An offer in compromise is an offer for an amount less than the total amount of tax liability due made by a taxpayer to settle his entire outstanding tax liability. IRC § 7122. Generally, the amount of the offer should be equal to the taxpayer's net worth plus net disposable income for the next twelve months and must address all tax liability owed, including liability for tax years for which returns have not been filed. For many taxpayers whom the Clinic represents, the net worth and net disposable income for the next twelve months are zero or minimal. The law prohibits the IRS from rejecting an offer simply because of the amount of the offer.
A compromise settles the entire amount of outstanding assessed liability for taxes, penalties and interest. All questions of tax liability for the year(s) or period(s) covered by the offer are conclusively settled. Neither the taxpayer nor the government can reopen a compromised case unless there was falsification of information or documents, concealment of assets, a mutual mistake of a material fact sufficient to set aside or reform a contract, or the taxpayer fails to meet his filing requirements for the five years following the acceptance of the offer. Tax refunds received during the tax year following the year in which the offer is submitted are applied to the unpaid tax. Currently, as a condition to an acceptable offer, all returns must be filed. For the purposes of an Offer in Compromise, if the IRS prepares a substitute return, the return for that year will be treated as filed.
The IRS has set forth its policy for accepting an offer in compromise from a taxpayer in bankruptcy (See CC-2004-025). Although it is the position of the IRS not to accept an offer when the taxpayer is in bankruptcy, exceptions are provided.
An offer in compromise may be submitted based on the following:
When an offer is submitted, financial information usually must be disclosed. It is the Clinic's policy to audit all financial data presented by a client before it is submitted to the IRS. Whenever possible, student attorneys should obtain documentary support for all financial data submitted with an offer. Exhibits should support key facts whenever possible. Treasury Circular 230 is explicit that if misleading information is submitted by a taxpayer’s representative, the representative may be barred from practice before the IRS.
A taxpayer is required to file a Form 656-L, Offer in Compromise (Doubt as to Liability), when the taxpayer believes that the tax liability is incorrect, while Form 656, Offer in Compromise, should be filed only when there is doubt as to collectability that the tax liability could ever be paid in full or when the offer is submitted on the basis of effective tax administration (ETA). A taxpayer is not permitted to file offers concurrently claiming both that the tax liability is incorrect, and there is doubt as to collectability.
An offer in compromise becomes pending when it is accepted for processing. If an offer accepted for processing does not contain sufficient information to permit the IRS to evaluate whether the offer should be accepted, the IRS will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the IRS has requested within a reasonable time period after such a request, the IRS may return the offer to the taxpayer. The IRS may also return an offer if it determines that the offer was submitted solely to delay collection or was otherwise non-processable. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the IRS returns the offer to the taxpayer. This affects the period of time that the statute of limitations is suspended.
The taxpayer may withdraw an offer any time before the IRS accepts the offer. The withdrawal must be in writing, and it is effective upon the IRS's receipt or upon the issuance of a letter by the IRS confirming the taxpayer's withdrawal.
An offer is not accepted until the IRS issues a written notification of acceptance. It is also not rejected until the IRS issues a written notice advising of the rejection, the reason(s) for rejection, and the right to an appeal. The taxpayer has 30 days from the date on the rejection letter to request an appeals conference with the Office of Appeals. The taxpayer may not request an appeal if the offer was returned because it was non-processable (required tax returns not filed or taxpayer in bankruptcy proceeding), because taxpayer failed to provide requested information, or because the IRS determined that the offer was submitted solely for purposes of delay.
The following must be included in an offer in compromise package sent by the Clinic to the IRS (refer to bottom of page to link to forms):
Basis of an Offer in Compromise
In preparing an offer, ensure that you clearly state in the opening paragraph of the memorandum under what ground you are submitting the offer.
A taxpayer may submit an offer-in-compromise based on doubt as to liability ("DATL”) if there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Treas. Reg. § 301.7122-1(b)(2). DATL does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. The IRS may not reject an OIC-DATL because it could not find its administrative file. The taxpayer must submit a detailed written statement explaining why he/she does not owe the tax along with Form 656-L. A financial statement (Form 433) does not need to be included with an offer made on the basis of DATL.
Although an attempt to challenge a levy submitting a request under § 6330 for a hearing is prohibited if the taxpayer received a notice of deficiency, only a final court decree will bar the submission of an OIC-DATL. Thus one may be submitted after a petition to the Tax Court if filed but before a final decree is entered.
