and penalties due on such withdrawals.
Observation
In the past, several Offer Specialists have
stated that 60% of the value of IRAs and 401(k)s was acceptable in computing
the amount of cash from such sources. What
many Taxpayers forget when filling out the IRS financial statement, Form
433-A, is that usually the Offer Specialist wants to see "pay stubs" which
sometimes reflect 401(k) contributions, sometimes overlooked by Taxpayers as
available liquid assets.
If a Taxpayer were forced to sell assets hurriedly to get the needed cash to
fend off an IRS seizure, for example, he or she would sell for less, in theory. In broad strokes, the QUICK SALE VALUE means 80% of the Fair Market Value
in assets, less secured debt, like mortgages. (Previously this was called the Forced Sale Value.)
For example, if the Taxpayer owed an unencumbered car worth $10,000, then the
IRS wants at least $8,000. If the
car is subject to a secured loan of $5,000, then the amount required to be
offered would be $3,000 ($10,000 Fair Market Value x 80% = $8,000, less the
mortgage of $5,000 = $3,000).
Observation
Prior to the 1999 guidelines, the quick sale percentage figure accepted by
the IRS was 75% of fair market value. Why
a supposedly kinder and gentler IRS would increase the amount by 5% is
interesting and troubling.
In the past, it was not mandatory for the IRS to allow Taxpayers to exclude
specific amounts when calculating the value of assets. It is now. A Taxpayer
can deduct $6,560, which represents the value of furniture or personal effects
in household items of personal use, livestock or poultry. In addition to the $6,560, an additional amount, $3,280, can be excluded
for "trade or business tools." Taking
these deductions into account and assuming $100,000 of realizable value and some
trade tools, the amount of realizable cash would be further reduced by $9,840
($6,560 + $3,280) to $90,160.
Observation
In the past, business and trade tools could avoid seizure (if the Taxpayer
was staying current in paying taxes). If
tools were seized and the Taxpayer then couldn't work, the IRS would be
defeating the purpose of collecting the most tax possible!
Assuming no assets, but some income, the Offer requires that some of the
income be paid to the IRS, either in cash, or, as is now allowed, in
installments. For those Taxpayers
who have been battling with the IRS over payment of delinquent taxes for years,
it is rather common to find no assets in their name. Often a spouse (or friend or relative) not liable for a tax
debt will be the owner of any property the Taxpayer purchased in recent times. That way, the only leverage the IRS has to collect such tax delinquencies
is to garnish salary or levy on receipts (of independent contractors).
Since 1999, the IRS has taken a major step in the right direction by giving
Taxpayers the option to pay the offered amount over time and to reduce the
amount due by factoring in the remaining time in the 10-year collection period.
In the past, assuming no assets but some "available income," in order to
have an Offer accepted, at a minimum a Taxpayer needed to offer 60 months of
available cash flow, now called "future income" or "monthly payments." In these materials we will continue to use the term "available cash
flow" since it seems much more descriptive than other terms. Prior to 1999, many practitioners knew that this 60 months of available
cash flow could be "discounted to present value" depending on the prevailing
interest rate.
Let's say available income after subtracting allowable expenses was $100
per month, and the periodic monthly rate was 8.38%. Rather than paying a lump sum payment of $6,000 ($100 x 60), if the 60
months of payments were discounted to present value, the factor was 47 times one
month's available cash flow, so the Taxpayer would pay a lump sum payment of $4,700
rather than $6,000.
Superficially, it may seem that the IRS is offering two new ways to pay
Offers, the "Cash Offer" and the "Deferred Payment Offer." In reality, there is only one new way to pay. As explained later, there are different ways to compute the amount due.
Who says there is only one new way? The
new "Cash Offer" is, in essence, the old 60-month cash payment discounted to
an amount approaching present value. Since
the instructions regarding Form 656 do not indicate the interest rate the IRS is
using for the discounting, it is not known exactly how it came up with a
multiple of 48 times one month's cash flow.
