Offers in Compromise and Tax Refunds – Part Two

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In this post I will review which refunds the IRS will seize to when a taxpayer seeks an OIC, and discuss when the taxpayer has options to keep their refund.  

The rules depend on the type of offer. At the end of Part One, I summarized the four types of offers that a taxpayer can make the IRS to settle their tax debt. This background is important because the danger to the client’s refund depends on the type of offer they are seeking. The possible offers to the IRS are: 

  1. Doubt as to liability (DATL) 
  2. Doubt as to collectibility (DATC) 
  3. Doubt as to collectibility with special circumstances (DATC-SC) 
  4. Effective Tax Administration (ETA) 

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A compromise is a binding contract between the government and a taxpayer. The terms of the contract for DATC, DATC-SC, and ETA offers can be found in the IRS’s Form 656 booklet. For doubt as to liability offers, the terms are in Form 656-L 

Refund Considerations: Pre-Offer 

When a taxpayer owes a debt to the IRS or to certain other agencies, the taxpayer’s refund may be applied to that debt pursuant to IRC 6402. Some taxpayers decide to stop filing as a result. This is generally counter-productive. If a taxpayer waits too long to file, they will lose the refund to the statute of limitations anyway, without receiving any reduction in their debt. Also, the IRS generally requires filing compliance before it will consider any proposal by the taxpayer for a collection process other than full payment or enforced collection.  

Many potential clients call LITCs seeking an Offer in Compromise even though they have unfiled returns. So, the first hurdle is getting the tax returns filed.  

A taxpayer should not have to be in filing compliance for a Doubt as to Liability offer to be processable. Alternatives to DATL – including audit reconsideration and Form 843 claims for refund or abatement – do not require filing compliance. A DATL offer is solely concerned with the correct liability for the tax period in question. Form 656-L lacks language on filing compliance which is present in the general 656 booklet, and a DATL offer does not include a 5-year compliance period post-acceptance. However, Rev. Proc. 2003-71 section 5.04 says that an offer can be returned if the taxpayer fails to file a return, and it does not appear to limit this statement by type of offer. I also found the IRM sections on offer processability unclear on this point. Perhaps I missed the relevant IRM provision, but it appears to me that IRM 5.8.2 could use clarification. Disagreements over processability of an offer are some of the most frustrating in tax representation, since the Service takes the position that its processability decision is not subject to appeal. Rev. Proc. 2003-71, sec. 5.05. I recall LITC reports a few years ago about centralized OIC processors refusing to forward an offer to the specialized DATL unit. If that is still a problem, it would be helpful to have a specific IRM provision on processability of DATL offers. I invite readers to comment on their recent experiences with this. 

Refunds generally don’t “count” towards the taxpayer’s offer 

If refunds are due for any unfiled years, our clients naturally would like the balances to count towards their offer. Taxpayers frequently ask whether they can just offer the IRS their next tax refund, or their refund from an unfiled year. Unfortunately for them, Congress in IRC 7122(d)(1) said that IRS gets to make the rules for the OIC program, and the IRS has decided that offset tax refunds don’t count as payments towards a DATC offer, nor do they reduce the taxpayer’s minimum offer amount for DATC, DATC-SC, or ETA offers. IRM 5.8.1.13.3, Amount Offered states 

The total amount of money offered must be indicated and must be more than zero. The amount offered may not include money already paid, expected future refunds, funds attached by levy, or anticipated benefits from capital/net operating losses. 

This is mirrored in the Form 656 booklet, p. 3.  

However, doubt as to liability offers are different – if IRS agrees that the correct liability should be lower, it will adjust the assessment and refund any excess payments that are within the refund statute of limitations. This is noted in the Form 656-L terms. So in that sense, refunds that have been offset will “count” as payment for DATL offers.  

The policy on not considering refunds as payments for DATC offers seems extremely unfair to most of my clients, but it is a logical policy. When the IRS is accepting less money than it is owed based on “doubt as to collectability,” it naturally wants to consider that refunds should be coming in to the Treasury anyway under section 6402. Taxpayers have filing obligations, and as mentioned above the IRS will not consider making a deal unless those obligations are being met. The taxpayer needs to offer more than that to make a compromise worthwhile for the IRS.  