An OIC-DATL will be rejected where the underlying tax liability was previously stipulated in a Tax Court decision. In this situation the tax liability can't validly be considered a "doubtful liability" under the applicable regulation. Sec. 301.7122-1(b)(1); Oyer v. Commissioner, T.C. Memo. 2003-178, affd. 97 Fed. Appx. 68 (8th Cir. 2004).
Doubt as to Collectability and Doubt as to Collectability with Special Circumstances
A taxpayer may submit an offer based on doubt as to collectability ("DATC") or doubt as to collectability with special circumstances ("DATC-SC") if the taxpayer believes that he/she cannot ever pay the full amount of the tax owed. Treas. Reg. § 301.7122-1(b)(3). DATC and DATC-SC exists in any case where the taxpayer has sufficient assets or income to pay some of the liability but the taxpayer's assets and income are less than the full amount of the liability. The taxpayer must include with the request Form 433-A (OIC) or 433-B (OIC) showing his or her current financial situation
A determination of DATC will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses (see Collection Financial Standards). The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer's case. To guide this determination, guidelines published by the Secretary on national and local living expense standards are taken into account.
Where a taxpayer is offering to compromise a liability for which the taxpayer's spouse has no liability, the assets and income of the non-liable spouse will not be considered in determining the amount of an adequate offer. The assets and income of a non-liable spouse may be considered, however, to the extent property has been transferred by the taxpayer to the non-liable spouse under circumstances that would permit the IRS to effect collection of the taxpayer's liability from such property (e.g., property that was conveyed to defraud a creditor), property has been transferred by the taxpayer to the non-liable spouse for the purpose of removing the property from consideration by the IRS in evaluating the compromise.
Where collection of the taxpayer's liability from the assets and income of the non-liable spouse is permitted by applicable state law (e.g., under state community property laws), the assets and income of the non-liable spouse will be considered in determining the amount of an adequate offer except to the extent that the taxpayer and the non-liable spouse demonstrate that collection of such assets and income would have a material and adverse impact on the standard of living of the taxpayer, the non-liable spouse, and their dependents.
Doubt as To Collectability with Special Circumstances
A DATC-SC offer is different from an offer submitted on the basis of Effective Tax Administration ("ETA") because in the former the amount that could be collected is less than the full amount of the liability but special circumstances exist that warrant acceptance for less than the amount of the calculated reasonable collection potential (RCP). An offer submitted on the basis of ETA is one where the full tax liability could be collected from assets of the taxpayer, but should not be collected because to do so would cause a hardship to the taxpayer. Nonetheless, the IRS applies several of the criteria and procedures related to an offer submitted on the basis of ETA to offers submitted on the basis of DATC-SC.
Internal Revenue Manual section 188.8.131.52 provides detailed guidance on an offer based on DATC-SC. That section of the manual refers to the factors to consider and refers the reader to the factors in the Manual dealing with an offer submitted on the basis of ETA. The Manual also refers to IRC § 6343, and Treas. Reg. § 301.6343-1, which provide that a levy can be released on the basis of economic hardship. I.R.M. 184.108.40.206.1 gives examples and specific provisions for the IRS employee to consider when making his or her decision.
In IRM 220.127.116.11.1 (5) other factors that may be taken into account when considering an offer based on DATC-SC are listed that impact the taxpayer's financial condition other than basic living expenses, as follows:
Each of these factors must be specifically addressed in the OIC memorandum submitted by the Clinic.
In IRM 18.104.22.168.1(6) factors constituting economic hardship are listed:
These factors also must be specifically addressed in the OIC memorandum.
Frequently, the client has a negative cash flow and no assets with equity except possibly in their vehicle. Assuming you have determined the reasonable value of the vehicle and there is some equity in the vehicle, the IRS will insist that that equity is the minimum amount required for an offer unless you are able to convince them that the client comes within the provisions of the Manual dealing with economic hardship or some other provision dealing with special circumstances and effective tax administration.
In dealing with vehicles, several best practice suggestions include: providing evidence of the inability of the client to borrow against the vehicle and what would be added to the taxpayer’s monthly expenses should the client borrow against the vehicle; pictures of the vehicle showing damages or poor condition; the need to transport dependent children or other members of the taxpayer's household in the vehicle; and the taxpayer's health or employment situation necessitating use of the vehicle. Beginning in May 2012, the IRS has provided interim guidance to offer examiners under a “Fresh Start” program that allows a $3,450 exemption for each vehicle up to two vehicles if there are two individuals in the household. This is after computing the equity in the automobile and reducing that equity by 20% as listed on the Form 433 (OIC). The memorandum and attachment that deals with the Fresh Start program linked below should be attached as an exhibit when an offer notebook is submitted.
