Hans Kasper, MS-CPA, PS

An offer in compromise (OIC) is a written agreement between the IRS and a taxpayer (usually entered into at the collection level) that enables the taxpayer to pay a lesser amount in full satisfaction of an unpaid tax liability, including interest and penalties (IRC Sec. 7122). The OIC program is a way for taxpayers to resolve their tax liability and for the IRS to collect funds that may not be collected through other means.

An OIC provides a considerable benefit because it closes the taxpayer's entire tax liability for the period covered. In past years, the IRS rejected far more OICs than it accepted—in large part because of the "conventional wisdom" that the 10-year collection limitations period, coupled with the federal tax lien and offset authority, held out the hope that the IRS would eventually collect the full amount. But in recent years, the OIC procedures have been substantially revised and liberalized. Now, the OIC must reasonably reflect collection potential and give the taxpayer a "fresh start."

Grounds for Acceptance or Rejection

Generally, taxes can be compromised only when doubt exists as to liability, collectibility, or effective tax administration. Effective tax administration requires that collection of the tax would create an economic hardship or would be unfair or inequitable. A liability cannot be compromised if it is established by a valid judgment or the government's ability to collect the amount owed is not in doubt [Reg. 301.7122-1(a)].

1. Collection employees deal primarily with OICs based on doubt as to collectibility. In these types of offers taxpayers must offer an amount equal to the realizable value of their assets and the amount that could be secured from their future income. An offer based on doubt as to liability will not be accepted if the liability can be paid under an installment agreement.
2. Examination has the primary responsibility for doubt as to liability OICs, except for offers dealing with the trust fund recovery penalty. When submitting an OIC based on doubt as to liability, taxpayers must substantiate why they feel they don't owe the liability they want to compromise.
3. An effective tax administration basis for compromise exists if collection of the full liability (a) would create an economic hardship or (b) would be detrimental to voluntary compliance. Acceptance of an OIC on this basis is limited to situations where compliance by taxpayers with federal tax laws would not be undermined. Collection has primary responsibility for processing these types of offers.

New Fee for Processing OICs

Beginning November 1, 2003, the IRS will charge a $150 fee for processing OICs (News Release IR-2003-99). The fee will help offset the cost of providing this service and will reduce the number of frivolous offers. Taxpayers who file an OIC will have to pay the fee with their submission unless the offer is based solely on doubt as to liability, or the taxpayer's total monthly income falls at or below income levels based on the Department of Health and Human Services poverty guidelines. Taxpayers who claim the poverty guideline exception must certify their eligibility on Form 656-A (Offer in Compromise Application Fee Instructions and Certification).

Observation: IRC Sec. 7122(c)(3)(A) prohibits the IRS from rejecting OICs from a low income taxpayer solely on the basis of the amount offered. Requiring payment of a user fee from a low income taxpayer would undermine IRC Sec. 7122(c)(3)(A) in cases where the taxpayer does not have the ability to pay the fee.

The imposition of the fee on other taxpayers will not change the net amount paid because the fee will be taken into account when considering whether the amount offered is acceptable. Although taxpayers will not receive a refund if their OIC is withdrawn, rejected, or returned after being accepted for processing, the IRS will work with taxpayers to perfect incomplete or inadequate offers before returning or rejecting them. Furthermore, no additional fee will be charged if a taxpayer resubmits an OIC the IRS determines to have been rejected or returned in error.

New Rules for Submitting and Processing OICs

Newly released Rev. Proc. 2003-71 (2003-36 IRB) explains the procedures for submitting and processing OICs. These new procedures are effective August 21, 2003, and reflect the new $150 application fee discussed above, which is not effective until November 1, 2003. These procedures apply to all offers to compromise a civil or criminal liability submitted to the IRS, but not those submitted to the Office of Appeals. However, they don't apply to offers to compromise a tax liability after a case involving a civil or criminal liability has been referred to the Department of Justice for prosecution or defense.

