An offer in compromise is an officially recognized method of compromising with the IRS or state tax collector and settling the entire claim for what ever the taxpayer can afford to pay today.
In many cases vast tax debts have been settled for $500, or $1,000, or $5,000, depending on circumstances. In some cases a compromise may involve payment of, say, $50,000, but if the taxpayer owes $1 million, that's a bargain!
The IRS Restructuring & Reform Act of 1998 mandates that the IRS should be more liberal in considering and accepting taxpayers' offers of compromise settlement. Thus, this is a good time to arrange such a compromise with the Government.
However, the offer-in-compromise program does not work for everybody. Some taxpayers are unable to meet the IRS guidelines for settlement.
THE IRS EXPLAINS OIC
Pursuant to section 7122 of the Internal Revenue Code, taxpayers may offer to compromise tax liabilities for less than the full amount owed (including interest and penalties).
In order for an offer to be considered, taxpayers must submit an offer-in-compromise form (Form 656), a collection information statement (Form 433A and/or Form 433B), and other documents that may be required. The Service will not consider offers from taxpayers who have not filed all required tax returns, or who are debtors in ongoing bankruptcy proceedings.
Businesses choosing to file an offer must also demonstrate that they have been in full compliance with employment taxes for the preceding two quarters, and have remained current with all federal tax deposits during the quarter in which the offer is filed.
After verifying that the offer meets these processability tests, the IRS evaluates the taxpayer's financial condition to determine the amount that the IRS could collect from the taxpayer. This amount is known as the taxpayer's Reasonable Collection Potential (RCP). The IRS generally accepts offers if the offered amount equals the taxpayer's RCP.
However, the IRS may accept offers of lower amounts in cases of economic hardship, or if acceptance would promote effective tax administration. The OIC program gives taxpayers the opportunity to comply with the tax laws and to get a fresh start.
Since 1916 The IRS has had an offer-in-compromise policy, embodied in Internal Revenue Code § 7122. The idea of an offer-in-compromise is that the taxpayer cobbles together a little money and offers it to the IRS in exchange for forgiveness of the balance. If the IRS figures that's all you can pay without ending up in the poor house, they are supposed to accept the offer. This sometimes results in a settlement payoff of only "pennies on the dollar." Another ground for settlement is the "equitable" ground, which means collection would be unfair in view of the totality of the circumstances.
The offer-in-compromise program is set forth primarily in IRC § 7122, Compromises, and IRM Part 5, Chapter 8, §§ 5.8.1 et seq.
In fiscal year 1991, the Internal Revenue Service accepted 25% of all Offers submitted. In fiscal year 1992, that figure had risen to 45% of all offers submitted. In fiscal year 1993, the Internal Revenue Service was accepting up to 53% of all offers. During fiscal year 1992 the Internal Revenue Service received 17,749 offers. It accepted 4,356, rejected 3,209 and 2,208 were withdrawn. During fiscal year 1993 the Internal Revenue Service received 51,220 Offers. It accepted 18,020 offers, rejected 8,247 and 7,745 were withdrawn.
Statistics give a picture of a lot of tax debt being compromised in favor of the taxpayers. In the nine months of fiscal year 1994 to June 1994, the Service accepted 50% of all offers, for $208 million out of $1.2 billion of liability. This compares with the 53% acceptance rate for 1993 and $209 million out of $1.3 billion compromised.
In 1996 the IRS received 134,000 offers and accepted $287 million to compromise claims. The number of offers submitted declined in 1997 to 114,000, according to IRS figures. In 1998 the IRS accepted $290 million in compromise settlements, and forgave $1.971 billion in delinquent taxes. This means the average delinquent tax claim was settled for roughly 15 cents on the dollar.
In 1998 the President signed into law the IRS Restructuring & Reform Act of 1998. This major overhaul of the IRS structure, mission, policies and procedures included a clear statement that Congress desires the IRS to be more liberal in its evaluation of offers for compromise. The Senate Finance Committee Report on the OIC provisions states:
The Committee believes that the ability to compromise tax liability and to make payments of tax liability by installment enhances taxpayer compliance. In addition, the Committee believes that the IRS should be flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations and remain in the tax system.
Accordingly, the Committee believes that the IRS should make it easier for taxpayers to enter into offer-in-compromise agreements, and should do more to educate the taxpaying public about the availability of such agreements.