Cash Offers
Discounting to present value, described immediately above, is the apparent
foundation for what the IRS is now calling a "Cash Offer." The IRS now simply instructs Taxpayers to multiply the amount of
available monthly cash flow by 48 without any reference to interest rates. There was no mention of "present value" calculations or theories in
the old Offer instructions, either. The
key difference between the old and new Offer in Compromise instructions (for
cash lump sum payments) is that now an unsophisticated Taxpayer will not be
Offering 60 times one month's available cash flow.
Deferred Payment Chart
In 1999 the IRS published the chart shown below which permits Taxpayers to
compute the number of income payments due based upon the time remaining on the
10-year IRS collection period. Under the 1999 and 2001 guidance, the total amount due can be
reduced to reflect the life of the collection period. A "Deferred Payment Offer Chart"
is contained in the instructions (reproduced below) and it shows the number of
payments required if a Taxpayer wants to pay the offered amount in installments. If credit is utilized, there is an interest charge.
Click here to see the "Deferred Payment Offer Chart".
The chart indicates that Taxpayers with
considerable time left in the 10-year collection period will be paying much more
than 60 times one month's available cash flow. A Taxpayer who has nine to 10 years left in the 10-year collection
period, and who is using IRS financing for an Offer in Compromise, is required
to pay 108, not 60, monthly payments. Using
$100 of available monthly cash flow, again, this Taxpayer would pay a total of
$10,800 after nine years rather than the $4,800 if a Cash Offer could be paid. Viewed another way, nine years of credit (108 months) requires paying
$6,000 ($10,800 - $4,800) more than the cash amount of $4,800.
There are now several different ways to make deferred payments on an Offer. These are:
- Short Term Deferred Payments
- Plan One -
- Full payment of "realizable values" (the 80% quick sale value)
within 90 days of IRS acceptance, and
- Payment within two years (24
months) of Offer acceptance of the amount collectible over 60 months (future
income) or the remaining life of the collection period.
- Plan Two -
- Partial payment of "realizable values" (the 80% quick
sale value) within 90 days of IRS acceptance, and
- The balance of the realizable value, plus the amount collectible over 60
months (future income) or the remaining life of the collection period, within
two years (24 months).
- Plan Three -
- The Offer amount in monthly payments not to exceed two years.
It does not appear that the differences between Short Term Deferred Payment
Offer Payment Plans one and two are significant. Plan Two differs from "One" in that "Two" allows a partial
payment of "realizable values." Stated differently, all of the 80% available quick sale value
does not have to be paid within 90 days (or less) of Offer acceptance by the
IRS.
Plan Three permits payment of the offered amount over two years without the
up front payment of a sum equal to the quick sale value of assets.
- Long Term Deferred Payments
In addition to the "Short Term Deferred Payment Offer" described
above, there is now a "Deferred Payment Offer" with three options,
described below:
All three options mentioned below have one important and favorable timing
factor. They are all payable over
the "remaining statutory period." The IRS has 10 years within which to collect IRS taxes that have been
assessed. If six years have elapsed
since the date of assessment, then the IRS has four years remaining to collect
the tax.
For reasons not readily apparent, the "Offer Chart" contained in
this material is no longer published in the IRS guidance for Offers in 2001. Why this chart has been omitted is not stated by the IRS.
Instead of following the "Offer Chart," the IRS now suggests that
Offerors should call 1 (800) 829-1040 to receive assistance concerning the
remaining life of the statute of limitations. Good luck on getting the IRS on the phone.
After obtaining assistance from the IRS (again good luck, or using the
materials contained here) the types of long-term Offers are:
- Plan One -
- Realizable Assets within 90
days of an acceptance, and
- Future income over the life
of the collection statute.
- Plan Two -
- Cash payment of a portion
of realizable value, and
- The remainder of realizable
value, plus future income over the life of the collection statute.
