Wednesday, June 4, 2008

Offer in Compromise Defined

An offer in compromise (OIC) is a contractual agreement between the IRS and a taxpayer under which the taxpayer agrees to pay a specified amount in full settlement of assessed tax liabilities, including interest and most penalties (Code Sec. 7122(a)). The compromise process is primarily used by taxpayers experiencing financial difficulties, as a means by which they can have their tax liability reduced and settled without resorting to expensive litigation. While closing agreements relate to the agreed-upon tax liability of the taxpayer, offers in compromise are agreements between the taxpayer and the IRS as to the amount of tax liability that will be paid and how that amount will be paid.

The IRS has authority to compromise any civil or criminal case arising under the internal revenue laws. A taxpayer's offer to compromise tax liability must be based on one or all of the following grounds:

(1) doubt as to liability for the amount of taxes assessed;

(2) doubt as to the collectibility of the full amount of tax, penalty and interest assessed (Reg. §301.7122-1(b)); and/or

(3) promotion of an effective tax administration (Reg. §301.7122-1(b)(3)).

The IRS Restructuring and Reform Act of 1998 (P.L. 105-206) required the IRS to develop employee guidelines for determining whether a proposed offer in compromise is adequate and should be accepted to resolve a dispute (Code Sec. 7122(d)(1), as redesignated by the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222)). As a result, the IRS revised its procedures in this area, as set forth in regulations (Reg. §301.7122-1), the Internal Revenue Manual (see CCH IRS OFFER IN COMPROMISE HANDBOOK; Internal Revenue Manual 5.8, 09-01-2005), and Rev. Proc. 2003-71 (full text at ¶41,130.45). These guidelines include national and local allowances under which IRS employees may determine the basic living expenses of a taxpayer entering into a compromise. The IRS was directed to determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the standard allowances is appropriate. Local and national standards are not to be used to the extent that they would result in a taxpayer not having adequate means to provide for basic living expenses (Code Secs. 7122(d)(1) and (2), as redesignated by P.L. 109-222).

Under the offer-in-compromise guidelines, IRS employees may not reject an offer from a low-income taxpayer solely on the basis of the amount of the offer. If an offer in compromise is based on doubt as to liability, the IRS may not reject an offer solely because the IRS cannot locate a taxpayer's return or return information for verification purposes. Moreover, anyone seeking an offer in compromise based on doubt as to liability is not required to provide a financial statement (Code Sec. 7122(d)(3), as redesignated and amended by P.L. 109-222).

The Conference Committee Report to P.L. 105-206 contemplates that the IRS will consider factors such as equity and hardship when determining whether to accept an offer in compromise. The conferees urge the IRS to be flexible in finding ways to work with taxpayers who are sincerely trying to meet their tax obligations. This could be accomplished, for example, by forgoing penalties and interest amounts that have accumulated while determinations of taxpayer liability were being made.

A compromise may be entered into before a case is referred to the Department of Justice for prosecution or defense. The Attorney General or delegate may compromise a case after it has been referred to the Department of Justice (Code Sec. 7122(a)).

The IRS views an offer in compromise as a legitimate alternative to declaring a case currently uncollectible or to participating in a protracted installment agreement, and it has provided guidelines that set forth the procedures to be followed by taxpayers and IRS personnel when accepting an offer in compromise (Internal Revenue Manual 5.8, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK).

The IRS's objectives in accepting offers in compromise are:

(1) to effect collection of what could reasonably be collected at the earliest time possible 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 give taxpayers a fresh start toward future voluntarily compliance with all filing and payment requirements; and

(4) to collect funds which may not be collectible through any other means (Internal Revenue Manual, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK).

As a contract, the offer in compromise is subject to the rules governing general contract law (Walker v. Alamo Foods Co., 1 USTC ¶207, and Ely & Walker Dry Goods Co., 1 USTC ¶423, at ¶41,130.50, as well as R.C. Lane, 62-1 USTC ¶9467, and B.R. Kurio, 71-1 USTC ¶9112, at ¶41,130.25).

The contract spells out the terms for payment of the tax liability. The underlying assessment is not abated, and interest accrues even if the offer in compromise is accepted by the IRS. The original liability can be revived if the taxpayer defaults on the terms of the compromise agreement (Instructions to Form 656, Offer in Compromise (Rev. February 2007), p. 16). See ¶41,130.04.

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