Internal Revenue Manual 22.214.171.124.3(5) (10-22-2010) provides some assistance in determining operating expenses of older cars. Subsection (5) provides that in situations where the taxpayer has a vehicle that is currently over six years old or has reported mileage of 75,000 miles or more, an additional monthly operating expense of $200 will generally be allowed per vehicle.
(1) The taxpayer, who has a 1998 Chevrolet Cavalier with 50,000 miles, will be allowed the standard of $231 per month plus $200 per month operating expense (because of the age of the vehicle), for a total operating expense allowance of $431 per month.
In addition, do not just rely on one of the on-line services to determine value. While these are good starting places, investigate other services. Ask the client to obtain a written appraisal from a used car dealer, or the amount a lender is willing to loan on a car. As important as the above are, the value of the vehicle is determined many times by the condition of the vehicle. Pictures of the vehicle or maintenance records are good, additional information concerning the factors that can be considered in setting the value of the vehicle.
Even though a taxpayer is able to pay the tax in full, a compromise may be entered to promote ETA when:
Economic hardship is defined as the inability to pay reasonable basic living expenses. Treas. Reg. § 301.6343-1. In determining reasonable basic living expenses, the IRS is to consider relevant information such as the taxpayer's age, employment status and history, number of dependents, and other exceptional circumstances. Factors to support a finding of economic hardship include, but are not limited to the following:
Compromise based on equity and public policy is not accepted if collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. The circumstances must be such that compromise is justified even though a similarly situated taxpayer may have paid his liability in full.
The Form 433 must be consistent with the Memorandum you prepare as well as the amount offered. There are two main areas of the Form 433 that IRS Offer Unit examines in determining the reasonable collection potential: the assets and liabilities sections and the income and expense section. The sections should not contain net numbers; that is, the assets should not be offset with the liabilities and the income should not be offset with expenses.
In determining the correct amount to offer, the amount must be greater than the collection potential of the equity in all assets and the surplus in monthly income. Always review the Financial Analysis and the Future Income sections of I.R.M. 5.8.5 (revision 5-21-12). The IRS is routinely revising these sections. The links below are to the latest information. In completing the Form 433 sections listing assets and liabilities be aware that any amount of equity shown is normally the minimal amount of an offer. However, if the Form 433-A (OIC) shows cash on hand of $1,000 or less the IRS will treat the account as no cash on hand. If the amount of cash on hand or in savings and checking accounts is less than $1,000 list “0” as the amount of equity, but include in the accompanying memorandum an explanation of why you have done so and attach the IRS announcement that deals with the Fresh Start program linked below as an exhibit Furthermore, if the amount exceeds $1,000 and the client can show that the amount is used to pay for taxpayer's monthly allowable living expenses, then that amount will not be included as a positive asset. In some instances it is helpful to present more than three months of bank statements if the average more clearly reflects the cash on hand. In all instances the memorandum you prepare is critical to explain the financial assets of the client.
The IRS now provides at I.R.M.126.96.36.199 that the IRS will exclude $3,450 from the net equity valuation of vehicles used for work, for production of income, and/or for the welfare of the taxpayer's family, up to two cars per household. The reduction is from the value that is determined to be the current value of the automobile. For most of our clients, this virtually eliminates the equity and reduces the time you have to devote to determining value.
Dissipation of Assets (I.R.M.188.8.131.52) If the IRS determines that the taxpayer has disposed of assets within a three year period prior to the submission of the offer, the client must explain in detail what occurred and why those funds are not available. However, if for example the funds from an IRA were withdrawn to invest in a business and there was no prior liability, those amounts are not treated as dissipated assets. The Manual has other specific examples and should be reviewed carefully.
In addition, if there is equity in any one asset, the offered amount must include the amount of that equity or a more careful analysis of the fair market value to reduce the equity is called for.
For clients that are either unemployed or underemployed, the IRS may imputed income to them under the assumption that they will be employed. In cases where this is the case, refer to the provisions of I.R.M § 184.108.40.206, "Future Income". These sections provide guidance to IRS personnel in reviewing offers and other collection actions.
The Manual instructs the examiner to consider the possible future earning potential of the taxpayer in judging what the income of the taxpayer will be . The Manual gives specific examples of child support of the payor ending or a debt being paid, which would possibly indicate an increase in discretionary income. The Manual cautions not to automatically add the additional income. We should address any future discretionary income in the memorandum. The period of the future income is different depending on whether the offer is paid within a 5 month period or a 24 month period. The IRS will look only to a 12 month period if the offer is paid in 5 months which will mean generally that the offer amount may be less than if the client seeks to pay the offer over 24 months. In any event, the future income over the remaining life of the collection statute of limitations is no longer used.
