All About IRS Offers in Compromise
An economic downturn increases the ability for thousands of Americans to settle their outstanding tax debt with the IRS. That means that for many, now may be the time to take advantage of the economic uncertainty and to position themselves for a successful tax settlement—and a fresh start.
An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service (IRS) to settle a tax liability for less than the full amount owed. For many taxpayers, the IRS’s Offer in Compromise program is a path toward a fresh start. To qualify, a taxpayer must submit an offer package (including all required documentation and forms) that meets IRS criteria. Taxpayers should take care to comply with all applicable IRS criteria—submitting a non-compliant or rejected offer may harm the taxpayer’s position or ability to submit a subsequent offer with success.
Section 7122 of the Code provides broad authority to the Secretary to compromise any case arising under the internal revenue laws, as long as the case has not been referred to the Department of Justice for prosecution or defense.
The IRS will accept an offer in compromise when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects the taxpayer’s “collection potential,” a term of art that is defined in IRS regulations. The goal of an offer in compromise is to collect such amounts as early and efficiently as possible. Taxpayers with significant tax debts can potentially take advantage of the IRS’s Offer in Compromise Program and a skilled tax attorney can help navigate the regulatory complexities and position a taxpayer for the best possible settlement with the IRS.
Official IRS policies provide that an Offer in Compromise is a tool for providing taxpayers with a “fresh start” and reaching a resolution that is in the best interest of both the taxpayer and the IRS:
The ultimate goal [of the Offer in Compromise Program] is a compromise which is in the best interest of both the taxpayer and the Service. Acceptance of an adequate offer will also result in creating for the taxpayer an expectation of and a fresh start toward compliance with all future filing and payment requirements.
Thus, acceptance of an offer in compromise conclusively settles the liability of the taxpayer, absent fraud or mutual mistake. Compromise with one taxpayer, however, does not extinguish the liability of any person not named in the offer who is also liable for the tax to which the offer relates. The Service may therefore continue to take action to collect from any person not named in the offer.
An offer to compromise a tax liability must be submitted in writing on the IRS’s Form 656, Offer in Compromise. None of the standard terms can be removed or altered, and the form must be signed under penalty of perjury. The offer should include the legal grounds for compromise, the amount the taxpayer proposes to pay, and the payment terms. Payment terms include the amounts and due dates of the payments. The offer should also contain any other information required by Form 656 or IRS regulations.
An offer to compromise a tax liability should set forth the legal grounds for compromise and should provide enough information for the Service to determine whether the offer fits within its acceptance policies. There are three categories for OIC relief: (1) Doubt as to liability; (2) Doubt as to collectability; and (3) Promotion of effective tax administration.
(1) Doubt as to liability
Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence of the liability.
An offer to compromise based on doubt as to liability generally will be considered acceptable if it reasonably reflects the amount the Service would expect to collect through litigation. This analysis includes consideration of the hazards of litigation that would be involved if the liability were litigated. The evaluation of the hazards of litigation is not an exact science and is within the discretion of the Service.
(2) Doubt as to collectability
Doubt as to collectability exists in any case where the taxpayer’s assets and income cannot satisfy the full amount of the liability.
An offer to compromise based on doubt as to collectability generally will be considered acceptable if it is unlikely that the tax can be collected in full and the offer reasonably reflects the amount the Service could collect through other means, including administrative and judicial collection remedies. See Policy Statement P-5-100. This amount is the reasonable collection potential of a case. In determining the reasonable collection potential of a case, the Service will take into account the taxpayer’s reasonable basic living expenses. In some cases, the Service may accept an offer of less than the total reasonable collection potential of a case if there are special circumstances.
(3) Promotion of effective tax administration
The Service may compromise to promote effective tax administration where it determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship. Economic hardship is defined as the inability to pay reasonable basic living expenses. See § 301.6343-1(d). No compromise may be entered into on this basis if the compromise of the liability would undermine compliance by taxpayers with the tax laws.
An offer to compromise based on economic hardship generally will be considered acceptable when, even though the tax could be collected in full, the amount offered reflects the amount the Service can collect without causing the taxpayer economic hardship. The determination to accept a particular amount will be based on the taxpayer’s individual facts and circumstances.
If there are no other grounds for compromise, the Service may compromise to promote effective tax administration where a 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 that the tax laws are being administered in a fair and equitable manner. The taxpayer will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full. No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.
An offer to compromise based on compelling public policy or equity considerations generally will be considered acceptable if it reflects what is fair and equitable under the particular facts and circumstances of the case.
Under §7122(c) factors such as equity, hardship, and public policy will be considered in certain circumstances where granting an offer in compromise will promote effective tax administration. The legislative history of this provision (H. Conf. Rep. 599, 105th Cong., 2d Sess. 289 (1998)) states that:
the conferees expect that the present regulations will be expanded so as to permit the IRS, in certain circumstances, to consider additional factors (i.e., factors other than doubt as to liability or collectibility) in determining whether to compromise the income tax liabilities of individual taxpayers. For example, the conferees anticipate that the IRS 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. The conferees anticipate that, among other situations, the IRS 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. The conferees believe that the ability to compromise tax liability and to make payments of tax liability by installment enhances taxpayer compliance. In addition, the conferees believe that the IRS should be flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations and remain in the tax system. Accordingly, the conferees believe that the IRS 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.
The IRS will generally take into account a number of circumstances bearing on potential economic hardship, including:
- The taxpayer’s age, employment status and history, ability to earn, number of dependents, and status as a dependent of someone else;
- The amount reasonably necessary for food, clothing, housing (including utilities, home-owner insurance, home-owner dues, and the like), medical expenses (including health insurance), transportation, current tax payments (including federal, state, and local), alimony, child support, or other court-ordered payments, and expenses necessary to the taxpayer’s production of income (such as dues for a trade union or professional organization, or child care payments which allow the taxpayer to be gainfully employed);
- The cost of living in the geographic area in which the taxpayer resides;
- The amount of property exempt from levy which is available to pay the taxpayer’s expenses;
- Any extraordinary circumstances such as special education expenses, a medical catastrophe, or natural disaster; and
- Any other factor that the taxpayer claims bears on economic hardship and brings to the attention of the director.
The following non-exclusive list of factors support (but are not conclusive of) a determination that collection would cause economic hardship:
- Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer’s financial resources will be exhausted providing for care and support during the course of the condition;
- Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and
- Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.
Making the Offer
The offer should include all information necessary to verify the grounds for compromise. Except for offers to compromise based solely on doubt as to liability, this includes financial information provided in a manner approved by the Service. Individual or self-employed taxpayers must submit a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, together with any attachments or other documentation required by the Service. Corporate or other business taxpayers must submit a Form 433-B, Collection Information Statement for Businesses, together with any attachments or other documentation required by the Service. The Service may require the corporate officers or individual partners of a business taxpayer to complete a Form 433-A.
A Pending Offer
Section 6331(k)(1) generally prohibits the IRS from making a levy on a taxpayer’s property or rights to property while an offer to compromise a liability is pending with the Service, for 30 days after the rejection of an offer to compromise, or while an appeal of a rejection is pending. The statute of limitations on collection is suspended while levy is prohibited. An offer to compromise becomes pending when it is accepted for processing. The Service accepts an offer to compromise for processing when it determines that: the offer is submitted on the proper version of Form 656 and Form 433-A or B, as appropriate; the taxpayer is not in bankruptcy; the taxpayer has complied with all filing and payment requirements listed in the instructions to Form 656; the taxpayer has enclosed the application fee, if required; and the offer meets any other minimum requirements established by the Service. A determination that the offer meets these minimum requirements means that the offer is processable.
If an offer to compromise accepted for processing does not contain sufficient information to permit the Service to evaluate whether the offer should be accepted, the Service will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the Service has requested within a reasonable time period after such a request, the Service may return the offer to the taxpayer. The Service also may return the offer after it has been accepted for processing if:
- The Service determines that the offer was submitted solely to delay collection;
- The taxpayer fails to file a return or pay a liability;
- The taxpayer files for bankruptcy;
- The offer is no longer processable; or
- The offer was accepted for processing in error.
