New OIC 20% partial payment requirement could backfire.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) amended Sec. 7122(c) (1) to require most taxpayers to make a 20% partial payment with an offer-in-compromise (OIC) application, effective July 16, 2006. The legislation was passed despite opposition from the AICPA, the American Bar Association's Section of Taxation and other stakeholders.

The change applies to lump-sum OICs. "Lump sum" is defined by Sec. 7122(c)(1)(A)(ii) as an offer to make payments in five or fewer installments. Any applicable OIC that does not include a partial payment may be returned to the taxpayer as unprocessable; see Sec. 7122(d)(3)(C).

The $150 user fee imposed on OIC applicants since Nov. 1,2003, is still in effect; see Notice 2006-68.

Under Sec: 7122(f), the IRS will consider any properly submitted OIC to be acceptable if it has not made a determination within 24 months of the submission date. However, a tax liability covered under the OIC that involves any judicial proceeding will suspend the 24-month period. Taxpayers must be current with their filings and any payments subsequent to the period covered by the OIC while they are waiting a resolution.

A Break with Tradition

Since the 1860s, taxpayers have had the ability to compromise and settle deficiencies as a last resort. Historically, this has been good business for the government. In testimony before the House Small Business Committee on April 5, 2006, Nina Olsen, the IRS Taxpayer Advocate, said that, on average, accepted OICs have resulted in the Service collecting 16 cents on every dollar owed. This is a better return than 13 cents on the dollar, which is what the IRS has typically collected on debts two or more years old. According to Ms. Olsen, in cases in which OIC applications are rejected, the IRS collects less than 80% of what it might have collected under an initial taxpayer offer. In over 20% of those cases, the Service recoups nothing at all.

Despite the success, and even before the current legislation, recent statistics show an overall decline in the OIC program. A General Accounting Office study noted that taxpayers applied for about 123,000 OICs in fiscal-year 2002. By fiscal-year 2005, the number was closer to 73,000. The number of OICs accepted has declined as well. OIC acceptances for fiscal-year 2002 were approximately 28,000. Fiscal-year 2005 saw only about 15,000 offers accepted; see "ILLS Offers In Compromise: Performance Has Been Mixed; Better Management Information and Simplification Could Improve the Program" (GAO-06-525, 5/23/06), available at www.gao.gov/htext/d06525.html.

Due to impediments introduced with the TIPRA, many practitioners and advocates have expressed concern that the new legislation will effectively kill the OIC program. How many taxpayers will be willing to incur the emotional and financial costs of providing a partial payment, knowing their chances of having an offer accepted are slim? The most common means of financing an OIC payment are:

1. Cashing in an IRA and paying tax and penalties;

2. Refinancing real estate with a loan; and

3. Obtaining funds from parents or friends.

Is There Any Relief?

As a way to avoid the 20% initial payment, some commentators propose structuring an OIC to include more than five installments. Under this scenario, taxpayers would make monthly installments while awaiting IRS approval. However, as final approval may take several years, this approach may be impractical.

Another alternative is a hardship waiver. New Sec. 7122 (c) (2) (C) gives the Secretary authority to issue regulations allowing waivers for certain classes of taxpayers. Ms. Olsen has requested examples from the AICPA Tax Division's IRS Practice and Procedures Committee, which can form the basis of as broad a hardship waiver as practical. The Committee is in the process of submitting examples.

Conclusion

The Joint Committee on Taxation has estimated that revenue will increase by almost $2 billion from this provision. On the contrary, many practitioners predict that the 20% partial payment is a significant barrier that will encourage taxpayers not to apply for an OIC and will result in an overall decrease in revenue.

FROM ROBERT M. CAPLAN, CPA, FOSTER CITY, CA