In certain circumstances, the IRS will allow taxpayers to pay less than the full amount they owe. One example is where doubt as to liability exists. Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax debt under the law. If a taxpayer has a legitimate doubt that he or she owes part or all of a tax debt, then a Form 656-L, Offer in Compromise (Doubt as to Liability), should be completed. Doubt as to liability cannot be disputed or considered if the tax debt has been established by a final court decision or judgment concerning the existence or amount of the assessed tax debt or if the assessed tax debt is based on current law. Submitting an offer application does not guarantee that the IRS will accept the taxpayer’s offer. It begins a process of evaluation and verification by the IRS.
In Whitesell v. Commissioner, Tax Court Memorandum 2017-84, the Tax Court held that no valid settlement with the IRS arose when a couple sent a check for payment of their liabilities along with a Form 656-L, Offer in Compromise (Doubt as to Liability), which the couple heavily modified, even though the IRS deposited (but later refunded) the check that accompanied the Form 656-L. The Tax Court rejected the couple’s argument that, by cashing the check, the IRS accepted the couple’s offer.
If the IRS determines that there are grounds for compromise of a taxpayer’s tax liability, it may, at its discretion, compromise the taxpayer’s civil or criminal tax liability before the taxpayer’s case is referred to the Department of Justice for prosecution or defense (Code Section 7122(a); Regulation Section 301.7122-1(a)(1)). An agreement to compromise may relate to a civil or criminal liability for taxes, interest, or penalties. Unless the terms of the offer and acceptance expressly provide otherwise, acceptance of an offer to compromise a civil liability does not remit a criminal liability, nor does acceptance of an offer to compromise a criminal liability remit a civil liability (Regulation Section 301.7122-1(a)(2)).
Generally, a record is kept whenever a compromise is made in any case. The opinion of the General Counsel for the Department of the Treasury or his delegate is placed on file and must detail the reason for the compromise along with a statement of:
(1) the amount of tax assessed;
(2) the amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed; and
(3) the amount actually paid in accordance with the terms of the compromise (Code Section 7122(b)).
There is an exception, and no opinion is required for a compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. However, such compromise is subject to continuing quality review.
In Hinerfeld v. Commissioner, 139 Tax Court No. 10 (2012), the Tax Court held that the rule requiring a record to be kept meant that the IRS Appeals and the IRS Area Counsel were obligated to communicate with each other regarding a taxpayer’s amended Offer in Compromise and, consequently, their communications were not prohibited ex parte communications under Revenue Procedure 2000-43.
Grounds for Compromise: There are several grounds on which the IRS may compromise a taxpayer’s liability:
(1) doubt as to liability;
(2) doubt as to collectibility;
(3) economic hardship; and
(4) promoting effective tax administration.
Tax Compliance Tip:
Taxpayers who believe they may qualify should submit their offers by filing Form 656, Offer in Compromise. If the offer is rejected, the taxpayer has 30 days to ask the Appeals Office of the IRS to reconsider the offer.
Practice Tax Tip:
The IRS offers fast track mediation services to help taxpayers resolve many issues including a dispute regarding an offer in compromise.
Doubt as to liability: Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. Special rules apply to the rejection of offers in cases where the IRS is unable to locate the taxpayer’s return or return information to verify the liability (Regulation Section 301.7122-1(b)(1)).
Doubt as to collectibility: Doubt as to collectibility exists in any case where the taxpayer’s assets and income are less than the full amount of the liability (Regulation Section 301.7122-1(b)(2)).
A determination of doubt as to collectibility includes a determination of ability to pay. In determining ability to pay, the IRS permits taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses is founded upon an evaluation of the individual facts and circumstances presented by the taxpayer’s case. To guide this determination, guidelines published by the IRS on national and local living expense standards are taken into account (Code Section 7122(d)(2); Regulation Section 301.7122-1(c)(2)(i)).
An Offer to Compromise based on doubt as to collectability is acceptable only if it reflects the taxpayer’s reasonable collection potential (RCP) (Revenue Procedure 2003-71). Reasonable collection potential is generally calculated by multiplying a taxpayer’s monthly income available to pay taxes by the number of months remaining in the statutory period for collection and adding to that product the realizable net equity in the taxpayer’s assets. The Internal Revenue Manual directs Appeals officers to reject offers for less than a taxpayer’s reasonable collection potential unless the taxpayer proves he has special circumstances. Special circumstances include economic hardship to the taxpayer if the IRS collected the full RCP, or other considerations of public policy or equity that would also justify accepting less (Murphy v. Commissioner, 125 Tax Court 301 (2000), Affirmed, 469 Federal 3d 27 (1st Curcuit 2006)).
