- A collateral agreement enables the government to collect funds in addition to the amount actually secured by the offer or to add additional terms not included in the standard Form 656 agreement, thereby recouping part or all of the difference between the amount of the offer or additional terms of the offer and the liability compromised.
- After consideration of all the facts and circumstances, the refusal to enter into an appropriate collateral agreement may be a reason to reject the taxpayer's offer. The offer file must be clearly documented with the basis for the rejection.
- Collateral agreements may be appropriate in situations where a significant recovery is anticipated or securing a collateral agreement will facilitate resolution. The monitoring aspects of the agreement should also be considered when making the decision as to whether a collateral agreement is appropriate. The basis for securing the collateral and reasoning why additional recovery is being sought must be fully documented in the AOIC and/or ICS history.
- Do not use a collateral agreement to accept an offer amount less than the taxpayer's financial condition indicates.
- In lieu of a collateral agreement, the taxpayer may increase the amount of the offer equivalent to what the government could reasonably expect to recover from the collateral agreement.
- A collateral agreement may be appropriate in the following situations:
If the taxpayer… Then consider securing a… Anticipates a substantial increase in future income Future income collateral agreement. Is compromising the income tax liability of a defunct professional corporation Future income collateral agreement from the majority or sole owner of the professional corporation to collect from their future individual income. Has real or personal property that is being depreciated Collateral agreement to reduce the basis of the asset. Has net operating losses or capital losses arising from prior years available for deduction in future years A collateral agreement to waive the loss.
Note:Monitoring for this type of collateral is limited to the CSED timeframe for the tax periods on the accepted offer.
Is seeking to compromise a TFRP and qualifies to take a capital loss benefit from the defunct corporation on Form 1040 A collateral agreement from the individual taxpayer to waive the capital loss.
Note:Monitoring for this type of collateral is limited to the CSED timeframe for the tax periods on the accepted offer.
- It is appropriate to consider future collateral agreements for individuals, limited liability companies, and corporations when the investigation reveals that a substantial increase in the taxpayer's future income is expected.
- The use of a future income collateral agreement may be an option when the calculation of the taxpayer's future income for RCP purposes does not reasonably reflect the taxpayer's earnings potential. Scenarios where the taxpayer's future income may be substantially higher include the following:
- The taxpayer's past income does not provide an accurate analysis for what may be earned in the future based on their earnings potential due to their training or education.
Example:(1) The taxpayer is an engineer, but is currently employed as a salesman earning less than half of his prior salary due to difficulty he has had in obtaining a job in the engineering field at the present time; (2) The taxpayer is a student and is expected to graduate soon and begin earning a significant annual income;
- The taxpayer's current income is minimal or considerably less than what the taxpayer has earned in the past and a reasonable expectation exists that the taxpayer's earnings will be increasing substantially prior to the expiration of the CSED.
Note:The use of income averaging is appropriate, based on current economic conditions, when an average calculation of taxpayer's past earnings reasonably reflect their future earnings potential. Refer to IRM 22.214.171.124.
- Do not secure a future income collateral agreement:
- To collect future income that should be included in the offer amount.
- Merely on unfounded speculation about an increase in income.
- To cover statistically improbable events, such as lottery winnings.
- To attempt collection from a potential inheritance.
- Future income collateral agreements must be monitored annually for the life of the agreement. The cost of monitoring and the difficulty in tracing income structured through other entities should be considered when deciding whether such an agreement is warranted. When necessary, include instructions to MOIC regarding when it is appropriate to issue an other investigation to follow up on the receipt of potential funds.
Note:Consult Area Counsel relative to the wording of unique collateral agreement situations.
- Use Form 2261, Collateral Agreement — Future Income (Individual), for individual taxpayers or Form 2261–A, Collateral Agreement — Future Income (Corporation) for corporate taxpayers.
- The beginning year is defined as the year following acceptance of the offer. The ending year is defined as the last year for which the collateral agreement will remain in effect.