The Taxpayer’s Ability to Pay
Courts have held that the “[t]he IRS may reject an offer-in-compromise because the taxpayer’s ability to pay exceeds the compromise proposal.” Under IRS procedures, the agency will not accept a compromise that is less than the reasonable collection value of the case, absent a showing of special circumstances. See Rev. Proc. 2003–71(2). The IRS considers the reasonable collection value of a case to be the funds available after the taxpayer meets basic living expenses. Id.
The IRS determines the taxpayer’s ability to pay based on the tax liabilities (assessed and unassessed) due at the time the offer is submitted.
When the IRS receives an offer in compromise submission, the IRS will generally complete an initial calculation to determine if the taxpayer can fully pay the tax debt through an installment agreement based on the IRS’s applicable guidelines. If the initial calculation indicates that the taxpayer cannot full pay the tax through an installment agreement, the IRS will continue its OIC investigation to determine the taxpayer’s reasonable collection potential (RCP).
In determining whether an offer reasonably reflects collection potential, the IRS takes into consideration amounts that might be collected from (1) the taxpayer’s assets, (2) the taxpayer’s present and projected future income, and (3) third parties (e.g., persons to whom the taxpayer had transferred assets). Although most doubt as to collectability offers only involve consideration of the taxpayer’s equity in assets and future disposable income over a fixed period of time, the IRS on occasion also will consider whether the taxpayer should be expected to raise additional amounts from assets in which the taxpayer’s interest is beyond the reach of enforced collection (e.g., interests in property located in foreign jurisdictions or held in tenancies by the entirety).
If during the IRS’s OIC investigation, the financial information provided by the taxpayer becomes older than 12 months and it appears significant changes have occurred, the IRS will generally request updated information. If the taxpayer’s circumstances have significantly changed since the submission of the OIC (for example, a change of employment, loss of job, etc.), the IRS will generally seek updated information.
Equity in Assets
The IRS will seek to determine the taxpayer’s equity in his or her assets. In doing so, the IRS may, among other steps, review the following documents to determine whether there are undisclosed assets or income and to assist in valuing the property:
- Divorce decrees or separation agreements to determine the disposition of assets in the property settlements;
- Homeowners or renters insurance policies and riders to identify high value personal items such as jewelry, antiques, or artwork;
- Financial statements recently provided to lending institutions or others to identify assets or income that may not have been revealed on the CIS.
For an ongoing business, the IRS may make field calls to validate the existence and value of business assets and inventory. The IRS may follow other special procedures related to an on-going business, and in some situations, the IRS may accept offers for less than the business’s RCP.
Net Realizable Equity
For offer in compromise purposes, a taxpayer’s assets are valued at net realizable equity (NRE).
Net realizable equity is defined as the quick sale value (QSV) less amounts owed to secured lien holders with priority over the federal tax lien, if applicable, and applicable exemption amounts
The QSV is defined as an estimate of the price a seller could get for the asset in a situation where financial pressures motivate the owner to sell in a short period of time, usually 90 calendar days or less. Generally, the QSV is less than the fair market value (FMV) of the asset.
Generally, QSV is calculated at 80% of FMV. IRS guidance provides that a higher or lower percentage may be applied in determining QSV when appropriate, depending on the type of asset and current market conditions. If, based on the current market and area economic conditions, it is believed that the property would quickly sell at full FMV, then the IRS may consider QSV to be the same as FMV. This is occasionally found to be true in real estate markets where real estate is selling quickly at or above the listing price. If the IRS believes that the value chosen represents a fair estimate of the price a seller could get for the asset in a situation where the asset must be sold quickly (usually 90 calendar days or less) then the IRS may use a percentage other than 80%. Generally, it is the policy of the IRS to apply QSV in valuing property for offer purposes.
When a particular asset has been sold (or a sale is pending) in order to fund the offer, the IRS will not provide for a reduction for QSV. Instead, it will verify the actual sale price, ensuring that the sale is an arms-length transaction, and use that amount as the QSV. The IRS may allow for a reduction for the costs of the sale and the expected current-year tax consequence to arrive at the NRE of the asset.
Jointly Held Assets
When taxpayers submit separate offers but have jointly-owned assets, the IRS will generally allocate equity in the assets equally between the owners. However, the IRS will allocate the equity in a different manner under certain circumstances: If the joint owners demonstrate that their interest in the property is not equally divided, the IRS will allocate the equity based on each owner’s contribution to the value of the asset.
If the joint owners have joint and individual tax liabilities included in the offer in compromise, the IRS will generally apply the equity in assets first to the joint liability and then to the individual liability.
For property held as tenancies by the entirety when the tax is owed by only one spouse, the taxpayer’s portion is usually considered to be 50% of the property’s NRE. However, applicable state law, such as community property and registered domestic partnership laws, may impact property ownership rights and may change the taxpayer’s interest in assets that should be included in RCP for offer in compromise purposes.
Assets Held By Others as Transferees, Nominees, or Alter Egos
The IRS will also conduct an investigation to determine what degree of control the taxpayer has over assets and income that are in the possession of others, particularly when the offer will be funded by a third party.
The IRS will seek to determine whether there are any transferee, nominee, or alter ego issues present. If the IRS determines that the taxpayer has a beneficial interest in assets or income streams that are held by a transferee, nominee, or alter ego, the IRS will reflect the value of such assets or interest in the RCP.
When determining an individual taxpayer’s RCP, the IRS will generally utilize the amount of cash listed on the taxpayer’s Form 433-A (OIC) for the amount of cash in the taxpayer’s bank accounts, though it will reduces such amount by $1,000.
When determining a business taxpayer’s RCP, the IRS will generally utilize the amount listed on the Form 433-B(OIC) for the amount of cash in the taxpayer’s bank account. The $1,000 reduction applicable to individual bank accounts is not applicable with respect to business taxpayers.
The IRS will review the taxpayer’s checking account statements over a reasonable period of time, generally three months for wage earners and six months for taxpayers who are non-wage earners. The IRS will seek to ascertain whether there is unusual activity, such as deposits in excess of reported income, withdrawals, transfers, or checks for expenses not reflected on the CIS.
If a taxpayer offers the balances of certain accounts—for example, certificate of deposit, savings bonds, etc.—to fund the proposed offer, the IRS may allow for any penalty for early withdrawal and allow for expected current year tax consequences with respect to the account withdrawal.
Securities and Stocks of Closely Held Entities
Financial securities are considered an asset and the IRS includes their value in its determination of the taxpayer’s the RCP.
If the taxpayer proposes to liquidate an investment in order to fund the proposed offer in compromise, the IRS will allow for the associated fees in addition to any penalty imposed on the taxpayer for early withdrawal, as well as the expected current year tax consequences.
In order to determine the value of “closely held” stock that is not traded publicly or for which there is no established market, the IRS may consider the following methods to value the stock:
- a recent annual report to stockholders.
- recent corporate income tax returns.
- an appraisal of the business as a going concern by a qualified and impartial appraiser.
IRS standards provide that when a taxpayer holds only a negligible or token interest in the stock, or has made no investment and exercises no control over the corporate affairs, it is permissible to assign no value to the stock.
The IRS may be skeptical when a taxpayer claims that they have no interest in a closely held corporation or family owned business but the facts indicate that their interest may have been transferred or assigned. Under such circumstances, the IRS will generally conduct additional investigative measures.
There are additional considerations when it comes to offers involving closely held entities:
- Compensation to Corporate Officers – The IRS may not allow wages and/or other compensation, (i.e., draws) paid to corporate officers in excess of applicable expenses allowable per National and Local standards as business expenses. The officer’s ownership interest in the business and any control over the compensation received is generally a consideration in the IRS’s determination of whether the officer compensation is deemed excessive.
- Stock Holder Distributions and Repayment of Loans to Officers – Because these expenses are discretionary in nature, the IRS may evaluate distributions of this nature made after the incurrence of the outstanding tax liability under the “dissipated asset” provisions. Loans to officers are generally considered an account receivable and valued according to their collectability. If the IRS believes that the taxpayer may be receiving income from loans and that their wages are not reasonable, the IRS may consider a referral to the Examination Division.