In 220.127.116.11.4 and 18.104.22.168.5 several situations are listed and how they should be treated them where there is unemployment or underemployment. These sections should be carefully considered and commented on in in the memorandum. For instance, if the taxpayer is temporarily unemployed or underemployed, the IRS will then average past income in certain circumstances. A best practice is to affirmatively discuss the client's situation and provide an analysis of past income. Explain how the present and past are different and why the client will not again reach the prior level of income because of such things as medical problems, age, etc. The section provides specific examples. You may want to consider citing the manual and the example in the application of fact to law section of the memorandum and provide a copy of the excerpt as an exhibit.
In some situations in lieu of averaging past income, the IRS accepts the current income, but enters into a Collateral Agreement which becomes a part of the offer. The Agreement provides that the taxpayer will agree to pay a percentage of future income if that future income is over certain agreed upon amounts. The Agreement covers the situation when the taxpayer's income substantially increases in future tax years. We may agree to enter into these agreements in appropriate cases. I.R.M. section 22.214.171.124 (10-22-10) Future Income Collateral Agreement sets forth the parameters for entering into a Collateral Agreement.
The IRS considers whether the tax would be dischargeable in bankruptcy as a factor in determining the amount of the offer (not whether the client has filed and received a discharge, but whether if they were to file, the tax would be dischargeable). We should comment on this if it is applicable.
One other note, the Manual provides that if a client has a roommate, we should not be required to produce the roommate's income if they are maintaining separate households. However, whether and to the extent that the roommate contributes to household expenses should be addressed.
As always , prior to citing and authority, including any section of the IRS Manual, you should check for any updates.
The IRS has provided national and local Standards for use in determining whether there is doubt as to collectability. The amount paid by the taxpayer for the items covered by the national standards need not be proved. Thus, the taxpayer is allowed the maximum amount regardless of what the taxpayer paid for those items. However, those expenses covered by the local standards are allowed only to the extent the taxpayer can prove that the expenditure was made. In general, no amount will be allowed in excess of the local standard.
The IRS in its initial review of an offer in compromise will determine whether the taxpayer is in compliance and if the taxpayer is not, the offer will be returned as not “processable”. Thus, in connection with the submission of an OIC, all required federal income tax returns must be filed and current taxes paid. This may necessitate changing income tax withholding or making estimated payments to ensure that at the end of year in which the offer is submitted and into the future there will be no further unpaid tax or failure to file tax returns. If an offer is accepted, the acceptance is dependent upon the taxpayer remaining compliant for 5 years after the offer is accepted.
In addition, the IRS will require that the taxpayer:
Consequences of an Offer
Compromise of a Compromise
If the taxpayer is unable to pay the balance of an accepted offer, the IRS has the option to: (1) temporarily adjust the terms of the offer, (2) formally compromise the existing compromise or (3) exercise the default provisions of the offer. The Internal Revenue Code authorizes the Commissioner under § 7122 to accept an offer in compromise of an accepted offer. The new offer to compromise the original offer must be based on doubt as to collectability.
The taxpayer must send a current financial statement (Form 433-A or 433-B) and a written proposal of the new offer in letter format to the office where the original offer was submitted. The letter should be addressed to the Commissioner of the Internal Revenue Service and include the following information:
The compliance agreement (item 8 on Form 656) will remain in effect from the date the original offer was accepted.
Potential Default Cases
An offer can reach a potential default status in one of two ways: the taxpayer failed to make timely payments of the amount due based on the terms of the offer or a related collateral agreement, or the taxpayer has not adhered to the compliance provisions of the offer contract. The revenue officer has the discretion to grant up to a six-month extension if the taxpayer can pay the defaulted amount in 6 months or less.
Appeal of Rejected Offer
Typically, after submission of an offer the IRS will ask for supplemental information. The failure to provide the information will result in rejection of the offer. It is imperative that you stay in contact with the IRS during this time and provide the supplemental information timely and accurately. Any supplemental letters or memoranda must be reviewed by a Clinic Director prior to mailing.
Once the offer has been accepted for processing, an Offer Specialist will review the completed offer. In some cases, the Offer Specialist will determine an ability to pay in excess of what the client is able to pay. This is usually based on a disagreement as to the value of assets, income or reported expenses. If you are not able to resolve the dispute with the Offer Specialist, the offer will be rejected in writing and you will be afforded 30 days within which to appeal the determination to reject the offer.
