Today we welcome first time guest blogger Marilyn Ames. Marilyn and I worked together at IRS Chief Counsel’s office for many years separated by about 1,500 miles. She is retired now and living in Alaska but assisting me in rewriting the Saltzman and Book collection chapters. We are working on the offer in compromise section of the book and by chance I received a question from another clinic about what to do when the IRS begins auditing your client for a period covered by the offer. This past summer I had drawn a question from another clinic about what to do when your client discovers they should have received a large refund for a period covered by the offer. As we looked at those situations, we decided that the effect of the offer was clear under the law but perhaps not clear to those entering into the offer. That discussion led to this post and I thank Marilyn for her efforts. Keith
The IRS has had the authority to compromise with taxpayers since the first income tax code, and taxpayers and the IRS have been litigating over the effect of an accepted compromise almost as long. Usually it has been the taxpayer who has requested what my children used to call a “do over” when they played games; as in “I don’t like what happened in the move I just completed and now I want to take that move back.” Recently, however, it appears that the IRS has begun to ask for do overs in the area of offers in compromise.
Section 7122 and its predecessors give the IRS the authority to compromise any civil or criminal case arising under the internal revenue laws. In the first reported do over case involving an accepted offer in compromise, Ely & Walker Dry Goods Co. v. United States, 34 F.2d 429 (8th Cir. 1929), the taxpayer discovered after it entered into a compromise involving its income tax liability and the fraud penalty for its fiscal year ending in 1918, that its inventory was incorrectly computed. The parties agreed that absent the compromise, the taxpayer would be entitled to a refund. The taxpayer argued that the compromise was only of the fraud penalty, not the tax, so the compromise was not precluded by the acceptance of the offer in compromise. The court rejected the taxpayer’s argument, holding that the income tax liability “constituted an entire, single liability, that this single liability, treated as such by the parties, was duly compromised, and that such compromise is a bar to this action.” 34 F.2d at 432.
Since 1929, taxpayers have unsuccessfully attempted to get a do over by distinguishing the holding in Ely & Walker Dry Goods that a compromise of a tax liability closes that tax year, and the liability cannot be reopened. The Internal Revenue Service has agreed with that holding, both in its litigation positions and in its publicly stated policy. Treas. Reg. § 301.7122-1(e)(5) expressly states that acceptance of an offer in compromise conclusively settles the liability of the taxpayer specified in the offer, and that neither the taxpayer nor the Government will be permitted to reopen the case after an offer has been accepted unless the taxpayer has committed fraud by supplying false information or documents, or by concealing assets or the ability to pay. The regulations further allow the liability included in an offer in compromise to be reopened in the event of a mutual mistake of material fact. The court in Rosenberg v. United States, 313 F. Supp. 28 (N.D. 1970)upheld this regulation, stating that it had the force and effect of law as it was not clearly unreasonable.
Absent fraud or mutual mistake of fact, the courts have not allowed taxpayers the requested do over. One of the more recent attempts to avoid the binding effect of an offer in compromise was made by the taxpayer in Dutton v. Commissioner, 122 T.C. 133 (2004), in which the taxpayer tried persuade the Tax Court that his claim for innocent spouse relief should be granted and he should receive a refund. The Tax Court rejected his argument that there was a mutual mistake sufficient to have had a material effect on the agreed exchange of performances.
In Revenue Procedure 2003-71, written for the purpose of describing the process for submitting and resolving an offer in compromise, the IRS emphasizes in section 8.02 that “Acceptance of an offer in compromise will conclusively settle the liability of the taxpayer specified in the offer.” In PLR 5807022300A, the IRS stated “So long as an offer in compromise is in effect, all rights to further adjustments for the year or periods involved are waived. For a compromise is a binding contract, conclusive against both the Government and the taxpayer.”
Despite the long-settled legal position that an accepted offer in compromise closes out all tax periods and years included in the offer, the recent case arising in one clinic suggests that the IRS seeks to give itself a de facto do over. It contacted a taxpayer with an accepted offer seeking to audit years included in the compromise. The contact came in the form of a CP 2000 notice. These notices are issued by the Automated Under Reporter (AUR) Function when the information returns filed with the Service do not match the information reported on the taxpayer’s return. Presumably this is not a compromise where the IRS has discovered that there was fraud or a mutual mistake of fact, as the taxpayer has not received the letter required for a rescission IRM 18.104.22.168.1, Rescission Procedures (September 23, 2008) of an accepted offer in compromise. Absent fraud, it is doubtful that the existence of this potential additional liability would constitute a mutual mistake of fact that would have kept the IRS from accepting the offer in compromise, and that the compromise could be rescinded.
Apparently this is a case of the right hand and the left hand of the IRS not knowing what the other is doing, although if the IRS computer systems can match income information with returns, it would seem that the system could also be programmed to recognize the existence of an accepted offer in compromise for this tax period. The possibility exists that the AUR Function did not pick up the computer code entered in the offer case or the timing of the underreporter case came just before the offer code appeared on the account. Since these cases are worked basically by computers rather than individuals, the timing of the offer and the AUR notices may have been ships passing in the night that no one at the IRS observed.
The Internal Revenue Manual IRM 22.214.171.124, Pending Assessments (May 10, 2013) contains clear instructions on how to handle audits that are open when an offer in compromise is submitted for the same year, but doesn’t appear to recognize that an audit could be opened after the offer is accepted. While a taxpayer with an accepted offer who receives a CP 2000 notice may find someone at the IRS who understands the tax year is closed, or may have competent counsel who can make the argument, the possibility exists that many taxpayers in this situation would simply pay the additional liability. Because this has happened in only one known case, it is unclear if a systemic issue is at play or an anomaly.
One final aspect of later discovered issues in offers bears mentioning. If the IRS discovers a tax period that should have been included in an offer in compromise but was not, and both parties are in agreement, the procedure is simply to add the additional tax periods to the original offer. The additional liability must have been assessed before the original offer in compromise was accepted. IRM 126.96.36.199, Overlooked Periods (April 15, 2011). While you want to put every period in which the taxpayer has an assessed liability into an offer and you want to resolve all periods for which the taxpayer is under audit at the time of the offer, sometimes a period gets overlooked. This procedure can fix the problem if the assessment occurred before the offer acceptance. This procedure cannot fix the problem if the audit did not result in an assessment. It also cannot help the taxpayer who later “discovers” they were due a refund for a period covered by the offer. Because of the binding nature of the offer, a complete review of taxpayer’s circumstances for all open years should take place in conjunction with the submission of the offer to avoid problems of the failure to cover periods or the failure to seek a refund before it’s too late.