The Internal Revenue Manual (IRM) lists various situations which may warrant placing a different value on future income than current or past income would indicate. Examples include where:
(1) a taxpayer is temporarily or recently unemployed or underemployed;
(2) a taxpayer unemployed and not expected to return to their previous occupation or previous level of earnings;
(3) a taxpayer is long-term unemployed;
(4) a taxpayer is long-term underemployed;
(5) a taxpayer has an irregular employment history or fluctuating income;
(6) a taxpayer is in poor health and his or her ability to continue working is questionable;
(7) a taxpayer is close to retirement and has indicated he or she will be retiring; or
(8) a taxpayer will file a petition for liquidating bankruptcy (Internal Revenue Manual Section 5.8.5).
In Leago v. Commissioner, Tax Court Memorandum 2012-39, the Tax Court advised the IRS to consider the Internal Revenue Manual provisions regarding special circumstances when evaluating the offer-in-compromise of a homeless man with a brain tumor.
Where a taxpayer is offering to compromise a liability for which the taxpayer’s spouse has no liability, the assets and income of the nonliable spouse are not considered in determining the amount of an adequate offer. The assets and income of a nonliable spouse may be considered, however, to the extent property has been transferred by the taxpayer to the nonliable spouse under circumstances that would permit the IRS to effect collection of the taxpayer’s liability from such property (for example, fraudulent conveyance), property has been transferred by the taxpayer to the nonliable spouse for the purpose of removing the property from consideration by the IRS in evaluating the compromise. The IRS also may request information regarding the assets and income of the nonliable spouse for the purpose of verifying the amount of and responsibility for expenses claimed by the taxpayer (Regulation Section 301.7122-1(c)(2)(ii)(A)).
Where collection of the taxpayer’s liability from the assets and income of the nonliable spouse is permitted by applicable state law (for example, under state community property laws), the assets and income of the nonliable spouse are considered in determining the amount of an adequate offer except to the extent that the taxpayer and the nonliable spouse demonstrate that collection of such assets and income would have a material and adverse impact on the standard of living of the taxpayer, the nonliable spouse, and their dependents (Regulation Section 301.7122-1(c)(2)(ii)(B)).
In Campbell v. Commissioner, Tax Court Memorandum 2019-4, the Tax Court held that an IRS Appeals officer abused her discretion in a collections due process hearing by rejecting a taxpayer’s Offer in Compromise. The court found that the Appeals officer improperly included assets held by an irrevocable grantor trust in the taxpayer’s reasonable collection potential and failed to consider relevant facts in determining that the taxpayer wasted his wealth in investments in an effort to deprive the government of funds.
In Snipes v. Commissioner, Tax Court Memorandum 2018-184, the Tax Court rejected the taxpayer’s argument that a settlement officer (SO) abused her discretion by failing to determine the taxpayer’s exact reasonable collection potential. The Tax Court found that the Internal Revenue Manual does not require the Appeals Office to calculate an reasonable collection potential with the level of precision suggested by the taxpayer and that, given the disparity between the taxpayer’s Offer in Compromise and the settlement officer‘s calculation of his reasonable collection potential, among other factors, the settlement officer (SO) was justified in rejecting the taxpayer’s offer. However, in Moore v. Commissioner, Tax Court Memorandum 2019-129, the Tax Court held that an settlement officer (SO) abused his discretion by attempting to collect by levy unpaid trust fund recovery penalties from the taxpayer. The court found that the settlement officer (SO) did not properly verify that an IRS office, which terminated an Offer in Compromise that the taxpayer had in effect, had followed the administrative procedures for terminating the Offer in Compromise and the settlement officer’s failure to properly verify such information was an abuse of discretion.
