Offer In Compromise And Reasonable Collection Potential

Command Central is working two Collections cases with the same revenue officer.

For the most part, I am staying out of it. There is a young(er) tax guy here, and we are exposing him to the ins-and-outs of IRS procedure. This is a subject not taught in school, and training today is much like it was when I went through: a mentor and mouth-to-ear. Friday morning we spent quite a bit of time trying to determine whether someone’s tax year was still “open,” as it would make a substantial difference in how we approach the situation.

COMMENT: This is the statute of limitations. The IRS has three years to assess your return and then ten years to collect. Hypothetically one could get to thirteen years, but that would require the IRS to run the three-year gamut before assessing and then the ten-year stretch to collect. I do not believe I have ever seen the IRS do that. No, of greater likelihood is that the taxpayer has done things to suspend the statute (called “tolling”), things such as requesting payment plans or submitting offers in compromise. Do this repetitively and you might be surprised at how long ten years can stretch. 

Personally, I suspect one of these two clients is dead in the water.

Why?

Let’s like at some inside baseball for an offer in compromise.

Collections looks at something called reasonable collection potential (RCP). As a rule of thumb, figure that the IRS is looking at a bigger number than you are. RCP has two components:

(1)  Net realizable equity in your assets

The classic example is a paid-off house.

To be fair, the IRS does spot you some room. It will use 80% (rather than 100%) of the house’s market value, for example, and then allow you to reduce that by any mortgage. Yes, the IRS is pushing you to refinance the house and take out the equity. It is not unavoidable, however. The push could be mitigated (if not stopped altogether) in special circumstances.

(2)  Future remaining income

This is a multiple of your monthly disposable income.

Monthly disposable income (MDI) is the net of

·      Monthly income less

·      Allowable living expenses (ALE)

Trust me, what you consider your ALE is almost certain to be significantly higher than what the IRS considers your ALE. There are tables, for example, of selected expense categories such as allowable vehicle ownership and operating costs. The IRS is not going to spot you $1,000/month to drive a luxury SUV when calculating your ALE. You may owe it, but they are not going to allow it. Yep, the math has to give, and when it gives, it is going to fall on you.

MDI is then multiplied by either 12 or 24, depending on which flavor offer in compromise you are requesting.

The vanilla flavor, for example, requires you to submit a 20% deposit with the offer request.

That is a problem if you are broke.

Then you have to pay the remaining 80% payments over five months.

 But – you say – that 80% includes twelve months of income. How am I to generate twelve months of income in five months?

I get it, but I did not write the rules.

Let’s look at a recent case. We will then have a quiz question.

Mr. D owed taxes for 2009 through 2011, 2013 through 2017, and payroll tax trust fund penalties for quarter 2, 2014 and quarters 3 and 4, 2015. These totaled a bit under $410 grand.

Shheeessshhh.

Mrs. D owed taxes for 2011 and 2013 through 2017.

OK. Those were joint income tax liabilities and would already have been included in Mr. D’s $410 grand.

They filed and owed with their 2018 return.

In March 2020 they requested a Collection Due Process Hearing.

They filed and owed with their 2019 return.

In July 2020 they offered $45,966 to settle their personal taxes for 2009 through 2011 and 2013 through 2019. Total personal tax was about $437 grand.

Now began the Collections dance.

Their offer was submitted to the specialized unit that works with offers. The unit wanted more information. The D’s had disclosed, for example, that they had retirement accounts.

The IRS asked: could you send us paperwork on the retirement accounts? 

The D’s send information for her IRA but not for his 401(k).

COMMENT: It almost never works to play this game.

The IRS calculated RCP based on their best available information.

Let’s look at just one facet: the house.

The D’s said the house was worth $376,600 on their original application. It had a mortgage of $310,877.

The IRS said that the house was worth $680,816.

COMMENT: Really? Did they think the IRS had never heard of Zillow or Movoto?

Following is the taxpayers’ comment:

On September 24, 2021, petitioners acknowledged that this value did not reflect the actual fair market value of the personal residence, stating that ‘we always start low as the initial starting point of the negotiation.’”         

COMMENT: Again, it almost never works to play this game.

Here is the math for NRE:

FMV	680,816
	80%
Adjusted	544,653
Mortgage	(310,877)
RCE	233,776

                                          

 

 

The D’s argued that the $680,816 value for the house was ridiculous.