- The period of time a future income collateral agreement should cover will be determined by the circumstances identified in the offer investigation based on the taxpayer's financial situation. Generally the period of time the agreement covers should coincide with the future compliance provision.
Example:(1) If the offer terms are for a cash or short term deferred payment and based on 48 or 60 months, the future income collateral agreement should generally run for five years; (2) If the offer terms are based on deferred payments calculated through the collection statute periods, the future income collateral should generally run through the last full year before the statutory period for collection expires;The offer file should document the basis for the time frame used for each collateral agreement.
- The beginning dollar amount should allow for the taxpayer to meet reasonable and necessary living expenses during the term of the offer. The offer specialist (OS) should be flexible allowing for the expected rate of inflation, as well as any additional expenses such as those for an expected additional child or a replacement auto which may occur while the collateral agreement is being monitored. Generally, the initial dollar amount should approximate one and one-half times the taxpayer's current necessary and reasonable living expenses, less federal income tax (including self-employment tax, if applicable).
Note:A future income collateral agreement should not be used to recover minimal amounts the taxpayer may receive from future cost of living or other longevity raises. The expected recovery should be based on a reasonable assumption of a substantial increase in the taxpayer's income based on changes in their situation.
- The percentages and amounts determined appropriate in Item 1 of Form 2261 or Form 2261–A are negotiable and should be based on the taxpayer's situation and reflect appropriate anticipated increases in reasonable and necessary expenses. The beginning percentage should be determined based on the facts and circumstances of the case. Increases in the percentage amounts may also be included, when appropriate. The OE/OS should use judgment in determining the amounts used when completing Form 2261.
Example:The taxpayer has submitted an offer which is greater than reasonable collection potential (RCP) and is deemed acceptable. There is also a reasonable basis that the taxpayer's income will increase substantially over the next two years to over $100,000 per year. The total current reasonable expenses from the income/expense table (IET) used in the offer evaluation is $ 4000 per month ($750 per month is the federal tax liability). Based on this information a collateral agreement Form 2261 is secured. The amount used on Form 2261 is 40% of any amount over $58,500 per year (4000 - 750 = 3250 x 1.5 x 12 = 58500.
Example:Taxpayers have submitted an offer which is greater than RCP and is deemed acceptable. The taxpayer has been involved in multi-million dollar developments and there is a reasonable basis to determine the taxpayer may receive a substantial payment from a future development within the next 24 to 48 months. The current reasonable expenses for the household from the IET used in the offer evaluation is $ 5000 per month ($1000 per month is the federal tax liability). Based on this information a collateral agreement Form 2261 is secured. Amounts used on Form 2261 are 40% of any amount between $72,000 (5000 - 1000 = 4000 x 1.5 x 12 = 72000) and $150,000, plus 75% of any amount over $150,000.
Note:These examples are not meant to be all inclusive, judgment must be used to determine the appropriate percentages and dollar amounts when completing Form 2261 and Form 2261-A. It is also not necessary to always have graduated payments, a set percentage as in the first example will be appropriate in most instances.
- Offers with future income collateral agreements must be approved by the authorized approving official of the offer in compromise. The approving official will indicate approval by signing Form 7249, Offer Acceptance Report, and the acceptance letter. Form 2261 may be signed by the authorized official in Delegation Order 25–2.
- The initial basis of an asset is equal to the cost of acquiring it. Adjustments to the basis are made each year for the cost of improvements and accumulated depreciation. When an asset is sold, the basis is used to determine the amount of capital gain to be taxed.
- A collateral agreement may be used to reduce the basis of a specific asset, after accumulated depreciation (book value), to a lesser amount or zero. The effect of reducing the basis of a specific asset include limiting or eliminating the amount of deprecation deduction allowed in future years, potentially having the taxpayer incur a higher capital gain tax to be paid if the asset is later sold for an amount more than the adjusted basis or reducing the amount of the loss the taxpayer can claim.