- Stock Held by Beneficial Owner – The value of stock ownership in a closely held corporation/LLC is generally included in the RCP of a taxpayer submitting an offer to compromise their individual liabilities.
Virtual Currency. The taxpayer may have in interest or ownership in virtual currency (e.g. bitcoin). A virtual currency is an electronic currency that isn’t legal tender and isn’t issued by a government. For tax purposes, the transactions are treated as an exchange of property. The IRS will generally include the value of virtual currency in the taxpayer’s RCP. The value will generally be determined in the same manner as a publicly traded stock.
The IRS will may treat life insurance differently depending upon the type and nature of the insurance policy. The IRS will seek to identify the type of insurance, the conditions for borrowing or cancellation, and the current loan and cash values on the policy.
Under IRS guidance, life insurance as an investment (e.g., whole life) is generally not considered “necessary.”
When determining the value in a taxpayer’s insurance policy, consider:
- If the taxpayer will retain the insurance policy then the equity is considered to be the cash surrender value
- If the taxpayer will sell the policy to help fund the proposed offer, then the taxpayer’s “equity” is considered to be the amount that the taxpayer will receive from the sale of the policy. Documentation from a broker may be required to verify the selling price and related expenses.
- If the taxpayer will borrow on the policy to help fund the proposed offer, then the taxpayer’s “equity” is considered to be the cash loan value less any prior policy loans or automatic premium loans required to keep the contract in force.
The IRS will generally allow reasonable premiums for term life insurance policies as a necessary expense.
If the taxpayer has a whole life policy, the IRS will generally allow a reasonable amount of the premiums that is attributable to the death benefit under the policy.
Retirement or Profit-Sharing Plans
Funds held in a retirement or profit-sharing plan are considered an asset and must be valued for purposes of the offer in compromise.
The IRS considers does not consider contributions to voluntary retirement plans to be a necessary expense. The IRS provides for a number of rules based upon the type of account at issue:
|The account is an Individual Retirement Account (IRA), 401(k), or Keogh Account||The taxpayer is not retired or close to retirement||Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable.|
|The account is an Individual Retirement Account (IRA), 401(k), or Keogh Account||The taxpayer is retired or within one year of retirement||· Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable.
· The plan may be considered as income, if the income from the plan is required to provide for necessary living expenses.
|The contribution to a retirement plan is required as a condition of employment||The taxpayer is able to withdraw funds from the account||Equity is the amount the taxpayer can withdraw less any tax consequences and early withdrawal penalty, if applicable.|
|The contribution to an employer’s plan is required as a condition of employment||The taxpayer is unable to withdraw funds from the account but is permitted to borrow on the plan||Equity is the available loan value.|
|Any retirement plan that may not be borrowed on or liquidated until separation from employment||The taxpayer is retired, eligible to retire, or close to retirement||Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable, or plan may be considered as income if the income from the plan is necessary to provide for necessary living expenses.|
|The plan may not be borrowed on or liquidated until separation from employment and the taxpayer has no ability to access the funds within the terms of the offer||The taxpayer is not eligible to retire until after the period for which we are calculating future income||The plan has no equity.|
|The taxpayer may not access the funds in the retirement account due to an existing loan||The taxpayer is not eligible to retire until after the period for which we are calculating future income||Determine what equity remains in the account taking into consideration when the loan was taken out, whether the proceeds were used for necessary living expenses, and the remaining equity in the account. If the loan proceeds were used for necessary and allowable expenses and you confirm the taxpayer cannot further access (borrow against) the account given the outstanding loan, the value of the account should be the equity remaining in the plan less the amount of the loan. If the loan proceeds were not used for necessary and allowable living expenses, the IRS may analyze the proceeds under the dissipation of assets rules.|
|The plan includes a stock option||The taxpayer is eligible to take the option||Equity is the value of the stock at current market price less any expense to exercise the option.|
Furniture, Fixtures, and Personal Effects
The IRS will generally accept the taxpayer’s declared value of household goods unless there are articles of extraordinary value, such as antiques, artwork, jewelry, or collector’s items. In such cases, the IRS may even personally inspect the assets.
There is a statutory exemption from IRS levies that applies to a number of items, including the taxpayer’s furniture and personal effects. This exemption amount is updated on an annual basis. This exemption applies only to individual taxpayers.
The property is owned jointly with any person who is not liable for the tax, the IRS will determine the value of the taxpayer’s proportionate share of property before allowing the levy exemption.
While the furniture or fixtures used in a business may not qualify for the personal effects exemption, they may qualify for the levy exemption as tools of a trade.
If the property has a valid encumbrance with priority over the NFTL, the IRS will allow the encumbrance in addition to the statutory exemption.
Motor Vehicles, Airplanes, and Boats
Equity in motor vehicles, airplanes, and boats is included in the taxpayer’s RCP. The general rule for determining Net Realizable Equity applies when determining equity in these assets. However, unusual assets such as airplanes and boats may require an appraisal to determine FMV.
In most cases, the IRS will discounted at 80% of FMV to arrive at the QSV for a vehicle.
The IRS will exclude $3,450 per car from the QSV of vehicles owned by the taxpayer and used for work, the production of income, and/or the welfare of the taxpayer’s family (up to two cars for joint taxpayers and one vehicle for a single taxpayer).
Note that when assets in this category are used for business purposes, they may be considered income producing assets.
The IRS will seek to verify the FMV of real property. FMV is defined as the price at which a willing seller will sell, and a willing buyer will pay, for the property, given time to obtain the best and highest possible price. The IRS will seek to verify the type of ownership through warranty and mortgage deeds, and may seek to verify or determine the FMV of the property through various sources, including:
- The value listed on real estate tax assessment statements.
- Market comparables.
- Recent purchase prices.
- An existing contract to sell.
- Recent appraisals.
- A homeowner’s insurance policy.
The equity in real estate is included when calculating the taxpayer’s RCP to determine an acceptable offer amount.
Note, however, that there may be circumstances in which an offer under ETA or Doubt as to Collectibility with Special Circumstances (DATCSC) may be appropriate for an amount which does not include some or all of the real property equity.
For real estate and other related property held as tenancies by the entirety when the tax is owed by only one spouse, the IRS usually treats the taxpayer’s portion as 50% of the property’s NRE.
Accounts and Notes Receivable
Accounts and notes receivable are considered assets unless the IRS makes a determination to treat them as part of the taxpayer’s income stream when they are required for the production of income. When the IRS determins that liquidation of a receivable would be detrimental to the continued operation of an otherwise profitable business, the receivable may be treated as future income.
Accounts Receivable – The value of accounts receivable to be included in the taxpayer’s RCP may be adjusted based on the age of the account. Accounts receivable that are current (i.e. less than or equal to 90 days past due is generally considered current for these purposes) generally may be discounted at Quick Sale Value (QSV), if the taxpayer presents accounting or industry rules or other substantiation providing for devaluation of such accounts. If the account is determined to be delinquent it may be discounted appropriately based on the age of the receivable and the potential for collection.
When the receivables have been sold at a discount or pledged as collateral on a loan, the IRS will apply the provisions of IRC 6323(c) to determine the lien priority of commercial transactions and financing agreements.
The IRS may closely examine accounts of significant value that the taxpayer is not attempting to collect, or that are receivable from officers, stockholders, or relatives.
In order to determine the value of a note receivable, the IRS may consider, among other things, the following:
- Whether it is secured and if so by what asset(s),
- What is collectible from the borrower, and
- If it could be successfully levied upon.
When an offer includes business assets, the IRS conducts an analysis to determine if certain assets are essential for the production of income. When it has been identified that an asset or a portion of an asset is necessary for the production of income, the IRS will adjust the income or expense calculation for the taxpayer to account for the loss of income stream if the asset was either liquidated or used as collateral to secure a loan to fund the offer.
