The new IRS offers in compromise policy.
Since the early 1930s, Congress has allowed the Internal Revenue Service to settle delinquent accounts at reduced amounts. This settlement procedure has been conducted under the strict guidelines of the IRS's offers in compromise (OIC) policy. Under these guidelines, a tax liability could be compromised on one or both of two grounds: doubt as to liability and doubt as to collectibility. With the infrequent number of OIC settlements over the years, and the significant rise in receivables, the IRS has changed its policy. Earlier this year, a new policy statement made sweeping changes: An offer also will be accepted "if in the best interest of the government."
Will the new OIC policy solve the growing receivables problem or will it create new problems for the IRS? This article explores this question by addressing
* Significant policy changes intended to help resolve the accounts receivable problem.
* New OIC procedures.
* Potential problems stemming from these changes.
In 1989, over 175 million tax returns were filed and the IRS carried $66 billion in accounts receivable, $8 billion of which was rendered uncollectible. By 1991, the accounts receivable balance grew by $44 billion, or 67%, to an alarmingly high $110 billion. Some of this increase is mitigated by the November 1990 change in statutory limitations whereby Congress added four years to the six years previously granted the IRS to collect an assessed tax.
Despite the immense accounts receivable amount, taxpayers proposed fewer than 9,000 offers to settle tax claims in 1991. This remarkably low figure is attributable to two factors:
* Revenue officers assigned to delinquent accounts were neither informing taxpayers of the OIC option nor advising them on how to complete the necessary forms.
* More than 80% of offers actually submitted during the 1980s were rejected, leaving taxpayers little incentive to explore this option.
In a November 5, 1981, report, the Government Accounting Office noted the negligible OIC volume and concluded the IRS lacked a uniform policy to help revenue officers decide when to suggest and when to accept offers. It recommended the IRS undertake a study on the most effective use of OIC. Almost 10 years later, new changes are taking effect.
The objective of the Internal Revenue Code compromise provision remains unchanged: to effect maximum collection with the least possible loss or cost to the government. However, a new meaning to this objective is circulating through IRS district offices: to achieve collection of what is potentially collectible "in the shortest time possible." The new policy was released February 26, 1992, under Internal Revenue Manual 57(10).
To illustrate the new policy, assume the IRS assesses a $10,000 tax on John Doe. Doe has no assets, but his earning capacity may enable him to accumulate $2,000 each year after "necessary expenses." Under prior policy, no basis for compromising Doe's liability was available to the IRS because the assessed amount was collectible over time through an installment, direct debit or payroll deduction agreement.
Such agreements, however, are not always an effective solution to collections since they require continual IRS monitoring and run a high default risk. In the absence of compromise, Doe's liability might be included in IRS accounts receivable for as long as 10 years from the assessment date. Under the new policy, the IRS will settle with taxpayers at a smaller amount under certain circumstances.
If Doe borrows say, $5,000 from outside sources to settle the claim, the revenue officer would evaluate not only Doe's financial condition but also his medical condition and other factors. If Doe is in poor health, the revenue officer may recommend accepting $5,000 or even a lower amount, if offered.
Generally, the revenue officer expects the amount offered in compromise to approximate the present value of future installments the taxpayer could otherwise make. These future installments are discounted at the statutory rate provided in IRC section 6621(a)(2).
If Doe is not in poor health and has a steady income but no assets, the revenue officer, before responding to Doe's offer, goes to a computer workstation and performs a computation similar to the one shown in the exhibit on page 77. Since the $5,000 offer is less than the $8,095 present value, the revenue officer is instructed to ask Doe to consider family, friends or other sources who might lend him the additional funds he needs.
If Doe cannot find additional funds, the revenue officer nevertheless is required to forward a properly completed offer to the OIC group for consideration--no matter how low the amount. However, the revenue officer probably will not recommend acceptance if Doe's physical health is good and his future earning capacity promising. On the other hand, if Doe can borrow an additional $3,000 from an outside source, the revenue officer probably will recommend acceptance of his offer. Once accepted and the $8,000 paid, the $2,000 balance is abated. Any tax liens are removed. For some specific questions on OIC procedures, see the sidebar on pages 78 -79.
NEW OIC PROCEDURES Some notable procedural changes include
Advising taxpaxers of the OIC option. The revision to Internal Revenue Manual 57(10) requires revenue officers to explain taxpayers' rights and alternatives. Past guidelines set by the national office were so broad this discretion was left to district personnel. Since the OIC procedure is somewhat cumbersome and lengthy, revenue officers could choose to avoid additional paperwork by not bringing it up. The revenue officer's role regarding the initial offer amount remains unchanged. The initial OIC must be devised by the taxpayer with no suggestion of an offering amount from the revenue officer. The revenue officer begins negotiations only after receiving the taxpayer's initial offer.
