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Effective Tax Administration offers in compromise - why so ineffective?

In the 1998 Internal Revenue Service Restructuring and Reform Act (RRA 98), Congress granted the Internal Revenue Service (Service) the ability to compromise on tax debt in order to promote effective tax administration. Congress intended the Effective Tax Administration (ETA) offer to be available in cases where taxpayers can afford to fully pay their tax debts, but there are equitable reasons for excusing the debts. This mechanism is far underutilized: only 3% of offers in 2013 were submitted under these criteria. This is in part because the public is uninformed about the ETA offer and in part because practitioners are aware that Service agents are reluctant to accept these offers. That reluctance stems from a lack of training and a lack of clear and specific guidance in the Regulations and Internal Revenue Manual (IRM). The current Service administration of its authority under the 1998 law is inconsistent with the spirit of the law and with congressional intent. The Service's failure to recognize the limited future earning potential of the unemployed, as well as its failure to allow for the consideration of economic hardship suffered by small businesses are particularly concerning. ETA offers should be better publicized and more widely accepted based on Service guidance that is clear, specific, and more generous. Ultimately, greater use of the ETA offer represents a win for both taxpayers and the Service.

      A. Offers in Compromise as a Valuable Collection Option
      B. Appeals vs. Collection Due Process Hearings
      A. Definition of Economic Hardship
      B. Economic Hardship Does Not Apply to Small Businesses
      C. Examples in the Regulations
      D. Requirement That Allowance of ETA Offer Does Not
         Undermine Public Confidence
      E. Acceptable Offer Amount
      A. Public Policy/Equitable Consideration Offers
      B. Examples in the Regulations
      C. "Tax Shelter and Delay " Cases as a Factor in Non
         Hardship ETA Offers
      A. Hardship Cases
         1. Hardship Generally
         2. Leago and the "Saving For" Argument
         3. Public Confidence
      B. Non-Hardship Cases
         1. Delay/Tax Shelter Cases
         2. Complex Tax Laws
         3. Service "Bad-Faith"
         4. Small Businesses


In 1998, Congress gave the Internal Revenue Service (Service) a tool intended to enable the Service to accept Offers in Compromise (OIC) on the basis of equity, in order to promote effective tax administration. (1) Section 7122 of the Internal Revenue Code (Code) permits the Service to compromise a tax liability for less than the actual amount due. (2) Prior to 1998, the Service could only consider offers on the basis of "doubt as to collectability" (3) or "doubt as to liability." (4) Section 7122, however, permits the Service to consider offers based on equity, hardship, and public policy. (5)

This article begins with a brief overview of the Service's collection process and then describes the rationale for Congress's authorization of the effective tax administration (ETA) offer. The article next discusses how the Service has implemented that authority through both formal guidance to taxpayers and its employees, via Treasury Regulations and the Internal Revenue Manual (IRM), and through individual decisions by Service employees in the collection and appeals divisions. Nevertheless, Service statistics, the experiences of the author and other practitioners, and Tax Court decisions reviewing Service action for "abuse of discretion" indicate room for improvement. I conclude that the Service has failed to achieve goals of Congress as a result of faulty and vague guidance, coupled with the reluctance of Service employees to grant offers without specific guidance.


A. Offers in Compromise as a Valuable Collection Option

Generally, tax collection begins with the filing of a federal income tax return. (6) Taxpayers use the return form to report what they believe to be their correct tax liability. If the government disagrees with a taxpayer's report, the taxpayer has the opportunity to challenge the government's position prior to payment at several levels of the Service and before the United States Tax Court. (7) If the taxpayer does not succeed in overturning the asserted liability, the Service may assess the tax due. (8) That assessment triggers the Service's collection power.

Following an assessment, there are basically three collection alternatives (9) available to taxpayers to avoid involuntary Service collection: (1) qualifying for Current Non-Collectible status (CNC), (10) (2) entering a part-pay or full-pay installment agreement, (11) or (3) filing an OIC. (12) An ETA offer is a particular type of OIC. (13)

Pursuant to section 7122 of the Code, "The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense." (14) An OIC reflects the Service's willingness to accept less than full payment of the delinquent tax due. (15) Treasury Regulations authorize the Service to compromise a debt on three grounds: doubt as to liability (DATL), doubt as to collectability (DATC), and, since 1998, to promote effective tax administration. (16)

The OIC process requires full disclosure of a taxpayer's assets, monthly income, and expenses. Taxpayers make this disclosure on a financial form similar to an application for a bank loan, often referred to as a "roadmap to the taxpayer's financial life." (17) After determining a taxpayer's monthly income and expenses, and the net value of his assets, the Service uses these figures to estimate what the taxpayer can actually afford to pay. Once an offer is accepted, a taxpayer has the option of paying in a lump sum or by a periodic payment offer. (18) All offers are conditional on the taxpayer remaining current in tax filings and payments for the subsequent five years.

DATL offers are used by taxpayers who maintain that the amount of assessed tax is incorrect. (19) DATC offers, by far the most common, (20) are used when taxpayers admit they owe the tax, but simply lack the ability to pay in full. (21) ETA offers, on the other hand, are appropriate in situations where taxpayers can pay the tax in full, but where doing so would create an economic hardship, where public policy dictates the acceptance of an offer, or other equitable conditions exist. (22)

Many taxpayers currently facing financial hardship cannot use the DATC offer because, when the Service evaluates the monthly income of an unemployed taxpayer, it simply attributes to the taxpayer the amount it believes to be the taxpayer's earning potential. (23) The Service will input a figure which represents the salary the taxpayer had been able to earn in years past based on what was reported in previously filed tax returns. In many cases, the Service does not take into account the reality that the current economic climate bears no resemblance to the one that existed when the OIC rules were originally promulgated. (24) Many taxpayers are either unemployed or underemployed and working temporary or part time jobs. The Service's estimated income may artificially inflate the taxpayer's income so it appears as if the taxpayer's income exceeds his or her expenses, rendering the taxpayer ineligible for an OIC.

In a news release issued by the Service's Media Relations on March 10, 2010, the Service stated that agents have "greater flexibility when considering offers in compromise from the unemployed." (25) Unfortunately, this greater flexibility seems not to have trickled down to Service agents processing offers in the field. This is a dire situation since, for example, all of the offers I have submitted this year (other than those for taxpayers on social security or disability) have been for unemployed taxpayers.

The Service recognizes that OICs represent a valuable tool for the government. (26) Agents are to consider offers in the best interest of the government (27) and "[t]he decision to accept or reject an offer to compromise, as well as the terms and conditions agreed to, is left to the discretion of the Secretary [of the Treasury]." (28) Offers generally present an excellent opportunity for the government. They enable the Service to maximize revenue collection relative to resource expenditure, and they can boost the likelihood of future tax compliance by requiring taxpayers to stay current in their tax filings and payments for the next five years. (29) Additionally, the Service may be better off accepting a payment that is only partial, but is relatively prompt. Like other creditors, the Service would benefit from the time value of money, and could make efficient use of its collection employees. Furthermore, the longer the debts are outstanding, the more difficult it is to collect on them.

B. Appeals vs. Collection Due Process Hearings

The OIC process can start in one of two ways. A taxpayer may submit an OIC to the Service's Centralized OIC Group for consideration by an office examiner. If the examiner recommends denial of the OIC, the taxpayer may appeal the denial to the Service's Office of Appeals (Appeals). If the Appeals Officer (AO) agrees with the examiner, the officer will issue a "Notice of Federal Tax Lien Filing and Your Right to Hearing" under section 6320. The taxpayer must file a Form 12153 within 30 days of receipt of this lien notice to request a collection due process (CDP) hearing. (30) If the CDP officer refuses to reconsider the decision, the officer returns the case to Appeals for issuance of a Notice of Determination Concerning Collection Action(s) under section 6320 and/or 6330. (31) The taxpayer then has a right to petition the U.S. Tax Court to review the decision under a standard of abuse of discretion. (32)

Alternatively, a taxpayer may begin with a CDP hearing after receiving notice of a tax lien. As part of the CDP hearing, the taxpayer may propose to submit an OIC in settlement of his or her debt. The assigned Settlement Officer (SO) (33) will request a Financial Form (34) from the taxpayer in evaluating whether an OIC is a viable option. (35) The SO has the authority to accept or reject the OIC. If the OIC is rejected, this taxpayer also then has the right to petition the Tax Court to review SO's rejection of the OIC under the abuse of discretion standard.

In practice, there appears to be a difference in result when the case is handled by an AO versus an SO. AOs generally have a background in Service Examinations. They handle appeals of Service un-agreed audits, review cases for settlement before a case goes to Tax Court for trial, (36) and also review Forms 1040X (amended returns).

