College of Law :: Georgia State University

Offers In Compromise

An offer in compromise is an offer (usually less than the total amount 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 five years and must address all tax liability owed, including liability for tax years for which returns have not in the past been filed.  (As a condition to an acceptable offer, all returns must be filed.)   For many taxpayers who the Clinic represents, the net worth and net disposable income for the next five years are minimal, and the law prohibits the IRS from rejecting an offer simply because of the amount of the offer.  

A compromise is effective for 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 such offer in compromise 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 was made that would be 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.

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:

1. Doubt as to liability
2. Doubt as to collectability
3. Doubt as to collectability, with special circumstances
4. Effective tax Administration

When an offer is submitted, financial information must be disclosed.  It is the Clinic's policy to audit all financial data presented by a client.  Whenever possible, student attorneys should obtain documentary support for all data submitted with an offer. It is essential that the facts presented in the offer memorandum make sense. Exhibits should support key facts whenever possible. 

A taxpayer is required to file a Form 656-L, Offer in Compromise (Doubt as to Liability), when it is believed 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 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,along with an inability to pay it. 

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 to compromise a tax liability 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.

The taxpayer may withdraw an offer any time before the IRS accepts the offer.  The taxpayer must notify the IRS in writing.  The withdrawal is effective upon the IRS' receipt of the notice or upon the issuance of a letter by the IRS confirming the taxpayer's notice. 

An offer is not accepted until the IRS issues a written notification of acceptance to the taxpayer or the taxpayer's representative.  It is also not rejected until the IRS issues a written notice to the taxpayer or his representative, 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 to compromise 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:

1. Cover letter and memorandum containing the facts and a discussion of the law.
2. Form 656-B (Booklet with forms), Form 656 (Form alone) or 656-L
3. Form 433A or Form 433B (not needed if Doubt as to Liability)
4. Form 656-A (Application Fee Waiver), Application Fee Waiver Worksheet or $150 application fee
5. Supporting documents for Form 433A or B

Basis of an Offer in Compromise

Doubt as to Liability

A challenge to the amount of the tax liability made in the form of an OIC-DATL by a taxpayer who has received a notice of deficiency is a challenge to the underlying tax liability. Because the taxpayer had his or her chance to challenge that liability, section 6330(c)(2)(B) bars them from challenging it again.

Similarly, an OIC-DATL will be rejected where the underlying tax liability was previously stipulated in a Tax Court decision. In this situation also 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 ("OIC-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's assets and income are less than the full amount of the liability.  The taxpayer must submit Form 433-A or 433-B showing his or her current financial situation

Doubt as to Collectability 

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 will be 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 in fraud of creditors), 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.

The IRS has provided Standards for use in determining whether there is doubt as to collectability.

• National Standards have been established for five categories of living expenses: food, housekeeping supplies, apparel and services, personal care products and services, and miscellaneous.
• National Standards have been established for out-of-pocket health care expenses including medical services, prescription drugs, and medical supplies (e.g. eyeglasses, contact lenses, etc.).  The out-of-pocket health care standard amount is allowed in addition to the amount taxpayers pay for health insurance.
• Local Standards have been established for housing and utilities.  The housing and utilities standards are derived from Census and BLS data, and are provided by state down to the county level.  The standard for a particular county and family size includes both housing and utilities allowed for a taxpayer’s primary place of residence. Housing and utilities standards include mortgage or rent, property taxes, interest, insurance, maintenance, repairs, gas, electric, water, heating oil, garbage collection, telephone and cell phone.
• Local Standards have been established for transportation. The transportation standards for taxpayers with a vehicle consist of two parts:   nationwide figures for monthly loan or lease payments referred to as ownership costs, and additional amounts for monthly operating costs broken down by Census Region and Metropolitan Statistical Area (MSA).   A conversion chart has been provided with the standards that list the states that comprise each Census Region, as well as the counties and cities included in each MSA.  The ownership cost portion of the transportation standard, although it applies nationwide, is still considered part of the Local Standards

Doubts 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.

Internal Revenue Manual section 5.8.4.3 provides detailed guidance on an offer based on DATC-SC. That section of the manual refers to the factors to consider and refers you to the factors in the Manual dealing with an offer submitted on the basis of ETA.   The Manual also refers you to IRC section 6343, specifically Treas. Reg. section 301.6343-1 which provides that a levy can be released on the basis of economic hardship.  I.R.M. 5.8.11.2.1 gives examples and specific provisions for the IRS employee to look for in making his or her decision.

In IRM 5.8.11.2.1 (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:

• the taxpayer’s age and employment status
• number, age and health of taxpayer’s dependents
• cost of living in area the taxpayer resides
• any extraordinary circumstances such as special education expenses, medical catastrophe, or natural disaster

Each of these factors must be specifically addressed in the OIC memorandum submitted by the Clinic.

In IRM 5.8.11.2.1(6) factors constituting economic hardship are listed, such as:

• The taxpayer is incapable of earning a living because of a long term illness, medical condition or disability and it is reasonable that the financial resources will be exhausted.
• The taxpayer has set monthly income and no other means of support, and the income is exhausted each month in providing for the care of dependents.
• The taxpayer has assets, but is unable to borrow against the equity in those assets, and liquidation to pay the outstanding tax would render the taxpayer unable to meet basic living expenses.

These factors also must be specifically addressed in the OIC memorandum.

Frequently, the client has a negative cash flow, no assets with equity except for their vehicle.  Assuming you have thoroughly explored the actual value of the vehicle and there is still 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 under the provisions for 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 the cost would be added to the monthly expenses should the client borrow against the vehicle; pictures of the vehicle; the need to transport dependent children or other members of the taxpayer’s household in the vehicle, the taxpayer’s health situation necessitating use of the vehicle.