They had it appraised at $560,000.

The IRS said: OK. Even so, here is the NRE:              

FMV	560,000
	80%
Adjusted	448,000
Mortgage	(310,877)
RCE	137,123

The IRS of course determined the D’s could pay significantly more than their proposed offer. I want to stop our discussion here and go to our quiz question:

I have given you enough information to know the IRS would turn down their offer of $45,966. How do you know?

Go back and review how RCP is calculated.

It is the sum of realized assets and some multiple of income.

The offer was less than RCP.

In fact, it was less than the asset component of RCP.

Could it happen? Of course, but it would take exceptional circumstances: think elderly taxpayers, maybe severe if not terminal illness, the residence being the only meaningful asset, etc.

That is not what we have here.

So the D’s tried a gambit:

Petitioners propose that this Court find as fact their allegations that the SO was ‘hostile, irate [and] yelling’ and ‘not qualified to be impartial and honest in this case.’”

That might work. Must prove it though.

Jawboning the SO when gathering information does not seem like such a brilliant idea now.

Here is the Court:

Since the record before us (which we are bound by) is silent as to any of the SO’s alleged acts of impropriety or bias, we find this argument by petitioners to be unsubstantiated.”

Offer denied.

Our case this time was Dietz v Commissioner, T.C. Memo 203-69.

Giving The IRS A Reason To Reject Your Offer In Compromise

 

Can the IRS turn down your offer in compromise if the offer is truly the best and most you are able to pay?

My experience with OICs and partial payment plans has generally involved disagreement with the maximum a client can pay. I do not recall having the IRS tell me that they agreed with the maximum amount but were going to reject the OIC anyway. Some of that – to be fair – is my general conservatism with representing an OIC.

COMMENT: There are tax mills out there promising pennies-on-the-dollar and inside knowledge of an IRS program called “Fresh Start.” Here is inside knowledge: the IRS Fresh Start program started in 2011, so there is nothing new there. And if you want pennies on the dollar, then you had better become disabled or fully retired with no earning power, because it is not going to happen.

Today we are going to talk about James O’Donnell.

James did not believe in filing tax returns. Sometimes the IRS would prepare a substitute return for him; it did not matter, as he had no intention of paying. This went long enough that he was now dragging over $2 million in back taxes, penalties and interest.

I suppose his heart softened just a bit, as in May, 2016, he submitted an offer in compromise for $280,000. He attached a check for $56,000 (the required 20% chop) and simultaneously filed 12 years’ worth of tax returns.

When reviewing an OIC, the IRS will also review whether one is up-to-date with his/her tax compliance. The IRS did not see estimated tax payments for 2016 or 2017. In September, 2017 the IRS rejected the offer, saying that it would reconsider when James was in full compliance.

Bummer, but those are the ropes.

James must have hired someone, as that someone told the IRS that James did not need to pay estimated taxes.

Odd, but okay. The IRS decided to reopen the case.

The pace quickened.

In October, 2017 the IRS wanted to lien.

James requested a CDP hearing as he - you know – had an offer out there.

I agree. Liens are a bear to remove. It is much better to avoid them in the first place.

In March, 2018 the IRS rejected the offer.

In April, 2018 James appealed the rejection. His representative was still around and made three arguments:

(1)  The unit reviewing the offer erred in concluding the offer was not in the government’s best interest.

(2)  James was in full compliance with his tax obligations.

(3)  James was offering the government all he could realistically afford to pay.

There was paperwork shuffling at the IRS, and James’ case was assigned to a different settlement officer (SO). The SO sent a letter scheduling a telephone conference on May 15, 2018.

James skipped the call.

Sheeesshhh.

James explained that he never received the letter.

The SO rescheduled another telephone conference for June 14, 2018.

Two days before the hearing – June 12 – Appeals sustained the rejection of the offer, reasoning that acceptance of James’ offer was not in the government’s best interest because of his history of “blatant disregard for voluntary compliance.”

James made the telephone conference on June 14. The SO broke the bad news about the offer and encouraged James to resubmit a different collection alternative by June 26.

James filed with the Tax Court on August 20, 2018.