An OIC must be submitted on Form 656 (Offer in Compromise). None of the standard terms may be stricken or altered, and the form must be signed under penalty of perjury. The offer should include all liabilities to be covered by the compromise, the legal grounds for compromise, the amount the taxpayer proposes to pay, and the amount and due date of the payments.

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, but not where the liability has been established by a final court decision or judgment. An OIC based on doubt as to liability generally will be considered acceptable if it reasonably reflects the amount the IRS would expect to collect through litigation, including an analysis of the hazards of litigating the issue in court.

Doubt as to Collectibility. Doubt as to collectibility exists where the taxpayer's assets and income cannot satisfy the full amount of the liability. An OIC based on doubt as to collectibility generally will be considered acceptable if it is unlikely that the tax can be collected in full and the offer reflects the amount the IRS could collect through other means, taking into account the taxpayer's reasonable basic living expenses.

Promotion of Effective Tax Administration. The Service may compromise to promote effective tax administration where collection in full could be achieved, but would cause the taxpayer economic hardship. Economic hardship is defined as the inability to pay reasonable basic living expenses [Reg. 301.6343-1(d)]. An OIC based on economic hardship generally will be considered acceptable when the amount offered reflects the amount the IRS could collect without causing the taxpayer economic hardship.

If there are no other grounds for compromise, the Service 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. An OIC based on compelling public policy or equity considerations generally will be considered acceptable if it reflects what is fair and equitable under the facts and circumstances.

Required Financial Information. Except for OICs based solely on doubt as to liability, the taxpayer will be submitting supporting financial information. Individual or self-employed taxpayers must submit Form 433-A (Collection Information Statement for Wage Earners and Self-Employed Individuals), while corporate or other business taxpayers submit Form 433-B (Collection Information Statement for Businesses). The IRS also may require the corporate officers or individual partners of a business taxpayer to complete Form 433-A.

Acceptance of OIC for Processing. The IRS accepts an OIC for processing when it determines that the (1) offer is submitted on the proper version of Form 656 and Form 433-A or B, as appropriate; (2) taxpayer is not in bankruptcy; (3) taxpayer has complied with all filing and payment requirements listed in the instructions to Form 656; (4) taxpayer has enclosed the application fee, if required; and (5) offer meets any other minimum requirements established by the IRS.

A determination is made to accept an OIC for processing when the proper IRS official signs the Form 656. As of this date, a levy is prohibited unless the IRS determines that collection of the liability is in jeopardy.

Once the IRS accepts an OIC for processing, it begins to gather the basic information necessary to evaluate the offer. During this initial processing, the IRS may contact the taxpayer to secure information or documentation that was incorrect or omitted from the offer documents. After this information has been obtained, the IRS determines whether the taxpayer's offer is acceptable.

The taxpayer can withdraw an OIC any time prior to its acceptance. An OIC that has been withdrawn is no longer pending and the IRS may levy to collect the liability that was the subject of the offer. When an offer is withdrawn, the IRS won't refund the application fee submitted with the offer.

Acceptance or Rejection. An OIC is not accepted until the IRS issues a written notification of acceptance to the taxpayer. Compromise with one taxpayer does not extinguish the liability of anyone else who is also liable for the tax.

Similarly, an OIC is not rejected until the IRS issues a written notification of rejection to the taxpayer. [Under IRC Sec. 7122(d), the IRS must conduct an independent review before the rejection is communicated to the taxpayer to verify that the rejection is reasonable based on the facts and circumstances.] When an OIC is rejected the IRS does not refund the application fee submitted with the offer.

The taxpayer can appeal an OIC rejection to the Appeals Office. An appeal is timely if it delivered to the IRS or postmarked within 30 days from the date of the letter of rejection. Under IRC Sec. 6331, the IRS can't levy on the taxpayer's property or rights to property for 30 days following the rejection of an OIC or while the appeal of a rejection is pending.