If a taxpayer is unable to pay their tax bill now or in the foreseeable future with monthly income or current assets, then he or she may qualify for the IRS’s Offer-In-Compromise program to settle the total debt for less than the full amount. The idea that you can settle for “pennies on the dollar” is often hyped by commercials from tax resolution firms that boast that they have turned a $50,000.00 tax bill into a mere $200.00. In reality, these types of resolutions on federal tax debt are rarely granted and only under certain circumstances. Do you qualify to resolve your tax debt with an offer-in-compromise?
The U.S. Department of Treasury and the Internal Revenue Service is explicitly authorized to “compromise any civil or criminal case arising under the internal revenue laws…”. 26 U.S.C. §7122(a). In addition, the Department of Treasury “shall prescribe guidelines for officers and employees of the Internal Revenue Service to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute.” 26 U.S.C. §7122(d)(1). The three grounds for compromise are as follows:
(1) Doubt As To Liability
- “Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability.” 26 CFR 301.7122-1(b)(1).
- “Offers submitted on the basis of doubt as to liability cannot be rejected solely because the IRS is unable to locate the taxpayer’s return or return information for verification of the liability.” 26 CFR §301.7122-1(f)(4).
(2) Doubt As To Collectability
- “Doubt as to collectability exists in any case where the taxpayer’s assets and income are less than the full amount of the liability.” 26 CFR §301.7122-1(b)(2).
- “A determination of doubt as to collectability 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. 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.” 26 CFR §301.7122-1(c)(2)(i).
- The Internal Revenue Service will calculate your “total positive income” (e.g. wages, dividends, rents, etc.) and compare it against national and local standard living expenses to determine if there should be any discretionary income left to pay taxes:
- For 2020, the Allowable Living Expense National Standards for food, housekeeping supplies, apparel, personal care products and other miscellaneous items are $715.00 per month for one person, $1,298.00 per month for two persons, $1,433.00 per month for three persons, $1,740.00 per month for four persons and $378.00 for each additional person beyond four.
- For 2020, the Allowable Out-Of Pocket Health Care Standards for medical services, prescription drugs and medical supplies such as eyeglasses or contact lenses is the TOTAL of the amount the taxpayer pays in health insurance PLUS $56.00 per month if under age 65 OR $125.00 per month if age 65 or older.
- The IRS uses Local Standards for housing and income broken down by the state and county. For example, in 2020, the Local Standards for Housing and Utilities in Monroe County, Michigan are $1,357.00 per month for one person, $1,593.00 per month for a family of two, $1,679.00 per month for a family of three, $1,872.00 per month for a family of four, and $1,902.00 per month for a family of five. The taxpayer would be entitled to use the local standard or the actual expense, WHICHEVER IS LOWER.
- The IRS uses Local Standards for transportation and calculates it in two ways. In 2020, if the taxpayer owns a vehicle, the average ownership costs (e.g. monthly payments on loan or lease) are $521.00 per month per vehicle (up to two vehicles), and operating costs (e.g. gas, maintenance, etc.) are broken down by metropolitan region. In the Detroit, Michigan metropolitan area, the local standard for operating costs of a vehicle to a taxpayer are $314.00 per month per vehicle (up to two vehicles). If the taxpayer does not own a vehicle, the taxpayer may use the single nationwide allowance for public transportation based on fares for trains, buses, taxis, etc. A taxpayer with no vehicle in 2020 can use the national standard for public transportation of $224.00 per month without question regardless of actual expenses.
- These national and local standards are adjusted annually to account for increased costs and inflation. The IRS will rigidly apply these standards to your monthly income to determine what disposable income you have available to pay your tax bill. If your total income is less that the total allowances permitted under the national and local standards without any likelihood of improvement, you may be strongly considered for an offer in compromise.
(3) Promote Effective Tax Administration
- “A compromise may be entered into to promote effective tax administration when the [IRS] determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship…”. 26 CFR §301.7122-1(b)(3)(i). Economic hardship exists if satisfaction of the tax debt in whole or in part will cause an individual taxpayer to be unable to pay his or her reasonable basis living expenses. Factors supporting (but not conclusive) a determination that collection would cause economic hardship include, but are not limited to:
- “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” (26 CFR §301.7122-1(c)(3)(i)(A));
- “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” (26 CFR §301.7122-1(c)(3)(i)(B));
- “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.” (26 CFR §301.7122-1(c)(3)(i)(C)).