- Plan Three -
- Payment in monthly installments of the entire amount over the remainder
of the collection statute.
Observation - Long Term Plans
These three plans mirror the choices under "Short Term Plans" with the
exception that the "two year" short term time limit is replaced by the
period of time referred to as the "life of the collection statute." That is, the number of years left for the IRS to collect during the
10-year collection period.
Observation - Credit
Often Taxpayers who get into these tax situations have gotten there by over extending credit opportunities, namely, by borrowing too much. It could be argued that this type of IRS credit is more of the same and
a potential trap for those who can't manage their monetary affairs very
well. Credit, rather than a wage
garnishment, will be a decidedly tempting option to many Taxpayers. Furthermore, many individuals with IRS liens filed against them cannot
borrow from conventional lenders in any event.
Short Timers - a Benefit
For those who have less than five years left in the 10-year collection
period, the news is especially good. For all deferred IRS payment arrangements, the 1999 and 2001
guidelines direct the Taxpayer to use the number of years left as the starting
point on the Chart. Quite a few
Taxpayers have IRS assessments for taxes that are "old and cold." Many IRS collection cases have been placed in uncollectible status for
years because the Taxpayer was impoverished and there simply was no way to
collect the debt. Prior to 1999,
when the statute was about to expire, the IRS rather vigorously insisted on a
waiver of the statute of limitations.
The other unfortunate scenario is the installment plan that fails to cover
accruing interest. Rather frequently the IRS would enter into an installment
payment agreement with a Taxpayer that provided for payments that were so small
that the installments did not pay the accruing interest. Consequently, interest continued to accumulate and the total
debt increased albeit at a lesser rate.
Now, to address, in part, these situations and to reduce the backlog of
uncollected taxes, the length of time remaining in the 10-year collection
statute is humanely factored into the equation.
Using the example in our March-April 1999 newsletter,
here is how it works. Let's
assume a Taxpayer owes a large uncollected debt for Trust Fund taxes (941 and
940 returns) of $200,000, has been impoverished for some time and has no assets,
but has available monthly cash flow of $200. Assuming there are 23 months left in the collection period, a Taxpayer
would go to the last line of the chart showing "1 to 2 years" and discover
that only 12, not 23, monthly payments are required. Assuming available monthly cash flow of $200, it
appears, based on the instructions, that only $2,400 would have to be offered.
Finally, the IRS has addressed the problem of the expiration of the 10-year
statute of limitations. Previously,
when the 10-year period was about to expire, the IRS insisted, in many cases, on
a waiver to extend the 10-year period for collection. In some cases, the IRS would give a Taxpayer the option to either sign a
waiver of the 10-year period (sometimes extending the collection period beyond
the Taxpayer's life expectancy), or the IRS would garnish (seize) most of the
Taxpayer's salary. The 1998 IRC
amendments to Sec. 6502 address this area by deleting the provision that
previously allowed the IRS to extend the 10-year collection period by using a
written waiver, IRS Form 900.
Now, if less than five years are left in the 10-year collection period, the
IRS has agreed to reduce the outstanding tax liability in proportion to the time
remaining. Perhaps the IRS reached
this point because it cannot now present Taxpayers with the Draconian choice of
signing a waiver or having salary garnished or assets seized. Now, the amount due and the period within which to pay the Offer in
installments may be significantly reduced if the time remaining to collect the
tax debt is less than five years.
When Were the Taxes Assessed?
Many Taxpayers have only a vague idea when their returns were filed, or even
if they have been filed. In some
cases, Taxpayers fail to file and the IRS "files" for them using a
statutorily approved "Substitute for Return."
The 2001 instructions suggest calling a local IRS office or "1 (800) 829-1040" to determine the "years remaining on the
collection statute." Another,
and better, way to determine the number of years left is to get an IRS
transcript for each year. Transcripts
should be obtained, but it is not always an easy or quick task to get IRS
transcripts.