This policy makes less logical sense when it comes to effective tax administration and DATC-SC. One could incorporate past or imminent refund offsets into the taxpayer’s economic hardship or public policy argument, and propose a lower offer due to the hardship or public policy implications of the offsets. However, this argument needs to be couched in the language of ETA hardship or public policy justifications. (See Part One.) It will not work to simply ask for past refunds to be credited towards the offer.  

There is one exception to the rule that seized refunds don’t count as payments towards an offer (DATC, DATC-SC, or ETA). If a taxpayer would receive their refund in the normal course of events (i.e. it is not due to be offset under the terms of the OIC or for any other reason), they can ask the IRS in writing to apply it to an outstanding offer amount. (IRM 5.19.7.2.21.3, Applying Refunds for Non Recoupment Tax Years.) As we’ll see below, this will mostly be applicable to DATC-SC and ETA offers 

Tax refunds while an OIC is under consideration 

The IRS will offset tax refunds while an offer is under consideration. This applies to all types of offers per the Procedure & Administration Regulations, sec. 301.7122-1(g)(5). This is business as usual for the Service under section 6402.  

Keith has written about circumstances where the IRS will not exercise its right of offset. If a taxpayer is facing serious economic hardship, it may be possible to receive an offset bypass refund (OBR). Taxpayers often ask if this is a possibility when an offer is pending.  

The question then arises whether requesting an OBR might violate the terms of the contract that the IRS requires for an OIC, in which case requesting an OBR could cause the IRS to reject the offer. Form 656-L does not contain any provisions regarding refund offsets. The DATC contract terms regarding offsets are: 

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.  

Thankfully the contract goes on to exclude DATC-SC and ETA offers from those terms: 

The refund offset does not apply to offers accepted under the provisions of Effective Tax Administration or Doubt as to Collectibility with special circumstances based on public policy/equity considerations. 

So taxpayers seeking offers based on doubt as to liability, doubt as to collectibility with special circumstances, or effective tax administration are free to request an OBR to save their refund while an offer is pending. For DATC the question is more complicated and is discussed below under planning concerns and uncertainties 

Tax refunds after an OIC is accepted 

Refund offsets should stop for taxpayers with DATC-SC and ETA offers when the offer is accepted.  Offsets will stop for taxpayers with accepted DATL offers after the agreed-upon correct liability is paid.  

For regular DATC offers, unfortunately, the OIC offset terms extend to the calendar year in which the offer is accepted. The 656 booklet explains on page 1 that  

The IRS will keep any refund, including interest, for tax periods extending through the calendar year that the IRS accepts the offer. For example, if your offer is accepted in 2018 and you file your 2018 Form 1040 on April 15, 2019 showing a refund, IRS will apply your refund to your tax debt. The refund is not considered as a payment toward your offer. 

This can come as a surprise to taxpayers, and it can cause serious hardships. (As we saw above, the DATC offset terms do not apply to ETA or DATC-SC offers.)  

The National Taxpayer Advocate has recognized that multiple refund offsets can cause hardships for low-income taxpayers who rely on refunds to pay basic living expenses. In her 2018 Annual Report to Congress, she designated problems with the OIC program as a Most Serious Problem facing taxpayers. This is particularly concerning where additional refunds are lost because of the time it takes the IRS to process the offer. If an offer is rejected and appealed, Office of Appeals consideration adds an average of 6.5 months in processing time. This can easily push the taxpayer into the next calendar year. To solve this problem as a matter of fairness and to prevent hardship, the NTA recommends that the IRS change its policy to only seize one tax refund while an offer is pending.  

DATC Offer Planning Considerations and Uncertainties  

One way to avoid the standard offset provisions of Form 656 would be to request a “special circumstances” offer. If the offer can be so categorized, you avoid the need to reform or change the OIC contract. As we saw in Part One, an offer for DATC-SC technically requires the taxpayer to offer less than their reasonable collection potential, and to justify this on hardship or public policy grounds. Since calculating RCP involves judgment calls on the value of assets, and can involve judgment calls as to appropriate household income and living expense figures, there may be cases in a gray area between “regular” DATC and DATC-SC. The offset provisions could weigh towards making a DATC-SC offer, depending on the taxpayer’s circumstances.  