The SO, on the other hand, is a generally an individual with a background in Service Collections. SOs handle CDP cases, Collection Appeals cases, and settlement of trust fund recovery penalty cases. (37) The background of SOs in collections seems to reduce their willingness to accept an OIC. The Service's collections function has traditionally been to collect the most taxes possible. That mindset may taint an SO's judgment regarding the acceptance or denial of an OIC.

Statistics show that AOs are more likely to be flexible than SOs in exploring alternatives to collection. This is consistent with my theory that Service employees are reluctant to think outside the box, especially with respect to innovative collection alternatives, such as the ETA offer. SOs have been trained to work on OICs where taxpayers cannot full pay the tax. If a taxpayer has the ability to full pay, it is a stretch for the SO to conceive of granting any type of OIC. The SO will look to any other alternative, such as a full pay installment agreement, (38) before considering an ETA offer.

Overall, neither AOs nor SOs grant a tremendous number of ETA offers. Both internal and external pressure may contribute to the institutional reluctance. The mission of both the AO and the SO is to "strive for uniformity and consistency with respect to taxpayers in similar circumstances." (39) Perhaps this goal speaks to why both AOs and SOs are so hesitant to grant ETAs; they may be concerned about a "snowball" effect with respect to similarly situated taxpayers.

In addition, section 7431 permits a taxpayer to bring a civil action for damages against the Service if an officer or employee of the Service knowingly or negligently discloses the taxpayer's return or return information in violation of the Code. While these "personal" sanctions may not specifically relate to the consideration of an ETA offer, the potential for exposure to liability for disclosure--particularly negligent disclosure--of taxpayer information may have adversely affected the willingness of officers to consider offers in the first place. The reluctance of both AOs and SOs to grant these offers may have something to do with the atmosphere of fear that exists at the Service since enactment of these provisions.


In a letter to the Attorney General in 1933, seeking guidance regarding this authority to compromise liabilities under section 7122, the Treasury Secretary stated:
   In requesting an opinion from the Attorney General, Acting
   Secretary of the Treasury Acheson expressed concern that the
   country was trying to recover from the depression. He suggested
   that the public interest required compromise of tax claims where
   collection of the tax would "destroy a business, ruin a tax
   producer, throw men out of employment, or result in the
   impoverishment of widows or minor children of a deceased taxpayer."
   The Secretary expressed the belief that in ordinary times,
   compromise of cases on public policy grounds should be rare but
   that, in light of the current state of the country, public policy
   should play a significantly greater role. Expressing the belief
   that it was more important that "the business of the taxpayer be
   preserved and not destroyed," Acting Secretary Acheson suggested
   that cases should be "compromisable wherever justice, equity, or
   public policy seems to justify the compromise." (40)

Both the opinion issued by the Attorney General in response and subsequent regulations seem as if they were sources for the limitation of the authority to compromise to situations involving doubt as to liability or collectability.

The Restructuring and Reform Act of 1998 (RRA 98), authorizes the Service to consider the ETA OICs under section 7122, directing the service to consider equity, public policy, and hardship, where doing so would promote effective administration of the tax laws. (41) A Conference Agreement, which became a part of RRA 98, expanded Treasury Regulations promulgated under that section, which discuss the circumstances under which an ETA offer should be granted. (42) In Treasury Decision 8829, the preamble to the proposed regulations under 7122 (43) states:
   Although the statutory language of Section 7122 does not explicitly
   place limits on the Secretary's authority to compromise, opinions
   of the Attorney General and the regulations issued under section
   7122 prior to RRA 1998 authorized the Secretary to compromise a
   liability under the revenue laws only when there was doubt as to
   liability (uncertainty as to the existence or amount of the tax
   obligation) or doubt as to collectability (uncertainty as to the
   taxpayer's ability to pay). The opinion of the Attorney General
   most often cited as the principal source of these limitations is
   the 1933 opinion of Attorney General Cummings that was issued in
   response to an inquiry from then Acting Secretary of the Treasury
   Acheson. (44)

The Conference Agreement elaborates further on OICs based on ETA by describing the circumstances under which the tax liability will be compromised. (45) Notably that the House Report states, "[T]he conferees anticipate that ... the Service may utilize this new authority to resolve longstanding cases by forgoing penalties and interest which have accumulated as a result of delay in determining the taxpayer's liability." (46) Finally, the House Report states that the Service should make it easier for taxpayers to receive these types of OICs, and should educate the public about the ETA OIC. (47) The legislative history makes it evident that Congress intended to introduce this third type of OIC to provide a remedy for a taxpayer who could fully pay the tax, but in doing so would incur a hardship, or where collection of the tax would somehow be inequitable or against public policy.


The IRM directs the Service employee investigating an OIC to determine what amount of tax is owed and whether the taxpayer has the ability to pay in full. (48) The agent is instructed to first determine whether the taxpayer qualifies for a DATL or DATC offer, before considering an ETA offer. (49) The ETA offer is available to a taxpayer only after the Service has determined that the taxpayer has sufficient assets and income to pay the tax in full. (50) If collection of the taxpayer's assets and net monthly income would be insufficient to satisfy the tax in full, a taxpayer cannot be considered for an ETA offer. (51) The IRM treats consideration of ETA offers as a last resort.

For example, consider two of my clients: a low income couple in their sixties who owed back taxes for several years. The back taxes resulted from the husband's failure to pay self-employment tax from his carpentry business. Additionally, the wife was undergoing cancer treatment, and the husband had health issues as well. They were on a fixed income of Social Security and their only asset was a house with approximately $30,000 of equity in it. Their tax debt totaled approximately $38,000. We could not submit a DATC offer because of the equity in the home, but we had heard about a new type of OIC, the ETA offer. Furthermore, the ETA offer seemed as if it had been created for situations just like this one: the couple's income and assets could cover their back taxes but liquidating their only asset would cause a hardship. Selling the home to take out the equity would have forced the couple to move but their fixed income would have made renting nearly impossible. We submitted the OIC on the basis of ETA and, in the alternative, Doubt as to Collectability with Special Circumstances (DCSC).

The ETA OIC was rejected because the Service stated that the taxpayers could not full pay the tax. (52) We then asked the SO53 to consider the DCSC offer. The Service again rejected the OIC finding that no special hardship circumstance existed to warrant the granting of any type of offer of less than $30,000.

Ultimately, these taxpayers were placed in CNC status and the Service is currently maintaining a lien on their house, which has decreased in value since our ETA offer. It is unlikely that the Service will ever collect any revenue from these individuals. The ETA offer constituted a better deal for both sides. The taxpayers would have satisfied their obligation, and the Service could have collected something and ensured taxpayer compliance for the next five years. (54)


A. Definition of Economic Hardship

Of the various types of ETA offers, the "economic hardship" offer is the most common. (55) A full discussion of case law will follow in a section of this paper under "Case Law." (56) The regulations define economic hardship as inability to pay "reasonable basic living expenses." (57) Courts look at cases involving economic hardship claims very narrowly, and the standard enumerated in the regulations is exceedingly difficult to meet. (58)

The Service has provided guidance for its offer specialists in training materials and in the IRM, which contains the formula the Service uses to determine a taxpayer's ability to pay. (59) The Service will reduce the taxpayer's income by the national and local expense standards. (60) In determining whether a hardship exists despite the taxpayer's ability on paper to full pay, the Service will reduce the taxpayer's "ability to pay" amount, if the taxpayer can show that factors exist unique to his situation, that will cause a hardship. (61)

According to the regulations, economic hardship includes situations where treating a medical condition will exhaust a taxpayer's funds, a taxpayer's monthly income is needed to care for dependents, and a taxpayer has certain assets, but borrowing against, or the liquidation of, those assets would render the taxpayer unable to meet basic living expenses. (62) In practice, evidence of adverse circumstances resulting from a taxpayer's health, age, dependents' issues, employment status and any other circumstances which might constitute an economic hardship should be raised in the OIC "Explanation of Circumstances." (63) There, taxpayers can explain in narrative form the compelling circumstances that make their situation one in which the Service should accept their offer. (64)

B. Economic Hardship Does Not Apply to Small Businesses

It is the position of the Service that since only "individuals" can suffer economic hardship, under its definition of being unable to meet basic needs, only "individuals" will be considered for hardship ETA offers. According to the current rules, the factors considered by the Service in granting a standard OIC to individuals do not readily translate to a small business. In many cases, the Service views the "net value in assets" of the small business as disqualifying for purposes of the offer because, if liquidated, such assets could satisfy the tax debt. (65) At the same time, however, requiring a small business owner to liquidate assets to pay the tax due would put the small business owner out of business.