In some cases, IRS assessments may not be made for months after a return is
filed. A transcript will show
"when" the assessment occurred (the beginning of the ten-year period), as
well as provide information, such as the filing of prior Offers and waivers,
which could extend the statute of limitations on collection. Another reason for obtaining a transcript is to check on the application
of prior installment payments. If
payments have been misapplied or penalties or interest incorrectly calculated,
such errors can be discerned from transcripts. Finally, the only way to confirm the time left in the IRS collection
period is to check the IRS transcript. Transcripts
are what the IRS employees rely on for that information, so it is good practice
to make sure, if possible, that the transcripts are approximately correct.
Interest
In addition to interest charged automatically based on the Chart, interest is
also imposed on cash payments based on the time between acceptance of an Offer
and payment. Sometimes this
interest, quickly paid on cash Offers, is based on days or weeks and seems to be
more of a hindrance than a necessity. The
IRS somewhat slavishly insists on extracting this small amount of interest even
if it is only $1.13. If this, or a
similarly small amount of interest is not paid, then, technically, the Offer is
not complete and the Offer will be eventually in default.
Hopelessly Insolvent
Even if the Taxpayer is clearly insolvent, owing a host of debts to state tax
collectors, credit card companies and others, the IRS still abides by the
guidelines stated above. This means
that if the Taxpayer owes a total amount that is many times the IRS debt, but
has equity in assets, say, a motorcycle, the equity in that motorcycle has to be
offered. In many bankruptcy cases,
creditors of the same class have to share the assets of a debtor and receive,
usually, only a small percentage of their claim. The IRS is not subject to, or bound by, such bankruptcy conventions when
considering an Offer. Consequently, if there is equity in an asset, e.g. the
motorcycle, then the IRS must be offered that equity.
Installment Agreements
For some time, the IRS has permitted some Taxpayers who can't pay all their
tax debts immediately to pay their tax liabilities over time in installments. Such payment arrangements, called "Installment
Agreements," basically constitute the same arrangement one would have with
a credit card company, paying off an account over time. The primary difference is that credit card companies do not have the
collection powers of the IRS. Interest
on principal and interest on penalties (if any) continue to accrue under an IRS
Installment Agreement until the tax debt is fully satisfied.
For years, some wondered why the amount due with an Offer in Compromise could
not be paid over time in installments. Now,
the answer is, "Yes, Offers can be paid over time," as discussed above, in
accordance with the "Deferred Payment Offer Chart."
Frequently, Taxpayers agree, sometimes under pressure, to pay monthly amounts
in excess of their means. In the
past, such a situation created problems. If
the monthly payment amount was too rich, the old discounted amount (47 times one
month's cash flow) could have exceeded the total amount due, in which case, an
Offer in Compromise based on collectibility, would have been automatically rejected. Now,
with the new guidelines, even if a Taxpayer has entered into an IRS installment
agreement in excess of his or her financial means to keep up the payments, it
appears that a Cash Offer, 48 times one month's available cash flow, could
still be negotiated. If true, this
may be a welcome change from the prior dilemma of having to default on an IRS
installment agreement in order to submit an Offer in Compromise.
Previously (and perhaps in the future), if it became apparent that the
Taxpayer was going to be forced to default on an installment agreement because
the payments could not be maintained, it was important to plan accordingly and
inform the IRS that payments would be stopping and an Offer would follow. When there is a default on an IRS Installment Agreement, the Taxpayer may
become subject to enforced collection procedures, levies and the like, unless a
professional coordinates with the IRS in advance. Usually the IRS will forgo enforced collection measures if a tax
professional becomes involved in the matter and coordinates with appropriate
Revenue Officers about the forthcoming Offer.
Allowable Expenses - Married Taxpayer(s)
What if only one spouse is liable for a tax debt? Often, it is the Husband who is saddled with tax debts from a failed
business, and the Wife is current on her tax liabilities. If the Taxpayer is employed, then the monthly cash flow component of an
Offer in Compromise must be computed. In
this situation, how should the allowable expenses be computed?