Keith gave this very good advice to a commenter on his OBR post: 

One of the “preprinted” provisions of the standard offer in compromise is that the IRS will keep the refund, if any, for the year in which the offer was approved. Because the refund comes months, or sometimes even a year, later the retention of this refund comes as an unpleasant surprise to many who have received relief through an offer. The existence of this provision requires discussion and planning with the client at the time of acceptance to ensure that withholding in the year of offer acceptance carefully matches the anticipated liability. If the client can claim the EITC or other refundable credits, it is usually not possible to adjust withholding in order to prevent a refund yet the money provided by the EITC refund could be critical to the financial success of the individual. Although I have never done it, I am told that it is possible to negotiate concerning this provision when entering into the offer. So, if you anticipate a big refund in the year of offer acceptance and if the refund will be critical to the financial success of the individuals obtaining the offer try at that point to negotiate out of the offer contract the provision allowing the IRS to offset the refund for the year of the offer. If you cannot do that or if it was not done, you can request offset bypass at the time you file the return for the year of offer acceptance but you are asking for something different than offset bypass under the IRS’ ability to waive offset under 6502 you are asking to reform the contract. I have never done this and do not know the chances of success. I expect the IRS would treat it similar to a regular bypass request but am unsure. Consult the IRM.  

I followed that advice and consulted the IRM. Unfortunately, it is not clear to me that it will be possible to reform the DATC contract to allow a refund to reach the taxpayer. Perhaps I missed a relevant provision; if so please let me know in the comments. It should not hurt to call the offer examiner, or call TAS, and inquire.

A taxpayer cannot alter the preprinted DATC conditions up front. IRM 5.8.1.13.5 (05-05-2017) Standard Conditions provides that

If the taxpayer submitted the Form 656 altering any of the provisions of Form 656, Section 7, the offer should be immediately deemed not processable based on an altered Form 656.

In some cases it is possible to make a collateral agreement to an offer. However, the IRM section on collateral agreements appears to foreclose the possibility of using a collateral agreement to get around the refund provisions:

Form 656 contains a term which waives refunds and overpayments for all tax years through the year the offer in compromise is accepted. This waiver is a standard term, which cannot be altered. 

IRM 5.8.6.4 (10-04-2017) Waiver of Refunds 

I also checked the IRM sections on offset bypass refunds, IRM 21.4.6.5.11 (05-07-2018) Hardship Manual Refunds and 21.4.6.5.11.1 (11-08-2017) Offset Bypass Refund (OBR). These do not mention OICs. If you have experience with obtaining a refund through the OBR or another process while a DATC offer was pending or accepted, please share your experience with us in the comments. It is an important issue for affected taxpayers who may be faced with choosing between an OBR to avoid eviction and maintaining their DATC compromise.

 

Christine Speidel About Christine Speidel

Christine Speidel is Assistant Professor and Director of the Federal Tax Clinic at Villanova University Charles Widger School of Law. Prior to her appointment at Villanova she practiced law at Vermont Legal Aid, Inc. At Vermont Legal Aid Christine directed the Vermont Low-Income Taxpayer Clinic and was a staff attorney for Vermont Legal Aid's Office of the Health Care Advocate.

Comments

  1. Charles Zagara says:

    If I file my three years of tax returns still eligible for a refund in January, and in February, before the returns are processed, I file my OIC DATC. Shouldn’t those refunds be an asset and figured into the RCP, and like a bank account or IRA be available to make the offer payment.

    • Guest Blogger Christine Speidel says:

      The refunds are not actually available to the taxpayer because they will never appear in the taxpayer’s bank account. They will be offset – applied against the debt. It is good that expected refunds don’t increase RCP since under IRS policy they don’t count as payments. Essentially the IRS decided to ignore refunds in the DATC calculations rather than include them as assets and then credit them as (involuntary) payments.