On July 30, 2019 (yes, almost a year later) the IRS filed a motion to return the case to the agency, so it could revisit the offer and its handling. The Tax Court agreed.

The IRS scheduled another conference call, this one for January 28, 2020. The IRS presented and James verbally agreed to a partial-pay with monthly payments of $2,071, beginning March, 2020.

COMMENT: This strikes me as a win for James. Failing the OIC – especially given the reason for the fail – a partial-pay is probably the best he can do.

The SO sent the partial-pay paperwork to James for his signature.

James blew it off.

He now felt that the SO had not considered all his expenses, making $2,071 per month unmaintainable.

OK. Send the SO your updated numbers – properly substantiated, of course – and request a reduction. Happens all the time, James.  

Nope. James wanted that OIC. He did not want a partial-pay.

It would be all or nothing in Tax Court.

COMMENT:  A key difference between the OIC and a partial-pay is that the IRS can review a partial-pay at a later point in time. As long as the terms are met, an OIC cannot be reviewed. If one’s income went up during the agreement period, for example, the IRS could increase the required payment under a partial-pay. This is the downside of a partial-pay compared to an offer.

James was betting all his chips on the following:

Appeals calculated the reasonable collection potential of $286,744. James had offered $280,000. Both sides agreed on the maximum he could pay.

The Tax Court pointed out that – while correct – the IRS is not required to accept an offer if there are other considerations.

Offers may be rejected on the basis of public policy if acceptance might in any way be detrimental to the interest of fair tax administration, even though it is shown conclusively that the amount offered is greater than could be collected by any other means.”

What other consideration did James bring to the table?

For two decades (if not longer) petitioner failed to file returns and failed to pay the tax shown on SFRs that the IRS prepared for him. During this period he was evidently a successful practitioner in the insurance and finance business. As of 2016 his outstanding liabilities exceeded $2 million, and he offered to pay only a small fraction of these liabilities. Because of his lengthy history of ignoring his tax obligations, the Appeals Office determined that acceptance of his offer could be viewed as condoning his ‘blatant disregard for voluntary compliance’ and that negative public reaction to acceptance of his offer could lead to ‘diminished future voluntary compliance’ by other taxpayers.”

The Tax Court bounced James, but it was willing to extend an olive branch:

We note that petitioner is free to submit to the IRS at any time, for its consideration and possible acceptance, a collection alternative in the form of an installment agreement, supported by the necessary financial information.”

Accepted OICs are available for public review. It is one thing to compromise someone’s taxes because of disability, long-term illness and the similar. That is not James’ situation. The Court did not want to incentivize others by compromising for fourteen (or so) cents on the dollar with someone who blew-off the tax system for twenty years.

Our case this time was James R. O’Donnell v Commissioner, T.C. Memo 2021-134

Memphian Appeals An Offer In Compromise

I am looking at a case dealing with an offer in compromise.

You know these from the late-night television and radio advertisements to “settle your IRS debts for pennies on the dollar.”

Yeah, right.

If it were so easy, I would use it myself.

Don’t get me wrong, there are fact patterns where you probably could settle for pennies on the dollar. Unfortunately, these fact patterns tend to involve permanent injury, loss of earning power, a debilitating illness or something similar.

I will just pay my dollar on the dollar, thank you.

What caught my attention is that the case involves a Memphian and was tried in Memphis, Tennessee. I have an interest in Memphis these days.

Let’s set it up.

Taxpayer filed tax returns for 2012 through 2014 but did not pay the full amount of tax due, which was about $40 grand. A big chunk of tax was for 2014, when he withdrew almost $90,000 from his retirement account.

Why did he do this?

He was sending his kids to a private high school.

I get it. I cannot tell you how many times I have heard from Memphians that one simply cannot send their kids to a public school, unless one lives in the suburbs.

In December, 2016 he received a letter from the IRS that they were going to lien.

He put the brakes on that by requesting a Collection Due Process (CDP) hearing.

Well done.

In January he sent an installment agreement to the IRS requesting payments of $300 per month until both sides could arrive at a settlement.

The following month (February) he submitted an Offer in Compromise (OIC) for $1,500.

That went to a hearing in April. The IRS transferred the OIC request to the appropriate unit.

In late August the IRS denied the OIC.

