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IRS in Transition: A Practitioners Perspective: Offers in Compromise
Please note that I wrote this article which ran in the National Association of Enrolled Agents EA Journal in November/December 1999. The amounts listed for allowable transportation expenses have changed twice since this article was written. Make sure to consult my office for all changes to the IRS Offer program.
By: Steven H. Kassel, EA
Nowhere are the changes in today’s IRS more profound than in the Collection Division. For years, taxpayers and practitioners could count on collection employees to be surly, difficult to work with and consistently inconsistent. In the post-Senate Finance Committee hearings/RRA ’98 era, those things are no longer true. Well, not exactly.
Changes are coming so quickly that IRS employees are having a very difficult time keeping up with the daily deluge of memos from National Office. Indeed, many Revenue Officers have complained to me that the contradictions in those memos have left them uncertain what to do with the most mundane of matters.
For practitioners trying to assist clients with past due liabilities, how should we approach the “new” IRS? First, enforcement action is at an all-time low. According to the New York Times, (May 18, 1999) “Seizures of property are down 98 percent over the last two years. Levies & garnishments of bank accounts and paychecks are just one-fourth the level of two years ago. And the filing of tax liens are down two-thirds.”
My own cases show me that the IRS is doing everything possible NOT to take enforcement action. That may be due in part to fear among Revenue Officers and Automated Collection System (ACS) personnel of being personally sued under RRA ’98. Does that mean that now is the time to file delinquent returns, set up a payment agreement or submit an Offer in Compromise?
In the case of filing old returns, absolutely yes. Frankly, there has never been a particularly good reason to hold off filing delinquent returns. You can’t submit an Offer in Compromise (OIC) or get an Installment Agreement (IA) approved without all returns being filed, so get them filed now.
From there it gets tricky. For the last few years the IRS has streamlined procedures for Installment Agreements (IAs) on balances under $10,000 that could be paid in full in three years or less. That policy was codified in the Restructuring and Reform Act of 1998. Earlier this year the IRS took the policy even further. Assuming no unusual circumstances exist, taxpayers who owe $25,000 or less and can pay the liability in full within five years will be approved for an IA without even taking a financial statement. That’s the good news.
However, recent changes that have not been highly publicized are causing major problems for taxpayers with larger past due balances. Until just a few months ago and for as long as anyone can remember, the IRS routinely approved payment agreements that clearly would never result in full payment. That is no longer the case. The IRS Office of Chief Counsel ruled that according to the language in IRC 6159, installment agreements had to “satisfy” the tax debt. Counsel defined “satisfy” as meaning payment in full. Thus, if an installment agreement will not result in satisfaction of the liability, that agreement cannot be approved.
In the “old” days that would have been rectified by the IRS demanding that the taxpayer sign a waiver of the collection statute for as many years as would be needed to ensure the tax being paid in full. When I testified before The National Commission on Restructuring the IRS in 1997, I brought a stack of waivers the IRS had forced my clients to sign out as far as 2025. RRA ’98 brought an end to that practice. Under present law, the IRS may only request the signing of a collection statute waiver concurrent with the granting of an IA.
As a matter of policy, the IRS exceeded the legislation by limiting waivers to no more than five additional years and even then, only if no previous waiver had been signed. As further proof of today’s ever changing policies, I received a call two weeks ago from the National Office Analyst-Installment Agreements, who told me that NO waivers are being approved at present.
So, what do you do with those clients who owe $110,000 and can pay $600 per month? If you need to buy some time go through the motions and request the IA. You may find that the Revenue Officer or ACS employee initially gives you verbal approval. But, mark my word, the manager WILL turn around and instruct that employee to reject the agreement. From there, the case will be given to an “independent” reviewer. Just how independent that reviewer is, is something I can’t answer, but I can tell you that in this case the reviewer will uphold the rejection. You’ll then get a formal letter of denial along with appeal rights and a Notice of Intent to Levy. Yes, despite doing your best to settle the case in a proper manner, the IRS will turn around and threaten your client with enforcement action. Not to worry. Exercise those appeal rights and in a few days you’ll receive a call from an Appeals Officer. That Appeals Officer may tell you that they disagree with Chief Counsel’s opinion (from recent personal experience this is more likely than not), but that their hands are tied. In a few days you’ll receive another letter denying your appeal and informing you that the case is being sent back to the collection division.