      • Richard Gavaghan says:

        Not statutory or procedural, but the contractual refund offset has been bypassed administratively in very limited circumstances for present economic hardship conditions. By present economic hardship conditions, I mean quite literally the difference between; “my utilities are shut off and I will be evicted, to I am evicted here is the notice, I am now homeless.” They do happen, but again very limited and no rhyme to the administrative decision.

        • joel palmer says:

          Richard
          I have lost your number; can you please call me at 215 574 5050 in re; US v Richard Braude Thank you Joel Palmer at Scioli Turco

  2. Burton B. Smoliar says:

    What happens if a return shows an overpayment and asks it to be credited to the next year’s estimated tax?

  3. Norman Diamond says:

    “A compromise is a binding contract between the government and a taxpayer.”

    No it isn’t. If a taxpayer reneges I expect the court would rule against the taxpayer, but when the government reneges the court also rules against the taxpayer. Furthermore the government gets to be represented by the DOJ so the IRS’s position isn’t even considered.

    “When a taxpayer owes a debt to the IRS or to certain other agencies, the taxpayer’s refund may be applied to that debt pursuant to IRC 6402.”

    The IRS can even use offset power to collect a debt that it conceded, and again the IRS’s position doesn’t matter any more after the DOJ gets involved.

    “The total amount of money offered must be indicated and must be more than zero.”

    If a person doesn’t believe they owe an alleged liability, why would they ever do this?

    When I looked at a DATL form, it contained language making the taxpayer concede they owe the alleged debt. Again, why would a person ever sign such a declaration?

    “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.”

    That’s neat, when the IRS uses methods of mailing that are reasonably calculated to be delivered more than 30 days after the date of notification.

  4. Losing tax refunds for five years after an acceptance is dumb. All this does is motivate taxpayers to reduce withholdings so they don’t have a refund in post-acceptance years. But, of course, not paying in enough is what gets most of these people in trouble in the first place. No wonder no one trusts the IRS anymore.

    • The 5-year compliance period is a requirement to timely file and pay all taxes that come due in the 5 years after the offer is accepted. (See page 6 of the 656 booklet) This compliance requirement doesn’t involve seizure of refunds. The refund seizure language is quoted above in the post – for DATC offers the last refund seized is the refund for the tax year in which the offer is accepted. You’re right that it motivates people to minimize their refund for that year.

      • Norman Diamond says:

        Dr. Spradling is also right about “No wonder no one trusts the IRS anymore” and there’s even more to it. A friend received letters from the IRS alleging that he had income from US sources, demanding US tax returns, presumably intending to demand payment of some alleged debt on the basis of alleged US sourced income. After the 1990’s IRS scandal hit Congress the IRS conceded there was no basis for the allegation that he had US sourced income and the IRS stopped bothering him. Other honest people envy his luck.

      • Joe Cole says:

        The one year refund rule makes sense in that taxpayers will sometimes over-withhold on their paychecks in order to get a better chance at an OIC. This can lead to an undeserved windfall for an OIC applicant.

        Tax withholdings are an allowable expenses for OIC purposes. If an OIC applicant increases their withholding by $100 per month, the applicant can reduce their OIC collection potential up to $12,000. ($100 per month x 12 months per year x 10 years on the CSED). Of course higher withholdings can yield greater reductions in an OIC collection potential.

        The one year rule minimizes a windfall an OIC applicant may receive from over-withholding. An OIC applicant can overwithhold all her or she wants during the OIC process, the IRS is going to pocket any refund the applicant may take.

  5. Daniel Kempland says:

    Also worth noting, and something that I don’t feel is always clearly expressed in acceptance letters, is the ability to get the OIC application fee refunded or applied to the offered amount on accepted DATC-SC or ETA offers.

    While many OIC applicants will qualify for the low income fee waiver, non-qualifying applicants are required to submit a $186 fee (current amount) to have their offer processed. If their offer is accepted under DATC-SC or ETA, they are supposed to either have that amount applied to the offered amount, or refunded, at the taxpayer’s direction. See IRM 5.19.7.2.9.6 (08-25-2017).

    This was listed under “Paying for your offer – Application Fee” on the 656 Booklet instructions March 2017 revision, but was removed in the March 2018 revision. The IRM provision still exists however, and representatives should be aware of the option if it is not offered in the acceptance letter.

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