Wednesday, June 4, 2008

Section 7122 - Compromises: Determination of an adequate offer

An offer in compromise based on Doubt as to Collectibility (DATC) amount must generally equal or exceed a taxpayers reasonable collection potential (RCP) in order to be considered for acceptance (Internal Revenue Manual, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK). There may be exceptions for cases with unusual or special circumstances, such as advanced age, serious illness from which recovery is unlikely, or unusual circumstances that impact the ability to pay the tax and continue to provide for the taxpayer's family. If special circumstances apply, the taxpayer should fill out the "Explanation of Circumstances" portion of Form 656, Offer in Compromise.

A taxpayer's reasonable collection potential is the net equity of the taxpayer's assets plus the amount that the IRS could collect from the taxpayer's future income. If the IRS's analysis indicates that the taxpayer has the ability to pay the tax liability in full, either immediately or through an installment arrangement, then the IRS will not accept the offer in compromise.

The IRS provides a worksheet for the taxpayer to use to estimate the amount that the IRS will view as the taxpayer's reasonable collection potential (Instructions to Form 656, Offer in Compromise). The worksheet indicates that the IRS will generally expect to collect all of a taxpayer's financial assets, plus 80 percent of the taxpayer's equity in cars and real estate, plus 80 percent of the taxpayer's equity in other personal assets, reduced by a small allowance (less than $10,000). The IRS will also expect to collect an additional amount based on the taxpayer's income. The amount the IRS expects to collect from a taxpayer is made up of the following components:

(1) the amount collectible from the taxpayer's assets;

(2) the amount collectible from the taxpayer's future income;

(3) the amount collectible from third parties, such as transferees; and

(4) the amount collectible from the taxpayer that the taxpayer should reasonably be expected to raise from assets in which he has an interest that is beyond the reach of the government, such as property located outside the United States or property owned by tenancy by the entirety.

The starting point in the consideration of an offer submitted based on doubt as to collectibility is the value of the taxpayer's assets less encumbrances that have priority over the federal tax lien. Ordinarily, the liquidating or quick sale value of assets is to be used. In some cases, it is reasonable to consider minimum bid price in determining collection potential. All assets must be considered in determining the amount collectible from the taxpayer (Internal Revenue Manual 5.8.5, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK).

A taxpayer's education, profession or trade, age and experience, health, and past and present income will be considered in evaluating his future income prospects for purposes of determining collectibility. An evaluation must be made of the likelihood that any increase in real income will be available to pay the delinquent taxes. Cost of living increases must also be taken into account in determining amounts potentially collectible from future income (Internal Revenue Manual 5.8.5, 09-01-2005).

Frivolous submissions. The civil penalty for frivolous tax returns has been increased from $500 to $5,000, and now applies to all taxpayers and all types of federal taxes and submissions (Code Sec. 6702(a), as amended by the Tax Relief and Health Care Act of 2006 (P.L. 109-432)). Therefore, the $5,000 civil penalty now also applies to any request for a collection due process hearing, an installment agreement, or an offer-in-compromise that raises frivolous arguments. The Secretary will prescribe, and periodically revise, a list of positions identified as frivolous.

As extended, the penalty applies to any "person" who files a return, not just to an "individual" (Code Sec. 6702(a), as amended by P.L. 109-432). The definition of the term "person" includes an individual, a trust, estate, partnership, association, company or corporation, as defined in Code Sec. 7701(a)(1).

A "specified frivolous submission" is a specified submission that either:

-- based on a position that the Secretary has identified as frivolous in his prescribed frivolous positions list; or

-- reflects a desire to delay or impede the administration of federal tax laws

(Code Sec. 6702(b)(2)(A), as added by P.L. 109-432). A "specified submission" is:

(1) a request for a hearing after --

(a) the IRS files a notice of lien under Code Sec. 6320, or

(b) the taxpayer receives a pre-levy Collection Due Process Hearing Notice under Code Sec. 6330,


(2) an application relating to --

(a) agreements for payment of tax liability in installments under Code Sec. 6159;

(b) compromises under Code Sec. 7122; or

(c) taxpayer assistance orders under Code Sec. 7811

(Code Sec. 6702(b)(2)(B), as added by P.L. 109-432). Any portion of an application for an offer-in-compromise under Code Sec. 7122 or for an installment agreement under Code Sec. 6159 will be treated as if it were never submitted and will not be subjected to any further administrative or judicial review, if that portion of the application meets either requirement for a specified frivolous submission (Code Sec. 7122(f)[(g)], as added by P.L. 109-432).

The IRS has issued a news release announcing updated guidance which describes and rebuts frivolous arguments that taxpayers should avoid when filing their tax returns (IRS News Release, IR-2006-45, March 16, 2006). The IRS has also updated the document entitled "The Truth About Frivolous Tax Arguments" (November 30, 2006; available at, that addresses false arguments about the legality of not paying taxes or filing returns.

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