Huh? That same collection division has your case back and guess what, they have no idea what to do next. At least we’re all in the same boat. A few weeks ago, one befuddled Revenue Officer tried to tell me that I had to submit an Offer in Compromise on behalf of my client. In fact, the Revenue Officer told me that’s why the new Deferred Payment Offer in Compromise (DPOIC) was developed. But, what if a DPOIC isn’t right for your client? The IRS cannot force you to submit an Offer. Period, no ifs ands or buts, end of discussion. In the case of my client, the statute of limitations on $90,000 of $110,000 owed expires in 12 months. It would be malpractice to submit an Offer in that situation, especially under present rules which extends the statute of limitations by 12 months plus the time the Offer is under consideration. (Author’s note- beginning 1/1/2000 the statute of limitations is only extended by the period the Offer is under consideration plus 30 days)
So, now you may have a situation where you can’t get an IA approved and an Offer doesn’t make sense. Will the IRS take enforcement action? That is highly unlikely given the present mindset of the IRS. Bankruptcy may be an option. While as non-attorneys we must be careful not to cross the line of giving legal advice, you should be aware of the cases where bankruptcy appears to be a good alternative. If you haven’t already done so, get comfortable enough with bankruptcy law as it relates to taxes so you can make a referral to a bankruptcy attorney when it is appropriate. However (it seems like every paragraph contains this word at least once), proposed changes to the Bankruptcy Code may limit the cases where taxpayers can file Chapter 7 (liquidation). Don’t even ask about the ramifications of that.
Oh yes, back to my original thought. What will the IRS do? I have heard from practitioners across the country that the IRS has put many of these cases into 53 (Currently Not Collectible) status. That means the IRS is allowing taxpayers who have the ability to make substantial monthly payments to pay nothing. If you think Congress will be upset by this, you’re right. The IRS is actually leaving money sitting on the table. Remember, this is not the fault of the Collection Division. Place the blame for this folly squarely on the back of Chief Counsel. I’ve been told that the IRS is looking for a legislative solution to this mess and I’m sure NAEA will have a hand in correcting this problem.
What about the Offer in Compromise program? Many of us were disappointed in the changes announced in March. The only substantive change eliminated the use of the confusing Present Value table in favor of a straight multiplier of 48. Thus, to determine the minimum amount of an Offer, we now multiply the monthly ability to pay by 48 and add to that the equity in assets.
But, once again, here’s where things get fun. At one time, IRS personnel valued assets in a variety of ways. One IRS District might value real property at a 20% reduction from fair market value (FMV) while other Districts were only allowing for costs of sale, typically 7-8%. National Office standardized that policy at a 20% reduction FMV for real property, vehicles, etc. While there could be disagreement over the FMV, most disputes were easily resolved.
Retirement assets have been valued to take the tax ramifications of withdrawal into account. For most of my clients, that has typically meant a 50% reduction after federal and state taxes and the additional taxes for withdrawal prior to age 59 ½. Once again, Chief Counsel has ruled that this is not correct. Under rules so new that most Revenue Officers and virtually all practitioners are unaware of them, no reduction will be given unless the taxpayer is using the retirement funds to pay the Offer. The ramifications of this are dramatic. Let’s take two taxpayers who each owe $500,000 in unpaid taxes. Taxpayer 1, let’s call him Bob, has a home with a FMV of $500,000 and a mortgage of $400,000. Bob has a 401(k) of $200,000. Taxpayer 2, let’s call her Carol, has a home with a FMV of $500,000 and a mortgage of $400,000. Carol also a 401(k) of $200,000.
The IRS has accepted Bob’s Offer in Compromise of $100,000, but has informed Carol that she must Offer $200,000.
No, you’re not losing your mind. Don’t waste your time going back and reading over this scenario. Instead, you’ve fallen into “The Chief Counsel Zone”. You see, Bob told the Revenue Officer that he was going to liquidate his 401(k) to come up with the money for the Offer. To fund her Offer, Carol decided (wisely in my not so humble opinion) that she would borrow against the equity in her home. Sorry. Chief Counsel says that because you aren’t actually liquidating the retirement assets, you can’t take that reduction. Never mind that taxpayers with identical financial circumstances will be treated differently. In fact, this may be illegal for that very reason. It’s my belief that if this were to go to court, the IRS would lose. It’s also my belief that once Congress hears about it, they will go ballistic.