In Reed v. Commissioner, 141 Tax Court No. 7 (2013), the Tax Court was asked whether the IRS can be required to reopen an Offer in Compromise based on doubt as to collectibility that the IRS had returned to the taxpayer as unprocessable years before a collection due process hearing began. The question involved the interaction of Code Section 7122 and Code Section 6330 and the consequences that flow from the IRS’s rejecting an Offer in Compromise versus returning an Offer in Compromise. In this case, the taxpayer was asking that the IRS consider in the current year an offer based on doubt as to collectibility submitted three years earlier. Taxpayers must submit current financial data when proposing an Offer in Compromise based on doubt as to collectibility and, the Tax Court said, allowing the IRS to evaluate an Offer in Compromise based on doubt as to collectibility using the taxpayer’s past financial circumstances would impermissibly expand the IRS’s authority.
In Churchill v. Commissioner, Tax Court Memorandum 2011-182, the IRS considered the income of a taxpayer’s spouse when calculating the amount the taxpayer could afford to pay the IRS for back taxes. Even though the couple did not file joint returns, the fact that they lived in a community property state was enough to allow the IRS to include the spouse’s income in the calculation. The Tax Court held that this was acceptable and rejected the taxpayer’s argument that his wife’s income shouldn’t be considered because theirs was a marriage of convenience – he had married her only for her health insurance. However, after the taxpayer’s wife left him, the Tax Court remanded the case back to the IRS for revised calculations of the amount the taxpayer could afford to pay due to “changed circumstances.”
Economic hardship: A compromise may be entered into to promote effective tax administration when the IRS determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship within the meaning of Regulation Section 301.6343-1 (Regulation Section 301.7122-1(b)(3)(i)).
Under Regulation Section 301.6343-1(b)(4)(i), an economic hardship results where the financial condition of the taxpayer is such that satisfaction of a levy will cause an individual to be unable to pay his or her reasonable basic living expenses. This determination is made by the IRS and varies according to the taxpayer’s unique circumstances. Unique circumstances do not include the maintenance of an affluent or luxurious standard of living.
Factors supporting (but not conclusive of) a determination that collection would cause economic hardship include, but are not limited to:
(1) the taxpayer is incapable of earning a living because of a long-term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer’s financial resources will be exhausted providing for care and support during the course of the condition;
(2) although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and
(3) although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses (Regulation Section 301.7122-1(c)(3)(i)).
Tax Tip Example 1:
Alice Smith has assets sufficient to satisfy his past due tax liability. Alice provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that Alice will need to use the equity in her assets to provide for adequate basic living expenses and medical care for her child. Alice’s overall compliance history does not weigh against compromise. Alice would be a likely candidate for an offer in compromise.
Tax Tip Example 2:
Todd is retired and his only income is from a pension. Todd’s only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave Todd without an adequate means to provide for basic living expenses. Todd’s overall compliance history does not weigh against compromise. Todd would be a likely candidate for an offer in compromise.
Tax Tip Example 3:
Bill is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. Bill also owns a modest house that has been specially equipped to accommodate his disability. Bill’s equity in the house is sufficient to permit payment of the liability he owes. However, because of his disability and limited earning potential, Bill is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because Bill’s home has been specially equipped to accommodate his disability, forced sale of his home would create severe adverse consequences for Bill. Bill’s overall compliance history does not weigh against compromise. Bill would be a likely candidate for an offer in compromise.
In Lindsay Manor Nursing Home, Inc. v. Commissioner, 148 Tax Court No. 9 (2017), a corporate taxpayer argued that Regulation Section 301.6343-1(b)(4)(i) was invalid because it conflicted with Code Section 6343(a)(1)(D), which provides that the IRS must promptly notify a taxpayer that a levy on the taxpayer has been released when the IRS has determined that such levy is creating an economic hardship due to the financial condition of the taxpayer. According to the taxpayer, the regulation was invalid because it redefined the term “taxpayer” to include only individuals. The IRS countered that a regulation limiting economic hardship relief to individual taxpayers was consistent with Code Section 6343(a)(1)(D) because only individual taxpayers could suffer hardship.
The Tax Court held that Regulation Section 301.6343-1(b)(4)(i) was valid but, citing Code Section 6330(c)(3), also left open the door that a corporation could be eligible for a compromise as a result of suffering economic hardship. In Lindsay Manor Nursing Home, Inc. v. Commissioner, Tax Court Memorandum 2017-50, the Tax Court said that Code Section 6330(c)(3) properly takes into account a taxpayer’s specific economic realities, including the taxpayer’s financial position, as well as the consequences of a proposed collection action in determining if a compromise is warranted. However, in that case, the Tax Court held that the IRS did not abuse its discretion in rejecting the taxpayer’s collection alternative where the taxpayer habitually did not comply with employment tax requirements and did not comply with prior installment agreements.
