Taxpayers often fail to grasp the relationship between offers in compromise and tax refunds. Based on recent email list queries, tax season is a good time for a refresher.
Before we get to tax refunds, a brief overview of OICs will set the stage. Guest blogger Marilyn Ames explained in a previous post that “section 7122 and its predecessors give the IRS the authority to compromise any civil or criminal case arising under the internal revenue laws.” (Read her post for a discussion of the permanent nature of a compromise.) There are three grounds for a compromise with the IRS: Doubt as to Liability (DATL), Doubt as to Collectibility (DATC), and Effective Tax Administration (ETA). 26 C.F.R. 301.7122-1. Revenue Procedure 2003-71 describes the three types of offers as well as the process for submitting and resolving offers.
Doubt as to Liability means what it says. An OIC-DATL is an alternative to an audit reconsideration for taxpayers who can demonstrate that the assessment is likely erroneous either wholly or partially. Under Rev. Proc. 2003-71, the taxpayer’s offer must “reasonably reflect the amount the Service would expect to collect through litigation,” if the underlying liability were litigated.
Effective Tax Administration is less obvious. It originates from a Congressional directive in the legislative history of the IRS Restructuring and Reform Act of 1998. The implementing regulation at § 301.7122-1(b)(3) provides in part:
(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 § 301.6343-1.
(ii) If there are no [other] grounds for compromise …, 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. …
The regulation goes on to give helpful examples of appropriate ETA offers. There are three hardship examples:
The taxpayer has assets sufficient to satisfy the tax liability. The taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the taxpayer will need to use the equity in his assets to provide for adequate basic living expenses and medical care for his child. The taxpayer’s overall compliance history does not weigh against compromise.
The taxpayer is retired and his only income is from a pension. The taxpayer’s only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses. The taxpayer’s overall compliance history does not weigh against compromise.
The taxpayer is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate his disability. The taxpayer’s equity in the house is sufficient to permit payment of the liability he owes. However, because of his disability and limited earning potential, the taxpayer is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because the taxpayer’s home has been specially equipped to accommodate his disability, forced sale of the taxpayer’s residence would create severe adverse consequences for the taxpayer. The taxpayer’s overall compliance history does not weigh against compromise.
However, most offers are submitted and accepted on Doubt as To Collectability grounds. That is also fairly obvious, although the devil is in the details of the minimum acceptable offer. Rev. Proc. 2003-71 explains,
An offer to compromise based on doubt as to collectibility generally will be considered acceptable if it is unlikely that the tax can be collected in full and the offer reasonably reflects the amount the Service could collect through other means, including administrative and judicial collection remedies. …This amount is the reasonable collection potential of a case. In determining the reasonable collection potential of a case, the Service will take into account the taxpayer’s reasonable basic living expenses. In some cases, the Service may accept an offer of less than the total reasonable collection potential of a case if there are special circumstances.
That last sentence is important – doubt as to liability with special circumstances (DATC-SC) can be considered the fourth type of offer, although it does not appear in the regulation. The distinction matters when it comes to tax refund issues, as we will see below. I.R.M. 18.104.22.168 explains that “an offer based upon doubt as to collectibility with ‘special circumstances’ will be evaluated using the same criteria as an ETA offer.” Those considering a “special circumstances” offer should review the examples in the regulation at § 301.7122-1(c)(3).
To summarize, the four OIC flavors are:
- Doubt as to liability – I should not owe this; I am offering or what I’d likely owe if the liability were litigated (or at least $1).
- Doubt as to collectibility – I can’t pay this; I am offering to pay my “reasonable collection potential” (or at least $1).
- Doubt as to collectibility with special circumstances – I can’t pay this, and I am offering less than my “reasonable collection potential” for hardship or public policy reasons.
- Effective Tax Administration – my “reasonable collection potential” is more than I owe, but I am offering less for hardship or public policy reasons.
With that background, we will move on to refund issues in the next post.