STATE BAR OF CALIFORNIA TAXATION SECTION 1 RECOMMENDATION FOR CONGRESSIONAL HEARINGS ON THE ADMINISTRATION OF THE IRS OFFER IN COMPROMISE PROGRAM

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1 STATE BAR OF CALIFORNIA TAXATION SECTION 1 RECOMMENDATION FOR CONGRESSIONAL HEARINGS ON THE ADMINISTRATION OF THE IRS OFFER IN COMPROMISE PROGRAM This proposal was written by Steven J. Mopsick and Betty Jean Little. The authors wish to thank Stuart Hurwitz and Joseph A. Broyles for their contributions to this paper. 2 Contact Person: Steven J. Mopsick Mopsick & Little, LLP 3600 American River Drive, Suite 220 Sacramento, CA (916) The comments contained in this paper are the individual views of the authors who prepared them, and do not represent the position of the State Bar of California or the Los Angeles County Bar Association. 2 Although the participants on the project might have clients affected by the rules applicable to the subject matter of this paper and have advised such clients on applicable law, no such participant has been specifically engaged by a client to participate on this project.

2 EXECUTIVE SUMMARY A long-standing provision of the Internal Revenue Code has allows the IRS discretionary authority to compromise a tax liability ( OIC ) for less than the full amount owed either for doubt as to liability or doubt as to collectibility. An IRS Policy Statement as recent as 1992 places the IRS on record as supporting the OIC program. Congress signaled its support, if not a desire to broaden the offer in compromise program in the IRS Restructuring and Reform Act of Nevertheless, during recent years there is clearly a wide-spread perception among tax practitioners as well as the National Taxpayer Advocate which holds that the Service is less than committed to the OIC program and that technicians and managers responsible for administering the program appear to be operating under a directive to find ways to reject offers rather than look for ways to help get offers approved. Tax practitioners generally believe that the current Offer in Compromise program is administered today in a way which is inconsistent with clearly expressed Congressional policy which favors a liberalization of the Program. Accordingly, it is recommended that Congress conduct hearings at which Service representatives are called to testify and address the negative perceptions of the Program among tax practitioners and the public at large. DISCUSSION I. LEGAL BACKGROUND A. Statute, Regulations, and IRS Policy Statement For many years, the Internal Revenue Code has allowed the IRS discretionary authority to compromise a tax liability ( OIC ) for less than the full amount owed either for doubt as to liability or doubt as to collectibility. Section 7122(a) of the Code provides, [t]he Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense; and the Attorney General or his delegate may compromise any such 2

3 case after reference to the Department of Justice for prosecution or defense. 3 3 The Treasury Regs. under section 7122 provide in part, Compromises. (a) In general--(1) If the Secretary determines that there are grounds for compromise under this section, the Secretary may, at the Secretary s discretion, compromise any civil or criminal liability arising under the internal revenue laws prior to reference of a case involving such a liability to the Department of Justice for prosecution or defense. (2) An agreement to compromise may relate to a civil or criminal liability for taxes, interest, or penalties. Unless the terms of the offer and acceptance expressly provide otherwise, acceptance of an offer to compromise a civil liability does not remit a criminal liability, nor does acceptance of an offer to compromise a criminal liability remit a civil liability. (b) Grounds for compromise--(1) 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. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. (2) Doubt as to collectibility. Doubt as to collectibility exists in any case where the taxpayer's assets and income are less than the full amount of the liability. (3) Promote effective tax administration-- (i) A compromise may be entered into to promote effective tax administration when the Secretary determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship within the meaning of (ii) If there are no grounds for compromise under paragraphs (b)(1), (2), or (3)(i) of this section, the IRS 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. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full. (iii) No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws. (c) Special rules for evaluating offers to compromise--(1) In general. Once a basis for compromise under paragraph (b) of this section has been identified, the decision to accept or reject an offer to compromise, as well as the terms and conditions agreed to, is left to the discretion of the Secretary. The determination whether to accept or reject an offer to compromise will be based upon consideration of all the facts and circumstances, including whether the circumstances of a particular case warrant acceptance of an amount that might not otherwise be acceptable under the Secretary's policies and procedures. (2) Doubt as to collectibility--(i) Allowable expenses. A determination of doubt as to collectibility will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer's case. To guide this determination, guidelines published by the Secretary on national and local living expense standards will be taken into account. 3