In Loveland v. Commissioner, 151 Tax Court No. 7 (2018), the Tax Court held that the IRS’s failure to consider a couple’s claim of economic hardship if they were required to pay their tax liability in full was an abuse of discretion because their hardship claim was not properly considered by the IRS. The court stated that, in a collection due process (CDP) hearing, the IRS is required to consider all issues raised by the taxpayer. The court found that although the couples’ economic hardship claim was noted in the administrative record and the notice of determination, the IRS never evaluated the claim. Because the couple explicitly raised the issue of economic hardship, the court concluded that the IRS abused its discretion in failing to consider it.
In Gillette v. Commissioner, 2020 PTC 6 (7th Curcuit 2020), the Seventh Circuit held that the IRS did not abuse its discretion in denying a taxpayer’s Offer in Compromise where the taxpayer had sufficient net equity in rental real estate assets to pay her tax liability in full. The Seventh Circuit also found that it was reasonable for the IRS to propose that the taxpayer sell two rental properties to pay her taxes because the court found that doing so would not create an economic hardship for the taxpayer.
Promoting effective tax administration: If there are otherwise no grounds for compromise (that is, no grounds relating to doubt as to liability, doubt as to collectability, or economic hardship), the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise is justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. For this purpose, a taxpayer proposing compromise will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full (Regulation Section 301.7122-1(b)(3)(ii)).
No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws (Regulation Section 301.7122-1(b)(3)(iii)).
Factors supporting (but not conclusive of) a determination that compromise would undermine compliance include, but are not limited to:
(1) the taxpayer has a history of noncompliance with the filing and payment requirements of the Internal Revenue Code;
(2) the taxpayer has taken deliberate actions to avoid the payment of taxes; and
(3) the taxpayer has encouraged others to refuse to comply with the tax laws (Regulation Section 301.7122-1(c)(3)(ii)).
Tax Tip Example:
In October of 2012, Linda developed a serious illness that resulted in almost continuous hospitalizations for a number of years. Linda’s medical condition was such that during this period that she was unable to manage any of her financial affairs. Linda has not filed tax returns since that time. Linda’s health has now improved and she has promptly begun to attend to her tax affairs. She discovered that the IRS prepared a substitute for return for the 2012 tax year on the basis of information returns it had received and had assessed a tax deficiency. When Linda discovered the liability, with penalties and interest, the tax bill was more than three times the original tax liability. Linda’s overall compliance history does not weigh against compromise. In this case, Linda is a candidate for an Offer in Compromise.
Submitting an Offer in Compromise: Generally, if a taxpayer submits an offer in compromise, the IRS will delay certain collection activities. The IRS usually will not levy on the taxpayer’s property to settle the taxpayer’s tax bill:
(1) while the IRS is evaluating an Offer in Compromise;
(2) during the 30 days immediately after the offer is rejected; or
(3) while the taxpayer’s timely-filed appeal is being considered by Appeals.
Also, if the IRS rejects a taxpayer’s original offer and the taxpayer submits a revised offer within 30 days of the rejection, the IRS generally will not levy on the taxpayer’s property while it considers the revised offer.
In general: the submission of any lump-sum Offer in Compromise must be accompanied by the payment of 20 percent of the amount of such offer (Code Section 7122(c)(1)(A)(i)).
For this purpose, the term “lump-sum offer-in-compromise” means any offer of payments made in five or fewer installments (Code Section 7122(c)(1)(A)(ii)).
The submission of any periodic payment Offer in Compromise must be accompanied by the payment of the amount of the first proposed installment (Code Section 7122(c)(1)(B)(i)).
Any failure to make an installment (other than the first installment) due under such Offer in Compromise during the period the offer is being evaluated by the IRS may be treated by the IRS as a withdrawal of such offer-in-compromise (Code Section 7122(c)(1)(B)(ii)).
The application of any payment to the assessed tax or other amounts with respect to such tax may be specified by the taxpayer (Code Section 7122(c)(2)(A)).
In the case of any assessed income tax or other amounts imposed under the income tax provisions that is the subject of an Offer in Compromise, such tax or other amounts must be reduced by any user fee imposed with respect to such offer in compromise (Code Section 7122(c)(2)(B)).
