The only bad thing about the change in IRS policy in Offers in Compromise (OIC) is that it comes too late for me to change a forthcoming law review article on offset. The inability to update the article which is headed to press matters little. The new policy regarding offset in OICs represents a significant shift in collection policy for the benefit of taxpayers with accepted offers. Kudos to the decision makers behind this policy shift. A recent blog post from the National Taxpayer Advocate sets out the shift in policy and does a nice job of providing background as well as summarizing the new policy. This post seeks to complement the information provided by the NTA but is somewhat duplicative. Christine wrote a two-part blog post on offers and refunds, here and here, if you want more background on this subject.
Offsets after OICs
Section 7122 gives wide discretion to the IRS to enter into an OIC with taxpayers when the IRS finds that doing so serves the best interest of the government. As we have discussed previously, the IRS generally declined to enter into OICs until a shift in policy three decades ago brought about by the lengthening of the statute of limitations on collection. Once it decided to accept OICs as a regular part of its collection arsenal, it took the IRS some years to refine the process. As it did so, it developed language in Form 656, the form on which the taxpayer submits the OIC itself, which committed taxpayers to foregoing the refund for the year in which the IRS accepted the OIC. If you actually read the entire Form 656 you find it contains many provisions regarding the taxpayer’s commitment in accepting the OIC.
The specific language developed by the IRS regarding the commitment of the taxpayer to give up their refund in the year of the OIC acceptance is found on page 5 of the form in section 7(e), which states:
The IRS will keep any refund, including interest, that I might be due for tax periods extending through the calendar year in which the IRS accepts my offer. I cannot designate that the refund be applied to estimated tax payments for the following year or the accepted offer amount. If I receive a refund after I submit this offer for any tax period extending through the calendar year in which the IRS accepts my offer, I will return the refund within 30 days of notification.
This provision surprises many taxpayers. It has caused our clinic to carefully explain to taxpayers what to expect. The offset sometimes comes a year or more after the acceptance of the offer if the IRS accepts an OIC early in a calendar year. We would counsel clients to try to manage their taxes for the year of the offer acceptance so that they did not have a refund or, if they did, the refund was small.
Even though the IRS rarely accepted OICs prior to the change in its policy in 1992, it did have an OIC program. In the Sarmiento case, discussed below, the clinic traced this language back to at least 1964. At that time, however, refundable credits did not exist and the policy as originally designed would not have been intended to claw them back after OIC acceptance.
The policy fell hard on individuals receiving refundable credits as Congress pushed more and more benefits into the hands of individuals through the tax code. For some individuals, the offset could take the earned income credit and child tax credit of several thousand dollars even though these refundable credits did not really constitute a tax refund as much as a benefit payment through the tax code. Because of the way the offset operated in this situations, authors of this blog and others have criticized the taking of these refunds as part of the OIC process.
Taxpayers have essentially no leverage to negotiate the terms of an OIC. Even when aware of this provision in the offer contract and aware that it meant the taking of a large refund generated because of refundable credits, taxpayers could not negotiate their way out of the situation.
Now, for OICs accepted after November 1, 2021, the IRS will forego taking the post-OIC acceptance refund for the year of acceptance. It will still take refunds for the periods leading up to the acceptance of the OIC (subject to the discussion of Offset Bypass Refunds (OBRs) discussed below.) The benefit to taxpayers varies based on the amount of refund they might have received for the year of OIC acceptance. The NTA’s blog has some statistics on this; however, the individuals receiving significant refunds based on refundable credits, usually among the poorest of the taxpayers receiving acceptances, will definitely benefit.
The new policy does make clear that the IRS expects to offset any refunds related to pre-OIC acceptance tax years. This policy makes sense. It prevents taxpayers from delaying the submission of amended returns until after an OIC acceptance in an effort to circumvent having the refund offset. In this way, the policy operates similarly to the requirement that taxpayers disclose their interest in potential lawsuits and other claims not yet turned into a definite amount at the time of making the OIC. The IRS should receive these monies or at least know about them and make a judgment.