- Use Form 2261–B, Collateral Agreement — Adjusted Basis of Specific Assets. The beginning year is defined as the year after the last filed tax return. Insert the year of the last filed tax return in the phrase "for all taxable years beginning after" . Specifically describe each asset. Set the amount of the basis at the reduced or zero value.
Note:A specific description of the asset must be included in the collateral agreement in order for MOIC to monitor the agreement.
- Adjusted basis collateral agreements must be monitored annually until the asset is ultimately disposed of or the expiration of the collection statute expiration date(s) (CSED) on all tax periods included in the offer, whichever occurs first. Consider the cost to monitor the agreement and the difficulty in tracing the sale or exchange of the property when deciding whether such an agreement is warranted.
- Use Form 2261–C, Collateral Agreement —Waiver of Net Operating Losses, Capital Losses, and Unused Investment Credits. The beginning year is defined as the next year after the last filed tax return. Insert the year of the last filed tax return in the phrase "for all taxable years beginning after" . Waive net operating losses and capital losses arising from all years prior to and including the last filed tax return.
- Do not prohibit the deduction of losses that arise in years after the offer is accepted.
- The waiver of investment credits is obsolete.
- Waiver of losses collateral agreements must be monitored annually until all the losses are extinguished or the expiration of the CSED(s) on all tax periods included in the offer. Consider the cost to monitor the agreement and potential for recovery of future tax liabilities when deciding whether such an agreement is warranted.
- A waiver of losses collateral agreement may be secured to partially waive a loss, if the facts of the case support this determination.
- Net Operating Loss (NOL) may be incurred when expenses exceed the income of a business.
- The taxpayer must be able to prove the amount of the loss.
- Generally, losses may be carried back no more than five years and forward no more than twenty years or until all the loss is offset against taxable income.
- If the taxpayer only wishes to carry the loss forward, the taxpayer must elect to do so on a timely field return for the year of the loss, or if the original return is filed timely but no election is made on an amended return by the close of the period 6 months after the due date of the return excluding extensions.
- When the taxpayer has claimed a NOL, determine and verify the exact origin and amount of the loss. If a taxpayer has been associated with more than one business there may be multiple losses.
When… Then… Calculating the remainder of the NOL The loss can be located on the "other income" line or the "business loss" line on Form 1040 and should be labeled as Net Operating Loss. 1. Determine the original loss amount claimed on the tax return. 2. Subtract any carry backs. 3. Subtract the amounts claimed on subsequent tax returns from the year the NOL was established.
- Capital Loss is one in which the taxpayer experiences a loss associated with such investments as land, stock, paid in capital, or loans from shareholders. This loss is:
- Found on a Schedule D.
- Must be offset against only capital gain in the year it is incurred with the remainder carried forward for offset of only capital gain in future years. However, individuals are allowed to offset $3,000 against ordinary income in the year the capital loss is incurred and each succeeding year thereafter;
Example:A taxpayer has a $100,000 loss and a $40,000 gain. The taxpayer may offset $40,000 against the gain and an additional $3,000 loss against other income leaving a $57,000 loss that may be carried forward in future years.
- Individuals must carry capital loss forward and may carry the loss forward until it is exhausted without limit to the number of years of carry forward required. Corporations are generally limited to carry capital losses back 3 preceding years and forward 5 subsequent taxable years.
- When the taxpayer claims a capital loss, determine and verify the exact origin and amount of the loss.
If… Then… The loss is derived from personal investment The investment can be either loans to the corporation or the individual's capital investment in the corporation.
- Verify loans through copies of checks or general journal entries that establish the loan and track repayment.
- Verify capital investment through canceled checks or other documents which support the amount of the original loan.
Determining the remaining amount of the loss once you have determined the origin Trace the loss forward through the tax return copy or RTVUE.