Let’s talk about an OIC for a moment. I am thinking about a full post (or two) about OICs in the future, but let’s hit a couple of high spots right now.

The IRS takes a look at a couple of things when reviewing an OIC:

(1)  Your net worth, defined as the value of assets less any liabilities thereon.

There are certain arcane rules. For example, the IRS will probably allow you to use 80% of an asset’s otherwise fair market value. The reason is that it is considered a forced sale, meaning that you might accept a lower price than otherwise.

(2) Your earning power

This is where those late-night IRS settlement mills dwell. Have no earning power and near-zero net worth and you get pennies on the dollar.

There are twists here. For example, the IRS is probably not going to spot you a monthly Lexus payment. That is not how it works. The IRS provides tables for certain categories of living expenses, and that is the number you use when calculating how much you have “left over” to pay the IRS.

Let’s elaborate what the above means. If the IRS spots you a lower amount than you are actually spending, then the IRS sees an ability to pay that you do not have in real life.

You can ask for more than the table amount, but you have to document and advocate your cause. It is far from automatic, and, in fact, I would say that the IRS is more inclined to turn you down than to approve any increase from the table amount. I had a client several years ago who was denied veterinary bills and prescriptions for his dog, for example.

The IRS workup showed that the taxpayer had monthly income of approximately $12,700 and allowable monthly expenses of approximately $11,000. That left approximately $1,700 monthly, and the IRS wanted to get paid.

But there was one expense that made up the largest share of the IRS difference. Can you guess what it was?

It was the private school.

The IRS will not spot you private school tuition, unless there is something about your child’s needs that requires that private school. A special school for the deaf, for example, would likely qualify.

That is not what we have here.

The IRS saw an ability to pay that the taxpayer did not have in real life.

Taxpayer proposed a one-time OIC of $5,000.

The IRS said No.

They went back and forth and agreed to $200 per month, eventually increasing to $700 per month.

COMMENT: This is not uncommon for OICs. The IRS will often give you a year to rework your finances, with the expectation that you will then be able to pay more.

The taxpayer then requested abatement of interest and penalties, which was denied. Generally, those requests require the taxpayer to have a clean filing history, and that was not the case here.

The mess ended up in Tax Court.

Being a court, there are rules. The rule at play here is that the Court was limited to reviewing whether the IRS exercised abuse of discretion.

Folks, that is a nearly impossible standard to meet.

Let me give you one fact: he had net assets worth approximately $43 thousand.

His tax was approximately $40 thousand.

Let’s set aside the 80% thing. It would not take a lot of earning power for the IRS to expect him to be able to repay the full $40 grand.

He lost. There really was no surprise, as least to me.

I do have a question, though.

His monthly income was closer to $13 grand than to $12 grand.

It fair to say that is well above the average American monthly household income.

Private school is expensive, granted.

But where was the money going?

Our case this time was Love v Commissioner, T.C. Memo 2019-92.

Terrance Clem Wright v Commissioner

I have a question for you: if you wanted to convince the IRS that you are unable to pay back taxes because of financial hardship, would you hesitate to send them copies of your bank statements?

Let’s take a look at another pro se case before the Tax Court: Terrance Clem Wright v Commissioner. This is also a good opportunity to review the sequence of possible IRS Collections actions against a taxpayer.

Terrance Wright (TCW) fell behind on his taxes for 1999, 2000, 2001, 2003, 2004, 2005, 2006, 2007, and 2008.

On March 18, 2010 the IRS sent him a notice advising him that a notice of federal tax lien (NFTL) had been filed because of his back taxes and that he could request a hearing with the Appeals Office.

On April 25, 2010 TCW filed a request for a Due Process Hearing. The intent of a CDP is to delay a hasty IRS collection action and allow the taxpayer to propose an alternative. He did not contest the tax liabilities but instead requested an installment agreement.

On November 19, 2010, the IRS sent TCW a letter scheduling a telephone conference on January 18, 2011.  The IRS requested TCW to provide financial information and a payment proposal. This would help the IRS Appeals Officer make a decision.

On January 18, 2011, TCW and the Appeals Officer had their telephone conference. TCW told the Appeals Officer that he could not currently afford to make any payments. The Appeals Officer told TCW that - while he had provided some financial information – he unfortunately had not provided bank statements. She needed the bank statements to review his situation and make her decision. Until then she did not have enough information to determine whether TCW should be placed in currently not collectible (CNC) status. She encouraged TCW to pursue CNC status when he obtained all of the necessary financial documents.