In preparing an offer, ensure that you clearly state in the opening paragraph of the memorandum under what ground you are submitting the offer. 

Effective Tax Administration

Even though a taxpayer is able to pay the tax, a compromise may be entered to promote ETA when:

1. Collection of the full liability would cause the taxpayer economic hardship or
2. Compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability, and
3. Compromise of the liability will not undermine compliance by taxpayers with the tax laws [Treas. Reg.
   § 301.7122-1(b)(4)]

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:

1. Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer's financial resources will be exhausted providing for care and support during the course of the condition;
2. Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and
3. Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.

Compromise based on equity and public policy will only be accepted if, due to exceptional circumstances, 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.

Financial Analysis

General:  The Form 433 must be consistent with the Memorandum that is submitted as well as the amount offered.  There are two main areas of the 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 cannot be set off against each other.  In the event that the difference in the income and expenses is a negative number that amount will not be set off against the positive number of the assets.

In determining what is the correct amount to offer as part of the OIC, the amount must be greater than the collection potential of the equity in all assets and the surplus in monthly income.  In completing the 433 sections listing assets and liabilities be aware that any amount of equity shown is the minimal amount of an offer.  For instance, if the 433 shows cash on hand or bank balance average of $100.00, then the amount must be at least  that amount.  In some instances it is helpful to present more than 3 months of bank statements if the average more clearly reflects the cash on hand. 

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 § 5.8.5.6, "Future Income". These sections provide guidance to IRS personnel in reviewing offers and other collection actions.

For now a couple of observations: The section is headed "Future Income" 5.8.5.6.  The Manual instructs the examiner to consider the possible future earning potential 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.

In 5.8.5.6 (5) list several situations and how to treat them where there is unemployment or underemployment. Again, it offers guidance and instructions to the examiner how to treat these. 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.  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.  

The IRS considers whether the tax would be discharable 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 dischargable).  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.

Rules and Requirements For All Offers

1. All required federal tax returns must be filed
2. Not currently involved with a pending bankruptcy proceeding
3. Form 656 or 656-L
4. Form 433-A or 433-B (not needed if doubt as to liability) accompanies Form 656.  This form requires a substantial amount of supporting documents.  See Documents to Support Form 433.
5. Form 656-A (Application Fee Waiver), Application Fee Waiver worksheet, or $150 application fee.
6. Written detailed narrative as to the facts and circumstances of the taxpayer explaining why offer should be accepted.

Payment Terms

Consequences of an Offer

1. The taxpayer must file all required Federal tax returns and pay all required taxes for the next five years or until the offer amount is paid in full, whichever is longer.  Otherwise, the offer will go into default, and the full amount of the original liability (less any amounts paid pursuant to the offer) with interest will be reinstated.
2. The statute of limitations for the assessment of tax liability for the tax periods compromised is suspended.
3. The IRS will keep all payments and credits made, received or applied to the total original tax liability before the submission of this offer.
4. The IRS will keep any refund, including interest, the taxpayer is entitled to for the tax year the offer was accepted and the refund for the following tax year.
5. Once the IRS accepts the offer, the taxpayer cannot dispute the amount of tax liability in court or otherwise.
6. If the taxpayer should default on an accepted offer, then the IRS may also:
   1. Immediately file suit to collect the entire unpaid balance of the offer
   2. Immediately file suit to collect an amount equal to the original amount of the tax liability as liquidating damages
   3. File suit or levy to collect the original amount of the tax liability without further notice of any kind
7. The IRS may not levy against the property or rights to property of a taxpayer to collect the liability that is the subject of the offer during the period the offer is pending, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.
8. The statute of limitation on collection is suspended while an offer is pending.

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:

1. Name, address and Social Security number or the taxpayer identification number of the taxpayer
2. Amount proposed and the terms of the payment
3. Acceptance date of the original offer
4. Waiver of any and all claims to amounts due from the United States up to the time of acceptance to the extent of the difference between the amount offered and the amount of the claim covered by the offer and
5. Reasons why request is being made to compromise the existing agreement

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.

Typically, several weeks after submission of an Offer in Compromise, the IRS will ask for supplemental information. Usually, we are informed that 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 the Clinic Director or Associate Director or Supervising Attorney prior to mailing.

Once the OIC 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 sent to the Appeals Office in Holtsville, New York with the materials we provided and any comments the Offer Specialist wishes to make.  Our Appeal Memoranda/letter as a routine practice 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 in Holtsville, New York, 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) a two-year pilot program to apply the 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. Atlanta is one of the test sites and thus the Clinic Offers are impacted.

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 cases.

Types of issues that are subject to this process include:

1. Value of assets;
2. Value of dissipated assets;
3. Taxpayer’s proportionate interest in jointly held assets;
4. Projections of future income based on calculations other than current income
5. The calculation of a taxpayer’s future ability to ay when living expenses are shared with a non-liable person; and
6. Other factual determinations, such as whether a taxpayer’s contributions into a retirement savings account are discretionary or mandatory as a condition of employment.

Resources

The LITP Newsletter - Allowable expenses

Collection Financial Standards

Offer In Compromise To-Do List

Financial Analysis Handbook

Application Fee Waiver

Sample letter requesting documents to support offer

Supporting document checklist 

Statement Supporting OIC (include as attachment to Form 656)

Future Income Memo 5.8.5.6

Offer Payment Cover Letter

Internal Revenue Code

Treasury Regulations

Internal Revenue Manual

IRS Forms and Publications