The prudent tax preparer and financial advisor always should strive to follow the letter of the tax code when it comes to preparing a client’s tax returns or recommending tax strategies. But there are times, not always prompted by cause, when tax payment issues arise for clients. The Offer in Compromise (OIC) program of the Internal Revenue Service is a tax negotiation opportunity that in some cases can resolve your client’s tax problems. Don’t misunderstand: the Offer in Compromise program is not a tax amnesty program. It is an agreement between the IRS and the taxpayer to reduce or eliminate tax liabilities, interest, and penalties by accepting less than full payment under certain circumstances.
Conditions for an OIC Proposal
When does the Offer in Compromise program become an option? The Internal Revenue Code provides the IRS with the authority to compromise debts only for the following reasons:
Doubt as to Liability Doubt exists that the assessments of taxes are valid.
Doubt as to Collectibility A reasonable determination is made that your client could never fully pay the tax owed.
Effective Tax Administration There is no dispute that the assessment is correct or that your client can make the payment but an exceptional circumstance exists that you must demonstrate would create an economic hardship for the taxpayer.
There are similar but distinct state agency offer in compromise programs as well. The guidelines for the acceptance of offers may differ from state to state, but the local departments will accept a copy of the federal Offer in Compromise as part of its application process.
Who Is Eligible?
Who are the taxpayers that might consider going the OIC route? Three real-life examples illustrate who might qualify:
1) An elderly couple in their 70s owed the IRS more than $150,000. Considering their age and income limitations and life expectancies, the IRS agreed to a settlement of $17,000, but the money had to be paid within 30 days. An issue that has CPAs stumped is whether a taxpayer can be taxed on forgiveness of IRS debt. The answer: there is no taxation on the forgiveness of debt with income taxes.
2) A Wall Street investment banker earned over $1,000,000 and didn’t pay the required taxes on his partnership draw account. The next year, the economy reversed itself and he was out of business. He didn’t have the ability to pay the taxes from his current $100,000-per-year salary. Considering he had a mortgage and seven children to take care of (he and his wife had all of them in seven years) the IRS agreed to a settlement of $100,000 to be paid monthly over a period of 10 years.
3) After 9/11, a downtown Manhattan retail store owed more than $2,000,000 in sales taxes. Since there was no possibility of sales for the store during the cleanup process, the state agreed to settle for $1,000,000, which was to be paid in quarterly installments over the next 24 months.
If your financially distressed client qualifies for an Offer in Compromise agreement, the negotiation process will focus on the proper valuation of assets and accurate information about the client’s monthly income and living expenses. Expenses generally not considered in the negotiation process include tuition for private schools, public or private college expenses, charitable contributions, voluntary retirement contributions, payments on credit card bills, cable television charges, or similar types of non-essential living expenses. However, these expenses could be considered if the taxpayer provides a valid case that they are required for the health and well-being of his family or that they are essential for the production of future income.
This one-time forgiveness application process can proceed for approximately six to twelve months, depending on the activity schedules at the IRS district office handling the case. During this time, the IRS may request information such as bank statements, payroll stubs, child support payments, home loan statements, charge card statements, and other financial information that may help determine the disposition of your client’s OIC. This information must be supplied, upon only one request, to the district office within 45 days during the offer investigation. If your client does not timely respond to the requested information, he may lose the opportunity to compromise or have to start the application process all over again.
It is prudent for the taxpayer to coordinate his efforts with an experienced tax attorney or CPA who has established working relationships with OIC specialists working for the government agencies. This is accomplished by completing Federal Form 2848 “Power of Attorney,” which allows the professional to represent the taxpayer in submitting all matters relating to the OIC. If a taxpayer represents himself, one mistake in the application process could result in a rejection of the offer or cost him several thousand dollars.