This puts practitioners in a hairy predicament. Do you lie for your client and tell the IRS that they will be liquidating their retirement funds? Unless you want to serve time in a Federal Penitentiary, that probably isn’t a good idea. But, if you and your client are honest, your client will be treated unfairly. My remedy (and it’s not a cure by any stretch of the imagination) is to inform the IRS that “at this time my client is considering using their retirement assets to fund the Offer”. If that isn’t acceptable, let them reject the Offer and take it to Appeals. If that fails, I’ll be on the phone with every Senator on the Finance Committee and every Representative on the Ways and Means Committee as well as with every member of the press I can find. This may be the most unfair IRS ruling on Offers yet, but on this one, the hands of the Collection Division are clean.
Other than this problem, nothing has changed much in the Offer program. Individuals in high cost areas are still mistreated when it comes to housing costs. If you’ve got nothing better to do, take a look at the IRS web site for the Allowable Expenses for Housing and Utilities at http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-housing.html. You would have to be on another planet to not know that home costs in the San Francisco Bay Area are the highest in the nation. Yet, according to the IRS, it costs the same to live in Howard County, Maryland as it does in the City and County of San Francisco. I’m a transplanted Maryland boy and I know what it costs to live in Howard County and what it costs to live in San Francisco. Until these gross disparities are corrected, taxpayers in some parts of the country will continue to be officially mistreated by the IRS.
The new DPOIC does hold some benefits for taxpayers who can’t come up with the funds to pay off an Offer in a lump sum. It’s basically an Installment Agreement on an Offer in Compromise. In fact, that’s exactly what it is. This option allows the taxpayer to make monthly payments until the statute of limitations expire. When it was first announced, it made little sense to me. It appears that this is the IRS remedy for those cases where an Installment Agreement will not be approved. One big caveat is that the Federal Tax Lien will not be released until the Offer is paid off. If your client can come up with the money earlier, it is certainly in their best interests to do so.
If your client is a good Offer candidate, I would submit the Offer now. I have heard from other tax pros around the country that the IRS is going a little outside their normal guidelines to accept Offers as long as they are close on the numbers. Remember that every $1 difference in the ability to pay on the IRS financial statement is a $48 difference in the amount of the Offer. Be very careful to maximize all allowable expenses. If your client doesn’t have health insurance, I strongly suggest that they get a reasonable policy prior to submitting an Offer. Not only will this legitimately reduce the amount of the Offer; it is a necessary expense that no one should do without. If your client has children, I also suggest the purchase of a reasonable term life insurance policy. I have never, ever had the IRS question these expenses as long as they were appropriate for the situation.
But, what should you do if your client asks if it’s wise to purchase or lease a new car prior to filing an Offer? I’ve got an easy answer for that one…it depends. If your client owns a 1985 clunker that just rolled 200,000 miles and it’s highly questionable whether they’ll be able to keep it running another year, it’s not a bad idea. Remember that the maximum allowable expense for the purchase or lease of a primary car is $372 per month and it’s best not to exceed that figure. If your client has a car worth $5,000 and it happens to be in good shape with no mechanical problems and chooses to use the equity for a down payment on another car, that isn’t such a great idea. The IRS could disallow the monthly payment altogether so be careful when approaching this situation.
The IRS would prefer to accept your Offer if it is reasonable and if it represents a good deal for the government. Remembering that it is still the mission of the IRS to collect tax, make your Offer a sound one for all involved.
Finally, don’t be lulled into a false sense of security. There is a great deal of concern that the pendulum may start to swing the other way. IRS officials in Washington may put the word out that employees are being too lax and may expect them to start enforcement action.
Just because the IRS has been easier to work with the past couple years doesn’t mean that will continue into the future. It is best to take advantage of the climate now and get the most favorable treatment possible.
Copyright 1999 NAEA. All Rights Reserved. Last Update November 15, 1999