In keeping with the added emphasis on the taxpayer, the revised IRS Manual states as one of the four key objectives of the offer program, "The compromise process is available to provide taxpayers with a fresh start toward future compliance with the tax laws." IRM § 184.108.40.206. And this policy is repeated where the Manual sets forth the purposes of the compromise program, which includes; "To give taxpayers a fresh start to enable them to voluntarily comply with the tax laws." IRM § 220.127.116.11.2. Thus, the legislative intent appears to shift the emphasis of the IRS mission away from its previous undivided focus on collection of taxes, toward more emphasis on providing opportunities to help taxpayers "get back into the system."
An offer in compromise may settle the matter to the satisfaction of debtor and the taxing entity without need of filing the bankruptcy. In some situations it is possible for the debtor to compromise or settle a liability or a dispute with the IRS (or other tax entity) by offering to pay a smaller sum as payment in full, even though a larger sum may be owed. If an offer is accepted, tax liens will be removed and enforced collection activities ceased.
Beware that the 240-day time period for assessment relevant to dischargeability of the tax in bankruptcy (see discussion of discharge in bankruptcy) is tolled during any time an offer in compromise is pending, plus 30 days. In the case of an IRS claim, the making of an offer also tolls the statute of limitations periods for assessment and collection of a tax claim, plus one year thereafter. IRM § 57(10)4.1. Thus, the making of an offer in compromise could have the effect of seriously impairing the debtor's eligibility to have the tax wiped out in bankruptcy. Considerable thought must therefore be given to the real advantage, if any, to be gained by tendering an offer in compromise on behalf of the debtor.
The statute says the bankruptcy clock is tolled during any time the OIC is "pending" but there is little or no case law defining what is meant by "pending." One case has held that the period is tolled only if the offer in compromise is made after the start of the 240-day period, not prior to the commencement of the period. U.S. v. Aberl, 1994 U.S. Dist. LEXIS 16372 (N.D.Ohio).
One key advantage of an offer in compromise has to do with nondischargeable tax claims. Once a tax claim has become the subject of an accepted offer in compromise it becomes an executory contract. The trustee in bankruptcy has the right to accept or reject an executory contract. It is possible, therefore, that the debtor could enter into an offer in compromise for a nondischargeable tax claim, and then file bankruptcy and reject the contract, thus in effect wiping out the claim. The theory here is that once the priority tax becomes the subject of a contract it loses its character as a priority tax. However, the author has found no case authority to support this argument.
In the case of IRS claims, IRC §7122 (Compromises) states
"The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense, and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense."
CAUTION - if an OIC is being considered, it should be made very clear to the client that, if accepted by the IRS the compromise includes a five-year probation period during which the client cannot be late filing or paying taxes. A late filing or payment may result in default of the compromise.
The process is regulated in more detail in Regulations, §301.7122 and treated, as well, in the Internal Revenue Manual.
In recent years the I.R.S. has taken the position (and attempted to indoctrinate its revenue officers) that a compromise should always be accepted if there is a serious doubt that any more could be collected over a five-year period.
In fact, an internal memorandum dated April 13, 1992 addressed to all collection field personnel (i.e. revenue officers) stated unequivocally " ... we will accept an offer if the amount offered reasonably reflects collection potential." The memo goes on to acknowledge that this is a "significant change in the Service's philosophy and culture at all levels." And it states "However, if, after taking into consideration 'present value' we know that more can be collected than is offered, the offer should not be accepted."
BASIS FOR SETTLEMENT
The Internal Revenue Manual (IRM 57(10)1, 57(10)7.2.) provides three grounds upon which an offer may be accepted:
Doubt as to liability;
Doubt as to collectability;
Effective tax administration (i.e., collection would be unfair considering all of the circumstances)
The validity and enforceability of the compromise are basically based on the law of contracts. Big Diamond Mills v. U.S., 51 F.2d 721; (1931), 2 USTC ¶791.
The offer in compromise is made by filling out IRS Form 656 (Offer in Compromise), plus if based on inability to pay, form 433 (Statement of Financial Condition). These forms are submitted in duplicate. For requirements as to filling out this form and making an offer in compromise, see IRS Manual §57(10)2.2.