4 The Service is on record in Policy Statement P-5-100, issued in January of 1992, as supporting the OIC program. It provides in part: The Service will accept an offer in compromise when it is unlikely that the liability can be collected in full and the amount offered reasonably reflects collection potential. An offer in compromise is a legitimate alternative to declaring a case currently not collectible or to a protracted installment agreement. The goal is to achieve collection of what is potentially collectible at the earliest possible time and at the least cost to the Government. In cases where an offer in compromise appears to be a viable solution to a tax delinquency, the Service employee assigned the case will discuss the compromise alternative with the taxpayer and, when necessary, assist in preparing the required forms. The taxpayer will be responsible for initiation the first specific proposal for compromise. The success of the compromise program will be assured only if taxpayers make adequate compromise proposals consistent with their ability to pay and the Service makes prompt and reasonable decisions. Taxpayers are expected to provide reasonable documentation to verify their ability to pay. The ultimate goal is a compromise which is in the best interest of both the taxpayer and the Service. Acceptance of an adequate offer will also result in creating for the taxpayer an expectation of and a fresh start toward compliance with all future filing and payment requirements. 4

5 Congress signaled its support, if not a desire to broaden the offer in compromise program in 1998 in the IRS Restructuring and Reform Act of 1998, by requiring the IRS to take into account factors such as equity, hardship, and public policy where a compromise of an individual taxpayer s income tax liability would promote effective tax administration. 4 The Conference Report for the Act states the IRS should: (1) "be flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations;" and (2) "make it easier for taxpayers to enter into offer-incompromise agreements." 5 B. Practitioner Criticism of the OIC Program Notwithstanding this history, practitioners have expressed their concern over the Service s apparent lack of commitment to the offer program in recent years. In October of 2003, Tax Notes Today published a letter to the Small Business/Self-Employed Division Commissioner which was highly critical of the Service s handling of the offer in compromise program. 6 The letter described a survey conducted by the AICPA which reflected 80 responses from state CPA societies, and concluded that a broad cross-section of CPA s nationwide perceive that the Service is losing its commitment to the OIC program. In response to a question which asked, "[i]n your experience is the IRS more apt to look for reasons to accept an Offer; or does it appear that the Service is (as a matter of general policy) looking for reasons to reject the Offer?" the nearly unanimous response was that the IRS intentionally looks for reasons to reject an OIC. The AICPA reported that the 1998 Act led to a dramatic increase in OIC filings. In response, the IRS established two centralized offer in compromise sites in Memphis, TN and Brookhaven, NY to process OIC s. This centralized processing arrangement was designed to permit streamlined review procedures for simple OIC cases, using specially trained paraprofessionals. This would permit more complex cases to be assigned to revenue officers in the field and would expand the grounds for returning an OIC to the taxpayer without the need to conduct a full investigation. 4 H.R. Conf. Rep. No , 105 th Cong., 2d Sess., 289 (1998), Doc , 98 TNT Id TNT AICPA Submits Survey Results on Offer in Compromise Program, October 15, 2003, author, Robert A. Zarzar. 5

