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Tax Law Center
Who amongst us has not heard or read the above solicitation or something all but identical? Even neophyte lawyers know that extravagant claims which appear just too good to be true often times are. The above claim alludes to a “kinder gentler IRS” and its Offer In Compromise program discussed below.
IRS is owed approximately $280 billion dollars in delinquent federal taxes of all types. Senator Evert Dirkson is supposed to have said "A billion here, a billion there, and pretty soon you're talking real money" What steps can the Government take to collect at least a portion of what it is owed? An Offer in Compromise (hereinafter “OIC”) is one tool that the Government has at its disposal to collect delinquent taxes. An OIC allows certain taxpayers who are delinquent with their federal taxes the opportunity to settle their tax liabilities with the Government for sometimes pennies on the dollar. A properly executed OIC constitutes a legally binding contract between the Government and a taxpayer. See Big Diamond Mills v. United States, 10 AFTR 315, 318 (CA8 1931). A taxpayer must submit an OIC on Internal Revenue Service (hereinafter “IRS”) Form 656.
The Government’s objectives regarding OICs are to: 1) collect delinquent taxes at the earliest possible time and at the least cost to the Government, 2) to achieve a resolution that is in the best interest of both the individual taxpayer and the Government, 3) to provide the taxpayer with a fresh start to future voluntary compliance with all filing and payment requirements, and 4) to secure collection of revenue. See Internal Revenue Manual (hereinafter “IRM”) Part 22.214.171.124.4 (09-01-2005). From the Government’s perspective, an OIC is a viable alternative to declaring a taxpayer’s case not collectable or to a protracted installment agreement. See P. 1 IRS Form 656.
Before the IRS Restructuring and Reform Act of 1998 (hereinafter “RRA”), Public Law 105-206 (112 Stat. 685), the IRS accepted an OIC on only two grounds: 1) doubt as to liability, and 2) doubt as to collectibility. Pursuant to the RRA, the IRS must now “take into account factors such as equity, hardship and public policy where a compromise of an individual taxpayer’s income tax liability would promote effective tax administration.” See H.R. Conf. Rep. No. 599, 105th Cong., 2d Sess., 289 (1998). Accordingly, there are currently three grounds compromise: 1) doubt as to liability, 2) doubt as to collectibility, and 3) effective tax administration.
This article contains two parts. Part one discusses Code § 7122, which is the Code section authorizing an OIC. Part two cites the applicable Treasury Regulations that contain three grounds for an OIC. Part two also cites IRM sections applicable to an OIC.
Part 1: Code § 7122: The IRS’s Authority to Compromise a Taxpayer’s Tax Liability:
Code § 7122(a) grants the Secretary of the Treasury the power to compromise any civil or criminal case arising out of the IRS laws before the case is referred to the Department of Justice for prosecution or defense. Under Code § 7122(b) whenever the IRS makes a compromise, the General Counsel for the Department of Treasury must write an opinion and then file it in the office of the Secretary of the IRS. Note that an opinion is not necessary in any civil case in which the amount of unpaid tax assessed (including any additional interest and penalty) is less than $50,000. The IRS is required to establish procedures to independently review rejections of an OIC prior to the time that rejections are sent to the taxpayer. In addition, a taxpayer has the right to appeal such rejection within the IRS Office of Appeals. Code § 7122(d).
Part II: Grounds for Compromise Under The Treasury Regulations:
Pursuant to Treasury Regulation (hereinafter “Treas. Reg.”) § 301.7122-(1)(b) the IRS can compromise a tax liability under any of the following grounds: 1) doubt as to liability, 2) doubt as to collectibility, and 3) to promote effective tax administration either because (a) collection of the full amount would cause economic hardship for the taxpayer or (b) the taxpayer identifies compelling public policy/equity considerations providing a sufficient basis for compromising a liability.
The first ground for compromise is doubt as to liability (hereinafter “DL”). See Treas. Reg. § 301.7122-(1)(b)(1). A DL ground exists when there is a genuine dispute as to the existence or amount of the correct tax liability--meaning that the taxpayer believes that he does not owe the tax liability. In a DL ground the taxpayer is not required to complete an IRS Form 433-A collection information statement for wage earners and self-employed individuals (hereinafter “433-A”) or an IRS Form 433-B collection information statement for businesses (hereinafter “433-B”). An OIC based on grounds of DL is generally acceptable if it reasonably reflects what the IRS would expect to collect through litigation including the hazards of litigation. See Rev. Proc. 2003-71, 2003-2 CB 517 (2003).