Under prior IRS practice the making of an OIC did not automatically stop collection activity. However, the IRS Restructuring & Reform Act of 1998 established that, effective Dec. 31, 1999 once an offer is accepted by the IRS for consideration all levy activity must cease. Part IV, §3462 of the Act provides:
(b) LEVY PROHIBITED WHILE OFFER-IN-COMPROMISE PENDING OR INSTALLMENT AGREEMENT PENDING OR IN EFFECT-IRC Section 6331
''(k) NO LEVY WHILE CERTAIN OFFERS PENDING OR INSTALLMENT AGREEMENT PENDING OR IN EFFECT.-
''(1) OFFER-IN-COMPROMISE PENDING.-No levy may be made under subsection (a) on the property or rights to property of any person with respect to any unpaid tax-
''(A) during the period that an offer-in-compromise by such person under section 7122 of such unpaid tax is pending with the Secretary; and
''(B) if such offer is rejected by the Secretary, during the 30 days thereafter (and, if an appeal of such rejection is filed within such 30 days, during the period that such appeal is pending).
For purposes of subparagraph (A), an offer is pending beginning on the date the Secretary accepts such offer for processing.
Caveat; if the debtor files a bankruptcy, then attempts to negotiate an offer in compromise, the I.R.S. deems itself barred from considering an OIC, ostensibly due to fear such negotiations may be deemed a violation of the automatic stay.
This may create a problem for the debtor who needs immediate bankruptcy protection but also needs a compromise for, say, a nondischargeable tax claim. However, should an I.R.S. revenue officer raise this objection to your attempt to submit or negotiate an OIC while the automatic stay is still in effect, you may remind the revenue officer that the I.R.S. course manual for revenue officers on the subject of offers in compromise, at page 3-5 alludes to possible advantages to the I.R.S. of negotiating an OIC for a taxpayer in Chapter 11 or Chapter 13. In the case of a Chapter 7, the manual suggests that the OIC may be offered only by the trustee and be accompanied by a court order authorizing the trustee to submit the offer. No authority is given for this proposition. Furthermore, several published opinions allude to offers in compromise made during a bankruptcy without hinting that such activities violate the stay. See, for example, In re Teeslink, 165 B.R. 708 (Bkrtcy.S.D.Ga 1994).
Once entered into neither party can rescind or modify the agreement without either fraud or mutual mistake. Estate of Jones v. IRS, 795 F.2d 566 (6th Cir. 1986); It is well settled that a valid settlement agreement may be set aside on one of two grounds, either fraud or mutual mistake of fact. See Callen v. Pennsylvania R. Co., 332 U.S. 625, 630, 92 L. Ed. 242, 68 S. Ct. 296 (1948); see also Cheyenne Arapaho Tribes of Indians of Oklahoma v. United States, 229 Ct. Cl. 434, 671 F.2d 1305, 1311 (Ct. Cl. 1982). Indeed, the Internal Revenue Service's regulations expressly provide that a compromise may be set aside on the grounds of fraud or mutual mistake. 26 C.F.R. § 301.7122-1(c) (1983). This section states in part:
Neither the tax payer nor the Government shall, upon acceptance of an offer in com promise, be permitted to reopen the case except by rea son of (1) falsification or concealment of assets by the taxpayer, or (2) mutual mistake of a material fact sufficient to cause a contract to be reformed or set aside.
FINANCIAL GUIDELINES FOR SETTLEMENT
The IRS compromise program allows the taxpayer to pay today what he can afford to pay and the unpaid balance is erased from the books, if the amount offered by the taxpayer meets the minimum guidelines.
In order to consider an offer, the IRS will expect the taxpayer to pay the following amounts:
The taxpayer's average monthly surplus income multiplied by 48 (60 months of payments reduced to present value).
The cash equivalent of the taxpayer's assets if sold today. The actual present value in the equity in assets may be compromised down to reflect distress sale values, costs of liquidation, and other factors. The typical compromise, or discount, of the value of real and personal property is 20% of the fair market price.
If an offer is accepted, the taxpayer will be on "probation" for five years; during that time the taxpayer will have to file all tax returns on time and pay all taxes due on time; if not, the IRS may cancel the deal and the original amount will be owed again, plus interest accrued, less the amount paid for the original offer.
