After the Bankruptcy Abuse Prevention and Consumer Protection Act you thought it couldn’t get any worse for your tax delinquent clients? Wrong again. The latest Congressional gift to the IRS Collection Division is Section 509 of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). One must at least give grudging credit to the Congress for creative captioning, even though the substance of the law has little to do with the title.
The IRS National Office, flooded basement and all, is working on a new Form 656 to be used in submitting offers in compromise. When released, it will incorporate the statutory changes made by TIPRA, effective for offers received by the Service on or after July 16, 2006.2 In the meantime, understanding the major changes to the offer in compromise program requires a review of the statute itself (which amends IRC § 7122), and the IRS’s explanatory pronouncements issued on July 14, 2006, two days before the effective date of the new rules. These include Notice 2006-68, upon which taxpayers can rely until implementing Regulations are promulgated by the Service.
Heretofore, deposits could be made with offers in compromise, but the IRS discouraged the practice. In contrast, deposits will now be required in most cases, and failure to pay the required deposit (in addition to the $150 application fee) will cause the offer to be summarily returned as “unprocessable,” a determination that is subject to neither administrative appeal nor judicial review.
The amount of the required offer depends on the type of offer in compromise in question:
For a lump sum offer based on doubt as to collectibility, the required deposit is 20% of the total amount offered. (Separate checks should be submitted for the deposit and for the $150 application fee.) A lump sum offer for this purpose is any offer in compromise proposing to pay the amount offered in five or fewer installments.
For a periodic payment offer based on doubt as to collectibility, the taxpayer must deposit the initial proposed payment upon submission of the offer, and must thereafter continue to make the proposed periodic payments while the offer is under review. Failure to do so will result in the offer being returned as unprocessable. A periodic payment offer is one proposing more than five payments. This term therefore encompasses the pre-TIPRA “short-term deferred payment offer,” under which the offered amount is to be paid over a maximum of 24 months from the date of acceptance, as well as the “deferred payment offer,” involving payments over the entire remaining life of the collection statute of limitations.
No deposit is required for an offer based solely on doubt as to liability. Such an offer is submitted on the normal Form 656 with the appropriate box checked, or on the special Form 656-L Offer in Compromise (Doubt as to Liability) issued by the Service in January 2006.
Furthermore, a deposit waiver provision applies to certain low-income taxpayers. For this purpose, a low-income taxpayer is someone with income at or below the federal poverty level, as set by the U.S. Department of Health and Human Services. However, until further guidance is issued, the IRS will use the same standard as that applicable to the pre-TIPRA waiver of the offer in compromise application fee. A claim for eligibility for the waiver is made by filing a Form 656-A Income Certification for Offer in Compromise Application Fee and the related worksheet.
The only good thing that can be said about the new offer deposit requirement is that the taxpayer is at least allowed to designate how the deposit is to be applied. This is true whether the deposit is a single payment in connection with a lump sum offer, or a series of payments made under a periodic payment offer while the offer is under evaluation. However, the designation must be timely and in writing. If the taxpayer fails to provide a written designation at the time of payment, the IRS can apply the payment at its discretion in the best interest of the Service.
How best to designate an offer in compromise deposit requires thinking about a variety of issues, depending on the facts of the particular case. Thus, one might want to think about the dischargeability of the various liabilities, just in case the offer is rejected and the taxpayer must resort to bankruptcy. Even different components of a tax liability have different characteristics in bankruptcy, and these distinctions could lead to strategy decisions with respect to the designation of payments. For example, although a tax arising due to fraud and the interest thereon are not dischargeable, the fraud penalty itself, as well as interest on the penalty, can be discharged. Similarly, it would be important to consider the application of the statute of limitations on collection, and the respective exposure of married taxpayers to the various taxes making up the total amount due where some of the liabilities stem from joint returns and others are owed only by one spouse.3
If an offer in compromise is filed without the required deposit, it will be returned as unprocessable, with no appeal rights. Similarly, if a subsequent payment is missed while a periodic payment offer is under evaluation, the IRS will give the taxpayer one chance to make up the missing deposit. Failing this, the Service will return the offer as unprocessable, again with no appeal rights.
Prior to TIPRA, one issue that sometimes precluded the filing of an offer was “current compliance.” The IRS’s position was that an offer could not be processed unless the taxpayer was in full compliance. This meant that all required returns had to be filed, and the taxpayer had to be fully engaged in the “pay as you go” system by having adequate withholding and/or by making appropriate estimated tax payments. This door has been opened a little by TIPRA. Now, current compliance is not a prerequisite to the filing of the offer, but the taxpayer must get into compliance before the offer can be accepted. The IRS’s new position on this is explained in Q&A 15 of the “FAQs for New Offer in Compromise Rules,” which was issued along with Notice 2006-68 on April 14th:
Compliance will no longer be a processability criterion for OIC initial submissions. If compliance is the only issue, the offer will be deemed processable. However, IRS will contact the taxpayer by either telephone or correspondence requesting the delinquent return(s), and/or the required estimated tax payments(s) A reasonable amount of time will be provided to the taxpayer to comply. Failure to comply will cause the IRS to return the offer back to the taxpayer and retain the application fee. The taxpayer will not have appeal rights to this decision.
So the price of filing an offer and then failing to achieve current compliance is that the offer will be returned (not rejected, since “rejection” would invoke appeal rights), and the IRS will keep both the application fee and the deposit.
We will have to see whether these new rules achieve the intended purpose of reducing the number of offers filed, particularly the often poorly prepared products of the “pennies on the dollar” offer in compromise mills that have clogged the system, even though they have little chance of acceptance. Sadly, the new requirements may reduce the number of serious, large dollar offers, since 20% of a large proposed compromise amount obviously will itself be a substantial amount. But it may not reduce the number of small dollar offers, including the frivolous offers. The reason is that a requirement to deposit 20% of some small offer amount does not pose a major obstacle. This is the exact opposite of what the IRS and the Congress may have wanted.
- Mr. Haynes is a tax lawyer in Burke, Virginia. From 1973 to 1981 he served as a Special Agent with the IRS Criminal Investigation Division, and in 1980 was named “Criminal Investigator of the Year” by the Association of Federal Investigators. He specializes in civil and criminal tax disputes and litigation, tax collection cases, the tax aspects of bankruptcy and divorce, and the defense of individuals accused of financial crimes.
- A previous article by author titled “Negotiating Offers in Compromise” was published in the December 1998/January 1999 issue of The Freestate Accountant.
- All of these planning considerations are addressed in other articles by the author in this intermittent series on Dealing with the IRS Collection Division, as previously published in The Freestate Accountant. Reprints are available from the Society and the articles are posted on Mr. Haynes’ website at www.bjhaynes.com.