Unfortunately, although it would be helpful in the hypothetical situation above, small businesses cannot prove "economic hardship." Therefore, any Service relief provision for a taxpayer suffering "economic hardship," such as CNC status or release from a levy, is unavailable. (66) That result seems intentional. The legislative history of the ETA OIC illustrates that the Department of Treasury concluded that allowing ETA OIC offers from small business would not promote effective tax administration. (67)

In promulgating the final regulations on section 7122, the example of hardship as it applied to a business taxpayer, contained in the temporary regulations, was removed. The Service and Treasury concluded, "Permitting compromise in non-individual cases where there is no doubt as to collectability, for instance, would raise the issue of whether the government should be foregoing the collection of taxes to support a nonviable business." (68) Interestingly, however, in the 1933 letter, referred to previously, where Secretary Acheson discusses the need for compromise, he notes that public interest required compromise where tax collection would "destroy a business." (69)

In practice, there are situations where small businesses are in bad financial straits and are struggling to stay on their feet. An ETA is just what some could use to stay afloat. The process the Service uses to consider OICs on business tax debts makes it exceptionally difficult for a small business taxpayer to qualify for an OIC without liquidating the business. (70)

C. Examples in the Regulations

The three examples in the regulations illustrate the extreme circumstances under which a hardship OIC will be considered. (71) The first example involves a taxpayer who has assets that he could liquidate to pay his entire tax debt but has a child with a serious long-term illness. Equity in those assets will eventually be needed to provide for adequate living expenses and medical care for the child. The second example presents a situation in which a retired taxpayer living off a pension has no other means of support. Forcing him to liquidate his pension would render him unable to meet basic living expenses. (72) The third example is the most troublesome. It describes a disabled taxpayer who has no excess income each month with which to pay his tax debt, but owns a modest home that is specially equipped for his disability. The equity in the home is sufficient to pay the tax in full. While it is the usual practice of the Service agent to recommend that the taxpayer borrow against the equity to pay the tax, here the regulations recognize that "severe adverse consequences" would ensue for the taxpayer if forced to liquidate or sell his specially equipped primary residence. (73)

Those examples would lead one to think that many individuals would meet the criteria for a valid ETA OIC. As the statistics discussed in a later section of this paper show, however, this is just not the case. (74) The examples in the regulations may be overbroad. The third example, for instance, does not give clear guidance regarding whether a client in desperate financial straits is a good candidate for an ETA hardship offer. Typically, such a client lives from paycheck to paycheck and the client's only asset is a "modest home" with enough equity in it to fully pay the tax. The examples could be interpreted to mean that some other extreme factor, such as having the home specially equipped, must exist for an ETA offer to be considered. This appears to be the interpretation adopted by Service employees.

In my experience with these situations, the agent assigned to the case typically recommends that the taxpayer take out a second mortgage or borrow against the equity in his or her assets in some other way in order to pay the full amount of the tax. The second mortgage is almost always impossible because the taxpayer has no additional earning potential and would not be approved for a second mortgage, particularly in the economic climate of the past few years. The ETA offer procedure fails for individuals for whom it seems to have been created.

D. Requirement That Allowance of ETA Offer Does Not Undermine Public Confidence

The IRM goes on to explain that, even with a hardship ETA offer, no compromise will be reached if the granting of the OIC undermines compliance by other taxpayers. (75) The example given involves a taxpayer who transferred his only asset, his primary residence, to a child after the tax was assessed. Since the Service viewed this as a transfer to avoid payment of tax, the offer was rejected. Transferring an asset to a third party within three years of filing any type of OIC is deemed a "fraudulent transfer" for purposes of the OIC and the value of the transferred asset is reattributed to the taxpayer in calculating an acceptable offer amount. The IRM makes clear that the Service will not tolerate transfer of assets in the context of ETA offers.

E. Acceptable Offer Amount

If a taxpayer overcomes the hurdle of proving economic hardship under section 6343, the amount of the offer must be still acceptable to the Service. The amount is generally based on what the Service deems to be the collection potential after allowing for the taxpayer's reasonable living expenses. The example in the IRM deals with the taxpayer who Service determines has an economic hardship, owes $100,000, and has a reasonable collection potential (RCP) of $150,000. The taxpayer offers $35,000 to settle the debt but the Service deems $50,000 to be the RCP, which then represents the minimum acceptable offer. (76)

In one exceptional instance, though, the Service acted in accordance with the spirit of the ETA offer and its purpose. An ETA hardship offer, submitted by a colleague in Ohio, involved a retired taxpayer whose monthly expenses exceeded her income. Her only asset was a house with a small amount of equity in it, and a bank account with $20,000. She had saved $10,000 of the $20,000 for much needed repairs on the home, including a new roof. Additionally, the taxpayer had a pension that contained $80,000. She owed the Service $30,000. My colleague divided the $80,000 by the client's life expectancy according to the Social Security actuarial tables on the Social Security Administration website. (77) The result showed that the pension was necessary to cover the taxpayer's monthly income shortfall. The Service accepted a $10,000 ETA offer, which represented the amount she had in the bank after the house repairs were made, and removed the liens on her home. (78) In a perfect world, all such cases would result in a positive outcome for a taxpayer such as the retired woman in the above example. That result, however, was atypical.


A. Public Policy/Equitable Consideration Offers

The regulations provide:
   [I]f there are not grounds for compromise under paragraphs (b)(1),
   (2) or (3)(i) of this section, 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 and that
   the tax laws are being administered in a fair and equitable manner.

Public policy/equitable consideration ETAs (Policy ETAs) are usually considered together and not as two separate types of ETA offers. For a taxpayer to apply for a Policy ETA offer, the taxpayer would need to have no grounds for any other type of OIC, including a hardship OIC. (80)

The taxpayer has the burden of proving that compelling circumstances for allowing the OIC exist and that accepting the OIC would not undermine public confidence. (81) This includes demonstrating that forcing the taxpayer to pay its liability in full would undermine the public's confidence in the

fair administration of the tax laws. (82) Again, this is a very difficult burden for a taxpayer to meet, and courts rarely overturn denials since the standard for review is abuse of discretion. (83) Interestingly enough, regarding nonhardship ETA OICs, the IRM states, "Because the Service assumes that Congress imposes tax liabilities only where it determines it is fair to do so, compromise on these grounds will be rare." (84) This statement exemplifies the problem that exists with the Service's attitude towards these offers.

Moreover, taxpayers submitting an ETA offer must show that the acceptance of the offer would be warranted despite the disparity it might create for similarly situated taxpayers. (85) Revenue Procedure 2003-71 states that it is up to the taxpayer to "demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full." (86) Again, this is a very difficult burden for taxpayers to meet. How would you advise your client that he prove that no disparate treatment would ensue?

The National Taxpayer Advocate has criticized the Service for not articulating more specific rules and circumstances under which nonhardship ETAs should be accepted. (87) Specifically, she has stated that the circumstances under which non-hardship ETA offers should be accepted are unclear. (88)

B. Examples in the Regulations

The regulations provide two examples of qualifying offers under the equity provisions. (89) The first involves a taxpayer with a good compliance history who was severely ill for several years and could not attend to any of his financial affairs. After he recovered, he found that the Service had filed a substitute for return (SFR) for him for one of the unfiled years. This resulted in the taxpayer owing substantial penalties and fines. The amount owed for the year in which the Service prepared his SFR was three times his original tax liability. (90)

The second example involves a taxpayer who e-mailed the Service at its website, requesting technical advice on how to preserve all tax benefits while reinvesting his IRA. After receiving erroneous advice in writing from the Service regarding the timeframe in which to reinvest and retain the tax benefits, the taxpayer incurred the tax liability at issue. In that case, the taxpayer would have been granted an ETA offer based on policy considerations. (91)

As one can imagine, proving the equities of allowing a non-hardship OIC while showing that the tax law would not be undermined, or that similarly treated taxpayers would not receive disparate treatment, is onerous. Successfully overcoming these hurdles is unlikely. It should also be noted that the Service considers a taxpayer's compliance history in its decision to accept either type of ETA OIC--both hardship and nonhardship. (92) In both examples in the regulations, a good compliance history is a factor in allowing the offer.

