Let's Make a Deal

New York money manager Howard Winell, 65, was named 2000 market timer of the year by Timer Digest. But for reasons he won't discuss, he's had a hard time paying his taxes; he filed his 1992 through 1999 returns without paying all he owed. Last year the IRS agreed he could settle a $574,000 bill (including interest and penalties) for $182,000.

Lawrence Zunker, 53, of Richland, Wash., recently retired after 30 years as a utility lineman. In the 1980s and 1990s he invested with Walter (Jay) Hoyt III, who was convicted in 2001 of defrauding investors with a tax shelter scheme built around phantom cattle and overvalued ranch real estate. The $44,000 in disallowed Hoyt tax breaks Zunker claimed has grown, with interest and penalties, into a $240,000 tax debt. He's offered $60,900, which would wipe out his savings but leave him his pension, his trailer home and the land it sits on. The judge at Hoyt's trial asked the IRS to let duped investors settle for back taxes, with interest and penalties wiped out. But so far the IRS is insisting Zunker can pay more.

Atlanta accountant Robert Kalaf Sr., 50, exercised nonqualified stock options as he left a tech company in 1999, generating a $200,000 tax bill. By the time he could legally sell the restricted stock, it was worth only $110,000. Kalaf offered the IRS $42,000, all he says he could raise at that time. He was turned down, he says, because an IRS official figured that given his $105,000 salary back at the tech company, he could pay more over ten years. But Kalaf has been out of work for more than a year, has sold his home and is broke. "I feel like I'm in prison. It just feels hopeless," he says.

Why would the IRS compromise with Winell, but not Zunker or Kalaf?

Traditionally, the IRS has compromised tax debts only when a taxpayer offered as much as it could realistically wring out of him through forced collection, as was apparently the case with Winell. But in 1998 Congress fiddled with the offer-in-compromise program and, in a conference committee report, instructed the IRS to consider "factors such as equity, hardship, and public policy" in evaluating offers when doing so would "promote effective tax administration." Now tax lawyers and accountants are at odds with the IRS about Congress' intent. The program is a backlogged mess.

The IRS accepted just 16% of the 55,000 offers it processed or branded "not processable" in the first five months of fiscal 2003, down from 25% of the 48,000 it handled in the same period the year before. The IRS blames the decline in part on offer-in-compromise "mills," which it says are advising taxpayers to make unrealistic offers. It has proposed charging a $150 OIC user fee to discourage frivolous offers.

Private tax practitioners, however, say a bigger problem is that the IRS simply hasn't gotten the message Congress sent--that it wants offer standards liberalized and special consideration given to taxpayers caught in unfair situations--such as employees taxed on phantom stock option profits or ordinary folk victimized by slick promoters.

IRS National Taxpayer Advocate Nina E. Olson sees big problems with the program; a third of the time IRS employees don't correctly follow their agency's own rules for determining what a taxpayer can afford to pay. Moreover, she says, it's impossible to know whether too many or too few offers are being made and accepted, because the IRS hasn't compiled enough data about who's accepted and rejected, how old their debts are or how much is later collected from those who are turned down.

But, Olson also warns, taxpayers shouldn't expect a deal simply because, for example, taxing phantom option profits doesn't sound fair. "The tax code is unfair in many ways," she says. "The IRS doesn't have the discretion to change the effect of the law.'' Instead, she says, taxpayers will have to come up with convincing reasons, in each case, why they deserve a break--for example, a rank-and-file worker was misled by his bosses or by financial advisers about the tax treatment of options.