The IRS will generally use the following procedures when valuing income-producing assets:
|There is no equity in the assets||There is no adjustment necessary to the income stream.|
|There is equity and no available income stream (i.e. profit) produced by those assets||There is no adjustment necessary to the income stream.|
|There are both equity in assets that are determined to be necessary for the production of income and an available income stream produced by those assets||The IRS will compare the value of the income stream produced by the income producing asset(s) to the equity that is available.|
|An asset used in the production of income will be liquidated to help fund an offer||The IRS may adjust the income to account for the loss of the asset.|
|A taxpayer borrows against an asset that is necessary for the production of income, and devotes the proceeds to the payment of the offer.||The IRS may allow the loan payment as an expense and will consider the effect that the loan will have on the future income stream.|
As a general rule, equity in income-producing assets will not be added to the taxpayer’s RCP of a viable, ongoing business, unless the IRS determines that the assets are not critical to business operations. However, the IRS will include equity in real property in the calculation of RCP.
Moreover, even though rental property, owned by the taxpayer, may produce income, the IRS will generally include the equity in the taxpayer’s RCP. However, an adjustment to the taxpayer’s future income value may be appropriate if the taxpayer will be borrowing against or selling the property to fund the proposed offer.
The following examples provides some guidance with respect to the treatment of equity and income produced by assets:
(1) A business depends on a machine to manufacture parts and cannot operate without this machine. The equity is $100,000. The machine produces net income of $5,000 monthly. The RCP should include the income produced by the machine, but not the equity. Equity in this machine will generally not be included in the RCP because the machine is needed to produce the income, and is essential to the ability of the business to continue to operate.
The IRS considers it to be in the government’s best interests to work with taxpayer in this situation to maintain business operations.
Based on a taxpayer’s specific circumstances, there may instances where the IRS will treat the income producing assets in a Subchapter S corporation in a similar manner to assets owned by a taxpayer’s sole proprietorship business. Factors that are considered in this analysis include:
- Type of business activity
- Taxpayer’s occupation
- Current income received from the corporation as salary and the amount of future income that the taxpayer will receive
- Current income received from corporation as dividend
- Ability of the taxpayer to sell their interest in the corporation
Inventory, Machinery, Equipment, and Tools of the Trade
Inventory, machinery, and equipment may be considered income-producing assets. In order to determine the value of business assets, the IRS may use the following:
- For assets commonly used in many businesses, such as automobiles and trucks, the value may be determined by consulting trade association guides.
- For specialized machinery and equipment suitable for only certain applications, the IRS may consult a trade association guide, secure an appraisal from a knowledgeable and impartial dealer, or contact the manufacturer.
- When the property is unique or difficult to value and no other resource will meet the need, the IRS may utilize the services of an IRS valuation engineer.
- The IRS may ask the taxpayer to secure an appraisal from a qualified business appraiser.
There is a statutory exemption from levy that applies to an individual taxpayer’s tools used in a trade or business, which the IRS will allow in addition to any encumbrance that has priority over the NFTL. Whether an automobile is a tool of the trade depends on the taxpayer’s trade. The levy exemption amount is updated on an annual basis.
Business as a Going Concern
The IRS may evaluate a business as a going concern when determining the RCP of an operating business that is owned individually or by a corporation, partnership, or LLC. The IRS recognizes that a business may be worth more than the sum of its parts when sold as a going concern.
To determine the value of a business as a going concern, the IRS will consider the value of its assets, future income, and intangible assets such as:
- Ability or reputation of a professional.
- Established customer base.
- Prominent location.
- Well known trade name, trademark, or telephone number.
- Possession of government licenses, copyrights, or patents.
Generally, the difference between what an ongoing business would realize if sold on the open market as a going concern and the traditional RCP analysis is attributable to the value of these intangibles.
Dissipation of Assets
The inclusion of dissipated assets in the calculation of the reasonable collection potential (RCP) is no longer applicable, except where it can be shown that the taxpayer sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary, or other income) for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or during a period of up to six months prior to or after the tax assessment.
The evaluation of a taxpayer’s interest in property held as a nominee, transferee, or alter ego is evaluated separately from the determination of whether the taxpayer may have dissipated an asset in an attempt to avoid the payment of tax.
Generally, the IRS uses a three-year time frame to determine if it is appropriate to include a dissipated asset in the taxpayer’s RCP.
Even if the transfer and/or sale took place more than three years prior to the offer submission, the IRS may deem it appropriate to include an asset in the calculation of RCP if the asset transfer and/or sale occurred during a period of up to six months prior to or after the assessment of the tax liability. If the asset transfer took place upon notice of or during an examination, the IRS may not apply these time frames based on the circumstances of the case. Where the IRS is considering the inclusion of a dissipated asset, it may also look at whether the funds were used for health/welfare of the family or production of income.
Note that if the tax liability at issue did not exist prior to the transfer or the transfer occurred prior to the taxable event giving rise to the tax liability, generally, a taxpayer cannot be said to have dissipated the assets in disregard of the outstanding tax liability.
If a taxpayer withdraws funds from an IRA to invest in a business opportunity but does not have any tax liability prior to the withdrawal, the IRS will not consider the funds to have been dissipated.
Any tax paid as a result of the sale of dissipated assets may be allowed as a reduction to the value placed on the dissipated asset.
Retired debt is considered an expected change in necessary or allowable expenses. The necessary/allowable expenses may decrease after the retirement of the debt, which would change the taxpayer’s ability to pay.
For example, required child support payments may stop before the future income period ends. Under IRS standards, these retired payments would generally increase the taxpayer’s ability to pay.
Future income is defined by IRS guidance as an estimate of the taxpayer’s ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future.
As a general rule, the IRS uses the taxpayer’s current income in the analysis of the taxpayer’s future ability to pay. This may include situations where the taxpayer’s income has been recently reduced based on a change in occupation or employment status.
The IRS will also consider the taxpayer’s overall general circumstances, including age, health, marital status, number and age of dependents, level of education or occupational training, and work experience.
Depending on the circumstances, the IRS may place a different value on future income than current or past income indicates. The IRS may also seek to secure a future income collateral agreement based on the taxpayer’s earnings potential.
|Income will increase or decrease or current necessary expenses will increase or decrease||Adjust the amount or number of payments to what is expected during the appropriate number of months.|
|A taxpayer is temporarily or recently unemployed or underemployed||The IRS will generally use the level of income expected if the taxpayer were fully employed and if the potential for employment is apparent. The IRS will also consider special circumstances or ETA issues.|
|A taxpayer is unemployed and is not expected to return to their previous occupation or previous level of earnings||When considering future income, the IRS will allow anticipated increases in necessary living expenses and/or applicable taxes.|
|A taxpayer is long-term unemployed||The IRS will use the taxpayer’s current income in the future income calculation. If there is a verified expectation the taxpayer will be securing employment then the use of anticipated future income may be appropriate. The IRS may use anticipated future income where the future employment is uncertain.|
|A taxpayer is long-term underemployed||The IRS will generally use the taxpayer’s current income.|
|A taxpayer has an irregular employment history or fluctuating income||The IRS may use the taxpayer’s average earnings over the three prior years. However, this does not apply to wage earners. Calculations for wage earners are generally based on current income unless the taxpayer has unique circumstances.|
|A taxpayer is in poor health and their ability to continue working is questionable||The IRS will generally reduce the number of payments to the appropriate number of months that it is anticipated the taxpayer will continue working. The IRS will consider special circumstances that may warrant adjustments.|
|A taxpayer is close to retirement and has indicated they will be retiring||If the taxpayer can substantiate that retirement is imminent, the IRS will generally adjust the taxpayer’s future earnings and expenses accordingly. If not, the IRS will generally base the calculation on current earnings.|
|Taxpayer is currently receiving overtime.||If the overtime is regular and customary, it will generally be included in current income. If the overtime is sporadic, the IRS will use the taxpayer’s base pay.|
|The taxpayer is at or above the full retirement age to receive social security benefits and has decided to continue working||If the taxpayer is past the age when the taxpayer’s income does not impact receipt of their full social security benefits, the IRS may include the taxpayer’s potential social security benefits in current income. The IRS may seek to determine the taxpayer’s potential benefits by having the taxpayer secure an estimate from the Social Security Administration.|
|A taxpayer will file a petition for liquidating bankruptcy||Under these circumstances, the IRS may reduce the value of future income. It will not reduce the total value of future income to an amount less than what could be paid toward non-dischargeable periods, or what could be recovered through bankruptcy, whichever is greater.|
Allowable expenses consist of necessary and conditional expenses. Allowable expenses are discussed below.
