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.
When It’s Appropriate
Tax liabilities that create worrisome obligations for the taxpayer can be caused by many circumstances, including but not limited to: disallowance of tax shelters, audits of prior year deficiencies, marital problems, reversal of income, serious illness and hospitalizations, and advanced age, where the elderly taxpayer cannot borrow money because of limited retirement income. The amount offered to be paid should be done so as soon as possible. There are three options to pay the settled amount:
Cash Payment, which must be paid within 90 days.
Short-Term Deferred Payment Offer, which may be paid after 90 days but within two years.
Deferred Payment Offer, which allows payment past two years, but must not exceed the statutory period for collection of 10 years.
Liabilities to Be Compromised
To submit an Offer in Compromise, IRS Form 656 must be completed. Additionally, you must submit Form 433-A, Collection Information Statement of Individuals, or Form 433-B, Collection Information Settlement for Businesses, if the offer is based on the doubt that the taxpayer could ever pay the full amount of tax owed. The OIC offer should be a fair and reasonable one with the intention to satisfy the debt based on a true ability to pay.
The Form 433-OIC Worksheet is used in mathematically determining what a reasonable offer can be. An inadequate offer could be rejected without an opportunity to appeal the final determination made by the IRS.
All new Offers in Compromise from taxpayers living in Alaska, Alabama, Arizona, California, Colo- rado, Hawaii, Idaho, Kentucky, Louisiana, Missi-ssippi, Montana, Nevada, New Mexico, Oregon, Tennessee, Texas, Utah, Washington, Wisconsin, and Wyoming are filed in the Memphis Internal Revenue facility in Memphis, Tennessee, while all other states submit offers to the Brookhaven Internal Revenue Service facility in Holtsville, New York.
Evaluation of the Offer
The IRS will determine your client’s future income potential and ability to pay the obligations by evaluating the taxpayer’s education, profession or trade, age and experience, health, and overall history of filing and paying taxes. An Offer in Compromise is not considered if your client has not filed all federal tax returns or is presently involved in an open bankruptcy proceeding. Other considerations in determining payment include the current borrowing or liquidation value of marketable securities, cash values in life insurance policies, and IRA and Keogh accounts. However, any assets in 401(k) qualified retirement plans are not included in the determination of ability to pay. Personal property and real estate property values are reviewed at ownership percentage and appraisal values as well. If the taxpayer is a shareholder in a closely-held corporation, any interest over $10,000 is considered income for the repayment plan. This prevents any assets from accumulating in the corporation.
Only One Chance
Neither the taxpayer nor the government can reopen a settled case unless there was falsification of information, concealment of assets, or mistakes of material facts. To insure that taxpayers are not repeat offenders, the IRS requires a written agreement from the OIC taxpayer to file and pay taxes on time for the subsequent five years. If the taxpayer fails to comply with this obligation, then the original agreement is voided and the old tax debt, including interest and penalties, are returned to the IRS collection division and a Notice of Federal Tax Lien is filed on the tax liabilities. If your client filed a joint offer with his spouse or ex-spouse, the agreement will not default even if his spouse or ex-spouse violates the future compliance provisions.
How It Works
The negotiation process with the IRS will take place by mail, over the phone with the ACS Unit (Automated Collection System), or in person with an IRS Revenue Officer. If the amounts owed are more than $20,000, a Revenue Officer is personally involved with satisfying the case. In reality, very few of the Offers in Compromise applications are approved. However, the IRS will accept an offer that reflects potential collection. The OIC process is a legitimate alternative to satisfy a tax delinquency for the taxpayer at the earliest time and at the lowest cost to the government. When appropriate, an Offer in Compromise can be a win-win situation for the taxpayer and the government.