6 Notwithstanding the rationale for the Service s arrangement for OIC processing, the AICPA report concluded that based on the concerns expressed by many of our members, we do fear that the IRS employees at the COIC sites might be reducing OIC inventory levels based on implementation of rigid procedures; tight rules regarding what constitutes a "processable" offer and short time frames for submitting updated or missing documents. The AICPA report also echoed the National Taxpayer Advocate s Report to Congress, Fiscal Year 2004 Objectives, which also expressed concern over the new IRS structure for processing offers, and reported that the AICPA survey reflected the perception that training of IRS employees at the centralized processing cites is inadequate and that IRS employees there review OIC s in a mechanical fashion without giving any meaningful thought or consideration to the unique circumstances of each individual case. These respondents seem to believe that the COIC employees find it is easier to reject the Offer as opposed to finding reasons to accept it. The AICPA October, 2003, report was also critical of the way the Service appeared to be using the Congressional directive to establish national and local standards. Section 7122(c)(2) of the Code directs the Service to develop and publish guidance outlining national and local allowances for basic living expenses and grants IRS employees flexibility in how strictly to apply the allowances based on the individual circumstances of each taxpayer. Section 7122(c)(2)(B) of the Code specifically enjoins applying the schedules in a way that "would result in the taxpayer not having adequate means to provide for basic living expenses." The AICPA reported that practitioners have the perception that the IRS's 6

7 OIC personnel are looking for ways to reject offers as opposed to accept them. Using national or local standards as inflexible criteria is one way that OIC personnel appear to be thwarting Policy Statement P and section 7122(c)(2) which was enacted as part of the 1998 IRS Restructuring and Reform Act. Another area of concern reflected in the AICPA report is that it appears as though most offers are not reviewed until nine to twelve months after the offer is submitted. At that point the IRS OIC specialist will ask the taxpayer to resubmit new financial information because the information submitted with the initial submission is then viewed as out dated. The AICPA suggested that taxpayers should not be burdened by the government s inability to timely get to their work and noted that this delay not only add[s] to the stress incurred by the taxpayer, but also increase[s] the financial costs if practitioners are routinely required to gather and submit additional updated financial information for the client. The AICPA report also expressed concern about the fact that it can take as much as two years before an offer is initially submitted, reviewed and formally rejected and ultimately appealed to, and reviewed by Appeals. We find this to be an unduly long time period and not constructive to taxpayers or to the tax administration process. As noted above, Congress signaled its support, if not a desire to broaden the offer in compromise program in 1998 in the IRS Restructuring and Reform Act of 1998 by requiring the IRS to take into account factors such as equity, hardship, and public policy where a compromise of an individual taxpayer s income tax liability would promote effective tax administration. In her annual report to Congress for 2004, the National Taxpayer Advocate devoted a full seventeen pages to effective tax administration offers and 7

8 noted that in all of fiscal year 2004 the IRS accepted only one offer based on effective tax administration. 7 While the AICPA survey results were published in October of 2003, the practitioner community s negative perception of the Service s management of the OIC program has continued unabated. In her most recent report to Congress, the Taxpayer Advocate s 2005 Report dated December 31, 2005, in the context of the Service s centralization concept, referred specifically to the AICPA s October 2003 survey. In a section of her report entitled Most Serious Problems, the TA quoted extensively from the AICPA s October, 2003 report. As recently as December 23, 2005, the AICPA wrote to the ranking members of the tax writing committees commenting on several revenue provisions in the Tax Relief Act of 2005, in opposition to section 523, an illconceived proposal which would require a taxpayer who submits a "lumpsum" offer to include 20 percent of the amount of the offer at the time the offer is submitted. In voicing its opposition to the proposal, the AICPA again reiterated that it had received numerous reports from practitioners that the IRS's OIC program is not working due in large part to the Service's practice of classifying large numbers of offers as "non-processable" and the agency's high rejection rate. The AICPA comments are consistent with the public comments of National Taxpayer Advocate Nina Olson published on May 18, 2005, where she revealed that taxpayers submitted approximately 39,000 offers during the first six months of fiscal 2005, which is a 45 percent drop in the number of offers submitted for the same period in The Taxation Section of the American Bar Association has also noted a change in [the Service s] direction from the 1998 Taxpayer Bill of Rights with regard to offers. 8 Finally, the American Association of Attorney-CPAs has noted the steady decline in accepted offers and that the acceptance rate in the OIC program has dwindled to less than 23 per cent since For an excellent discussion of effective tax administration offers in compromise, see Fogel, The Effective Tax Administration Offer in Compromise, 2005 TNT , August 24, ABA Tax Section Opposes Provisions of Senate Tax Relief Act, 2006 TNT 3-16, January 4,