The IRS usually takes the position that even if the Wife is not technically
liable for the tax debts of the Husband, she may be helping with household
debts; therefore, the Husband has MORE available income to pay the IRS. While this is arguably correct in some cases, the IRS position is hard
for most Taxpayers to accept.
Explained in different words, the IRS position holds that the Husband cannot
deduct all of the expenses he could have deducted if he were single. In effect, this problem is a type of "marriage penalty." It is particularly hard to get Offers approved in such cases because
splitting living and housing allowances between spouses can greatly increase the
amount the Husband must offer. Additionally,
the computation methods used by the IRS to fractionalize (allocate) expenses
between spouses often leads to disagreements between the Offer Specialist and
the Taxpayer.
Observation
Because of these problems, in addition to the need to disclose transfer of
assets between spouses and reflect the Wife's income on the financial
statements, many "friends" wait to get married until an Offer in
Compromise has been accepted. In
fact, if the couple is living together and planning a marriage, I regularly
suggest not getting betrothed until the tax mess is resolved.
Another solution to the marriage-collection problem is to have the Wife or
Husband quit their job for the time being. It may seem unrealistic, but, in some cases (obviously, not all), having
one of the spouses unemployed until after the Offer in Compromise is accepted is
a solution. Clearly, such an
approach is permissible since the IRS cannot force a spouse to work. The other dimension to this problem is economics, people need to continue
eating and paying the rent.
Who Pays? - a Saint
Few think about the importance of who it is who pays the amount offered. The IRS Manual, IRM § 57(10)(10).1(1), addresses the subject as follows:
An Offer is adequate if it reasonably reflects collection potential. This will include amounts that can be collected from other parties
through suit, assertion of transferee liability, 100-percent penalty and other
actions. Additional consideration will be given to assets and income
that are available to the Taxpayer but beyond the reach of the government.
This section, part (4) concludes with the warning to Offer Specialists:
If an Offer is rejected because more can be collected than is offered, it
is generally expected that the amount determined to be collectible will
actually be collected [by the IRS].
(Emphasis added.)
The above reasoning adequately explains why, if possible, getting a relative,
or friend to pay the offered amount is often vitally important. If someone other than the Taxpayer will post the amount offered, this is
money the IRS cannot otherwise access. Clearly,
IRS employees are warned not to pass up funds they cannot otherwise obtain, and
if they do pass on the funds offered by a non-liable party, they must be darn
sure the amount is collected from the Taxpayer later.
Many Taxpayers and professionals are not aware that some income tax
liabilities (Form 1040 debt) can be discharged in Chapter 7 bankruptcy if the
income tax was assessed (billed) more than three years prior to beginning the
bankruptcy proceeding. It is beyond
the scope of this Offer in Compromise summary to delve into the complexities of
bankruptcy and the many exceptions to general rules stated here. The purpose of mentioning bankruptcy is to alert readers that, sometimes,
if income tax debt has been assessed for three years, or more, it may be
possible to have such tax debt discharged in bankruptcy.
Not all taxes are dischargeable. There are a variety of exceptions to discharge of liabilities
in bankruptcy, such as fraud or failure to file a return. Additionally, certain types of taxes referred to as Trust Fund taxes
(941, FICA) cannot be discharged in bankruptcy, but can be compromised using an
Offer in Compromise.
Special tax laws (Sec. 6672) allow the IRS to convert the Trust Fund debt of corporations
into a personal tax debt against "responsible parties," usually officers of
the defunct corporation. These
personal assessments against responsible parties are sometimes referred to as
the "Civil Penalty" by the IRS. Since
the Civil Penalty cannot be discharged in bankruptcy, often the only way to
address the burdens of this penalty is through the use of an Offer in
Compromise. Frequently, when a
corporation goes "belly-up," the IRS assesses the Trust Fund (Civil) Penalty
against everyone who was involved in corporate management, even those
individuals who were only tangentially involved and, in fact, were not
"responsible parties" as that term has been judicially interpreted. Out of despair, lack of funds, or apathy, many Trust Fund Civil Penalties
go uncontested until the individual(s) have recovered to some degree and need to
get their lives back; hence, the need for an Offer in Compromise.