The issue of compliance history is somewhat problematic for clients seeking relief through an ETA offer. Economic hardship may have indeed caused noncompliance, which results in the need for an ETA offer. In my view, to further the intent of Congress in creating the ETA offer, each case should be considered on its own facts and there should be no negative inference made for previous noncompliance. The conclusion, contained in the regulations, that allowing an ETA offer to a formerly noncompliant taxpayer would "undermine compliance within the meaning of Treas. Reg. 301.7122-(b)(3)(iii)" seems illogical and should be changed. (93)

The IRM gives further guidance to agents on non-hardship ETA considerations. The IRM directs agents to reject non-hardship ETA offers where: (1) the taxpayer is claims his tax deficiency is due to the actions of a third party (i.e., the taxpayer was defrauded); (2) the taxpayer claims that a specific Code provision is unfair; (3) the deficiency results from a tax shelter; or (4) the taxpayer has paid the tax in full, based on an erroneous notice of balance due sent by the Service. (94)

C. "Tax Shelter and Delay " Cases as a Factor in Non-Hardship ETA Offers

The legislative history cited previously (95) specifically refers to providing relief in non-hardship ETAs ignoring penalties and interest that have accumulated because of delay. (96) The legislative history further bears out that the Congressional Conference Committee added 7122(c) in anticipation that the Service could use this authority to resolve "delay" cases. (97) The intent of Congress was to utilize this tool to resolve longstanding cases. (98)

The specific language in the Conference Agreement states, "The conferees anticipate that, among other situations, the [Service] may utilize this new authority to resolve longstanding cases by forgoing penalties and interest which have accumulated as a result of delay in determining the taxpayer's liability." (99) The agreement goes on to conclude, "Accordingly, the conferees believe that the [Service] should make it easier for taxpayers to enter into offer-in-compromise agreements, and should do more to educate the taxpaying public about the availability of such agreements." (100) One would think that tax shelters cases, which can linger for many years, would be cases contemplated by Congress in granting relief in a nonhardship ETA offer situation. However, the IRM specifically instructs agents to disregard ETA offers where the underlying liability resulted from an investment in a tax shelter. (101)

While RRA 98 specifies that "delay" can be the basis for a nonhardship ETA offer, both practice and case law support the conclusion that the Service does not readily grant "delay" ETA OICs. The IRM instructs examining agents that the Service must avoid providing financial advantage through forgiveness of debt. (102) This curious statement seems to undermine the purpose of allowing OICs in general. It cuts against the Service's collection mission to allow a deserving taxpayer a fresh start. Certainly, forgiveness of any debt will provide a financial advantage, so the practical significance of the directive remains ambiguous.

As a practitioner, I have had greater success raising the issue of "delay" through at least two other means. The first option is for the taxpayer to challenge the accrual of interest and penalties as a result of Service "delay" via an "audit reconsideration." (103) This reconsideration process allows the taxpayer to have the Service revisit an issue as long as the taxpayer has not previously raised it. In practice, since audit reconsideration claims are notorious for lingering at the Service for long periods of time, many tax professionals shy away from this otherwise very useful tool. The second option is to file a Form 982 with the Service's Examination Division for abatement of interest and/or penalties. (104) Section 6404(e) gives taxpayers the basis for a claim for abatement of penalties and interest accrued as a result of Service "ministerial delay." (105) In attempting to have penalties and/or interest abated, Form 982 seems to present a more successful vehicle than an ETA non-hardship OIC.


It is very difficult for a taxpayer to prevail on appeal to courts when an OIC has been denied by the Service. The case law in this area is sparse, and cases that find an abuse of discretion are rare within it. Courts either find no abuse of discretion by the Service in denying the offer, or remand the case to Appeals for further consideration. Furthermore, even where a court has found an abuse of discretion, it is difficult to ascertain the ultimate resolution.

A. Hardship Cases

1. Hardship Generally

In general, the Tax Court decisions in the ETA area do not provide much analysis of the hardship criteria. The case of Dailey v. Commissioner, (106) however, is an exception and is instructive on several levels. There, the court does a thorough analysis of the ETA considerations and, in a seventeen page opinion, decides to remand the case.

In Dailey, decided in 2004, the taxpayers applied for a hardship ETA offer, which was rejected by the Service. Mr. and Mrs. Dailey were in their fifties, and Mr. Dailey was seeking work as a stockbroker or real estate agent. They had two seriously ill children and withdrew the funds from IRAs, during the tax years for which they incurred liability, to pay for medical expenses. Although Mr. Dailey was earning very little money at the time the ETA offer was filed and could barely support his family, the Service felt that the he could full pay the tax by liquidating the equity in his residence.

Mr. Dailey claimed that he would not be able to borrow against the equity in the residence. Although the Service agreed, it stated that the ETA regulations required that Mr. Daily not only prove his inability to borrow against the asset, but also required that he must have already been notified that seizure of the asset is imminent. (107) Since there was no evidence of imminent asset seizure in the Dailey case, the agent rejected the ETA offer and instead placed the case in CNC status.

In 2005, the Daileys received a Notice of Federal Tax Lien on their home. The taxpayers then filed a CDP request, arguing that their ETA OIC should be allowed. In her notes of the hearing, the SO conceded that the taxpayers "are currently earning very little but have a house with plenty of equity. It is unlikely that on their income they can get a second mortgage. However, this equity makes them poor candidates for an offer." (108)

The case was remanded to Appeals for clarification and further consideration. The judge reasoned that since the SO acknowledged that the petitioners were in a hardship situation, the officer should have made a determination as to whether exceptional circumstances creating this hardship merited the acceptance of the ETA offer. The AO had, without further explanation, stated that the taxpayers were not good candidates for an ETA offer and that "declaring the balances currently not collectible would be the best alternative to enforcement at the moment." (109)

The court listed factors that Appeals should have considered in making its determination. It was unclear whether the Service considered the ages of the Daileys, the effect the imposition of a lien would have on Mr. Dailey's ability to earn a living in the financial area, or the impact of substantial medical bills incurred by the Daileys to care for their children. As a result of a spurious record, the Court remanded the case to ensure all relevant factors would be considered before a decision was made as to whether to the Service should accept the hardship ETA OIC. (110)

There are few other reported, fully reviewed Tax Court cases. The reported cases in the Tax Court are cither summary or memo opinions. Nevertheless, some provide meaningful, albeit brief, insight into the hardship standard and its application.

In Pomeroy v. Commissioner, the petitioners originally submitted their OIC to the Service based on DATC. (111) The SO indicated that his investigation revealed the taxpayers could fully pay and therefore intended to deny the offer. (112) Petitioners argued that they raised the issue of petitioner's (husband's) health and provided medical documentation, but the SO would not consider the offer under ETA. (113) The court remanded the case to Appeals to consider further medical records, which might not have been initially considered by the SO in making the decision to deny the offer. (114)

Finally, in order to apply the hardship standard, the Service may be called upon to determine whether a medical procedure is medically necessary. This may not be easy to resolve objectively, as in the case of gender reassignment surgery. In 2010, the Tax Court in O'Donnabhaim v. Commissioner held that necessary treatment for gender identity disorder qualifies as a deductible medical expense. (115) This case, however, did not involve an OIC, and the court disallowed the cost of breast augmentation in the reassignment surgery as a medical expense for that petitioner. (116)

Obviously, in the ETA arena, a Service agent will expect the taxpayer to provide documentation from a medical professional. In relatively novel cases, such as those involving different stages of surgery for gender reassignment, however, a Service agent does not seem to be qualified to make this type of subjective decision, potentially overriding the opinion of a medical professional. Further guidance from the Service is needed.

2. Leago and the "Saving For" Argument

Leago v. Commissioner (117) is an interesting case because the taxpayer raised a novel issue in claiming his entitlement to an ETA offer. (118) Mr. Leago submitted an ETA OIC, which indicated that his RCP was enough for him to full pay the offer and still be able to meet basic living expenses. Mr. Leago, the sole proprietor of a video rental business with several employees, however, had a brain tumor and was saving for future brain surgery. The SO found that the taxpayer had not incurred significant out-of-pocket expenses for his health condition. In a letter to Mr. Leago, the SO stated, "I cannot allow expenses that you are not currently paying." (119) Her log stated that the petitioner's out-of-pocket medical expenses of $3100 per month were for "payments [that] were for future expenses he would need to incur for surgery." (120) The SO's log further stated that she "could not allow for future expenses that he may incur." In her work papers, she quoted petitioner's words as he left the interview room: "You would rather I pay my taxes than have surgery." (121)

The Court in Leago grappled with the issue of using DCSC as the basis to allow the offer, (122) since the IRM directs agents to consider all other potential types of offers before it considers the offer under ETA. (123) The key determining factor in whether an OIC is to be considered under DCSC or under ETA is the taxpayer's RCP. (124) If the taxpayer can full pay, the offer should be considered as an ETA offer. The IRM and the regulations indicate economic hardship exists where it is "reasonably foreseeable that taxpayer's financial resources will be exhausted providing for care and support during the course of the condition." (125)

The IRM also directs the Service to consider the effect of a taxpayer's medical condition on his future earning potential. (126) In Leago, the taxpayer was essentially arguing that the fact that he was "saving for" a critical operation should be reflected in his RCP. The SO's supplemental notice of determination contained an analysis of the petitioner's RCP but did not consider this a "special circumstance." (127) The SO only allowed the petitioner the National Standard of $60 per month for out-of-pocket medical expenses, plus a $200 per month allowance for medical insurance (even though the petitioner did not have insurance). The SO did not accept the $3100 per month expense the petitioner had listed since he was "saving for" a potentially life-saving surgery. (128) Mr. Leago had a letter from his doctors substantiating the medical necessity of the operation. (129) The court remanded the case to Appeals because it found that the reasons given in the agent's supplemental notice of determination were inadequate to determine whether or not she abused her discretion. The court also directed the Service to reconsider whether or not the petitioner had demonstrated that "special circumstances" existed to justify acceptance of his ETA OIC. (130)

The IRM directs Service agents to "exercise good judgment" in reviewing documentation in ETA offer cases. (131) The agents in Leago may have breached that vague standard. Leago demonstrates that the Service should consider a current established need for a life-saving medical procedure. It is true, though, that in taking a "snapshot" of the taxpayer's current financial condition and ability to pay, it would be impossible for a uniform and consistent result if the Service had to consider the situation where a taxpayer is told he or she might need some type of surgery in the future.

