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Offer in compromise: new policy and procedures.

The IRS recently issued new offer in compromise guidelines to its collection division. These guidelines should enable taxpayers and their representatives to achieve greater success in negotiating compromise settlements for past due tax liabilities. The message behind the guidelines is very simple--accept more offers in compromise.

In the past, the Service did not look favorably on offers in compromise; very few were accepted. A taxpayer who became delinquent on his tax obligation, and did not have the wherewithal to satisfy this obligation, was very unlikely to get relief from ever increasing interest and penalties.

The new IRS policy is: "Collect what is potentially collectible at the earliest possible time and at the least cost to the Government." Rather than try to intimidate taxpayers into finding dollars that they simply do not have, the Service is adopting a practical approach to limit its expense and hasten the collection of unpaid tax. It plans to do this by collecting the maximum amount possible currently.

Another objective of this new policy is the resolution of accounts receivable that cannot be collected in full or on which there is a legitimate dispute as to the amount owed. The IRS hopes to give taxpayers a fresh start to voluntarily comply with the tax laws. Consequently, as a condition to the acceptance of an offer, the Service will require taxpayers to stay current with all future tax liabilities, including the timely payment of estimates.

To have an offer in compromise considered by the IRS, a taxpayer must establish, to the Service's satisfaction, --the inability to pay; or --doubt as to the actual underlying liability.

In the past it could take up to a year to have an offer in compromise considered. The IRS announced that it hopes to trim this time period to six months. To achieve this goal, the 'Service has issued new user-friendly forms and streamlined its processing procedures. The new forms for submitting an offer in compromise are Forms 656 and 433-A for individuals and 433-B for businesses.

While streamlining the processing procedures, the IRS still uses strict guidelines in evaluating the adequacy of offers. A settlement amount that might be considered fair and adequate by an average person may not be acceptable to the Service.

An offer in compromise must be based on a taxpayer's maximum capacity to pay. This includes all of a taxpayer's equity in assets and present and prospective income. The IRS will also look for amounts that may be collectible through transferee assessments or suits, 100% penalty assessments, or from assets or income available to the taxpayer but beyond the reach of the Government.

To determine a taxpayer's equity, the Service first looks at the liquidating or quick-sale value of his assets. The quick-sale value is the amount that would be realized, less any encumbrances, from the sale of the assets when financial pressure causes the taxpayer to sell in a short period of time. Quick-sale value is a valuation method unique to the offer process.

Determining the quick-sale value can cause a problem in evaluating some assets. For example, a closely held corporation is particularly difficult to value. The IRS will normally require substantial disclosure of the company's financial data. It may also require submission of independent appraisals. These appraisals can be very expensive, which further reduces the taxpayer's ability to pay.

The Service also considers gofng concern value in the evaluation. Therefore, it normally will not accept the liquidation value of the company's tangible assets to be the sole measure of its value.

Pension plans can also pose a problem for valuation purposes. The Internal Revenue Manual states the following guidelines for evaluating a pension plan.

1. If, under the terms of employment, a taxpayer is required to contribute a percentage of his gross earnings to a retirement plan and the amount contributed, plus any increments, cannot be withdrawn until separation or retirement, these assets will be considered as having no realizable value.

2. If the taxpayer is within five years of retirement [including early retirement], and the plan permits the taxpayer to take the pension in a lump sum, a collateral agreement must be secured under which the taxpayer agrees to request the lump sum and pay over to the Service the amount of the lump sum, to the extent of the outstanding tax liability, when received.

3. When a taxpayer is not required as a condition of employment to participate in a pension plan, but voluntarily elects to do so, the realizable equity for compromise purposes will be the gross amount in the taxpayer's plan reduced by the employer's contribution. However, in these situations each case should stand on its own merits.

4. If a taxpayer is permitted to borrow up to the full amount of his equity in the plan, this should be taken into consideration in the computation of realizable equity. In spite of the [RS manual changes, taxpayer representatives should be aware of the recent Supreme Court decision in Patterson v. Shumate which, in the case of bankruptcy, may have moved pension assets beyond the reach of the IRS.

5. The current value of property deposited in an individual retirement account [IRA] or Keogh plan account should be considered in the computation of realizable equity. Cash deposits should be included at full value. If assets other than cash have been invested {stocks, mutual funds}, the IRA or Keogh should be valued at a quicksale value, less expenses. The penalty for early withdrawal should be subtracted in computing the net realizable equity.

In addition to looking to a taxpayer's equity in assets, the IRS may require a taxpayer to sign a collateral agreement. Under the agreement, a taxpayer agrees to pay a percentage of future income or equity earned in excess of a set amount over a period of years {normally, five).

Taxpayers and their representatives should view these new changes with enthusiasm, as it appears they will be able to negotiate and receive better results in dealing with the Service. From Richard W. Preston, CPA, Chicago, Ill.
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Article Details
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Author:Preston, Richard W.
Publication:The Tax Adviser
Date:Oct 1, 1992
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