For those taxpayers who might be in the unfortunate position of owing the US Government a large amount of income tax compounding with interest and penalties daily, an IRS approved “Offer-in-Compromise” (OIC), might be just what you are looking for. If you are thinking “that could never happen to me”, think again. Anyone who owns a business, even if you were not involved in the day to day operations, can be nailed by the Government for back payroll tax and the 100% penalty as “the responsible person who had check signing authority”. Or perhaps you have received K1s with amazingly large amounts of phantom income and your distributions are insufficient to pay the tax? How about a legal settlement for damages which net’s you not enough to cover the taxes because your attorney got paid first. Even worse what about a divorce settlement where you have to cover the tax liability of your “ex” and you don’t have the funds to pay the tax. Have I managed to get your attention? Are you at least curious how you would successfully negotiate an OIC with the IRS?
Sec. 301.7122 of the IRS Code authorizes the IRS to compromise the tax you owe. What this means is that if you owe $300,000 in tax to the Government, you can make an offer of $50,000 to settle the whole thing and the IRS can either accept your offer or not. If they accept you are home free. If you are thinking this deal is too good to be true you are only part right. Because like any deal too good to be true, there are always strings attached.
To better understand exactly what strings are attached to this “too good to be true” deal, let’s begin our OIC journey with Murphy vs IRS. Murphy owed over $250,000 in back tax for years 1992-2001. Murphy offered the IRS a $10,000 OIC to settle the case. His OIC was rejected by the IRS. After his OIC was rejected, the IRS proceeded to enforce a levy on Murphy. Murphy appealed to the US Tax Court claiming that the IRS abused its discretion by rejecting his OIC. The Tax Court Opinion sided with the Government. Murphy appealed to the 1st Circuit. Murphy v. Commissioner, 125 T.C. 301, 309 (2005), aff’d, 469 F.3d27 (1st Cir. 2006). The US Court of Appeals agreed that Murphy’s OIC was reasonably rejected by the IRS because Murphy could have made a larger settlement payment in light of his current income and expenses. The Court noted specifically Murphy had a monthly surplus of $1,128. Furthermore after numerous calculations and computations the Court found Murphy’s OIC could have been $80,000, significantly higher than the $10,000 Murphy offered. In fact the Court observed that Murphy never mounted a serious challenge to the IRS calculations other than to say the IRS calculation was “preposterous”. Citing Fargo 447 F.3d at 709-10, the Court of Appeals agreed with the US Tax Court and found that the IRS did not abuse its discretion in denying Murphy an OIC.
You may be interested to know that Fargo also argued that the IRS abused its discretion by rejecting his $7,500 OIC on approximately $100,000 in tax he owed. Fargo claimed his medical expense would soon balloon to $90,000 per year and paying the tax now would cause Fargo to file bankruptcy. The IRS and the Court noted however that Fargo had sufficient assets to pay the tax including income of over $100,000 annually, retirement of over $100,000 and equity in their house of over $300,000. The Circuit Court concluded that the IRS had the right to reject Fargo’s OIC because Fargo’s ability to pay exceeded his OIC.
After the Fargo and Murphy Opinions, you may be asking who then could qualify for an OIC? While in theory the IRS will accept a compromise that is equal to the reasonable collection value of the case-Rev. Proc.2003-71(2)-it is oftentimes hard to convert and transform “collection value” into an acceptable “offer” in dollars. The most often used method to determine reasonable collection value of a case is through both the Government’s and your tax attorney’s analysis of a completed and executed IRS Form 433A. What is Form 433A? Form 433A is a “Collection Information Statement for Wage Earners and Self-Employed Individuals” also known as a complete and absolute total disclosure of all your assets and income sources signed by you “under penalties of perjury”. Because you are signing 433A under criminal penalties of perjury, I personally feel 433A is an amazing trap for the unsuspecting or perhaps trusting taxpayer who feels they can go this route alone without a tax attorney present. Indeed, Section 3 paragraph 11 of Form 433A asks: In the past 10 years, have you transferred any assets for less than their full value? You are then asked to list the assets, the value, and the date transferred and finally “To Whom or Where was the asset Transferred”. That being said, you would be well advised to have your tax attorney present when you complete this form.
Finally, if you decide to go the OIC route, be prepared to make a reasonably large enough offer to the IRS to have your OIC accepted. If the IRS rejects your offer and you believe your offer was reasonable based on your unique financial situation, you can always appeal to the Office of IRS Appeals where perhaps your offer will have a better chance of being accepted. If you lose at the Appeals level you have the right to appeal to US tax Court. Finally if at some point in this journey you are fortunate enough to successfully negotiate an OIC with the IRS you must then abide by the conditions of the OIC or risk a default. Once the OIC is in default, the entire tax you originally owed and all interest and penalties that had accrued becomes due and payable immediately. Robinette v IRS US Tax Court Julu 20 20014 Page 40 . In conclusion, if you owe tax to the the IRS that you can not pay, there is no easy work around. But there is hope with a realistic OIC package submitted to and approved by the IRS. So save yourself and your family the stress of having to deal with IRS liens, levies and attachments flying at you from all directions. Negotiate an OIC. You will be happy you did.
Thanks for joining Chris Moss CPA. See you next time on TaxView.
Submitted by Chris Moss CPA