While this "saving for" argument may prove troublesome for the Service to manage, a tangential issue arises in determining what is considered "medically necessary." In practice, I have encountered opposition from the Service in an OIC proceeding for a client who had undergone gender reassignment surgery who was "saving for" his final procedure. He owed $18,000 in taxes and his only asset was a special money market account earmarked for his surgery, totaling $15,000. His monthly expenses slightly exceeded his monthly income. I offered the Service a good faith sum of $100, which the client was going to borrow from his relative to pay the offer. In considering his OIC, the Service agent countered with an acceptable offer amount of $15,000. The agent was not receptive to my argument that the taxpayer was saving for the last phase of his gender reassignment, arguing that it was not "ordinary and necessary" and would not be the type of expense that even qualified for a medical expense deduction. (132)

3. Public Confidence

In Veneziano v. Commissioner, the Tax Court upheld the Service's decision to deny the taxpayer an ETA hardship OIC. (133) Mr. Veneziano owed tax for several tax years, and was late in filing each year. During the relevant time period, he decided to use an IRA distribution of $365,000 to purchase property, rather than pay outstanding tax liabilities, which had accrued for several years prior. Based on these factors, the court determined that the Service did not abuse its discretion in denying the OIC. (134) Furthermore, the court also determined that less than full collection of petitioner's liabilities would undermine public confidence that the tax laws are being administered fairly. (135)

B. Non-hardship Cases

Reported cases in this area are few. There have been only a handful of recent reported cases on non-hardship ETA OICs.

1. Delay/Tax Shelter Cases

A decision in involving a 1980s cattle tax shelter (the Hoyt line of cases) had taxpayers owing tax, penalties, and interest up to twenty years after initially investing the tax shelter. (136) Thousands of investors in this tax shelter, comprising hundreds of partnerships, owed tax, which was the subject of litigation over a ten-year time span. (137) In the meantime, penalties and interest accrued. Many of these investors unsuccessfully attempted to have the Service abate the interest and penalties. (138) The Service prohibits taxpayers whose liability arises from participation in abusive tax avoidance transactions from qualifying for an ETA OIC in its IRM. (139)

The Ninth Circuit case of Keller v. Commissioner, (140) involved one of the thousands of investors in the Hoyt cattle shelter. The Court determined that the taxpayer was fraudulently induced into investing in the tax shelter. (141) Criminal charges were eventually filed against Mr. Hoyt, the tax shelter promoter, for victimizing approximately 4,000 investors. While the court found that the Service could consider a third party's actions in inducing the petitioner into investing in the shelter, it stated, "[W]e have never held that being victimized by a tax shelter scheme is along sufficient to require compromise." (142) Since the courts have upheld negligence penalties in the cases of individual investors in the Hoyt tax shelters, the Keller Court reasoned that these cases would not warrant a reduction of liability based on public policy or equity considerations. (143)

The Keller Court reasoned that, under the Hoyt rationale, it would undermine public confidence to allow an ETA offer even though the taxpayers were victims of fraud, because their intent was to illegally shelter income. This seems to say that the Service will require the taxpayer to prove his "intent" when defending a case based on third party fraud, yet another hurdle for the taxpayer to overcome.

The Conference Agreement discussion of ETAs states:
   The conferees anticipate that, among other situations, the
   [Service] may utilize this new authority to resolve longstanding
   cases by forgoing penalties and interest which have accumulated as
   a result of delay in determining the taxpayers' liability ...
   Accordingly, the conferees that the [Service] should make it easier
   for taxpayers to enter into offer-in-compromise agreements, and
   should do more to educate the taxpaying public about the
   availability of such agreements." (144)

It would seem that in cases like the Hoyt tax shelter cases, referred to above, the Service would consider the years of penalties and interest accrued; which grew to five to ten times the initial amount of tax due. (145) The major reason for this delay was that it took years to investigate and eventually indict Mr. Hoyt. (146)

Even though such cases involve huge amounts of accrued penalties and interest, the Service is rejecting these ETA offers because, despite being victims of third party fraud in that these taxpayers were induced into investing in these partnerships, the example given in the IRM supports rejection of these ETA offer. (147) Service agents are instructed not to consider third party fraud as a factor in favor of allowing a non-hardship ETAs. (148) This seems to contradict the congressional intent of RRA 98. Apparently, the Service views third-party fraud as an issue between the taxpayer and the individual guilty of defrauding him.

Many of the Hoyt line of tax shelter cases are non-hardship cases because they rely on the argument that the taxpayers involved were defrauded into investing into a tax shelter and the delay in collection (caused by years of investigation) resulted in the accrual of exorbitant amounts of interest and penalties. The issue of providing ETA OICs for taxpayers who suffer because of the Service delays discussed previously herein, has not been embraced by the Service or the courts as deserving a remedy. (149)

2. Complex Tax Laws

In West v. Commissioner, (150) the petitioner argued was that the Service should compromise his liability under ETA since his tax deficiency resulted from his inability to offset capital gains (incurred in 1999) with capital losses (incurred in 2000). He claimed that the tax laws were too complicated and unfair, and that they should allow for a capital loss to be carried back from 2000 to offset a gain from 1999. (151) As it is a well established tax principle that the Code does not permit a capital loss to be carried back, the Service would not entertain this notion. (152)

In denying the OIC, the AO stated in her case memo,
   Per IRM, compromise on public policy or equity
   grounds is not authorized based solely on a taxpayer's belief that
   a provision of the tax law is itself unfair. Where a taxpayer is
   clearly liable for taxes, penalties, or interest due to operation
   of law, a finding that the law is unfair would undermine the will
   of Congress in imposing liability under those circumstances. (153)

3. Service "Bad Faith"

The petitioners in United States v. Denkers based their complaint on a claim of "bad faith" by the Settlement Officer in denying their OIC. (154) They claimed that the SO told them they were "ideal candidates" for an ETA OIC. After reviewing the offer, the SO denied it. The Court found that the taxpayers' claim of "bad faith" on the part of the SO did not warrant the granting of a non-hardship ETA OIC.

4. Small Businesses

Currently, only a natural person can be considered for an ETA OIC, but this should be changed. (155) Nina Olson, in her testimony before Congress, noted that the process used by the Service to evaluate an OIC submitted by a business often requires liquidation of the business assets. (156) This can easily result in the termination of the business, since investigation of an ETA offer involves evaluating whether or not the taxpayer has a "hardship." This "hardship" standard does not translate well to the business world. Under the regulations for sections 7122 and 6343, (157) ETA OICs are therefore only available to natural person taxpayers. This presents a problem for small businesses, as their futures could depend on whether they are granted tax relief. (158)

The legislative history shows Congress considered this distinction. The legislative history states that allowing businesses to be considered for offers in compromise based on effective tax administration and economic hardship did not necessarily promote effective tax administration. (159) The Service training materials contain a case study involving a municipality that was defrauded by a payroll service provider (PSP) over a five-year period. (160) As soon as the municipality discovered the fraud, it assisted the government in convicting those responsible for the embezzlement; however, the municipality was only able to recoup a small amount of the payroll taxes embezzled. (161) The municipality owed back taxes of $5 million dollars as result of the illegal acts of the PSP, but if it had to pay that amount it would have been unable to fund essential community services. It therefore submitted an ETA OIC for $50,000. Since the position of the Service is that businesses cannot be considered for ETA offers, the Service returned the offer stating the offer was fded only to delay collection activity. (162)

Unfortunately, the Service does not consider the economic consequences of refusing an offer. This hypothetical case study scenario would justify allowing an ETA OIC, since collection of the tax due would be inequitable and against public policy. The intent of RRA 98 is being subverted here. Had this case involved a sole proprietorship, the ETA offer would be considered on the merits; however, since the taxpayer is a municipality, the ETA offer is not a viable option under the current regulations.

