This is a two-part piece. The first piece was featured in the February TaxStringer.  

C. Offers in Compromise

The OIC program allows a tax debtor to settle his or her tax liability for less than the amount owed. An OIC cannot be used if the taxpayer is in bankruptcy.

In order for the IRS to process any offer in compromise request, a taxpayer seeking an OIC must be in compliance with all of his or her current filing and payment requirements, including tax estimates if required.

To submit an OIC, a taxpayer seeking an offer must properly identify the liabilities or liabilities he or she is seeking to compromise, state the terms of the payment, sign the offer, submit a detailed statement, and submit supporting documentation, to support the request to compromise the liability. Additionally, the taxpayer must pay a filing fee of $205 and a 20% nonrefundable down payment of the offered amount with the OIC application (unless the taxpayer qualifies for low-income certification).

Levies generally cannot be issued during the pendency of an OIC, and the statute of limitations on collections is tolled from the time the offer is submitted and during its pendency.

Whether an offer should be accepted is within the IRS’s discretion. If the IRS rejects the offer, the taxpayer can request administrative review by IRS Appeals within 30 days. There is no judicial review if IRS Appeals rejects the offer, unless the rejection occurs in the context of a CDP hearing.  If within the context of a CDP Hearing, the rejection would have to be considered an abuse of discretion to be overturned in court.

It is also important to pay close attention to the date of rejection since the statute of limitations on collection is suspended during the time the offer is pending, for 30 days thereafter, and for any period that an appeal is under review.

Furthermore, if an OIC is accepted, the taxpayer must agree, among other things, to stay current in his or her tax and filing obligations for at least five years from the date the OIC is accepted. A taxpayer also forfeits any net-operating losses.

There are three grounds for an OIC: (1) doubt as to collectability, (2) doubt as to liability, and (3) an equity offer.

i. Doubt as to collectability offers

An OIC based on doubt as to collectability is appropriate when taxpayers can demonstrate that the offered amount equals or exceeds the amount that the IRS would be likely to collect through enforced collection over the remaining CSED.

The request for an OIC based on doubt as to collectability is made on a Form 656, Offer in Compromise, which also requires submitting Form 433-A(OIC) and/or 433-B(OIC) [if there are certain business interest(s) involved], and supporting statements and documents. The IRS objectively bases the acceptability of an offer on the RCP reflected in the Forms 433 submitted with the OIC application.

Appeals officers are instructed to reject offers substantially below the taxpayer’s RCP except in relatively rare situations where “special circumstances” justify acceptance of such an offer. Special circumstances are defined as: (1) facts demonstrating that the taxpayer would suffer “economic hardship” if the IRS were to collect from him or her an amount equal to the RCP; and (2) compelling public policy or equity considerations that provide a sufficient basis for a compromise. Some factors that may be considered special circumstances are advanced age or limited future earning potential.

In the vast majority of cases, an acceptable settlement offer must reflect the maximum amount the taxpayer can pay, based on his or her available assets and any income that exceeds the taxpayer’s allowable basic living expenses.

The formula to calculate RCP is: RCP = (Realizable net equity in assets) + (Net future monthly income) × (12 or 24).

Note: 12 is the multiplier if the taxpayer intends to pay within five installments or less, and 24 if the taxpayer intends to pay in between 5 and 24 months.

Although determination of an acceptable offer is designed to be dispassionate and objective, based solely on the assets, income, and expenses of the taxpayer, there is still some flexibility possible in the calculation. For example, the underlying bases for the computation of net equity and monthly disposable income are often somewhat subjective.

Making an OIC will require the signing of a Form 656, which waives the collection statute of limitations during the pendency of the offer plus 30 days. Because the statute of limitations is likely to be substantially extended by the filing of the offer, it may make sense to use the informal online “Offer in Compromise Pre-Qualifier” to determine whether the taxpayer may be eligible for an offer in compromise.  

a. Realizable net equity in assets

In calculating realizable net equity in assets, the taxpayer should use the forced/quick sale value of the assets. Similarly, the value of a 401(k) should take into account any taxes and/or early withdrawal penalty that would be due upon the liquidation of the funds in the account. Likewise, the valuation of a whole life insurance plan should be based on its cash value upon early termination. Bank assets are based upon the ending balance for the three months prior to the offer and can be significantly affected by the timing of the offer submission. The author has seen enormous variations in this metric for taxpayers whose income is seasonal.