- Passive Activity Loss is one that involves the conduct of any trade or business in which the taxpayer does not materially participate. This loss should not be confused with net operating loss.
- Any rental activity is a passive activity even if the taxpayer does materially participate.
- Losses from a passive activity generally cannot be deducted from other types of income (e.g., wages, interest, or dividends).
- The amount of the taxpayer's allowable loss is subject to the "at-risk" rules. Generally losses are limited to the amount of the taxpayer's cash contribution, adjusted basis of other property which contributes to the activity, and amounts borrowed for use in the activity if the taxpayer has personal liability for the borrowed amounts.
Note:Refer to the current Master Tax Guide for additional information.
- Because passive losses are not deducted from earned income, waiving them may have little or no effect. One option is to reduce the basis of the property to zero so that the taxpayer cannot carry the loss over to the tax year in which the property is sold and receive benefit of the loss against a capital gain at that time.
- When related taxpayers submit more than one offer to compromise different tax liabilities secure only one collateral agreement. Describe on the collateral agreement all the offers to which it relates.
- When more than one type of collateral agreement is secured for the same offer, separate collateral agreements may be secured or the terms of all the agreements may be incorporated into one Form 2261, Collateral Agreements – Future Income (Individuals) or Form 2261–A, Collateral Agreements – Future Income Corporation. The appropriate language may be found on Form 2261–B, Collateral Agreement – Adjusted Basis of Specific Assets, or Form 2261–C, Collateral Agreement – Waiver of Net Operating Losses, Capital Losses, and Unused Investment Credits.
Type of Agreement… Statement… Adjusted Basis of Assets "For the purpose of computing income taxes of the taxpayer for all years beginning after ___, the basis for certain assets, under existing law for computing depreciation and the gain or loss upon sale, exchange or other disposition shall be as follows:
Name of asset _____Other Identification _____
Dollar amount ______
That in no event shall the basis set forth above be in excess of the basis that would otherwise be allowable for tax purposes, except for this agreement."
Waiver of Net Operating Loss "For the purpose of computing income taxes of the taxpayer for all years beginning after ___, Any net operating losses sustained for the years before __shall not be claimed as net operating loss deductions under the provisions of Section 172 of the Internal Revenue Code." Waiver of Capital Losses "For the purpose of computing income taxes of the taxpayer for all years beginning after ___, Any net capital losses sustained for the years before __shall not be claimed as carryovers or carrybacks under the provisions of Section 1212 of the Internal Revenue Code."
- If there is insufficient space on the form to insert all the necessary paragraphs simply type the paragraph numbers followed by "See Attached" and fasten a separate sheet containing the added provisions.
- Form 656 contains a term which waives refunds and overpayments for all tax years through the year the offer in compromise is accepted. This waiver is a standard term, which cannot be altered.
- When accepting an offer based on DATL or under the basis of ETA involving public policy/equity considerations, the waiver of refunds is not applicable.
- In order to remove the waiver of refund provision for ETA offers involving public policy/equity considerations, both the taxpayer and the authorized official must sign an agreement and include it with the accepted offer in compromise. See Exhibit 5.8.6-1.
|Collateral Agreement — Modification of Waiver Provisions of Compromise Agreement|
|(For Use when offer is being accepted under Detriment to Voluntary Compliance or on the basis of Effective Tax Administration involving Public Policy/Equity considerations)|
|To: Commissioner of Internal Revenue|
|I submitted an offer dated (date) in the amount of $(amount), to compromise unpaid (kind of tax) tax, plus statutory additions, for the tax periods (dates).|
|The purpose of this letter is to modify that offer by stating that Section _____________ (insert appropriate section) of the agreement, Form 656, governing refunds and overpayments, will not apply to this offer. Acceptance of this offer will in no way alter my rights to refunds of overpayment or my ability to designate an overpayment to estimated tax payments for the following year:|
|I accept this modification on behalf of the Internal Revenue Service:|
|Signature of delegated official — Date|
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