A necessary expense is one that is necessary for the production of income or for the health and welfare of the taxpayer’s family. The national and local expense standards serve as guidelines in determining a taxpayer’s basic living expenses.
Taxpayers are allowed the National Standard Expense amount for their family size, without a need to substantiate the amount actually spent. However, if the total amount claimed is more than the total allowed by the National Standards, the taxpayer is required to provide documentation to substantiate and justify that the allowed expenses are inadequate to provide basic living expenses.
The IRS’s Offer in Compromise Program was impacted by a 1995 IRS initiative designed to ensure uniform treatment of similarly situated taxpayers. In administering its collection operations, including both the installment agreement program and the compromise program, the IRS has always permitted taxpayers to retain funds to pay reasonable living expenses.
In 1995, the IRS adopted and published national and local standards for determining allowable expenses, which were designed to apply to all collection actions, including offers to compromise. National expense standards were derived from the Bureau of Labor Statistics Consumer Expenditure Survey and were promulgated for expense categories such as food, clothing, personal care items, and housekeeping supplies. Local expense standards derived from Census Bureau data were promulgated for housing, utilities, and transportation.
The IRS allowable expense criteria play an important role in determining whether taxpayers are candidates for an offer in compromise.
Housing and Utilities
When determining a taxpayer’s housing and utility expense, the IRS seeks to use an amount that provides for basic living expenses. The IRS requires that deviations from the expense standards be verified, reasonable, and documented.
Transportation expenses are considered necessary when they are used by taxpayers and their families to provide for their health and welfare and/or the production of income.
The transportation standards are designed to account for loan or lease payments—referred to as ownership costs—and additional amounts for operating costs broken down by Census Region and Metropolitan Statistical Area. Operating costs include maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking and tolls.
Ownership Expenses – Expenses are allowed for the purchase or lease of a vehicle. Taxpayers are generally allowed the local standard or the amount actually paid, whichever is less, unless the taxpayer provides documentation to verify and substantiate that the higher expenses are necessary.
Operating Expenses – The IRS will generally allow the full operating costs portion of the local transportation standard, or the amount actually claimed by the taxpayer, whichever is less. Substantiation for this allowance is generally not required unless the amount claimed is more than the total allowed by any of the transportation standards.
A taxpayer who commutes long distances to reach his place of employment, he may be allowed greater than the standard operating expenses, as the additional operating expense would generally meet the production of income test.
If the taxpayer has a vehicle that is over eight years old or has reported mileage of 100,000 miles or more, an additional monthly operating expense of $200 will generally be allowed per vehicle (up to two vehicles when a joint offer is submitted).
Other expenses may be allowed in determining the value of future income for IRS offer purposes. The expense, however, generally must meet the necessary expense test by providing for the health and welfare of the taxpayer and/or his or her family or must be for the production of income. This is determined based on the facts and circumstances of each case.
Generally, the repayment of loans incurred to fund the offer and secured by the taxpayer’s assets will be allowed, if the asset is necessary for the health and welfare of the taxpayer and/or their family, i.e. taxpayer’s residence, and the repayment amount is reasonable. The same rule applies whether the equity is paid to the IRS before the offer is submitted or will be paid upon acceptance of the offer.
Minimum payments on student loans guaranteed by the federal government are allowed for the taxpayer’s post-high school education. Proof of payment, however, must generally be provided. If student loans are owed, but no payments are being made, the IRS may not allow them, unless the non-payment is due to circumstances of financial hardship, e.g. unemployment, medical expenses, etc.
Education expenses are generally allowed only for the taxpayer and only if it they are required as a condition of present employment. Expenses for dependents to attend colleges, universities, or private schools may not be allowed by the IRS unless the dependents have special needs that cannot be met by public schools.
Child support payments for natural children or legally adopted dependents may generally be allowed based on the taxpayer’s situation. A copy of the court order and proof of payments should be provided as part of the offer submission. If no payments are being made, the IRS may not allow the expense, unless the nonpayment was due to temporary job loss or illness.
The IRS will generally not allow payments for expenses, such as college tuition or life insurance for children, made pursuant to a court order. The IRS’s position is that the fact that the taxpayer may be under court order to make payments with respect to such expenses does not change the character of the expense. Therefore, the fact that a taxpayer is under court order to provide a payment may not elevate that expense to allowable status as an offer expense, if the Service would not otherwise allow it.
Generally, charitable contributions are not allowed in the RCP calculation. However, charitable contributions may be an allowable expense if they are a condition of employment or meet the necessary expense test.
Payments being made to fund or repay loans from voluntary retirement plans will generally not be allowed by the IRS. Taxpayers who cannot repay these loans will have a tax consequence in the year that the loan is declared in default and that consequence should be estimated and allowed as an additional tax expense on the IET for the required number of months necessary to cover the additional tax consequence.
Current taxes are allowed regardless of whether the taxpayer made them in the past or not. If an adjustment to the taxpayer’s income is made, an adjustment of the tax liability must also be made. Current taxes include federal, state, and local taxes. In a wage earner situation, allow the amount shown on the pay stub. If the current withholding amount is insufficient or was recently adjusted to substantially over-withhold, the tax expenses should be based on the actual tax expense.
Generally, the IRS will only a taxpayer the expenses that the taxpayer is required to pay. Consideration must be given to situations where the taxpayer shares expenses with another. Shared expenses may exist in one of two situations:
- An offer is submitted by a taxpayer who shares living expenses with another individual who is not liable for the tax.
- Separate offers are submitted by two or more persons who owe joint liabilities and/or separate liabilities and who share the same household.
Generally, the assets and income of a non-liable person are excluded from the computation of the taxpayer’s ability to pay. Treasury Reg. 301.7122-1 (c) (2) (ii) (A) only applies in non-liable situations.
Calculation of Future Income
Future income is defined as an estimate of the taxpayer’s ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. The number of months used depends on the payment terms of the offer.
|The offer will be paid in 5 months or less and 5 or fewer payments||The IRS will use the realizable value of assets plus the amount that could be collected in 12 months.|
|The offer is payable in six to 24 months||The IRS will use the realizable value of assets plus the amount that could be collected in 24 months.|
Generally, the amount to be collected from future income is calculated by taking the projected gross monthly income, less allowable expenses, and multiplying the difference by the number of months applicable to the terms of offer.
For lump sum cash and periodic payment offers, when there are less than 12 or 24 months remaining on the statutory period for collection, the IRS will use the number of months remaining on the statutory period for collection.
Calculation of Future Income – Cultivation and Sale of Marijuana in Accordance with State Laws
The value of future income when a taxpayer is involved in the cultivation and sale of marijuana, in accordance with applicable state laws, should be based on the following guidance:
- The IRS will determine the taxpayer’s gross income over a specific time period (normally annually);
- The IRS will limit allowable expenses consistent with Internal Revenue Code Section 280E, where a taxpayer may not deduct any amount for a trade or business where the trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances;
Since only expenses that are allowable based on current federal law will be included in determining future income value, the taxpayer’s most recent income tax return is generally the most appropriate document to use when completing the income/expense table.
Limited Liability Companies (LLC) Issues
Offers in compromise from a LLC involve unique issues, especially when the liabilities include employment or excise taxes.
The classification of the LLC for federal tax purposes is important. Yet, classification of the LLC for federal tax purposes does not negate state law provisions concerning the legal status of the LLC. For example:
- Classification of an LLC as a partnership does not mean the member/owners have liability for LLC debts as would be the case in a state law partnership.
- Under certain circumstances, an LLC may be disregarded as an entity separate from its owner. This classification does not mean that an LLC owned by an individual is the equivalent of a sole proprietorship.
Financial Analysis of an LLC
As with any entity, the IRS will require sufficient information to make an informed decision on the acceptability of the taxpayer’s compromise proposal. This requires a financial statement from the LLC, as well as employment tax liabilities for wages paid prior to January 1, 2009, where the classification of the LLC is a disregarded entity even though the LLC is not the liable taxpayer.