The second ground for submitting an OIC is doubt as to collectibility (hereinafter “DC”). In DC cases the assets and income of the taxpayer are less than the full amount of the tax liability. See Treas. Reg. § 301.7122-(1)(b)(2). An OIC based on DC grounds is generally accepted if it is unlikely that the tax will be collected in full and the offer reasonably reflects the amount the IRS could collect through other means including administrative and judicial collection remedies. See IRM Part 126.96.36.199 (09-01-2005. In a DC offer, the tax liability equals or exceeds the taxpayer’s reasonable collection potential. The reasonable collection potential equals a taxpayer’s net equity plus future income. Prior to the time the IRS considers a DC offer (absent special circumstance, see below) the taxpayer must demonstrate that he is not able to pay the taxes in full by either liquidating assets or through IRS prescribed installment agreement guidelines. Also, with DC cases, taxpayers must submit either Form 433-A or 433-B. In a doubt as to collectibility with special circumstances (hereinafter “DCSC”) case a taxpayer may qualify for an effective tax administration (discussed below) ground for an OIC when his reasonable collection potential is greater than his tax liability but there are economic hardship or public policy/equity circumstances that warrant the IRS’s acceptance of an OIC based on the DCSC ground. See IRM Part 188.8.131.52.2 (09-01-2005).
The third ground for an OIC is effective tax administration (hereinafter “ETA”). See Treas. Reg. § 301.7122-(1)(b)(3). In 2002, the IRS promulgated regulations, which list the requirements for an acceptable ETA offer. See Treasury Decision 9007 (July 19, 2002). In order to qualify for an ETA a taxpayer must have the ability to pay in full his tax liability. Likewise, the taxpayer cannot be eligible for an OIC based on grounds as to DL or DC. See Treas. Reg. § 301.7122-1(b)(3). The
IRS will not accept an OIC based upon ETA if it would contravene a taxpayer’s compliance with the tax laws. Treas. Reg. § 301.7122-1(b)(3)(iii). If a taxpayer has a history of not complying with IRS filing requirements, has encouraged others not to comply with tax laws, or has taken deliberate actions to avoid the payment of taxes, then the IRS will not accept an OIC based on an ETA ground. Treas. Reg. § 301.7122-1(c)(3)(ii).
In an ETA ground, the taxpayer has no doubt that the tax is correct and there is no doubt that the tax is collectable because the taxpayer can pay the full amount of his tax liability; however, exceptional circumstances exist that warrant the IRS to consider a taxpayer’s OIC. With ETA offers, a taxpayer must submit a Form 433-A or Form 433-B and he must send the IRS a written narrative that describes his special circumstances as to why paying the tax liability in full would create an economic hardship or would be inequitable under his circumstances. Treas. Reg. § 301.7122-(1)(b)(3)(i).
Economic hardship as described in IRM Part 184.108.40.206.1 (09-01-2005) encompasses situations in which a person’s tax liability can be collected in full but collection would create an economic hardship. Economic hardship occurs when a taxpayer is unable to pay reasonable basic living expenses. An ETA ground for compromise based on public policy/equity standards are justified in situations where collection of the full liability would undermine the public’s confidence that the tax laws are being administered in a fair and equitable manner. Therefore, a taxpayer trying to use a public policy/equity standard when submitting his OIC must demonstrate circumstances that justify the OIC even though a similarly situated taxpayer paid his tax liability in full. Treas. Reg. § 301.7122-(1)(b)(3)(2)(i).
A taxpayer seeking to settle his tax liability for less than the full amount of tax due may be able to execute an OIC with the IRS. However, failure to comply with IRS laws and procedures may negate a taxpayer’s opportunity to enter into an OIC with the IRS. In sum, when the IRS accepts a taxpayer’s OIC, the taxpayer is able to settle his tax liability for an amount less than the total tax he owes the Government. For some taxpayers, this could mean saving pennies on the dollar.