Instead, certain charitable or public interest organizations should be eligible for ETA OIC consideration. The municipality example is a good representation of when it would make sense to make exceptions for certain entities that are not considered "persons" under the Code. (163)


An analysis of the statistics concerning acceptance rates of ETA offers yields interesting results. The Service website contains tables delineating the total number of offers the Service receives each year and the number of offers accepted, but the tables do not distinguish between types of offers. (164) As to the trends of offers in general, the numbers of offer submitted from 2009 through 2012 has steadily increased. (165) The acceptance rates have also increased. (166) Acceptance rates increased from 21% in 2009 to 37% in 2012. (167) 2013 also showed an increase in the number of offers filed: 70,000, with a 45% acceptance rate. (168)

Statistics for ETA submission and acceptance rates are not readily available to the public. As reported by the Service Office of Disclosure, the following chart illustrates the number of ETA offers filed and accepted for each year, beginning in 2008, divided into "hardship" and "non-hardship" offers.

Comparatively, the number of OICs submitted under ETA is astonishingly low. The pattern does show an increase in the number of ETA offers filed each year, and a general increase in numbers accepted. The fact that the number of non-hardship ETAs accepted ranged from sixteen to thirty-eight throughout the entire country, however, evidences the lack of effectiveness of this collection option. The numbers of ETA offers filed pales in comparison to the other traditional types of offers. In 2013, while 70,000 offers were filed, only 2107 (or 3 %) of those were ETA offers. The statistics support the need for better education, both on the part of the Service and the general public, on the availability of this underutilized yet potentially life-altering tax collection tool.


Service agents seem not to know what to do with ETA OICs due to the lack of clear and appropriate guidance. Furthermore, agents seem reluctant to use their own discretion, which is to the detriment of Service collections. The Service needs to develop rational and clear guidelines for these offers. ETA offers have the potential to play a significant role in rationalizing the collection process and providing compassionate resolutions in situations where there is often serious hardship. One means of creating systemic change is to focus on the nature of taxpayer's assets at issue. If there is a taxpayer whose only asset is a primary residence, small pension, or retirement plan, the Service should be much more liberal in accepting offers. (169)

A common topic of conversation among tax professionals involves inquiries by frustrated representatives regarding how to get the Service to accept an ETA OIC when there is a home with enough equity to pay off the Service debt. The Service rejects these offers even though a taxpayer who tried to extract the equity would be left homeless. (170) Instead, the Service places the taxpayer in CNC status and files a lien on the property. The Service simply waits for the taxpayer to die or to sell the residence before the statute of limitation expires. (171) The morally compassionate response would take into account the devastating consequences of complete poverty and potential homelessness, which particularly affects the elderly and disabled. Accepting the offer is also the economically rational response. Delaying these offers only sets the stage for years of taxpayer inability to pay future tax obligations.

The Service also needs to better understand the current economic climate and devise a benchmark to measure the current earning potential of the unemployed. For example, if a taxpayer has been unemployed for more than one year, his or her earning potential should be measured by a more realistic standard. Specifically, it should not be assumed that the taxpayer has the ability to earn what he or she has in the past.

If a taxpayer is in a hardship situation and is "saving for" a life-saving medical procedure, the amount that the individual is saving, regardless of the particular vehicle for those savings, should not be considered in determining eligibility for an ETA OIC. Agents should be instructed to consider all medical evidence in assessing the necessity of incurring such medical costs.

The Service's current stance on "saving for" arguments further demonstrates the Service's inability to fairly administer rules governing acceptance of ETA offers. For example, while the Service insists on imposing a hypothetical earning potential on a taxpayer when calculating his or her monthly income, it refuses to consider an amount a taxpayer is actually setting aside for a critical medical procedure. While arriving at more measurable standards for ETA acceptance is a daunting task, further guidance on the principles governing income and expense amounts would clearly help both the taxpayer and the government.

Small or mid-sized businesses should be eligible for ETA offers, as should municipal agencies and charitable organizations. The economic consequences of denying an offer to such entities should be a listed a consideration for agents on their checklists for allowing ETA offers. Granting ETA offers to such entities would be in the spirit of the legislative history behind RRA 98. (172)

As to the issue of delay as a consideration for an OIC, Congress expressly stated that this is a factor in determining whether to allow an ETA OIC. In practice, however, the most common scenario in which interest and penalties double and triple are in the tax shelter arena, where the Service has rejected delay as a consideration in an ETA offer. I suggest allowing ETA offers where there is unreasonable delay, regardless of the reason for the initial disallowance--absent fraud on the taxpayers' part.

Furthermore, the Service should adopt a standard that would allow taxpayers to file an ETA OIC in cases where they are faced with a complex section of the Code, misinterpret it, and end up with a tax deficiency. The West case (173) was not appropriate for an ETA OIC since the law is well settled in that area. Truly complex code sections, however, should be considered as a valid underlying basis for allowing an ETA offer. (174)

RRA 98 expressly aimed to educate taxpayers about the availability of ETA offers as a viable collection alternative. This did not happen, as the statistics illustrate. Moreover, educating taxpayers about ETA offers seems fruitless since the success rate is minimal. An e-mail from a colleague who runs a tax clinic at Gonzaga Law School illustrates this point:
   [W]e only submitted one ETA OIC in my clinic because after that
   rejection (and others from years before in private practice), I
   decided that they are never accepted. Our client was 90 years old
   and the primary caregiver to his very ill wife (who has since
   passed). The only remaining assets totaled approximately $8,000,
   and we showed how they would need that amount for the remainder of
   their life expectance. (175)

In sum, ETA offers are tools that tax practitioners should use more liberally when advocating for their clients. Service agents need more education and clearer guidelines to enable them to accept these offers. This tool is almost fifteen years old and needs to be revamped. Agents seem to be afraid of using it, but instruction and clarification can allay that fear. The ETA OIC is a tool that is very relevant to this time in our history, and improving its efficiency and administration would be a win-win situation in an economy attempting to rise from the ashes.

(1) I.R.C. [section] 7122(a); see generally Restructuring and Reform Act of 1998, Pub. L. No. 105-206, [section] 3301(c)(2), 112 Stat. 685 (1998) [hereinafter RRA 98].

(2) I.R.C. [section] 7122.

(3) Treas. Reg. [section] 301.7122-1(b)(2) (2002).

(4) Treas. Reg. [section] 301.7122-1 (b)(1) (2002).

(5) The Committee Report for the RRA 98 expressed the intent to expand the use of the Offer in Compromise (OIC) procedures beyond the two original grounds: "[T]he conferees anticipate that the [Internal Revenue Service (Service)] will take into account factors such as equity, hardship, and public policy where a compromise of an individual taxpayer's income tax liability would promote effective tax administration." Treas. Reg. [section] 301.7122-l(b)(3) (2002).

(6) If the taxpayer fails to file, the Service may file a substitute for return (SFR) on the taxpayer's behalf. See I.R.C. [section] 6020(b).

(7) See I.R.C. [section] 6213(a).

(8) Id.

(9) Bankruptcy, a fourth alternative, is beyond the scope of this article and will not be discussed here.

(10) IRM (Oct. 18, 2013). In a recent important opinion, the Tax Court held that a taxpayer can be placed into CNC status when he is facing a hardship, even though he has delinquent returns due. See Vinatieri v. Commissioner, 133 T.C. 392 (2009). This is not the case with OICs. Before the Service will consider an OIC, a taxpayer must be current in all tax filings. See Topic 204--Offers in Compromise, IRS (Mar. 7, 2014),

(11) I.R.C. [section] 6159.

(12) I.R.C. [section] 7122; see also Rev. Proc. 2003-71, 2003-36 I.R.B. 517.

(13) I.R.C. [section] 7122(c).

(14) I.R.C. [section] 7122(a).

(15) Section 7122 allows the Service to compromise the tax due. I.R.C. [section] 7122. The Service uses a formula, which is set out in the instruction to the OIC form (Form 656), to determine the minimally acceptable offer amount. This formula calculates a taxpayer's "reasonable collection potential" (RCP) based on the net value of the taxpayer's assets plus any excess income over expenses each month. Internal Revenue Service Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals (2012).

(16) Treas. Reg. [section] 301.7122-1(b) (2002).

(17) See Internal Revenue Service Form 433-A; see also Internal Revenue Service Form 433-B, Collection Information Statement for Businesses (2012) (relating to OIC).