The IRS will generally also seek financial information of all member owners, except when a member owner holds only a negligible or token interest, has made no or minimal investment and exercises no control over the corporate affairs unless other factors are present to indicate the information is necessary to determine the acceptability of the taxpayer’s offer.
Financial Analysis of a Partnership Interest
Since the taxpayer’s interest in any asset should be included in RCP, if the taxpayer has any interest in a partnership, the IRS will make a determination of the appropriate value to include in an acceptable offer amount. The taxpayer’s interest in a partnership may be as a general or limited partner.
Generally, the value of the taxpayer’s interest would either be the taxpayer’s share of the underlying assets or the value of the transferable interest. The determination of the correct valuation may also be based on other factors, including whether the taxpayer is a general partner, how the taxpayer’s interest was acquired, how the assets of the partnership were acquired, the taxpayer’s relationship to the other partners, and the liquidity of the transferable interest.
Offer in Compromise Submitted on Cases Involving Collection Statute Expiration Date Extensions
Taxpayers that previously extended the CSED in connection with an installment agreement may request approval of an OIC.
Payment terms are negotiable, but the IRS will request that they provide for payment of the offered amount in the least time possible. If a taxpayer is planning to sell asset(s) to fund all or a portion of the offer, the payment terms for the offer may need to provide for immediate payment of the amounts received from the sale. If the taxpayer is planning to borrow a portion of the money, the payment terms of the offer may need to provide for payment of the borrowed portion at the time the funds are received.
For those taxpayers who agree to shorter payment terms, fewer months of future income are required:
|Payment Type||Payment Terms||Number of Months Future Income Required|
|Lump Sum Cash||5 or less installments within 5 months||12 months or the remaining statutory period, whichever is less|
|Periodic Payment||Within 6 to 24 months||24 months or the remaining statutory period, whichever is less|
While a periodic payment offer is being evaluated by the Service, the taxpayer is required to make subsequent proposed periodic payments as they become due. Even though there is no requirement that the payments be made monthly or in equal amounts, the IRS will base offer payments on the taxpayer’s specific situation and ability to pay. While the calculation of RCP and consideration of any special circumstances will ultimately assist the IRS in determining an acceptable offer amount, the IRS is not bound by the offer amount or the terms proposed by the taxpayer.
Offers in Compromise are generally and primarily governed by I.R.C. section 7122 and the regulations thereunder. We have provided the current versions of those most relevant authorities below:
I.R.C. Sec. 7122
(a)Authorization. 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; and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense.
(b)Record. Whenever a compromise is made by the Secretary in any case, there shall be placed on file in the office of the Secretary the opinion of the General Counsel for the Department of the Treasury or his delegate, with his reasons therefor, with a statement of—
(1) The amount of tax assessed,
(2) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed, and
(3) The amount actually paid in accordance with the terms of the compromise.
Notwithstanding the foregoing provisions of this subsection, no such opinion shall be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. However, such compromise shall be subject to continuing quality review by the Secretary.
(c)Rules for submission of offers-in-compromise
(1)Partial payment required with submission
The submission of any lump-sum offer-in-compromise shall be accompanied by the payment of 20 percent of the amount of such offer.
For purposes of this section, the term “lump-sum offer-in-compromise” means any offer of payments made in 5 or fewer installments.
(B)Periodic payment offers
The submission of any periodic payment offer-in-compromise shall be accompanied by the payment of the amount of the first proposed installment.
(ii)Failure to make installment during pendency of offer
Any failure to make an installment (other than the first installment) due under such offer-in-compromise during the period such offer is being evaluated by the Secretary may be treated by the Secretary as a withdrawal of such offer-in-compromise.
(2)Rules of application
(A)Use of payment
The application of any payment made under this subsection to the assessed tax or other amounts imposed under this title with respect to such tax may be specified by the taxpayer.
(B)Application of user fee
In the case of any assessed tax or other amounts imposed under this title with respect to such tax which is the subject of an offer-in-compromise to which this subsection applies, such tax or other amounts shall be reduced by any user fee imposed under this title with respect to such offer-in-compromise.
The Secretary may issue regulations waiving any payment required under paragraph (1) in a manner consistent with the practices established in accordance with the requirements under subsection (d)(3).
(3)Exception for low-income taxpayers
Paragraph (1), and any user fee otherwise required in connection with the submission of an offer-in-compromise, shall not apply to any offer-in-compromise with respect to a taxpayer who is an individual with adjusted gross income, as determined for the most recent taxable year for which such information is available, which does not exceed 250 percent of the applicable poverty level (as determined by the Secretary).
(d)Standards for evaluation of offers
The Secretary shall prescribe guidelines for officers and employees of the Internal Revenue Service to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute.
(2)Allowances for basic living expenses
In prescribing guidelines under paragraph (1), the Secretary shall develop and publish schedules of national and local allowances designed to provide that taxpayers entering into a compromise have an adequate means to provide for basic living expenses.
(B)Use of schedules
The guidelines shall provide that officers and employees of the Internal Revenue Service shall determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the schedules published under subparagraph (A) is appropriate and shall not use the schedules to the extent such use would result in the taxpayer not having adequate means to provide for basic living expenses.
(3)Special rules relating to treatment of offersThe guidelines under paragraph (1) shall provide that—
(A) an officer or employee of the Internal Revenue Service shall not reject an offer-in-compromise from a low-income taxpayer solely on the basis of the amount of the offer,
(B)in the case of an offer-in-compromise which relates only to issues of liability of the taxpayer—
(i) such offer shall not be rejected solely because the Secretary is unable to locate the taxpayer’s return or return information for verification of such liability; and
(ii) the taxpayer shall not be required to provide a financial statement, and
(C) any offer-in-compromise which does not meet the requirements of subparagraph (A)(i) or (B)(i), as the case may be, of subsection (c)(1) may be returned to the taxpayer as unprocessable.
(e)Administrative review. The Secretary shall establish procedures—
(1) for an independent administrative review of any rejection of a proposed offer-in-compromise or installment agreement made by a taxpayer under this section or section 6159 before such rejection is communicated to the taxpayer; and
(2) which allow a taxpayer to appeal any rejection of such offer or agreement to the Internal Revenue Service Independent Office of Appeals.
(f)Deemed acceptance of offer not rejected within certain period. Any offer-in-compromise submitted under this section shall be deemed to be accepted by the Secretary if such offer is not rejected by the Secretary before the date which is 24 months after the date of the submission of such offer. For purposes of the preceding sentence, any period during which any tax liability which is the subject of such offer-in-compromise is in dispute in any judicial proceeding shall not be taken into account in determining the expiration of the 24-month period.
(g)Frivolous submissions, etc. Notwithstanding any other provision of this section, if the Secretary determines that any portion of an application for an offer-in-compromise or installment agreement submitted under this section or section 6159 meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A), then the Secretary may treat such portion as if it were never submitted and such portion shall not be subject to any further administrative or judicial review.
(Aug. 16, 1954, ch. 736, 68A Stat. 849; Pub. L. 94–455, title XIX, § 1906(b)(13)(A), Oct. 4, 1976, 90 Stat. 1834; Pub. L. 104–168, title V, § 503(a), July 30, 1996, 110 Stat. 1461; Pub. L. 105–206, title III, § 3462(a), (c)(1), July 22, 1998, 112 Stat. 764, 766; Pub. L. 109–222, title V, § 509(a), (b), May 17, 2006, 120 Stat. 362, 363; Pub. L. 109–432, div. A, title IV, § 407(d), Dec. 20, 2006, 120 Stat. 2962; Pub. L. 113–295, div. A, title II, § 220(y), Dec. 19, 2014, 128 Stat. 4036; Pub. L. 116–25, title I, §§ 1001(b)(1)(F), 1102(a), July 1, 2019, 133 Stat. 985, 986.)
Treas. Reg. Sec. 301.7122-1 Compromises.
(a) In general
(1) If the Secretary determines that there are grounds for compromise under this section, the Secretary may, at the Secretary’s discretion, compromise any civil or criminal liability arising under the internal revenue laws prior to reference of a case involving such a liability to the Department of Justice for prosecution or defense.
