IRS gives broke taxpayers a break.

Individual taxpayers, who would suffer economic hardship if forced to pay their entire tax liability, can now breathe a sigh of relief. The IRS released temporary and proposed regulations (TD 8829 and IR-1999-64) that allow it to take into account hardship and equity factors in offers in compromise (OIC).

According to Charles O. Rossotti, commissioner of the IRS, the new regulations will help people the IRS has not been able to reach before. However, he warned taxpayers against interpreting the new law as an open invitation to avoid paying taxes.

Rossotti cautioned that the new hardship provisions are meant "only for taxpayers entangled in very severe circumstances" and are "not designed to be a sweeping program for everyone with financial difficulties."

The old regulations permitted the IRS to accept an offer in compromise only on grounds of doubt as to liability, collectibility or both. Taxpayers can still submit offers under the old rules, but now they may receive an OIC settlement even if liability or collectibility is not an issue.

Under the new rules, which went into effect July 21 and will be in force for three years, taxpayers will receive relief if collection of the liability would create economic hardship or if exceptional circumstances exist that would cause collection of the tax liability to be detrimental to voluntary compliance.

The regulations list the following examples of economic hardship:

* The taxpayer is incapable of earning a living because of long-term illness, medical condition or

* The taxpayer has a dependent whose long-term illness requires the taxpayer to use his or her resources for basic living expenses and medical care.

* The taxpayer would not be able to meet basic living expenses if his or her assets were liquidated to pay outstanding tax liabilities.

* The taxpayer is unable to borrow against his or her assets, and seizure and sale of the assets would have sufficiently adverse consequences to make enforced collection unlikely.

In the new regulations, the IRS gives two examples of cases where the new OIC rules would apply (see section 301.7122-IT(b) (4) (iv)).

In the first example, the taxpayer is retired and his only source of income is his pension. His only asset is his retirement account, and the funds in the account are sufficient to pay his tax liability. Liquidation of the account would leave the taxpayer without adequate means to provide for basic living expenses.

In the second example, the taxpayer was hospitalized for a number of years. When he was ill, he could not manage his finances and didn't file any tax returns. The taxpayer's health improved, and he began to file his tax returns. The IRS informed him it had prepared a substitute return for an earlier year. With penalties and interest, the tax bill is now more than three times the original tax liability.

In both these examples, the new rules would allow the taxpayers to obtain OICs from the IRS.

Observation. Taxpayers seeking relief under the new hardship/equity guidelines must submit the new form 656-A in addition to form 656 (the standard OIC form). If the offer is rejected, it will automatically receive an independent administrative review. In addition, the taxpayer has the right to appeal any rejection of an offer in compromise to the IRS Office of Appeals.

The temporary regulations, which are in effect through December 31, 1999, require taxpayers to waive the statute of limitations as a condition of the acceptance of an OIC. After January 1, 2000, the IRS will no longer require the waivers, but it will suspend the statute of limitations during the time it is considering an offer.

--Michael Lynch, CPA, Esq., professor of tax accounting at Bryant College, Smithfield, Rhode Island.