(18) Periodic payments may be made through short-term periodic payments or deferred periodic payments. See Internal Revenue Service, Form 656, Offers in Compromise (2014).

(19) Treas. Reg. [section] 301.7122-1(b)(1) (2002) (stating that doubt as to liability (DATL) exists where there is a "genuine dispute" about "the existence or amount of the correct tax liability").

(20) Approximately 95% of all OICs are submitted under doubt as to collectability (DATC), which means a request that the Service determine that there is no way it will be able to collect the full tax debt from the taxpayer. If the Service agrees, it will take something less, or what is equal to the RCP of the taxpayer. See U.S. Gov't Accountability Office, GAO-06-525, IRS Offers in Compromise: Performance Has Been Mixed; Better Management Information and Simplification Could Improve the Program 1 (2006).

(21) Treas. Reg. [section] 301.7122-1(b)(2) (2002).

(22) Treas. Reg. [section] 301.7122-1 (b)(3)(i)-(ii) (2002).

(23) IRM (Sept. 30, 2013).

(24) See id. This section is used to calculate income of currently unemployed taxpayers. The Service also uses this section to calculate the earning potential of taxpayers if it thinks they can earn more than they are currently earning, based on their employment history and education. See also I.R.C. [section] 7122.

(25) Press Release, Internal Revenue Service, IRS Outlines Additional Steps to Assist Unemployed Taxpayers and Others (Mar. 9, 2010), Unemployed-Taxpayers-and-Others.

(26) See Policy Statement 5-100, IRM [section] (Jan. 30, 1992). Note that this policy statement was issued six years before Congress added the ETA offer as an option.

(27) See IRM [section] (Mar. 7, 2014).

(28) I.R.C. [section] 7122; Treas. Reg. [section] 301.7122-1 (c)(l) (2002).

(29) See Internal Revenue Service Form 656, Offer in Compromise 3 (2011); see also, I.R.S. Chief Couns. Mem. 200102001 (Jan. 12, 2001) ("Should the taxpayer fail to keep [the] promise [to comply], the Service may terminate the compromise and take action to collect the full balance of the unpaid tax liabilities covered by the compromise."). Note that the taxpayer also agrees to forego any refunds due to him or her for the tax year prior to the year of the filing of the offer, and for one subsequent year as well.

(30) I.R.C. [section][section] 6320, 6330 (setting forth lien and levy provisions respectively).

(31) I.R.C. [section] 6330(d).

(32) Id. See also Sego v. Commissioner, 114 T.C, 604 (2000); Goza v. Commissioner, 114T.C. 176(2000).

(33) A settlement officer (SO) is a Service employee specifically assigned to represent the Service in CDP hearings. See IRM [section] (May 27, 2004).

(34) IRM 8.23.3 (Nov. 21, 2013).

(35) I.R.C. [section][section] 6320(c), 6330(c)(2)(A).

(36) See IRM (Oct. 25, 2013).

(37) See I.R.C. [section] 6672. Trust fund taxes result from the failure of a business to remit employment taxes withheld from employees, to the Service. The Service holds the "responsible officer" of the entity personally liable for the organization's tax debt.

(38) I.R.C. [section] 6159.

(39) IRM (Oct. 25, 2013).

(40) Treas. Reg. [section] 64.139 (1999) (citing Letter from Treasury Dept., Miscellaneous XIII-47-7137, 1934-2 C.B. 441 (I.R.S.), 1934 WL 61246 (1934)).

(41) I.R.C. [section] 7122(d); see also H.R. Rep. No. 105-599, at 289 (1998) (Conf. Rep.); IRM (Nov. 26, 2013).

(42) H.R. Rep. No. 105-599, at 289 (1998) (Conf. Rep.).

(43) The Final Regulations under section 7122 were adopted in 2002. See Compromise of Tax Liabilities; Corrections, 67 Fed. Reg. 53, 878-01 (Jul. 23, 2002).

(44) T.D. 8829, 1999-32 I.R.B. 235.

(45) H R. Rep. No. 105-599, at 289 (1998) (Conf. Rep.).

(46) Id.

(47) Id. Section 7122(d)(1), enacted in 1998, requires the Service to "prescribe guidelines" for determining whether an offer in compromise "is adequate and should be accepted to resolve a dispute."

(48) IRM 5.8.11(4) (Nov. 26, 2013).

(49) Id. at (5). Note that there is a hybrid offer: the "Doubt as to Collectability with Special Circumstances" (DCSC) offer. This may apply where the taxpayer's net equity in assets and future income stream, referred to as RCP, are not sufficient to full pay the tax. Id. Such an individual would not qualify for an ETA offer, but the Service may find that there are extenuating equitable circumstances which would permit the Service to consider the offer under a DCSC offer. I.R.M. [section] (Sept. 23, 2008).

(50) Treas. Reg. [section] 301.7122-1 (b)(3)(i) (2002).

(51) Id.

(52) They owed more than $30,000.

(53) This was part of a CDP case.

(54) A condition to acceptance of an OIC is that the taxpayers contract to be compliant in filing and paying all taxes for the five years subsequent to the granting of the offer. See Internal Revenue Service Form 656, Offer in Compromise 3 (2011).

(55) See infra Table 1.

(56) See infra Part VII.

(57) See Treas. Reg. [section] 301.6343-1 (defining economic hardship as the inability to pay reasonable basic living expenses). Those expenses take into account a taxpayer's age, employment status and history, number of dependents, and other "unique circumstances." Id.

(58) See Treas. Reg. [section] 301.6343-1(b)(4)(i)(1995).

(59) See Treas. Reg. [section] 301.7122-1(c)(2)(2002).

(60) Id.

(61) Treas. Reg. [section] 301.7122-1 (c)(2)(i)(2002).

(62) Id.

(63) See Internal Revenue Service Form 656, Offer in Compromise 3 (2011); see also Kevan P. McLaughlin, Esq., Strategies for Compromising Tax Debts: Three lesser-known techniques may improve chances of making a deal, J. Acct. (2011), http://www.joumalof

(64) See Form 656.

(65) IRM (Aug. 23,2008).

(66) Treas. Reg. [section] 301.6343-1 (d)(1)(i) (1995). See Treas. Reg. [section] 301.6343-1 (b)(4)(i) (1995).

(67) T.D. 9007, 67 Fed. Reg. 48,025, 48,026 (July 23, 2002).

(68) Id.

(69) See supra note 40.

(70) See Richard J. Kovach, Tax Complexity, Regulatory Ambivalence, and Disparate Benefits and Burdens in Deferred Compensation Planning for Small Businesses, 11 St. Thomas L. Rev. 141(1998).

(71) Treas. Reg. [section] 301.7122-1(c)(3)(iii), ex. (1), (2), (3) (2002).

(72) See id. at ex. (1), (2).

(73) Id. at ex. (3).

(74) See infra Table 1.

(75) IRM (Sept. 23, 2008).

(76) See id. at (9), (10).

(77) See Soc. Sec. Admin., Period Life Table, 2009 (2009) STATS/table4c6.html.

(78) E-mail from Dana Goldstein, Staff Attorney, Community Legal Aid services, Akron, Ohio to Sandy Freund, Clinical Professor and Co-Director, Rutgers Federal Tax Clinic (Sept. 10, 2013, 10:45 EST) (on file with author).

(79) Treas. Reg. [section] 301.7122-1 (b)(i) (2002).

(80) See IRM (Nov. 23 2013).

(81) See IRM (Nov. 23, 2013); IRM (Nov. 23, 2013).

(82) See supra note 72.

(83) The articulated standard of review of a denied OIC is "abuse of discretion." See Matick v. Commissioner, No. 22057-1 IS L, 2013 WL 4816733 (U.S. Tax Ct. Sept. 10, 2013).

(84) IRM (Nov. 23, 2013).

(85) Rev. Proc. 2003-71, 2003-36 I.R.B. 517.

(86) Id.

(87) Nina E. Olson, National Taxpayer Advocate, 2012 Annual Report to Congress, Doc 2005-256, 2005 TNT 9-21, (2012) userfiles/file/2013-Annual-Report-to-Congress-Executive-Summary.pdf.

(88) See id.

(89) Treas. Reg. [section] 301.7122-1(c)(3) (2002).

(90) Id.

(91) Id

(92) IRM (Nov. 23, 2013).

(93) See Treas. Reg. [section] 301.7122-1 (-(c)(3)(ii)(A) (2002).

(94) IRM (Sept. 23, 2008).

(95) See supra Part III.

(96) See T.D. 8829, 64 Fed. Reg. 39,020, 39,022 (July 21, 1999) ("From the 1930s to the early 1990s, offers to compromise were not widely used to resolve tax cases.").