(2) An agreement to compromise may relate to a civil or criminal liability for taxes, interest, or penalties. Unless the terms of the offer and acceptance expressly provide otherwise, acceptance of an offer to compromise a civil liability does not remit a criminal liability, nor does acceptance of an offer to compromise a criminal liability remit a civil liability.
(b) Grounds for compromise –
(1) Doubt as to liability. Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. See paragraph (f)(4) of this section for special rulesapplicable to rejection of offers in cases where the Internal Revenue Service (IRS) is unable to locate the taxpayer‘s return or return information to verify the liability.
(2) Doubt as to collectibility. Doubt as to collectibility exists in any case where the taxpayer‘s assets and income are less than the full amount of the liability.
(3) Promote effective tax administration.
(i) A compromise may be entered into to promote effective tax administration when the Secretary determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship within the meaning of § 301.6343-1.
(ii) If there are no 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 that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.
(c) Special rules for evaluating offers to compromise –
(1) In general. Once a basis for compromise under paragraph (b) of this section has been identified, the 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. The determination whether to accept or reject an offer to compromise will be based upon consideration of all the facts and circumstances, including whether the circumstances of a particular case warrant acceptance of an amount that might not otherwise be acceptable under the Secretary’s policies and procedures.
(2) Doubt as to collectibility –
(i) Allowable expenses. A determination of doubt as to collectibility will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer‘s case. To guide this determination, guidelines published by the Secretary on national and local living expense standards will be taken into account.
(ii) Nonliable spouses –
(A) In general. Where a taxpayer is offering to compromise a liability for which the taxpayer‘s spouse has no liability, the assets and income of the nonliable spouse will not be considered in determining the amount of an adequate offer. The assets and income of a nonliable spouse may be considered, however, to the extent property has been transferred by the taxpayer to the nonliable spouse under circumstances that would permit the IRS to effect collection of the taxpayer‘s liability from such property (e.g., property that was conveyed in fraud of creditors), property has been transferred by the taxpayer to the nonliable spouse for the purpose of removing the property from consideration by the IRS in evaluating the compromise, or as provided in paragraph (c)(2)(ii)(B) of this section. The IRS also may requestinformation regarding the assets and income of the nonliable spouse for the purpose of verifying the amount of and responsibility for expenses claimed by the taxpayer.
(B) Exception. Where collection of the taxpayer‘s liability from the assets and income of the nonliable spouse is permitted by applicable state law (e.g., under state community property laws), the assets and income of the nonliable spouse will be considered in determining the amount of an adequate offer except to the extent that the taxpayer and the nonliable spouse demonstrate that collection of such assets and income would have a material and adverse impact on the standard of living of the taxpayer, the nonliable spouse, and their dependents.
(3) Compromises to promote effective tax administration –
(i) Factors supporting (but not conclusive of) a determination that collection would cause economic hardship within the meaning of paragraph (b)(3)(i) of this section include, but are not limited to –
(A) Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer‘s financial resources will be exhausted providing for care and support during the course of the condition;
(B) Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and
(C) Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.
(ii) Factors supporting (but not conclusive of) a determination that compromise would undermine compliance within the meaning of paragraph (b)(3)(iii) of this section include, but are not limited to –
(iii) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary’s discretion, under the economic hardship provisions of paragraph (b)(3)(i) of this section:
The taxpayer has assets sufficient to satisfy the tax liability. The taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the taxpayer will need to use the equity in his assets to provide for adequate basic living expenses and medical care for his child. The taxpayer’s overall compliance history does not weigh against compromise.
The taxpayer is retired and his only income is from a pension. The taxpayer’s only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses. The taxpayer’s overall compliance history does not weigh against compromise.
The taxpayer is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate his disability. The taxpayer’s equity in the house is sufficient to permit payment of the liability he owes. However, because of his disability and limited earning potential, the taxpayer is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because the taxpayer’s home has been specially equipped to accommodate his disability, forced sale of the taxpayer’s residence would create severe adverse consequences for the taxpayer. The taxpayer’s overall compliance history does not weigh against compromise.
(iv) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary’s discretion, under the public policy and equity provisions of paragraph (b)(3)(ii) of this section:
In October of 1986, the taxpayer developed a serious illness that resulted in almost continuous hospitalizations for a number of years. The taxpayer’s medical condition was such that during this period the taxpayer was unable to manage any of his financial affairs. The taxpayer has not filed tax returns since that time. The taxpayer’s health has now improved and he has promptly begun to attend to his tax affairs. He discovers that the IRS prepared a substitute for return for the 1986 tax year on the basis of information returns it had received and had assessed a tax deficiency. When the taxpayer discovered the liability, with penalties and interest, the tax bill is more than three times the original tax liability. The taxpayer’s overall compliance history does not weigh against compromise.
The taxpayer is a salaried sales manager at a department store who has been able to place $2,000 in a tax-deductible IRA account for each of the last two years. The taxpayer learns that he can earn a higher rate of interest on his IRA savings by moving those savings from a money management account to a certificate of deposit at a different financial institution. Prior to transferring his savings, the taxpayer submits an e-mail inquiry to the IRS at its Web Page, requesting information about the steps he must take to preserve the tax benefits he has enjoyed and to avoid penalties. The IRS responds in an answering e-mail that the taxpayer may withdraw his IRA savings from his neighborhood bank, but he must redeposit those savings in a new IRA account within 90 days. The taxpayer withdraws the funds and redeposits them in a new IRA account 63 days later. Upon audit, the taxpayer learns that he has been misinformed about the required rollover period and that he is liable for additional taxes, penalties and additions to tax for not having redeposited the amount within 60 days. Had it not been for the erroneous advice that is reflected in the taxpayer’s retained copy of the IRS e-mail response to his inquiry, the taxpayer would have redeposited the amount within the required 60-day period. The taxpayer’s overall compliance history does not weigh against compromise.
(d) Procedures for submission and consideration of offers –
(1) In general. An offer to compromise a tax liability pursuant to section 7122 must be submitted according to the procedures, and in the form and manner, prescribed by the Secretary. An offer to compromise a tax liability must be made in writing, must be signed by the taxpayer under penalty of perjury, and must contain all of the information prescribed or requested by the Secretary. However, taxpayers submitting offers to compromise liabilities solely on the basis of doubt as to liability will not be required to provide financial statements.
(2) When offers become pending and return of offers. An offer to compromise becomes pending when it is accepted for processing. The IRS may not accept for processing any offer to compromise a liability following reference of a case involving such liability to the Department of Justice for prosecution or defense. If an offer accepted for processing does not contain sufficient information to permit the IRS to evaluate whether the offer should be accepted, the IRS will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the IRS has requested within a reasonable time period after such a request, the IRS may return the offer to the taxpayer. The IRS may also return an offer to compromise a tax liability if it determines that the offer was submitted solely to delay collection or was otherwise nonprocessable. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the IRS returns the offer to the taxpayer. See paragraphs (f)(5)(ii) and (g)(4) of this section for rules regarding the effect of such returns of offers.
(3) Withdrawal. An offer to compromise a tax liability may be withdrawn by the taxpayer or the taxpayer‘s representative at any time prior to the IRS’ acceptance of the offer to compromise. An offer will be considered withdrawn upon the IRS’ receipt of written notification of the withdrawal of the offer either by personal delivery or certified mail, or upon issuance of a letter by the IRS confirming the taxpayer‘s intent to withdraw the offer.
(e) Acceptance of an offer to compromise a tax liability.
(2) As additional consideration for the acceptance of an offer to compromise, the IRS may request that taxpayer enter into any collateral agreement or post any security which is deemed necessary for the protection of the interests of the United States.
(3) Offers may be accepted when they provide for payment of compromised amounts in one or more equal or unequal installments.
(4) If the final payment on an accepted offer to compromise is contingent upon the immediate and simultaneous release of a tax lien in whole or in part, such payment must be made in accordance with the forms, instructions, or procedures prescribed by the Secretary.
