by Scott E. Vincent
The Internal Revenue Service Restructuring and Reform Act approved last year by Congress called for an expansion of the "Offer in Compromise" program for resolving tax liabilities at a discount as one of several new taxpayer rights provisions. The Internal Revenue Service (IRS) formally announced implementation of the expanded offer program March 29, 1999 (IR-1999-30). IRS Commissioner Charles O. Rossotti stated that the IRS is "breaking down the barriers for the Offer in Compromise program," and "making the new rules flexible and making it easier for taxpayers to qualify for the program." The announcement was accompanied by release of a revised Form 656, Offer in Compromise. The IRS is also updating the Internal Revenue Manual to reflect the expanded program and planning to issue regulations later this year that will further expand the program.
Background of the Offer in Compromise Program
The IRS has for years administered an Offer in Compromise program, with varying success. Currently, the IRS accepts offers based on two grounds: (1) doubt as to liability; and (2) doubt as to collectibility. The "doubt as to liability" ground is for tax liabilities that were not properly assessed by the IRS audit system and really just represents a "second chance" for taxpayers to challenge the legal and factual basis for tax liabilities. The more common ground, "doubt as to collectibility," is for taxpayers who cannot pay tax liabilities in full due to their financial circumstances.
The IRS has significant discretion in determining whether or not to accept Offers based on doubt as to collectibility and has developed standardized approaches for making these determinations. In evaluating a doubt as to collectibility offer, the IRS compares the amount offered by the taxpayer with a hypothetical amount that the IRS believes could be collected from the taxpayer. This hypothetical amount includes the "net realizable value" (to the IRS) of the taxpayers assets and also includes the taxpayers "present value of future income." This income figure is the taxpayers monthly income less "allowable expenses," multiplied by an IRS factor intended to estimate 60 months of collection (currently about 48 to 50). In recent years, the IRS has strictly limited allowable expenses for purposes of this calculation to predetermined "national and local standards."
Because these valuation and income calculations are discretionary, the practical availability of the Offer in Compromise program for taxpayers in financial distress has varied significantly over time. In recent years, the program has noticeably constricted, due in part to the strict limitation on allowable expenses to theoretical national and local standards. The IRS acknowledges that only a relatively small number of Offers in Compromise are being accepted. In fiscal year 1998, the IRS indicates that "only 25,052 Offers out of 105,255 were accepted, leading to the collection of only $290 million out of $1.9 billion in outstanding tax bills." Commissioner Rossotti states that the IRS "wants to work with taxpayers to make it simpler for them to apply for an Offer in Compromise," and that "the process will be streamlined to make more and more people eligible."
Changes in Offer in Compromise Procedures
Recognizing the effect of the prior expense limitation methods, the new program promises flexibility in evaluating taxpayer expenses. Moving away from strict reliance on local and national standards for evaluating cost-of-living expenses to determine how much a taxpayer can afford to pay, the new guidelines allow IRS employees more freedom to assess an individuals particular financial hardship. This new program is to be implemented with the followig specific changes announced by the IRS:
• New, flexible IRS rules for processing taxpayer offers. Instead of the old, stringent application guidelines that often led to immediate rejections, the IRS will now work with taxpayers to fine tune their compromise offers -- a step that will lead to accepting more offers.
• Less documentation. Taxpayers will be asked to provide fewer financial documents to qualify for smaller compromise offers.
• New payment procedures. New deferred payment procedures provide more opportunities for compromise offers to be submitted by taxpayers who may have been excluded under the old guidelines. And a short-term deferred payment option allows taxpayers up to two years to pay the compromise offer.
• Specially trained IRS experts will be devoted to handling compromise offers. These new offer specialists will bring more consistency to the offer program and centralize offer processing.
• New independent reviews for each rejected compromise offer. These administrative reviews assess whether rejection is in the best interest of the taxpayer and the government.
These changes, if carried out, will certainly add flexibility to the Offer in Compromise process, which currently involves mechanical application of the national and local expense standards by the IRS. Allowing deferred payments will also be a welcome change, since most taxpayers do not have sufficient funds to pay offers immediately upon acceptance. As noted, the IRS is developing an updated version of its Internal Revenue Manual to implement these new procedures.
Revised Form 656, "Offer in Compromise"
The IRS has already made significant changes to the form used for submission of Offers in Compromise. Newly revised Form 656 is available on the IRS web site at www.irs.ustreas.gov. he IRS lists the following key changes reflected on the new form:
• For payments made within 90 days, compromise offers will now only require 48 months of future income.
• Clearer rules for evaluating assets of taxpayers. The new standards will be more uniform, and the fair market value of assets will be reduced by 20 percent up front.
• Innocent spouse protection for joint compromise agreements. New protctions will safeguard a spouse who complies with the agreement but the other spouse defaults on payments.
The change to 48 months for the "present value of future income" calculation previously discussed should have an immediate impact on offer amounts that the IRS deems acceptable, if the IRS continues to discount the projected payments to a present value. The current method is to discount the 60 months of required income by using a present value factor of about 48 to 50. With respect to asset valuations, most IRS personnel already reduce asset values by at least a 20 percent "forced sale discount," so this is not a significant change.
New Offer in Compromise Regulations
The IRS and the Treasury Department do expect to make additional changes by publishing regulations covering new elements of the Offer in Compromise program later this year. The regulations will create a new category of compromise offers and focus on equity and hardship factors affecting taxpayers seeking Offers in Compromise.
It remains to be seen how these changes will actually affect the Offer in Compromise program, but the announced intent is encouraging. Commissioner Rossotti states that "in the end, this helps all taxpayers," and "instead of collecting nothing from people with an unpaid tax bill, were able to collect something. And for taxpayers facing severe hardship, well work with them to help find a way to satisfy their tax obligations." As practitioners, we will certainly have to consider pursuing offers under the new procedures for clients with tax liabilities. The new procedures are already being implemented, so they should be effective for all offers currently being pursued.