- If there are no grounds for compromise due to doubt as to liability, doubt as to collectibility or economic hardship, “the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, 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. A taxpayer proposing compromise [for this reason] will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.” 26 CFR §301.7122-1(b)(3)(ii).
- “No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws.” 26 CFR §301.7122-1(b)(3)(iii). Factors supporting (but not conclusive) a determination that compromise would undermine compliance include, but are not limited to:
- “Taxpayer has a history of noncompliance with the filing and payment requirements of the Internal Revenue Code” (26 CFR §301.7122-1(c)(3)(ii)(A));
- “Taxpayer has taken deliberate actions to avoid the payment of taxes” (26 CFR §301.7122-1(c)(3)(ii)(B));
- “Taxpayer has encouraged others to refuse to comply with the tax laws” (26 CFR §301.7122-1(c)(3)(ii)(C)).
APPLYING TO THE IRS FOR AN OFFER IN COMPROMISE
Taxpayers must file Form 656 (Offer In Compromise) with the IRS to make the formal request. The Internal Revenue Service may also require an individual taxpayer to file a financial statement on Form 433-A (Collection Information Statement for Wage Earners and Self-Employed Individuals) for current income and asset information. Any businesses such as corporations or LLCs looking for an offer-in-compromise may also be required to file a financial statement on Form 433-B (Collection Information Statement for Businesses). If the request is based on doubt of liability, the taxpayer must instead file Form 656-L (Offer In Compromise – Doubt As To Liability). An offer-in-compromise submitted solely on the basis of doubt as to liability will not require financial statements. 26 CFR §301.7122-1(d)(1). The form is filled out under penalty of perjury and incomplete submissions will be returned to the taxpayer. The Internal Revenue Code also requires the following:
- LUMP-SUM OFFERS – The offer-in-compromise must be accompanied by a payment of 20% of the amount of such offer in addition to the application fee. 26 U.S.C. 7122(c)(1)(A)(i). Lump-sum offer-in-compromise means any offer of payments made in 5 or fewer installments. 26 U.S.C. §7122(c)(1)(A)(ii).
- PERIODIC PAYMENT OFFERS – The offer-in-compromise must be accompanied by a payment of the amount of the first proposed installment in addition to the application fee. 26 U.S.C. §7122(c)(1)(B)(i). Failure to make the installment payment due during the pendency of the offer can be treated by the IRS as a withdrawal of that offer. 26 U.S.C. §7122(c)(1)(B)(ii).
- The partial payment and user fee required in connection with an offer-in-compromise does not apply to a taxpayer who is an individual and whose gross adjusted income in the most recent taxable year does not exceed 250% of the applicable poverty level. 26 U.S.C. §7122(c)(3).
An offer-in-compromise has not been accepted by the IRS unless it issues a written notification of acceptance to the taxpayer. 26 CFR §301.7122-1(e)(1). The Internal Revenue Service has up to 2 years to consider an offer-in-compromise. In addition, any offer-in-compromise submitted that is not expressly rejected by the IRS within 2 years is deemed accepted (excluding any period during which the disputed tax liability is subject to a judicial proceeding). 26 U.S.C. §7122(f).
The following rules apply to the IRS accepting an offer in compromise:
- “As additional consideration for the acceptance of an offer to compromise, the IRS may request that the taxpayer enter into any collateral agreement or post any security which is deemed necessary for the protection of the interests of the United States.” 26 CFR §301.7122-1(e)(2).
- “Offers may be accepted when they provide for payment of compromised amounts in one or more equal or unequal installments.” 26 CFR §301.7122-1(e)(3).
- “If the final payment on an accepted offer to compromise is contingent upon the immediate and simultaneous release of a tax lien in whole or in part, such payment must be made in accordance with the forms, instructions, or procedures prescribed by the Secretary.” 26 CFR §301.7122-1(e)(4).
- “Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of, nor prevent the IRS from taking action to collect from, any person not named in the offer who is also liable for the tax to which the compromise relates.” 26 CFR §301.7122-1(e)(5). For example, an offer-in-compromise from one spouse or ex-spouse related to a joint return does not affect the tax liability of the other spouse who did not file an offer-in-compromise.