It is important to note that net equity in assets includes dissipated assets. A dissipated asset is any asset (liquid or illiquid) that has been “sold, transferred, or spent on non-priority items or debts and that is no longer available to pay the tax liability.” However, dissipated assets are only included in the calculation “where it can be shown the taxpayer has sold, transferred, encumbered, or otherwise disposed of assets in an attempt to avoid the payment of the tax liability.” Assets considered dissipated are those used for unnecessary items after the tax has been assessed or within six months before the assessment.

b. Net future income

Net future income is total monthly income less living expenses. Monthly income includes wages, interest, net business income, net rental income, distributions, pensions, and Social Security benefits. The IRS will consider an unemployed taxpayer’s health, education, skills, prior earnings, and professional background to determine if he or she is merely temporarily unemployed or actually unemployable. When a taxpayer has been unemployed for a long time, his or her current income should be used, and the revenue officer (RO) should not average income, nor should the RO use anticipated future income if the taxpayer's future employment is uncertain.

Allowable living expenses, as discussed above, are based upon national/local standards unless the taxpayer can show that the actual expenses are higher. These standards are available on the IRS website (tinyurl.com/y8h4c7qh).

Housing expense varies greatly by location. Using Manhattan as an example of a high-cost housing environment, the 2023 default basic housing and utilities expenses for a family of five is $4,602.

IRS standards are also available for vehicle loan and/or lease payments, public transportation costs, out-of-pocket healthcare, and food and clothing items.

The Tax Court has held that it is an abuse of discretion for the IRS to disregard actual documented expenses and rely solely on the national and local expense standards to determine the taxpayer’s basic living expenses.

ii. Doubt as to liability offers

An OIC may also be available based on doubt as to liability. In cases involving doubt as to liability, a taxpayer may have lost his or her ability to protest an assessment to the Tax Court because he or she failed to file a petition to challenge the assessment in time. While a taxpayer in those circumstances can generally pay the assessment in full and then seek a refund in federal district court, it is an expensive and cumbersome process. In practice, in most cases the “pay first, seek a refund later” mechanism may not be financially possible.

An OIC based on doubt as to liability gives a taxpayer the opportunity to present his or her case before the IRS for a second look, and possibly have the assessment reduced or canceled, without paying first or going to court, to the benefit of both the government and the taxpayer. OICs based on doubt as to liability are unrelated to the taxpayer’s ability to pay. An OIC based on doubt as to liability is sought by filing Form 656-L, Offer in Compromise (Doubt as to Liability).

iii. Promotion of effective tax administration: Equity offers

The IRS is authorized to accept an OIC to promote effective tax administration if collection of the entire liability will create an economic hardship. This type of Offer is the least common.

As a practice point, when choosing between collection alternatives, the CSED and RCP should be calculated before submitting any request. Usually, if the RCP is zero because the allowable expenses equal or exceed available total income and there are no substantive assets to levy, the best way to proceed is by requesting that the taxpayer be placed in CNC Status. CNC Status is often the best way to proceed, because it carries no threat of forced collection activity and yet does not suspend the statute of limitations on collections. Therefore, even if the taxpayer eventually has sufficient disposable income to come out of uncollectible status, the fact that there are fewer years remaining until the CSED expires reduces the taxpayer’s RCP; thus, the amount required for an eventual OIC. Entering uncollectible status for as long as possible before making an offer is generally desirable, absent some expectation of a future large windfall before the CSED. By contrast, requests for both OICs and installment agreements suspend the CSED—and of the two, the OIC request process takes much longer. Additionally, even if the taxpayer has an accepted payment agreement, the IRS will generally issue a warrant or lien to protect its interests until the amount is discharged in full unless the liability falls below a relatively low threshold. The thresholds are policy decisions; depending on the current threshold amount, a payment might possibly avoid a lien. Although liens can be embarrassing, they can also have devastating effects on a taxpayer’s business, such as affecting the ability to get business financing. One bright spot is the fact that passports are not suspended if a payment arrangement is in place, whether by installment agreement, OIC, or uncollectible status.

D. Failure to reach agreement on a collection alternative – Appeals and Judicial Review

If the taxpayer cannot reach a payment agreement with the IRS, he or she may have an avenue for appeal or judicial review depending on the contest of how the taxpayer sought the collection alternative. If the taxpayer sought a collection alternative during his or her CDP Hearing, they are able to appeal the determination to the U.S. Tax Court within 30 days of receiving the resulting Notice of Determination. As previously mentioned, although a taxpayer can appeal to the U.S. Tax Court, relief from the Tax Court in a collection matter requires proof by the taxpayer that the IRS abused its discretion, which is a very high bar.  Alternatively, if the taxpayer applied for an installment agreement after their time to request a CDP or Equivalent Hearing expired, he or she can seek relief through CAP.

Additionally, if the IRS denies a taxpayer’s request, outside of the context of a CDP Hearing, the taxpayer will receive a notice of rejection that can be appealed to IRS Appeals. The notice of rejection contains specific instructions for submitting an appeal.