An Offer to Compromise a tax liability must be made in writing on Form 656, Offer in Compromise, and must be signed by the taxpayer under penalty of perjury and include the processing fee. The offer must contain all of the information requested by the IRS. However, taxpayers submitting Offers to Compromise liabilities solely on the basis of doubt as to liability are not required to provide financial statements (Code Section 7122(d)(3)(B)(ii); Regulation Section 301.7122-1(d)(1)).
Pending Offers in Compromise: An offer to compromise becomes pending when it is accepted for processing. The IRS may not accept for processing any offer to compromise a liability following reference of a case involving such liability to the Department of Justice for prosecution or defense. If an offer accepted for processing does not contain sufficient information to permit the IRS to evaluate whether the offer should be accepted, the IRS will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the IRS has requested within a reasonable time period after such a request, the IRS may return the offer to the taxpayer. The IRS may also return an Offer to Compromise a tax liability if it determines that the offer was submitted solely to delay collection or was otherwise nonprocessable. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the IRS returns the offer to the taxpayer (Regulation Section 301.7122-1(d)(2)).
Withdrawal of an offer in compromise: An offer to compromise a tax liability may be withdrawn by the taxpayer or the taxpayer’s representative at any time before the IRS’ acceptance of the offer to compromise. An offer will be considered withdrawn upon the IRS’ receipt of written notification of the withdrawal of the offer either by personal delivery or certified mail, or upon issuance of a letter by the IRS confirming the taxpayer’s intent to withdraw the offer (Regulation Section 301.7122-1(d)(3)).
Acceptance of an Offer in Compromise: An Offer to Compromise is not considered accepted until the IRS issues a written notification of acceptance to the taxpayer or the taxpayer’s representative (Regulation Section 301.7122-1(e)(1)). However, any offer in compromise will be deemed accepted by the IRS if the offer is not rejected within 24 months after the date of submission. In determining the expiration of the 24 month period, any period during which any tax liability which is the subject of such Offer in Compromise is in dispute in any judicial proceeding is not taken into account (Code Section 7122(f)).
As additional consideration for the acceptance of an Offer to Compromise, the IRS may request that taxpayer enter into any collateral agreement or post any security which is deemed necessary for the protection of the interests of the United States (Regulation Section 301.7122-1(e)(2)).
Offers may be accepted when they provide for payment of compromised amounts in one or more equal or unequal installments (Regulation Section 301.7122-1(e)(3)).
If the final payment on an accepted Offer to Compromise is contingent upon the immediate and simultaneous release of a tax lien in whole or in part, such payment must be made in accordance with the forms, instructions, or procedures prescribed by the IRS (Regulation Section 301.7122-1(e)(4)).
Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of, nor prevent the IRS from taking action to collect from, any person not named in the offer who is also liable for the tax to which the compromise relates. Neither the taxpayer nor the government will, following acceptance of an Offer to Compromise, be permitted to reopen the case except in instances where:
(1) false information or documents are supplied in conjunction with the offer;
(2) the ability to pay or the assets of the taxpayer are concealed; or
(3) a mutual mistake of material fact sufficient to cause the offer agreement to be reformed or set aside is discovered (Regulation Section 301.7122-1(e)(5)).
Generally, if an Offer to Compromise is accepted, there will be placed on file the opinion of the Chief Counsel for the IRS with respect to such compromise, along with the reasons therefor. However, no such opinion will be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. Also placed on file will be a statement of:
(1) the amount of tax assessed;
(2) the amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed; and
(3) the amount actually paid in accordance with the terms of the compromise (Code Section 7122(b); Regulation Section 301.7122-1(e)(6)).
In Estate of Sanfilippo v. Commissioner, Tax Court Memorandum 2015-15, an estate proposed an Offer in Compromise to avoid a levy on estate property, but before the agreement was reduced to writing, a new IRS settlement officer was assigned to the case. The new officer ignored the offer, and instead focused on what he believed to be a valuation issue with a portion of estate property, sustaining the proposed levy. The Tax Court found the officer abused his discretion by relying on incorrect factual and legal assumptions in his valuation and refusing to consider the proposed collection alternatives that had been approved by the prior officer.