- “Neither the taxpayer nor the Government will, following acceptance of an offer to compromise, be permitted to reopen the case except in instances where false information or documents are supplied in conjunction with the offer, the ability to pay or the assets of the taxpayer are concealed, or a mutual mistake of material fact sufficient to cause the offer agreement to be reformed or set aside is discovered.” 26 CFR §301.7122-1(e)(5).
However, the following rules apply to the IRS rejecting an offer-in-compromise:
- “An offer to compromise has not been 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.” 26 CFR §301.7122-1(f)(1).
- The IRS cannot issue a written notice of rejection until an independent administrative review of any proposed rejection of the offer-in-compromise or installment agreement is complete. 26 U.S.C. §7122(e)(1); 26 CFR §301.7122-1(f)(2). The taxpayer may administratively appeal a rejection of an offer to compromise to the IRS Office of Appeals within 30 days of the date on the letter of rejection. 26 U.S.C. §7122(e)(2); 26 CFR §301.7122-1(f)(5)(i).
- No offer to compromise can be rejected solely on the basis of the amount of the offer without the IRS following its own procedures to evaluate it. 26 U.S.C. §7122(d)(3)(A); 26 CFR §301.7122-1(f)(3).
- No offer based on doubt as to liability can be rejected solely because the IRS is unable to locate the taxpayer’s return or return information to verify the tax liability. 26 U.S.C. §7122(d)(3)(b); 26 CFR §301.7122-1(f)(4).
EFFECTS OF RECEIVING AN OFFER-IN-COMPROMISE
The offer-in-compromise has the following effects on IRS collection activity:
- “The IRS will not levy against the property or rights to property of a taxpayer who submits an offer to compromise, 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 the IRS Office of Appeals.” 26 CFR §301.7122-1(g)(1). In addition, the IRS will not refer any case to the Attorney General’s Office to commence a court proceeding during any of these times UNLESS it is to file a counterclaim or third-party complaint in a refund action or join the taxpayer in any other proceeding where the tax liability subject to the pending offer-in-compromise is established or disputed. 26 CFR §301.7122-1(g)(6).
- The statute of limitations on collection (normally 10 years from assessment) is suspended during any time that tax levies are prohibited due to the pending or accepted offer-in-compromise. 26 CFR §301.7122-1(i)(1). This effectively tolls and extends the Collection Statute Expiration Date (CSED) so the IRS can undertake collection efforts in the future if necessary. For any offer to compromise, the IRS may require, where appropriate, the extension of the statute of limitations on assessment (which effectively waives the running of the statutory period to the CSED), but the taxpayer has the right to refuse this extension or limit the extension to particular issues. CFR §301.7122-1(i)(2).
- “If, following the rejection of an offer to compromise, the taxpayer makes a good faith revision of that offer and submits the revised offer within 30 days after the date of rejection, the IRS will not levy to collect from the taxpayer the liability that is the subject of the revised offer to compromise while that revised offer is pending.” 26 CFR §301.7122-1(g)(2).
- “The IRS may levy to collect the liability that is the subject of an offer to compromise during the period the IRS is evaluating whether that offer will be accepted if it determines that collection of the liability is in jeopardy.” 26 CFR §301.7122-1(g)(3).
- If the IRS determines that a pending offer did not contain sufficient information to permit evaluation of whether the offer should be accepted (e.g. Form 565 was incomplete), or that the offer was submitted solely to delay collection, or that the offer was otherwise non-processable, then the IRS may levy to collect the liability that is the subject of that offer at any time after it returns the offer to the taxpayer. 26 CFR §301.7122-1(g)(4).
An offer-in-compromise may be an effective way to deal with your tax situation. Only an experienced tax professional can advise you of the pros and cons of an offer-in-compromise and assist you with making the best possible case to the IRS. An accepted offer can reduce your overall tax debt, but a rejected offer can have the unintended consequence of giving the IRS more time to collect, especially if the taxpayer ultimately defaults on any installment payments in the offer-in-compromise.
If you have any questions about federal tax law or need legal assistance, then do not hesitate to contact the experienced attorneys at Kershaw, Vititoe & Jedinak PLC today.