Prior Litigation on This Issue
Carl Smith took on the language when he served as the director of the Cardozo Low Income Taxpayer clinic. Through litigation, the clinic tried to limit the refund offset in the year of acceptance to refunds that were not from refundable credits in Sarmiento v. U.S., 678 F.3d 147 (2d Cir. 2012), and its companion case, Maniolos v. U.S., 469 Fed. Appx. 56 (2d Cir. 2012). At the time, the OIC language stated that the IRS could keep “any refund, including interest, due to [the taxpayer] because of overpayment of any tax or other liability, for tax periods extending through the calendar year in which the IRS accepts the offer.” Carl and the clinic argued that, in the plain English in which the OIC was written (which they argued should apply instead of Codespeak), a refundable credit is not from any overpayment, and the policy reasons for the offset of refundable credits made no sense from both a history and policy perspective. The clinic’s brief stated:
Support for this colloquial-English interpretation is found in the alteration that has happened in the particular language regarding “additional consideration” from the time of the 1964 OIC at issue in Robbins Tire & Rubber Co, Inc. v. United States, 462 F.2d 684 (5th Cir. 1972). The Robbins Tire OIC provided that the United States could retain “any and all amounts of money to which the proponent may be entitled under the internal revenue laws, due through overpayments of any tax or other liability, including interest and penalties, made for periods ending prior to or during the calendar year in which this offer is accepted.” Id., at 686. This prior OIC language —“any and all amounts of money to which the proponent may be entitled under the internal revenue laws”—was later replaced in the version that each of the taxpayers signed with the more colloquial English words “any refund, including interest, due to me/us . . .”
Carl notes that the policy reasons for offsetting refunds from actual overpayments make sense as a means of stopping people from overpaying estimated tax payments in the year of OIC acceptance, just to get the excess back after an OIC is accepted based on assets lowered by the excess payments.
While the policy surprisingly still allows this creative tax planning, the old policy allowed creating planning to avoid having a refund – unless your refund resulted from a refundable credit. In that sense, the new policy just trades off on incentives and, in my experience, a relatively small number of individuals submitting offers engage in this type of planning.
The Second Circuit ruled that the word overpayment in the OIC had to be read as defined in the Tax Code, which included refundable credits. The litigation did cause the IRS to rewrite the OIC form to eliminate the words “because of overpayment”. Carl says that during the litigation the IRS Director of Collection Policy told Carl he was curious about the cases and would be following them. Carl felt the IRS sounded open to the ideas at issue in the litigation, though the IRS eventually did not change policy and in fact made the language more airtight to be able to keep all overpayments.
Offset Bypass Refunds
The NTA’s blog describes OBRs. Something we have done before here in the most visited post of any every written by this blog. The NTA’s blog announces a new policy regarding OBRs and OICs which appeared on the IRS website two weeks ago with little fanfare. If a taxpayer files a return during the time an OIC is pending, the IRS will offset any refund generated by the return up to the amount of the outstanding liability. Previously, a taxpayer with hardship who needed this refund to pay the rent or electricity could not take advantage of the OBR process while the OIC was pending.
OBRs have come under some criticism recently. TIGTA criticized them in a report discussed by Les in a post here. Les and I participated in an ABA Tax Section comment that focused on OBRs and made several suggestions seeking to make them more taxpayer friendly and accessible.
The new policy allows the taxpayer to submit a request for an OBR even while the offer is pending. Like the policy of offsetting refunds described above, it is another step in the right direction for protecting taxpayers and especially low income taxpayers. Under the new policy, the IRS will process the OBR just as if the taxpayer had not filed an OIC. This does not mean that the taxpayer will necessarily receive the refund, or the full amount of the refund, but does give the taxpayer a fighting chance to receive at least a part of the refund during a time of real need.
The NTA’s blog gives an example of how OBRs work. The blog does not cite to IRM provisions regarding the new policy because those have yet to be written. It notes that this process is not well known and not easy to find. The post concludes by saying that TAS is trying to prod the IRS to be more forthcoming about this process:
We continue to encourage the IRS to provide educational material on IRS.gov explaining the benefits of OBRs, the economic hardship requirements, and what taxpayers need to do to timely request an OBR. With the upcoming filing season, we encourage the IRS to get the OBR message out by leveraging its relationships with the public.
No doubt improvements could occur, but I applaud the IRS for acknowledging that taxpayers who have submitted an OIC may need an OBR just as much as those who have not made such a submission. Because the OBR process itself remains difficult and somewhat opaque, I do not expect that this policy change will open the floodgates. It will, however, allow some taxpayers in need to find relief.