Rejection of an Offer in Compromise: An Offer to Compromise is not considered rejected until the IRS issues a written notice to the taxpayer or his representative, advising of the rejection, the reason(s) for rejection, and the right to an appeal (Regulation Section 301.7122-1(f)(1)).
The IRS may not notify a taxpayer or taxpayer’s representative of the rejection of an Offer to Compromise until an independent administrative review of the proposed rejection is completed (Regulation Section 301.7122-1(f)(2)).
No Offer to Compromise may be rejected solely on the basis of the amount of the offer without evaluating that offer under the provisions of Code Section 7122 and the IRS’s policies and procedures regarding the compromise of cases (Regulation Section 301.7122-1(f)(3)).
Offers in Compromise submitted on the basis of doubt as to liability cannot be rejected solely because the IRS is unable to locate the taxpayer’s return or return information for verification of the liability (Code Section 7122(d)(3)(B)(i); Regulation Section 301.7122-1(f)(4)).
The IRS may reject an Offer in Compromise where the taxpayer’s ability to pay is greater than the amount he proposes to pay under the compromise proposal (Fargo v. Commissioner, 447 Federal 3d 706 (9th Circuit 2006), affirming Tax Court Memorandum 2004-13). Absent a showing of special circumstances, the IRS will not accept a compromise that is less than the reasonable collection value of the taxpayer (Revenue Procedure 2003-71). Section 5.8.5 of the Internal Revenue Manual discusses the financial analysis that the IRS will undertake in analyzing the taxpayer’s financial condition to determine reasonable collection potential. In Johnson v. Commissioner, 136 Tax Court 475 (2011), the Tax Court held that in declining the taxpayer’s informal Offer in Compromise proposal on the grounds that it offered less than his reasonable collection potential, the IRS did not abuse its discretion by including, in its calculation of the taxpayer’s reasonable collection potential, certain dissipated assets and the settlement officer’s final projection of the taxpayer’s earnings. Similarily, in Hinerfeld v. Commissioner, 139 Tax Court No. 10 (2012), the Tax Court held that there was no abuse in discretion in rejecting a taxpayer’s Offer in Compromise where amounts includible in a taxpayer’s reasonable collection potential included amounts collectible from third parties through a legal action, such as a suit to set aside a fraudulent conveyance.
In W. Zintl Construction, Inc. v. Commissioner, Tax Court Memorandum 2017-119, the Tax Court held that an IRS settlement officer’s rejection of a corporation’s offer in compromise solely on the basis of his calculation of reasonable collection potential that used the corporation’s going-concern valuation, but disregarded completely its tax liability, was not reasonable. According to the court, the IRS’s reasoning was faulty because it increased the corporation’s going-concern value by the amount of the corporation’s unpaid tax liability, which the appraisal took into account in its calculation of value, and based its determination of reasonable collection potential solely on this modified value. However, the problem with this is that the going-concern value is intended to give some indication of the value of a company as a continuing business; that is, what a third party might pay to buy the corporation as a whole, including all of its assets and liabilities. No third party would buy a company, the court noted, without taking into account the unpaid tax liability.
The taxpayer may administratively appeal a rejection of an Offer to Compromise to the IRS Office of Appeals (Appeals) if, within the 30-day period beginning the day after the date on the letter of rejection, the taxpayer requests such an administrative review in the manner provided by the IRS (Regulation Section 301.7122-1(f)(5)(i)).
Where a determination is made to return offer documents because the offer to compromise was nonprocessable, because the taxpayer failed to provide requested information, or because the IRS determined that the offer to compromise was submitted solely for purposes of delay, the return of the offer does not constitute a rejection of the offer and does not entitle the taxpayer to appeal the matter to Appeals. However, if the offer is returned because the taxpayer failed to provide requested financial information, the offer will not be returned until a managerial review of the proposed return is completed (Regulation Section 301.7122-1(f)(5)(ii)).
Frivolous submissions: If the IRS determines that any part of an offer in compromise is frivolous, then it may treat such portion as if it were never submitted and such portion will not be subject to any further administrative or judicial review (Code Section 7122(f)).
Observation: Two Code Section 7122(f) provisions have been enacted. One deals with accepting an offer in compromise within 24 months and the other deals with frivolous submissions. This will most likely be fixed in future technical amendments.
