Tax & Business Insights

New Rules on Offers in Compromise

Volume 18 Issue 3 --  May/June 2006

Forget “pennies on the dollar.” With new legislation, effective July 16, 2006, it will no longer be possible to submit an Offer in Compromise (OIC) based on doubt as to collectibility without at least a partial payment.

Offers are submitted for two main reasons — doubt as to collectibility (inability to pay the full amount within a reasonable period of time) and doubt as to liability (the amount is not owed). While some aspects of this new law will require guidance before it can be implemented, it is clear that the basic thrust of the law will be to prevent the submission of most Offers based on doubt as to collectibility without some payment in advance.

Under the new law, an OIC based on doubt as to collectibility will require partial payment at the time it is submitted. If the payment is to be in a lump sum, defined not as one payment but five or fewer installments, 20% of the total amount offered must be submitted with the OIC.

For example, if the Offer was for a payment of $100,000, it would be necessary to pay $20,000 with the Offer and then pay the remaining amount, $80,000, in four or fewer installments. The period of time over which the four payments must be made is not designated in the legislation and will, presumably, be addressed in Regulations.

If a non-lump sum OIC is submitted, then it is necessary to submit the first periodic payment with the OIC. After the OIC has been submitted, it will also be necessary to make each installment payment while the OIC is being evaluated by the IRS. The term “periodic payment” is not defined in the statute, but presumably it will be defined to mean “monthly payments.”

The Statute states that the payments made under the new OIC regime can be assigned as specified by the Taxpayer. The general rule which the IRS follows, unless there are specific directions, is that the payment is usually applied to the principal of the oldest tax period. In some unusual situations involving 941 taxes, this rule is not always followed. Also, there could be some situations where it would be better to have the tax applied to the more recent tax periods.

Financial data is not needed if an OIC is submitted to the IRS based on doubt as to liability (i.e. the amount is not owed). Read literally, it is not necessary to submit a sum of money if you are submitting an OIC based on doubt as to liability. As a practical matter, however, and as indicated in our prior newsletters, an OIC not accompanied by an offer to pay a sum of money is quite likely to be rejected by the IRS processors. See our newsletters of March/April and May/June of 2005.

It is clear that Congress wanted to raise the hurdle for submitting OICs based on doubt as to collectibility. The statute specifically states that if the amounts required to be paid with lump sum payments or periodic payments are not made on a regular basis, then the IRS is free to return the OIC to the taxpayer as “unprocessable.” This is the kiss of death in many situations because it usually takes a year or more to get an OIC processed.

A new subsection of IRC § 7122 entitled “Deemed Acceptance of Offer Not Rejected Within A Certain Period” has been added to cause the IRS to process an OIC rather than sitting on it indefinitely. In essence, the law now states that if an OIC is submitted and is not “rejected” within a two-year period (beginning with the date of submission) then the OIC is deemed “accepted.”

This restriction of the IRS’s unlimited period of time to work on OICs is a welcome change. If a rejection is not received within the 24-month period, then whatever was offered is deemed to be accepted.  One can envision a kind of poker match where a low offer, if not rejected within the two-year period, would be deemed accepted.

It has been commonly known by many professionals that deal with OICs that the IRS is not able to keep up with the large number of OICs that have been received. The number of OICs submitted may drop substantially with this new legislation. When and how the system will evolve is not clear at this point, but evolution is clearly in order.

The practical effect of the new law will be that, because the official policy of the IRS has been that there will be no enforced collection while a valid OIC is pending, it will no longer be possible to submit an OIC as a device to prevent enforced collection without the payment of some amount to be applied against the outstanding tax debt.

As soon as the IRS provides guidance for implementing the new rules, we plan to prepare another newsletter with information concerning how to process OICs.

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