(97) See T.D. 9007, 67 Fed. Reg. 48,025 (July 23, 2002).

(98) H. R. Rep. No. 105-599, at 289 (1998) (Conf. Rep.).

(99) Id.

(100) Id

(101) IRM (Sept. 23, 2008).

(102) IRM (Sept. 23, 2008) ("When compromising based on IRM [section] paragraphs 4, 5, and 8, in business cases in particular, the Service must be cautious to avoid providing financial advantages through the forgiveness of tax debt").

(103) The audit reconsideration process is "used by the Internal Revenue Service to help you when you disagree with the results of an [Service] audit of your tax return, or a return created for you by the [Service] because you did not file a tax return as authorized by the IRC 6020(b)." I.R.S., What You Should Know About the Audit Reconsideration Process, Pub. 3598 (Rev. 7-2012) available at

(104) Internal Revenue Service Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) (2013).

(105) I.R.C. [section] 6404(e).

(106) Dailey v. Commissioner, 95 T.C.M. 1582 (2008).

(107) IRM (Sept. 23, 2008).

(108) Dailey, 95 T.C.M. 1582.

(109) Id.

(110) Id.

(111) Pomeroy v. Commissioner, 105 T.C.M. (CCH) 1174 (2013).

(112) Id *3.

(113) Id *6.

(114) Id *7.

(115) O'Donnabhain v. Commissioner, 134 T.C. 34, 54 (2010).

(116) The court recognized that, in certain cases, breast augmentation may be considered a sex reassignment surgery and may be deductible under certain circumstances; however, the court did not find that aspect of the petitioner's costs deductible.

(117) Leago v. Commissioner, 103 T.C.M. (CCH) 1210(2012).

(118) Leago was also the subject of a Service Taxpayer Advocate Service training exercise entitled Collection Case Study: Effective Tax Administration (ETA) Offer in Compromise (OIC) (on file with author).

(119) See Leago, 103 T.C.M. (CCH) at *4.

(120) Id. at *5.

(121) Id. at *5.

(122) IRM (Dec. 2, 2013); IRM [section] (Nov. 26, 2013).

(123) IRM (Nov. 26, 2013).

(124) IRM (Nov. 26, 2013).

(125) Treas. Reg. [section] 301-7122-1(c)(3)(A) (2002); see also IRM (Nov. 26, 2013).

(126) IRM (Nov. 26, 2013).

(127) Leago v. Commissioner, 103 T.C.M. (CCH) 1210 (2012).

(128) See Internal Revenue Service Form 433-A (2012).

(129) Leago, 103 T.C.M. (CCH) at 1212, 1218 n.8.

(130) Id.

(131) IRM (Sept. 23, 2008).

(132) I.R.S. Medical and Dental Expenses, Pub. 502 (2013).

(133) Veneziano v. Commissioner, 102 T.C.M. (CCH) 22, *6 (2011).

(134) Id.

(135) Id.

(136) See, e.g., Bergevin v. Commissioner, 95 T.C.M. (CCH) 1031 (1998).

(137) See id.

(138) See id.; see also Keller v. Commissioner, 568 F.3d 710 (9th Cir. 2009).

(139) IRM (Sept. 23, 2008).

(140) 568 F.3d 710.

(141) Id

(142) Id. at 719.

(143) Id.

(144) H.R. Rep. No. 105-599, at 289 (1998) (Conf. Rep.).

(145) David M. Fogel, The 'Effective Tax Administration' Offer in Compromise, 108 Tax Notes 1015 (Aug. 29, 2005).

(146) See Bergevin v. Commissioner, 95 T.C.M. (CCH) 1031 (2008).

(147) See IRM (Sept. 23, 2008).

(148) Id.

(149) See supra Part VI.C.

(150) West v. Commissioner, 100 T.C.M. (CCH) 426 (2010).

(151) I.R.C. [section][section] 172(d)(2)(A), 1212(b).

(152) I.R.C. [section] 1211. Note that the taxpayer in West was also claiming that the taxation rules regarding incentive stock options under I.R.C. [section] 422 were also too complex.

(153) West, 100 T.C.M. (CCH) 426.

(154) United States v. Denkers, No. C 09-03403 WHA, 2010 WL 1267063 at *4-5 (N. D. Cal. Mar. 29, 2010).

(155) Businesses are able to submit OICs under criteria other than ETA.

(156) See also, How Tax Complexity Hinders Small Businesses: the Impact of Job Creation and Economic Growth: Before the Comm, on Small Business, 112th Cong. 19 (2011) (statement of Nina Olson, National Taxpayer Advocate) [hereinafter How Tax Complexity Hinders], 13_11.pdf.

(157) See Treas. Reg. [section] 301.7122-1 (b)(3) (stating that "hardship" is defined by Treas. Reg. [section] 301.6343-1 (b)(4), which is concerned with hardship is it affects the individual taxpayer).

(158) See IRM (Nov. 23, 2013).

(159) See How Tax Complexity Hinders, supra note 156, at 22-23.

(160) See supra note 118, Exhibit 3:1.

(161) Id.

(162) Id.

(163) In addressing ETA OICs, IRM [section] uses the word "taxpayer" as defined by section 7701 (defining a taxpayer as a "person").

(164) See Internal Revenue Service, SOI Tax Stats Delinquent Collection Activities IRS Data Book Table 16, (last updated Mar. 21, 2014).

(165) Offers submitted in 2008: 44,000; 2009: 52,000; 2010: 57,000; 2011: 59,000; 2012: 64,000 and 2013: 70,000. Id.

(166) In 2010, the Service instituted "streamlined" procedures for taxpayers filing OICs who are earning less than $100,000 and owe less than $50,000. See Treasury Inspector General For Tax Administration, Ref. No. 2012-30-033, Increasing Requests for Offers in Compromise Have Created Inventory Backlogs and Delayed Responses to Taxpayers, 19 (2012).

(167) Numbers of offers accepted in 2009: 11,000; 2010: 14,000; 2011: 20,000 and 2012: 24,000. 2013 also showed an increase in filed offers: 70,000, with a 45% acceptance rate. See Internal Revenue Service, SOI Tax Stats--Delinquent Collection Activities--IRS Data Book Table 16, (last updated Mar. 21, 2014).

(168) Id.

(169) There are situations where a taxpayer has equity in an asset, but still cannot full pay the tax. There should be more flexibility for agents to accept less than the value of the equity in those cases as well, but since those do not involve ETA offers they are beyond the scope of this article.

(170) See e-mail from Jennifer Gellner, Assistant Professor, Director, Federal Tax Clinic, Gonzaga University School of Law to Sandy Freund, Clinical Professor, Co-Director Rutgers Federal Tax Clinic (Jan. 8, 2014 19:11 EST) (on file with author).

(171) Being placed in CNC status is not desirable for a taxpayer who wishes to resolve his or her Service tax debt. While a taxpayer is on CNC status, the debt not only continues to accrue interest and penalties, but is also a blight on the taxpayer's credit report. The lien on the property prevents the taxpayer from being able to sell it or borrow against it as no title company can allow the house to be transferred without the withdrawal of the tax lien.

(172) See H. R. Rep. No. 105-599, at 289 (1998).

(173) West v. Commissioner, 100 T.C.M. (CCH) 426 (2010).

(174) For example, revamping the rules to allow a taxpayer to offset deficiencies with "barred" refunds, would thereby eliminate deficiencies in many situations.

(175) E-mail from Jennifer Gellner, Assistant professor, Director, Federal Tax Clinic, Gonzaga University School of Law to Sandy Freund, Clinical Professor, Co-Director, Rutgers Federal Tax Clinic (Dec. 30, 2013 18:34 EST) (on file with author)

Sandy Freund, Clinical Professor, Rutgers School of Law-Newark. I truly appreciate the comments and input of Professor Cynthia Blum, Rutgers School of Law-Newark, and the work of my tireless and amazing research assistant, Lisa Perri, Rutgers School of Law-Newark '14. Thanks also to Angel Falcon, Rutgers School of Law-Newark '12 for his preliminary research. I thank Rutgers School of Law-Newark and Jon Dubin, Clinical Director for all the generous support that has been provided to me during this process.

Fiscal Year              2008    2009    2010    2011    2012    2013

ETA Offers Submitted     763     1054    1496    1559    2054    2107
ETA Offers accepted      258     203     416     548     732     1066
  Based on Economic
ETA Offers accepted      38      27      16      27      21      26
  Based On Equity/
  Public Policy
Total ETA offers         296     230     432     575     753     1092
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Author:Freund, Sandy
Publication:Virginia Tax Review
Date:Jun 22, 2014
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