Dissipated Assets: The value of dissipated assets may be included in the calculation of the taxpayer’s reasonable collection potential (RCP) (Johnson v. Commissioner, 136 Tax Court 475 (2011); Samuel v. Commissioner, Tax Court Memorandum 2007-312). A dissipated asset is defined as any asset (liquid or non-liquid) that has been sold, transferred, or spent on non-priority items or debts and that is no longer available to pay the taxpayer’s tax liability (Internal Revenue Manual 22.214.171.124(1)).
If the taxpayer establishes that he used the dissipated assets for necessary living expenses, the Internal Revenue Manual instructs the settlement officer not to include them in the reasonable collection potential calculation (Internal Revenue Manual 126.96.36.199(4)). If the taxpayer fails to provide information substantiating the disposition of the funds from such assets, the settlement officer may consider including the full value of the dissipated assets as part of the taxpayer’s reasonable collection potential, for purposes of determining an acceptable offer amount (Internal Revenue Manual 188.8.131.52(8)).
Observation: A consequence of including dissipated assets in RCP is that the taxpayer is fictitiously assumed to have, as funds available to pay his tax liability, money that he manifestly does not have anymore–an assumption that may be discouraging to the delinquent taxpayer who is trying to get right with the IRS. However, the reason for this rule is to deter delinquent taxpayers from wasting money that they owe and should pay as taxes. Removing dissipated assets from reasonable collection potential (RCP) could create perverse incentives, and the IRS must have discretion to avoid that problem. Thus, it seems reasonable for the IRS to consider including dissipated assets in a taxpayer’s reasonable collection potential.
User Fees Applicable to Offer in Compromise Processing: The IRS charges $186 for processing an Offer in Compromise, which includes reviewing and monitoring the offer (Regulation Section 300.3). If a fee is charged and the offer is accepted to promote effective tax administration or accepted based on doubt as to collectability where the IRS has determined that collection of an amount greater than the amount offered would create economic hardship, then the user fee is applied against the amount to be paid under the offer unless the taxpayer requests that it be refunded (Regulation Section 300.3(b)(2)(i) and (ii)). No fee is charged if an offer is based solely on doubt as to liability, or made by a low-income taxpayer (Regulation Section 300.3(b)(1)(i) and (ii)). Proposed regulations would increase the fee to $300 (Proposed Regulation Section 300.3(b)(1)). The proposal would not modify the provisions that waive the user fee for Offers in Compromise submitted by low-income taxpayers and offers in compromise based solely on doubt as to liability. The increased user fee for Offers in Compromise is proposed to apply for offers submitted on or after February 27, 2017 (Proposed Regulation Section 300.3(b)(1)).
Effective for Offers in Compromise submitted after July 1, 2019, any user fee otherwise required in connection with the submission of an Offer in Compromise does not apply with respect to a taxpayer who is an individual with adjusted gross income, as determined for the most recent tax year for which such information is available, which does not exceed 250 percent of the applicable poverty level, as determined by the IRS (Code Section 7122(c)(3)).
Form 433-A and Form 433-B: The process of applying for an offer in compromise involves completing Form 433-A (Offer in Compromise), Collection Information Statement for Wage Earners and Self-Employed Individuals and/or Form 433-B (Offer in Compromise), Collection Information Statement for Businesses, filling out a Form 656, Offer in Compromise, and attaching an initial payment along with the applicable user fee for each offer sent into the IRS.
The information on Form 433-A and/or Form 433-B is used to calculate an appropriate offer amount based on the taxpayer’s assets, income, expenses, and future earning potential. If the taxpayer has an asset that is used to produce income (for example, a tow truck used in a towing business), the taxpayer may be allowed to exempt the equity in such asset. Where a taxpayer makes an offer that is less than the amount calculated on either Form 433-A or Form 433-B, a description of the special circumstances that apply should be included.
In Kreit Mechanical Associates, Inc. v. Commissioner, 137 Tax Court 123 (10/3/11), the taxpayer discounted the value of its accounts receivable shown on Form 433-B by 75 percent. The taxpayer claimed that the discount was based on the fact that some of the receivables were subject to joint checks (that is, a check written to more than one person). The Tax Court held that the discount was inappropriate because the taxpayer never submitted any documentation that its most current accounts receivable were subject to joint checks.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357
P.S. My firm is based upon referrals. Please feel free to refer my firm to anyone you know that is looking for a new CPA and/or tax preparer. Thank you in advance.