(5) Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of, nor prevent the IRS from taking action to collect from, any person not named in the offer who is also liable for the tax to which the compromise relates. Neither the taxpayer nor the Government will, following acceptance of an offer to compromise, be permitted to reopen the case except in instances where –
(i) False information or documents are supplied in conjunction with the offer;
(ii) The ability to pay or the assets of the taxpayer are concealed; or
(iii) A mutual mistake of material fact sufficient to cause the offer agreement to be reformed or set aside is discovered.
(6) Opinion of Chief Counsel. Except as otherwise provided in this paragraph (e)(6), if an offer to compromise is accepted, there will be placed on file the opinion of the Chief Counsel for the IRS with respect to such compromise, along with the reasons therefor. However, no such opinion will be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. Also placed on file will be a statement of –
(i) The amount of tax assessed;
(iii) The amount actually paid in accordance with the terms of the compromise.
(f) Rejection of an offer to compromise.
(1) An offer to compromise has not been rejected until the IRS issues a written notice to the taxpayer or his representative, advising of the rejection, the reason(s) for rejection, and the right to an appeal.
(3) No offer to compromise may be rejected solely on the basis of the amount of the offer without evaluating that offer under the provisions of this section and the Secretary’s policies and procedures regarding the compromise of cases.
(4) Offers based upon doubt as to liability. Offers submitted on the basis of doubt as to liability cannot be rejected solely because the IRS is unable to locate the taxpayer‘s return or return information for verification of the liability.
(5) Appeal of rejection of an offer to compromise –
(i) In general. The taxpayer may administratively appeal a rejection of an offer to compromise to the IRS Office of Appeals (Appeals) if, within the 30-day period commencing the day after the date on the letter of rejection, the taxpayerrequests such an administrative review in the manner provided by the Secretary.
(ii) Offer to compromise returned following a determination that the offer was nonprocessable, a failure by the taxpayer to provide requested information, or a determination that the offer was submitted for purposes of delay. Where a determination is made to return offer documents because the offer to compromise was nonprocessable, because the taxpayer failed to provide requested information, or because the IRS determined that the offer to compromise was submitted solely for purposes of delay under paragraph (d)(2) of this section, the return of the offer does not constitute a rejection of the offer for purposes of this provision and does not entitle the taxpayer to appeal the matter to Appeals under the provisions of this paragraph (f)(5). However, if the offer is returned because the taxpayer failed to provide requested financial information, the offer will not be returned until a managerial review of the proposed return is completed.
(g) Effect of offer to compromise on collection activity –
(1) In general. The IRS will not levy against the property or rights to property of a taxpayer who submits an offer to compromise, to collect the liability that is the subject of the offer, during the period the offer is pending, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.
(2) Revised offers submitted following rejection. If, following the rejection of an offer to compromise, the taxpayermakes a good faith revision of that offer and submits the revised offer within 30 days after the date of rejection, the IRS will not levy to collect from the taxpayer the liability that is the subject of the revised offer to compromise while that revised offer is pending.
(3) Jeopardy. The IRS may levy to collect the liability that is the subject of an offer to compromise during the period the IRS is evaluating whether that offer will be accepted if it determines that collection of the liability is in jeopardy.
(4) Offers to compromise determined by IRS to be nonprocessable or submitted solely for purposes of delay. If the IRS determines, under paragraph (d)(2) of this section, that a pending offer did not contain sufficient information to permit evaluation of whether the offer should be accepted, that the offer was submitted solely to delay collection, or that the offer was otherwise nonprocessable, then the IRS may levy to collect the liability that is the subject of that offer at any time after it returns the offer to the taxpayer.
(5) Offsets under section 6402. Notwithstanding the evaluation and processing of an offer to compromise, the IRS may, in accordance with section 6402, credit any overpayments made by the taxpayer against a liability that is the subject of an offer to compromise and may offset such overpayments against other liabilities owed by the taxpayer to the extent authorized by section 6402.
(6) Proceedings in court. Except as otherwise provided in this paragraph (g)(6), the IRS will not refer a case to the Department of Justice for the commencement of a proceeding in court, against a person named in a pending offer to compromise, if levy to collect the liability is prohibited by paragraph (g)(1) of this section. Without regard to whether a person is named in a pending offer to compromise, however, the IRS may authorize the Department of Justice to file a counterclaim or third-party complaint in a refund action or to join that person in any other proceeding in which liability for the tax that is the subject of the pending offer to compromise may be established or disputed, including a suit against the United States under 28 U.S.C. 2410. In addition, the United States may file a claim in any bankruptcy proceeding or insolvency action brought by or against such person.
(h) Deposits. Sums submitted with an offer to compromise a liability or during the pendency of an offer to compromise are considered deposits and will not be applied to the liability until the offer is accepted unless the taxpayer provides written authorization for application of the payments. If an offer to compromise is withdrawn, is determined to be nonprocessable, or is submitted solely for purposes of delay and returned to the taxpayer, any amount tendered with the offer, including all installments paid on the offer, will be refunded without interest. If an offer is rejected, any amount tendered with the offer, including all installments paid on the offer, will be refunded, without interest, after the conclusion of any review sought by the taxpayer with Appeals. Refund will not be required if the taxpayer has agreed in writing that amounts tendered pursuant to the offer may be applied to the liability for which the offer was submitted.
(i) Statute of limitations –
(2) Extension of the statute of limitations on assessment. For any offer to compromise, the IRS may require, where appropriate, the extension of the statute of limitations on assessment. However, in any case where waiver of the running of the statutory period of limitations on assessment is sought, the taxpayer must be notified of the right to refuse to extend the period of limitations or to limit the extension to particular issues or particular periods of time.
(j) Inspection with respect to accepted offers to compromise. For provisions relating to the inspection of returns and accepted offers to compromise, see section 6103(k)(1).
(k) Effective date. This section applies to offers to compromise pending on or submitted on or after July 18, 2002.
 An accepted offer in compromise is properly analyzed as a contract between the parties. United States v. Donovan, 348 F.3d 509, 512-13 (6th Cir. 2003); Roberts v. United States , 242 F.3d 1065 (Fed. Cir. 2001); Timms v. United States, supra at 833-36; United States v. Lane, 303 F.2d 1,4 (5th Cir. 1962); Robbins Tire & Rubber Co. Inc. v. Commissioner, 52 T.C. 420, 436 (1969). Consequently, an OIC, like certain other agreements between the Commissioner and taxpayers, is governed by general principles of contract law. Cf. Duncan v. Commissioner , 121 T.C. 293, 296, (2003) (contract law applied to stipulated arbitration agreement); Bankamerica Corp. v. Commissioner, 109 T.C. 1, 12 (1997) (contract law applied to stipulations of fact); Dorchester Indus., Inc. v. Commissioner, 108 T.C. 320, 330 (1997) (contract law applied to settlement agreement), aff’d without published opinion, 208 F.3d 205 (3d Cir. 2000); Woods v. Commissioner, 92 T.C. 776,780 (1989) (contract law applied to agreement to extend the period for making assessments). Courts have routinely held that OICs are valid and binding contracts. See Timms v. United States, supra at 492; Waller v. United States, 767 F. Supp. 1042, 1044-45 (E.D. Cal. 1991); Seattle-First Nat’l Bank v. United States, 44 F.Supp. 603, 610 (E.D. Wash. 1942), aff’d , 136 F.2d 676 (9th Cir. 1943), aff’d, 321 U.S. 583 (1944); Lang-Kidde Co. v. United States, 2 F. Supp 768,769 (Ct. CI. 1933).
 Generally, an acceptance of an OIC will conclusively settle the liability of the taxpayer specified in the OIC, absent fraud or mutual mistake. Dutton v. Commissioner, 122 T.C. 133, 138 (2004); Treas. Reg. § 301-7122-1(e)(5). See also Estate of Jones v. Commissioner, 795 F.2d 566, 573-74 (6th Cir. 1986), aff’g, T.C. Memo. 1984-53; Timms v. United States, 678 F.2d 831,833 (9th Cir. 1982). CCA LEG-142031-08, 11/17/2008
 Murphy v. Comm’r of Internal Revenue, 469 F.3d 27, 33 (1st Cir. 2006)
 Generally, the total number of persons allowed for national standard expenses should be the same as those allowed as dependents on the taxpayer’s current year income tax return. There may be reasonable exceptions.
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