The IRS will not accept an offer unless the taxpayer is currently "in compliance." This means the taxpayer must have filed his most recent tax return and paid his most recent tax liability.
OPTIONS FOR PAYMENT TERMS
Although a compromise settlement of the kind contemplated with the offer-in-compromise program is typically thought of as one lump-sum payment to the IRS, there are actually several different formulas, or payment terms, available. IRM § 5.8.1 prescribes these options;
There are three (3) options to pay the offered amount:
Cash Offer (must be paid in 90 days or less)
Short Term Deferred Offer (paid in more than 90 days but within 2 years)
Deferred Payment Offer (paid in more than 2 years)
The option selected is influenced to a certain extent to the amount of time left on the statute of limitations for collection of the tax. Some plan may be paid out in periodic payments stretched out for the remaining years of the statute; the statute of limitations is ten years from date of assessment of the tax. The Manual specifies -
There are three (3) options for payment of the deferred offer:
A. Payment of the realizable value of assets within 90 days of acceptance of the offer and the amount the Service could collect through monthly payments during the life of the collection statute;
B. Payment of a portion of the realizable value within 90 days of acceptance and the balance of the realizable value and the amount the Service could collect through monthly payments during the life of the collection statute; or
C. Payment of the entire offer amount over the life of the collection statute.
EXAMPLE OF LUMP SUM PAYMENT
Let's say the taxpayer owes $100,000 in personal income taxes.
His average monthly surplus income over and above reasonably necessary living expenses is $200.
He owns a car outright worth about $5,000.
His miscellaneous household and personal items and clothing are worth about $2,500.
He has an IRA with $2,000 in it. If liquidated, after penalties and taxes the IRA will yield $1,300 cash.
This is what the IRS will want:
Surplus income [48 x 200 = $9,600] $9,600
Cash value of car = $5,000 less 20% = $4,000
Cash-out value of IRA = $1,300
Equity in personal property = $0 (the cash value of home furnishings and personal property is exempt from levy up to a value of $6,250. Accordingly, the IRS may not take that amount into consideration in an offer).
Total settlement $14,900
In other words, the IRS would accept a lump payment from the taxpayer of $14,900, and the unpaid balance of the $100,000 tax claim will be erased from the books. The IRS may accept several payments totaling $14,900, thus making it easier for the taxpayer to round up the money.
A Tax Help Lawyer experienced with offers-in-compromise can often negotiate a lower "surplus" income, and demonstrate that the value of certain kinds of property in the debtor's possession is worth less than may appear at first glance. Thus, the total amount that must be paid may in many cases be reduced.
If the offer is accepted by the IRS the taxpayer will be expected to file all tax returns and keep current on all taxes for a period of five years following the settlement.
If you think an offer in compromise may be feasible for you, it is prudent to have a professional who is experienced with this program to represent you and do the negotiating. An attorney or an experienced enrolled agent would be advisable.
The "equitable" offer-in-compromise. The IRS Restructuring and Reform Act of 1998 added a third basis for accepting an offer, that is, that collection would be unfair under the circumstances. It is not yet clear whether an offer-in-compromise accepted on this basis would involve the mathematical calculation of income and assets described above. Only time will tell how this provision is implemented by the IRS.
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Appeal of rejected Offer
Code of Fed. Regs. § 301.7122-1
Appeal of rejection of an offer to compromise--(i) In general.
The taxpayer may administratively appeal a rejection of an offer to
compromise to the IRS Office of Appeals (Appeals) if, within the 30-day
period commencing the day after the date on the letter of rejection, the
taxpayer requests such an administrative review in the manner provided
by the Secretary.
(ii) Offer to compromise returned following a determination that the
offer was nonprocessable, a failure by the taxpayer to provide requested
information, or a determination that the offer was submitted for
purposes of delay. Where a determination is made to return offer
documents because the offer to compromise was nonprocessable, because
the taxpayer failed to provide requested information, or because the IRS
determined that the offer to compromise was submitted solely for
purposes of delay under paragraph (d)(2) of this section, the return of
the offer does not constitute a rejection of the offer for purposes of
this provision and does not entitle the taxpayer to appeal the matter to
Appeals under the provisions of this paragraph (f)(5). However, if the
offer is returned because the taxpayer failed to provide requested
financial information, the offer will not be returned until a managerial
review of the proposed return is completed.