E. A Representative’s Initial Contact with the IRS

Now that you have seen an overview of the IRS’ collection process – we can discuss strategy. Once a representative is retained by a taxpayer, it is vital for the representative to determine where the taxpayer is in the collection process to decide the best strategy to proceed.

A representative’s first contact with the IRS in attempting to resolve a client’s federal tax debt should be to request a collection hold while the representative determines the nature and scope of the liability. The IRS will typically grant one, especially if it is a first-time request and the representative has just been retained. If a collection hold is denied and collection activity is likely to cause harm to the taxpayer, immediately file a Form 911, Request for Taxpayer Advocate Service Assistance. [FN: The IRS will typically not levy against the taxpayer until the Form 911 has been resolved. The Taxpayer Advocate is an independent organization within the IRS that assists taxpayers, and their representatives solve their tax problems.]

As discussed at length above, if a notice of a proposed levy, a notice of levy, or a Notice of Federal Tax Lien has been issued, it will be accompanied by notice of a right to a Collection Due Process (CDP) hearing. As you now know, a CDP hearing request must be made within 30 days of the date on the notice or the right to the hearing and possible judicial review will be lost. A CDP hearing should be requested to preserve the taxpayer’s rights, regardless of any assumptions that negotiation will resolve the matter.

Once the lines of communication with the IRS are open and a collection hold is in place (and a CDP request is submitted if applicable), the next step is to determine if the liability is correct and legally subject to collection. A Freedom of Information Act (FOIA) request is used to obtain the taxpayer’s file for the years and taxes at issue, along with a request for transcripts by either calling the IRS, requesting them through the online Transcript Delivery Service (TDS) or by using Form 4506-T, Request for Transcript of Tax Return, to determine the chronology of assessment actions. Upon receipt of the transcripts, the representative should review the file and transcript to determine the nature of the liability, the manner in which it arose, the procedures by which it was assessed, and the accuracy of the calculation that underlies the bill. If any of the liability arises from trust fund taxes, such as withholding from payroll, the representative should carefully determine if payments were properly applied between trust fund and non–trust fund liabilities.

If it is the taxpayer’s position that the underlying liability is incorrect or that he or she is not liable, the representative will want to consider routes such as contesting the underlying liability at the CDP Hearing, spousal defenses, or OIC based on doubt-as-to-liability.

F. Is the collection of the debt time barred by the statute of limitation?

The next important consideration is whether the collection action is barred by the statute of limitations. In general, the statute of limitations on the IRS’s authority to collect a tax liability is 10 years from the tax assessment. However, numerous circumstances can “toll” or suspend the collection statute of limitation, including taxpayers’ making requests for installment agreements, offers in compromise, taxpayer advocate assistance, or CDP hearings, to name a few. Given that there are several potential circumstances that can suspend the collection statute of limitations, it is critical to review a taxpayer’s transcripts to determine the collection statute expiration date (CSED). The CSED is the IRS’s internal system for tracking the statute of limitations on a tax liability; each tax assessment has a CSED associated with it. Representatives should not assume the IRS’ CSED calculation is correct as many errors are made by the IRS in this respect.

If the IRS has filed a federal tax lien to collect a liability, it is generally valid until the taxpayer’s liability is satisfied or until the time for enforcing the lien expires. The IRS’s time to collect upon the lien may be extended in a variety of circumstances, including: (1) a taxpayer’s waiver in the case of an offer in compromise (OIC); (2) until six months after a bankruptcy stay under Sec. 6503(h); or (3) if a taxpayer is continuously outside the United States for at least six months.

In some circumstances, the IRS can mitigate the effect of the expiration of the collection statute of by requesting the Department of Justice to bring an action to reduce the federal liability to a money judgment before the CSED. Once reduced to judgment, the tax liability reflected in the judgment can be collected until it is satisfied or becomes unenforceable, as in bankruptcy. The judgment can also be incorporated into a judgment lien, which is good for an additional 20 years and is subject to renewal for an additional 20 years upon its initial expiration, depending on State law.

G. Understanding the Options

There is no doubt that the IRS has enormous power when it seeks to collect an outstanding tax liability. However, a thorough understanding of the procedures, restrictions, and policies that apply to the exercise of those powers can enable a taxpayer’s representative to mitigate the adverse effects of collection activity and potentially reduce the outstanding balance in appropriate circumstances.

Erika Colangelo, JD, is a tax associate in Polsinelli's Tax Group. Erika represents individuals and businesses in all stages of dispute and controversy with the IRS, New York State Department of Taxation Finance, New York State Department of Labor, and New York City Department of Finance, including in audits, collection matters, administrative appeals and tax litigation in courts and tribunals such as the United States Tax Court and the New York State Division of Tax Appeals.