Assisting taxpayers with OIC forms. As stated earlier, past policy did not encourage revenue officers to assist taxpayers in completing complicated OIC forms. Upon receiving an incomplete set of OIC forms, the IRS promptly returned them to the taxpayer without consideration. Often frustrated and intimidated, many taxpayers abandoned their attempts to reach compromise. Afterward, they suffered the/RS's constant collection demands while the/RS suffered the cost of carrying the account receivable. Under the new policy, revenue officers are required to advise taxpayers on how to complete OIC forms properly.
Processing OIC forms. In the past, the special procedures group reviewed completed OIC forms for completeness and accuracy and prepared all taxpayer correspondence, The new flow chart shifts most of these responsibilities to revenue officers. Any degree of frequency in forwarding incomplete forms to the OIC group for approval will reflect unfavorably on the revenue officer--all the more reason for the revenue officer to be more helpful.
Retaining OIC forms. The OIC forms taxpayers must complete will be virtually the same as before. Form 656, Offer in Compromise, contains some minor revisions. The revised form's effective date was November 1991, and it became available to the general public in February 1992.
Changing the minimum compromise amount requiring legal opinion. IRC section 7122(b)(3) is every bit as sensible as the New England blue law prohibiting taking a bath on Sunday. The section requires a legal opinion from the Treasury Department's general counsel or his or her delegee on all compromise cases in which the tax assessment exceeds $500. This limit was established over 60 years ago when $500 was equivalent to several months' wages of most Americans.
Given any reasonable standard of materiality, the $500 limit no longer makes sense, even given the chain of delegation from the general counsel of the Treasury down to the district counsel level. The IRS is proposing Congress change the minimum amount from $500 to $50,000. This new limit would apply to the excess of assessment amount over compromise amount rather than merely to the assessment amount, as provided currently.
Approving offers in compromise. Under past policy, OIC could be approved only by relatively high-ranking IRS officials. With the new policy, Collection Division chiefs may approve amounts of $100,000 and above. Field branch chiefs may approve OIC of assessments under $100,000. As under previous policy, no authority limits apply to OIC rejections.
A number of potential problems with the new program exist.
Inadequate staffing. A senior IRS official told me each of the three OIC groups in his district is currently overloaded with 35 to 40 offers in compromise--which do not reflect the new OIC policy. The OIC budget in his district allows two additional offer specialists. However, the national office expects a 500% OIC increase during the initial year of change; this increase is expected to create a growing backlog.
Mismatch between responsibility and training. Few revenue officers who work with taxpayers in OIC have had extensive training in effective negotiating techniques, financial condition evaluation or present value analysis. The negotiations require skilled judgment in many areas, including gathering relevant financial and personal data, evaluating this data and determining the appropriate means of collection. If a revenue officer receives an OIC from a taxpayer who provided complete information, the future cash flow trade-off and the discounted period must be determined. Only selecting a discount rate requires no exercise in judgment since this rate is mandated by IRS policy. Most revenue officers must go to computer workstations to perform present value computations, and some require assistance from supervisory OIC personnel in performing their evaluations. Time and efficiency are lost. The mismatch between responsibility and training suggests revenue officers will continue to rely heavily on an already overloaded OIC staff for assistance. Future compliance. The IRS handbook says examinations of returns are used as an enforcement measure to "promote the highest degree of voluntary compliance on the part of the taxpayers." Indeed, the level of voluntary compliance with U.S. tax laws is believed to be one of the highest in the world about 83% of tax owed on income from legitimate activities is voluntarily reported and paid. Will this excellent record be "compromised" by the new OIC changes? This question is undoubtedly on the minds of many IRS officials, and it is a good bet the IRS will monitor the frequency of repeat violations that previously had been compromised.
A STRONG COMMITMENT
The new OIC policy simplifies the OIC process for taxpayers and allows the IRS greater flexibility in approving offers in compromise. The result is a "win-win" situation for both qualifying taxpayers and for the IRS.
When the IRS compromises an assessment by accepting a discounted amount, the unpaid balance is abated, the taxpayer gets a fresh start and the IRS collects monies that may be uncollectible in the future. The new OIC policy also may create new problems for the IRS. As OIC volume begins to climb, the inadequacy of staffing will lead to a mounting case backlog. The potential for "shotgunning" cases to reduce the backlog is a real danger. The trade-off of future for immediate collections may lose some degree of balance. And if the new OIC objectives are misunderstood, taxpayer compliance may suffer.
The IRS is prepared to face these problems as they occur. But its immediate concern is the growing receivables balance. The 1992 change in OIC policy signals a strong IRS commitment to solving this enormous problem.
QUESTIONS AND ANSWERS ABOUT THE NEW IRS APPROACH TO OFFERS IN COMPROMISE
1. What is an offer in compromise (01C) ? An OIC is a process where a taxpayer agrees to settle due and unpaid Internal Revenue Service tax liabilities, usually at a reduced amount. An OIC is appropriate when taxes cannot be collected in full or there is a dispute as to the amount owed.