Temporary Relief in Bankruptcy
Occasionally, a Taxpayer may be informed that a bankruptcy proceeding will
stop the IRS from proceeding with a threatened levy (seizure) of assets. While it may be true that the IRS is "stopped," the "stopping"
may only be for the duration of the bankruptcy proceeding. Stated differently, if the taxes in question are not, in fact,
dischargeable, filing a bankruptcy proceeding to stop the IRS may only afford
temporary relief. Once the
bankruptcy proceeding is over, if the taxes are not dischargeable, the IRS is
free to resume collection again.
Item 8 of the Offer in Compromise Form 656 (Rev. 5-2001) contains a list of
16 conditions, (a) through (p), that the Taxpayer must agree to. The following are sometimes overlooked points, "Dingers" pertaining
to the conditions in Item 8. Each
point is labeled with the letter of the corresponding item on the Form 656. Not all of the 16 items [(a) through (p)] are discussed in this summary,
so some lettered items are not included in the following list.
(a) All payments must be made voluntarily.
(b) The IRS is free to apply your payments as it wants. Usually, a party paying a debt can designate how payments are to be
applied. This is not so with an
Offer, although this is a minor point unless the Offer is defaulted and the IRS
debt is restored.
(d) Tax returns must be filed with full payment for five years. Now, the default of one spouse (on a joint Offer) will not automatically
default the Offer Agreement if the non-defaulting spouse remains current. This area is still in development it appears.
(e) The statute of limitations on collection is extended while the Offer is
pending.
(g) Any refunds and interest due the Taxpayer are defaulted to the IRS while
an Offer based on collectibility is pending (being considered).
(i) The IRS will not
collect more than the amount offered. This is very important and is why Offers are important.
(l) Once the IRS accepts the Offer, the amount of the tax liability cannot be
contested in any Court.
(n) If the Taxpayer defaults on the Offer in Compromise, then the IRS is free
to collect the remaining debt minus credits received.
(o) The IRS will file a lien against the Taxpayer (or leave existing liens in
place) while the Offer is being paid.
Legal Fees
As the reader may have surmised from the preceding discussions and
observations, this is a difficult area of law. Many Taxpayers faced with the dilemma of what to do about an overwhelming
tax liability tend to blame others for their present problems. However, rather than continuing to blame former partners, divorced
spouses, the IRS, and others for their predicament, the Taxpayer needs to take
affirmative steps.
Under such circumstances, it is necessary for professionals to obtain
retainers and have the Client/Taxpayer replenish the retainer account as needed. If credit is provided by the professional and the IRS seizes the
Client/Taxpayer's assets or bank accounts, there is no way the Taxpayer can
continue to pay the law firm. The
retainer for Newland & Associates for most IRS collection matters (including
Offers in Compromise) is approximately $3,000. An introductory meeting to visit the office and meet the staff is free,
but will not include substantive discussions about the tax problems or advice
about what to do and possible alternatives.
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© by D. Alden (Dan) Newland
Published jointly by The Tax & Business Professionals, Inc. and the law firm of Newland & Associates as a service to their clients.
If you are a tax professional and would like more information about the subjects covered in this newsletter or any other tax and business matter, please call the Tax & Business Professionals, Inc. at (800)-553-6613, e-mail us at
, or visit our web site at http://www.tax-business.com.
For a full range of business law and tax-related services, call the law firm of Newland & Associates at (703) 330-0000.
If you are reading this newsletter but are not on our mailing list, and would like to be, please contact us at (800) 553-6613.
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.
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