Include in the appeal, the form “Request for Appeal of Offer in Compromise” (Form 13711). The Appeal Memoranda/letter focuses on the specific issues raised in the rejection letter. The appeal is sent to the Offer Specialist. It is helpful to provide additional documentation to support the basis for the client’s appeal. In some cases, the Appeal Memoranda/letter is sufficiently persuasive and the Officer Specialist will reconsider his or her rejection and offer additional opportunities to negotiate a new offer amount and thus resolve the case.
If the Offer Specialist is not persuaded to reconsider the rejection, the offer is forwarded to an Appeals Officer with the materials we provided and any comments the Offer Specialist wishes to make. Our Appeal Memoranda/letter should state at the end that we are requesting a face to face conference in Atlanta, Georgia. If we did not so state, once notice is received that the case is assigned to an Appeals Officer at another location, the student should immediately request a face to face conference in Atlanta, Georgia. This will typically take 30-60 days for the case to be transferred to Atlanta and an Appeals Officer in Atlanta will then contact us to arrange a conference.
Appeals Division of the Internal Revenue Service has begun (effective December 1, 2008) to apply arbitration and mediation process to Offers and Trust Fund Recovery Penalty cases. The process is described in Rev. Proc. 2002-44 and Rev. Proc 2006-44.
Internal Revenue Code section 7123 provides for non-binding mediation in Appeals on any issue unresolved at the conclusion of Appeals procedures, which occurs when Appeals sustains the IRS’s offer determination.
Mediation as to offers is limited to factual matters. The Revenue Procedure specifically limits the scope of Appeals jurisdiction to matters not related to the overall determination whether a taxpayer’s offer was acceptable. The Appeals Area Director must approve acceptance of all cases for arbitration and mediation.
Types of issues that are subject to this process include:
Procedure for processing an accepted offer and closing the case
Upon receipt of a letter from IRS accepting an offer in compromise, the client has generally 30-days to pay the lump sum amount offered. There are a few exceptions where the client and IRS have agreed to an installment payment of the offered amount. Our preference is that all offers use the lump sum payment, not the installment alternative.
The student attorney should immediately contact the client and request that the client send the payment to the Clinic. Our preference is that the payment be in the form of a Money Order; however, the IRS will also accept a personal check or a certified check. While it is acceptable for the client to send in the payment directly to the IRS (and some do before we learn of the acceptance), it is our policy to forward the payment to the IRS. That way, we are certain that the payment has been made, and we have found that the payment is less likely to get lost.
The student attorney sends the payment to the address listed on the letter (usually in Fresno, California) with a cover letter (linked below), and the front page of the offer acceptance letter. The student attorney should always make a complete copy of the above package. The package is then sent by UPS to the place designated. Each offer is sent in a separate UPS package to ensure that each offer payment is properly accounted for and processed.
Usually in approximately 4-6 weeks the client and the Clinic will receive a confirmation of payment. The student attorney should then include this confirmation in the file, close the file and send the client a closing letter (linked below). In addition the student attorney should purge the file of miscellaneous correspondence before turning in the file for closing.
'Fresh Start' - Future Income Explanation Letter 126.96.36.199.pdf (3-10-2010)
'Fresh Start' - Interim Guidance - Real Property Valuations (3-2010).pdf
Offer in Compromise Closing Letter
Offer in Compromise Cover Letter to I.R.S.doc
Offer In Compromise To-Do List.doc
Offer in Compromise supporting document request checklist.pdf
Offer Payment Cover Letter.doc
Sample letter requesting documents to support offer.doc
Supporting document checklist.pdf
Statement Supporting OIC.doc(include as attachment to Form 656)
The LITP Newsletter.doc - Allowable expenses
Documents on IRS.gov
Collections Financial Standards
IRS Form 433-A (OIC): Collection Information Statement for Wage Earners and Self-Employed Individuals (Fill-in) (5-2012)
IRS Form 433-B (OIC): Collection Information Statement for Businesses (Fill-in) (5-2012)
IRS Form 656: Offer in Compromise Booklet (5-2012)
IRS Form 656: Offer in Compromise Application only (5-2012)
IRS Form 656-L: Offer in Compromise (Doubt as to Liability application) (2-2012)
Part 5 Chapter 8: Collecting Process: Offers in Compromise
Part 8 Chapter 13: Closing Agreement Manual: Offers in Compromise
IRC § 7122: Compromises
Treas. Reg. § 301.6343-1(b)(4): Economic Hardship (4/02)
Treas. Reg. § 301.7122-1: Compromises (only old temporary regulations are available online at this time)