2. When will the IRS accept an offer?
The IRS should accept an offer if it agrees it is unlikely the taxes can be collected in full and the amount offered "reasonably reflects collection potential" and is "consistent with the taxpayer's ability to pay." In rare cases an offer will be rejected based on public policy considerations.
3. Is an accepted offer final? Absent falsification or concealment of assets, or a mutual mistake of a material fact, acceptance of the offer is final provided the taxpayer does not default on any payment or other condition of the offer and provided that for a period of five years after acceptance of the offer (the five-year filing period), the taxpayer complies with all provisions of the Internal Revenue Code relating to the filing of returns and payment of taxes.
4. What IRS division has jurisdiction over OIC?
* Cases based solely on doubt about collectibility. The Collection Division considers offers based solely on doubt about collectibility. When a determination of liability is pending in the Examinations or Appeals divisions and an offer is made solely on doubt as to collectibility, the respective division secures the taxpayer's conditional acceptance of a definite amount of liability, and then the Collection Division considers the offer based on collectibility.
* Cases based solely on doubt about liability. Generally, the Examinations Division considers offers based solely on doubt about liability. However, the Appeals Division considers such offers if the appeals office has determined the liability, the case is before the appeals office or the case is docketed in the Tax Court.
* Cases based on doubt about collectibility and liability. Generally, the Collection Division considers offers based on doubt about both collectibility and liability. However, the Appeals Division considers such offers if the appeals office has determined the liability, the case is pending before the appeals office or the case is docketed in the Tax Court.
* 100% penalty cases. The Collection Division considers all offers in 100% penalty cases whether based on doubt about collectibility or liability.
* Penalty-only offers. The IRS service center usually will consider offers to compromise assessments involving only penalties (that is, the taxpayer is not asking to compromise interest or taxes).
* Appeal of rejected offer. The Appeals Division has jurisdiction over rejected offers when a protest right exists.
5. How does submission of an OIC affect the running of any statute of limitations ? Form 656, Offer in Compromise, on which an OIC must be submitted, provides that the taxpayer agrees to suspension of the running of the statutory periods of limitation on both assessment and collection of the taxes in question during the period the offer is "pending" and for one year thereafter. An offer is considered pending from the date the IRS executes the form 656 accepting the taxpayer's waiver of the statutory period of limitations and remains pending until the offer is accepted, rejected or withdrawn. Accepted offers are "pending" during the time any installment payment remains unpaid and during the five-year filing period.
6. How does submission of an OIC affect collection activity?
Collection activity is suspended on open accounts on submission of an OIC meriting consideration unless collection activity would be jeopardized or there is evidence the offer was submitted so]ely to delay collection. An offer is properly submitted if the taxpayer provides all significant information requested on form 656, including a complete financial reporting form (form 433-A or 433-B).
7. When is the amount offered considered to reasonably reflect collection potential or to be consistent with the taxpayer's ability to pay?
In determining an offer's adequacy, the IRS considers a combination of factors, including the taxpayer's net worth (the value of assets less encumbrances with priority over the federal tax lien), the amount collectible from the taxpayer's present and future income (calculated at present value), amounts the IRS has legal fight to collect from other sources (such as through lawsuits, assertions of transferee liability and the 100% penalty applicable to income and employment trust fund taxes) and additional sources of potential funds the IRS has no legal right to but which may be available to the taxpayer (such as loans from relatives or friends, lending institutions, employers, suppliers and customers).
8. How does the IRS value a taxpayer's assets?
The IRS ordinarily uses the "liquidating" or "quick sale" value of assets to arrive at a taxpayer's net worth in determining an offer's reasonableness. Liquidating value and quick sale value are used interchangeably to mean "the amount which would be realized from the sale of an asset in a situation where financial pressures cause the taxpayer to sell in a short period of time." "Forced sale value,"a lower amount, also is used when extreme financial pressures make it appropriate.
9. What is the amount of income the IRS will consider in determining acceptability of an offer?
The amount of the taxpayer's income that must be accounted for in an acceptable offer is the amount realistically available to pay delinquent taxes. There is no fixed percentage or clear-cut test to apply; rather, the total circumstances, including the taxpayer's education, profession, health and past and present income are considered.
10. If a taxpayer can make installment payments, can afixed amount be arrived at and paid, or must an indefinite payment arrangement be agreed to?
If the taxpayer has available income to make installment payments, the IRS determines the present value of such payments over a five-year period. Generally, if the taxpayer can immediately pay the IRS this amount, it will give "serious consideration" to accepting the offer.
11. Why should a taxpayer take advantage of the OIC program?
The new policy makes good business sense. All taxes realistically collectible are paid. The taxpayer receives a fresh start and agrees to pay all taxes for five years.
--Marvin C. Gutter, Richard A. Josepher and Thomas Ruffin 111 are partners in the law firm Gutter & Josepher,
P.A., Fort Lauderdale, Florida.
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|Title Annotation:||includes related article on questions and answers about new policy|
|Author:||Ruffin, Thomas, III|
|Publication:||Journal of Accountancy|
|Date:||Nov 1, 1992|
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