Wednesday, November 26, 2008

Objectives of an Offer in Compromise

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 ¶41,130.50as 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).

The IRS does not have the authority to accept an offer in compromise (OIC) when:
(1) questions concerning the amount of the taxpayers liability or the collection of a liability for all or part of the periods the taxpayer owes is in litigation;

(2) the federal tax liability for all or part of the periods the taxpayer owes has been reduced to a judgment;

(3) the IRS has a civil or criminal prosecution pending against the taxpayer in the Department of Justice (DOJ) or United States Attorneys Office;

(4) acceptance of the offer is dependent upon the acceptance of a related offer or upon a settlement under the authority of the Department of Justice (Internal Revenue Manual, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK).

Taxpayers are responsible for initiating the first specific proposal for compromise and will not be advised on the amount to be offered. The offer should be a legitimate compromise proposal based on ability to pay. It should not be considered a fishing expedition based on the theory that the IRS will accept any amount.

Under regulations issued prior to the enactment of the Tax Increase Prevention and Reconciliation Act of 2005 ( P.L. 109-222), sums submitted with an offer in compromise or while an offer was pending were considered refundable deposits and would not be applied to the liability unless the offer was accepted or the taxpayer authorized in writing that the deposit could be applied to the liability. However, for offers submitted on or after July 16, 2006, taxpayers are required to make nonrefundable partial payments with their offers (Code Sec. 7122(c), as added by P.L. 109-222). See ¶41,130.0245.

If the offer is accepted, taxpayers waive certain refunds or credits that they might otherwise be entitled to receive. On doubt as to collectibility offers only, acceptance of the offer will require the taxpayer to comply fully with all filing and payment requirements over the next five years. Failure to comply will be treated the same as a default in payment.

Offers in compromise must be submitted using Form 656, Offer in Compromise (Rev. February 2007). The offer should include all information necessary to verify the grounds for compromise. If the offer is based on doubt as to collectibility, the taxpayer must include a completed financial statement on Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, and/or Form 433-B, Collection Information Statement for Businesses, or any other financial statement prepared by the taxpayer, as long as it conforms with the information requested on either of the forms and is signed by the taxpayer under penalties of perjury. If a taxpayer is self-employed, both financial statements are required (Instructions to Form 656, Offer in Compromise). The offer must also include the required partial payment of 20 percent of the amount offered or the first proposed installment, depending on the type of offer submitted on or after July 16, 2006.

If the offer is based on doubt as to liability, submission of a financial statement is not required, but the taxpayer must submit a detailed statement as to why the amount is not owed to the IRS.

Fixed monthly payment option. A simplified method of settling taxpayer debts under the offer in compromise program will allow taxpayers a fixed monthly payment option and will assist taxpayers and practitioners in situations where the full amount of the debt cannot be met. Under the program, the IRS will calculate the exact amount an individual will owe during the life of the offer in compromise payments (Instructions to Form 656, Offer in Compromise (Rev. February 2007); IRS News Release, IR-1999-105, December 29, 1999).

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