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Negotiating Offers In Compromise                                    

Series: Dealing With The IRS Collection Division

© by Burton J. Haynes, Esq.

 

The last article in this series on dealing with the Collection Division addressed Installment Agreements -- arrangements through which tax debts can be resolved by means of monthly payments. Some folks, however, owe so much that an installment agreement is not a practical solution. Interest and penalties can accrue so quickly that the liability actually increases, despite the monthly payments. For such clients, one option often considered is an "Offer in Compromise."

 

Statutory Authority.

The IRS's authority to accept compromises in full settlement of tax debts is found in IRC §7122. There are only two grounds for such compromises -- "doubt as to liability" and "doubt as to collectibility."² Compromises premised on doubt as to whether the underlying tax is properly owed are handled by the Examination Division. We will focus on offers based on doubt as to collectibility, which are presented to and investigated by the IRS Collection Division.

The IRS's reasons for entertaining and accepting Offers in Compromise are explained succinctly in Policy Statement P-5-100:

The Service will accept an Offer In Compromise when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects collection potential. An Offer in Compromise is a legitimate alternative to declaring a case as currently not collectible or to a protracted installment agreement. The goal is to achieve collection of what is potentially collectible at the earliest possible time and at the least cost to the government.

This statement of policy provides a frame of reference by which the Service's procedures and standards for evaluating offers can be more readily understood.

 

A History Lesson.

There have been radical shifts in the Service's attitude toward Offers in Compromise over the years. Prior to 1992, it was nearly impossible to convince the IRS to exercise its statutory authority to compromise tax liabilities. The Service was roundly criticized by Congress and taxpayer advocates for its refusal to enter into reasonable compromises, and for its inability to control the ever growing number and magnitude of delinquent accounts.

As a result of this criticism, on February 26, 1992, the IRS issued a new Internal Revenue Manual section dealing with offers.³ This signaled the start of what would turn out to be the Gold Age of the Offer in Compromise. Under the old rules, Collection Division personnel were discouraged even from informing hard-pressed taxpayers of the Service's authority to compromise tax debts. But under the new IRM provisions, employees were directed to "discuss the compromise alternative with the taxpayer and, when necessary, assist in preparing the required forms."⁴ As a result of the new liberalized attitude, acceptance rates and the number of offers filed both increased.⁵

Unfortunately, however, there were wide variances in the administration of the Offer in Compromise program in different parts of the country.⁶ Some practitioners, aware of these disparities, lobbied the IRS for more uniformity. At the same time, the system was being overwhelmed by the increasing number of offers. For these reasons the Service wanted to bring more efficiency and uniformity to the offer evaluation process. The result was yet another major change in policies and procedures. On August 29, 1995, the IRS adopted a system of local and nation-al "standards" for the evaluation of a taxpayer's "ability to pay," and dividing expenditures into categories of "necessary expenses" and "conditional expenses." This was discussed in detail in my last article on the subject of negotiating installment agreements because the standards used for determining ability to pay are the same. I explained in that article that these new expenditure classification and allowance standards make it more difficult to negotiate reasonable installment agreements. And they have the same effect on Offers in Compromise, often pushing the amount the IRS will accept beyond the reach of many taxpayers who might have fared better under the old procedures. These standards, however, represent the current environment. Thus, in drafting Offers in Compromise for our clients, we must deal with the rules as the IRS has defined them.

 

Inclusion of All Tax Liabilities.

As a preliminary matter, note that an Offer in Compromise must include all of the taxpayer's liabilities. Thus, it is often necessary to bring about the assessment of any taxes which could otherwise be assessed in the future. For income taxes, any unfiled returns must be prepared and filed so that the full liability is known.⁷ And for withholding taxes or trust fund recovery penalties, assessments must be made for all quarters for which the client is potentially liable.⁸ Furthermore, if there are unfiled returns the IRS typically will not consider the offer anyway because the taxpayer is not in "current compliance."⁹

 

Forms to be Submitted.

An Offer in Compromise is filed using IRS Form 656, accompanied by Form 433-A and/or 433-B.¹⁰ Guidance for properly completing these forms can be found in the instructions, in IRS Pub. 1854, and in IRM 57(10)6.1. If a computer generated Form 656 is used, the taxpayer must initial each page certifying that it is a verbatim duplicate of the official form.

The IRS is currently working on a new version of Form 656.¹¹ A controversial draft of the new form would have required the preparer to sign along with the taxpayer, certifying under penalties of perjury that he or she had "examined" the Offer and related documents, and that the information presented therein was true and correct to the best of the preparer's knowledge and belief. When presented at the AICPA Tax Division Annual Conference in late October, this draft produced a storm of protest, and in response the IRS quickly abandoned the idea of requiring the signature of anyone other than the taxpayer.¹²

 

Cash Versus Deferred Payment Offers.

The Service prefers cash offers. A "Future Income Collateral Agreement" (Form 2261) was once required for most Offers in Compromise, but is now rarely used.¹³ Today, the IRS only wants cash on the barrelhead. If the taxpayer can't fund a lump sum offer, and must by necessity deal with the taxes through monthly payments, the Service may permit an Installment Agreement, but generally will not agree to an Offer in Compromise. A cash offer means anything up to paying 90 days after notification that the offer has been accepted.¹⁴ Deposits are encouraged, but not required.¹⁵

Nevertheless, despite the Service's strong preference for cash offers, if your client simply can't come up with the money, you should know that the Internal Revenue Manual does permit the acceptance of offers with deferred payment periods of up to two years:¹⁶

(3) A deferred payment offer is one where any part of the amount offered is to be paid at any date(s) more than 90 days after acceptance of the offer. As a general rule, deferred payment should not be extended beyond two years. . .

(a) A longer or shorter period of time may be acceptable if extraordinary circumstances exist and are documented in the case file. However, regions or districts may not establish a general rule to require payment within a specific time frame.

(b) If the amount of the offer is acceptable and will be paid within two years, an offer will not be rejected unless exceptional circumstances are clearly defined.