NOTE: CNC status means that the IRS will not pursue action for a period of time, very often a year. It does not mean that the tax debt is gone, only that the IRS is granting time for you to get your financial affairs back in order.

Once informed by the Appeals Officer of the alternative, TCW liked the idea of CNC. This does not appear to have occurred to him previously, which indicates – at least to me – that he was not represented by a tax professional.

On February 2, 2011, the IRS issued a notice telling TCW that he would not receive an installment agreement or CNC.

OBSERVATION: Notice the dates: January 18 and February 2. This is not a lot of time, especially by IRS standards. Remember that it took him seven months to get to Appeals. TCW needed to have burnished his case by or before the hearing, as time is short once you are in Appeals.

The Appeals Office, at least in Cincinnati and this part of the country, is undermanned and overworked. I was told recently, for example, that Chicago Appeals are being heard in Wisconsin. My general experience with Appeals has been satisfactory, but one has to be aware and sensitive that these people are pressed for time. I am certain that TCW’s Appeals Officer was frustrated with his lack of cooperation.  

TCW, in a pique, filed a petition with the Tax Court on March 1, 2011.  TCW did not contest the underlying tax debt or the denial of an installment agreement. Instead, TCW’s only argument was that he could not afford to pay. He wanted the IRS to suspend collection action on the basis of his economic hardship. He wanted a CNC, and he wanted the Tax Court to tell the IRS to let him have one.

Here is the Tax Court:

Suspension of collection activity is a “collection alternative” that the taxpayer may propose and that the Office of Appeals must take into consideration. The Internal Revenue Manual (IRM) makes provision for a taxpayer's account to be declared “currently not collectible” in cases of “hardship.” To justify suspension of collection on the ground that the account should be deemed CNC, petitioner must show that he cannot afford to pay the liabilities; and to do so he must show his financial circumstances, including the money that is available to him and the expenses that he bears.

The Appeals officer requested that petitioner submit bank statements and other financial information so that collection alternatives could be considered. Petitioner submitted some of the requested information but failed to submit bank statements. Because petitioner failed to submit the requested bank statement information, the Appeals officer was unable to accurately ascertain petitioner's financial circumstances and, consequently, determined that she could not calculate the appropriate installment agreement terms or grant petitioner CNC status. In the absence of the requested information, respondent's Appeals officer did not abuse her discretion in denying petitioner's request for collection alternatives.

My take? Send the bank statements. It really is that simple.

The Collection Due Process Hearing

A client recently faxed me a Notice of Intent to Levy. His tax case is relatively simple, as we are not debating the amount of tax. Rather, he is in a position where he cannot pay-off his tax due. This requires a payment plan, which can blow up if the taxpayer misses a payment. He is self-employed with erratic income, so he is at ongoing risk of blowing up his payment plan. He unfortunately believes – or has believed – that we can reactivate a payment plan whenever he feels like missing a payment, but I believe we impressed upon him that this is not the case. The IRS becomes weary, and frankly so do we.

I thought this a good time to talk about the Collection Due Process hearing.

Once you receive a Notice of Federal Tax Lien (NFTL) or Intent to Levy, you have 30 days to request a CDP hearing. If so, the levy action will be suspended for the duration of the hearing. IRS Appeals conducts the hearing. The taxpayer can appeal a CDP hearing, if so inclined.

What happens if you miss the 30 days? Not all is lost. You can request an Equivalent Hearing as long as you file within one year of the NFTL or levy notice. The difference is that you cannot appeal an Equivalent Hearing.

You have to file a form (Form 12153) and state a reason for the hearing. In our case, we will request a collection alternative, such as an installment agreement. Our client does not qualify for an offer in compromise, which is another valid reason. Other reasons include requests to release or subordinate a lien, request for innocent spouse and a dispute over the amount of unpaid taxes. An important reason in today’s economy is financial hardship, which can include heavy medical bills, unemployment, and taxpayer’s reliance on social security or unemployment benefits.

An unfortunate note is that – even if the IRS accepts the collection alternative – interest and penalties will continue to accrue.