9 C. Anecdotal Evidence Suggests Continuing Concern The comments listed below reflect anecdotal evidence collected from members of the California Taxation Section Committee on Tax Procedure and Litigation, members of the Executive Committee at large of the Taxation Section and other California tax practitioners. While this inquiry can hardly be called scientific, anecdotal evidence suggests that each and every concern reflected in the October 2003, AICPA survey, the comments of the National Taxpayer Advocate, and the Taxation Section of the American Bar Association are shared by a large segment of California practitioners who are engaged in filing offers in compromise on behalf of their clients. What follows is a summary of the comments. 1. The offer specialists appear to be operating under a directive to find a way to reject an offer rather than look for ways to help the taxpayer get the offer approved. 2. There appears to be a lack of sufficient training on the part of offer specialists as to basic elements of income tax law such as the difference in the taxation of child support vs. alimony. 3. There appears to be a conscious effort on the part of the Service to make the offer specialist inaccessible to the practitioner in terms of fax numbers and responses to telephone calls. 4. The offer specialists are often misinformed or unable to properly locate correct information on their computers regarding the taxpayers filing and compliance history. 5. Offer specialists are generally reluctant to use the telephone to request clarification of a factual matter. A malicious compliance mind-set often characterizes the offer specialists tendency to reject an offer when a simple phone call would clarify matters. 9

10 6. Offer specialists appear to be confused about how to work offers in which the taxpayer lives with unrelated room mates. 7. Some practitioners believe that as a result of the poor training of the offer specialists at Brookhaven and Memphis, only the simplest offers survive at those locations and that Appeals is the only place at which a knowledgeable person will be able to understand most cases. 8. There appears to be no clear guidelines in the IRM as to how to apply the dissipated assets theory. 9. There appears to be no clear guidelines as to how to arrive at an income figure for a taxpayer whose income has historically fluctuated greatly. 10. There seems to be a general reluctance to grant a reasonable extension of time to supply additional requested information. 11. Effective Tax Administration offers appear to have been written out of the Code. Most practitioners advise their clients that the Service does not grant ETA offers. 12. Offer specialists appear to use the national and local standards as a straight jacket substitute for the exercise of independent judgment and understanding of the unique situation of each taxpayer. 13. It generally takes two years from the date of filing until an offer is either finally rejected or accepted. A common practice appears to be to have the offer first reviewed by a field revenue officer before the case is sent to either Memphis or Brookhaven. Offers often languish with the revenue officer for a year before it is forwarded requiring a whole new submission of up-to-date back up material. 10

11 14. Offer specialists often appear judgmental and sometimes take the attitude that an applicant is shirking his/her obligations to pay what they owe and that they are trying to get away with something or negotiate their own amnesty program. II. Congressional Hearings Are Appropriate A. Congress Should Provide the Service with Guidance Offers in Compromise are a major component of a tax controversy practitioner s tool box of remedies available to bring clients into compliance with the tax laws while at the same time provide relief to taxpayers in financial distress looking for a fresh start financially. Congress has indicated its support for this concept well before the codification of the 1939 Code and its most recent liberalizing amendments as expressed by the RRA 98 clearly indicate the direction Congress intends the executive branch to go. To the extent the Service appears to be writing section 7122 out of the Code by its narrow interpretation, it is clear that Congressional oversight is warranted at this time. III. CONCLUSION The proposal to seek Congressional oversight of the IRS s restrictive administration of the Offer in Compromise program will restore the public s confidence in the tax administration system and it will provide for a more equitable system of tax administration for taxpayers and the government. It has been noted that the Offer in Compromise program generates up to $400 million each year for the IRS. Under a properly administered doubt-as-to-collectibility Offer in Compromise program, the government should only be entitled an amount equal to the taxpayer s net realizable equity in his/her assets. No more and no less. Thus our proposal that Congress provide its oversight as to the way in which the Program is presently administered should be revenue neutral. The function of the 11

12 Offer in Compromise program was never intended to be a revenue raiser. Rather, the issue here is one of sound tax administration. 12