In my previous post IRS Offer In Compromise Overview I mentioned that the Offer In Compromise (OIC) is a contract with the government that creates obligations on the taxpayer.  The Form 656-B Offer In Compromise Booklet contains the terms of the agreement between the taxpayer and the government.  I believe the most noteworthy is compliance, and the IRS has begun to approach compliance even more seriously in the OIC context.

The OIC program is part of a larger effort by the government to improve taxpayer compliance.  By settling tax debts for less than the full amount owed, extending payment terms, or not taking collection action, the government resolves outstanding issues and enables the taxpayer to focus on current tax obligations.  This approach has proven largely successful and has been expanded over the years.  I’ve worked with many clients who were afraid to file any returns until they knew that collection could be resolved without causing hardship.

However, the government doesn’t merely facilitate compliance and hope for taxpayer cooperation when accepting an OIC.  It requires compliance.  For five years following acceptance of the OIC, the taxpayer must timely file all tax returns and pay all taxes due.  If a taxpayer fails to meet the obligations of the OIC, the IRS may collect the full amount of tax due before the OIC plus any applicable interest and penalties.

Consequently, I do not recommend the OIC for taxpayers with a pattern of noncompliance, particularly self-employed taxpayers.  If a taxpayer has not consistently made quarterly tax payments in the past, it is difficult to voluntarily comply with a significant new burden.  Hiring a lawyer, going through the long OIC process, getting it accepted, and making a significant payment is a horrible waste of time, money, and energy if the full liability comes back later.

When a taxpayer submits an OIC, the IRS reviews the taxpayer’s account for current compliance.  In the past, if the taxpayer had delinquent returns, the Offer Examiner would request that they be filed.  Any tax periods with a balance due would be added into the OIC to ensure that the taxpayer truly had a fresh start if the OIC was accepted.  This is no longer true.

New Processability Requirement

A collection manager at a recent IRS Practitioner Liaison meeting announced an important change in the OIC program.  The IRS will continue checking for current compliance at the time the OIC is submitted, but will no longer solicit delinquent returns and wait for the OIC to become processable.  Instead, the IRS will keep any payment included with the OIC, apply it toward the debt owed, and return the OIC to the taxpayer as not processable.

If the taxpayer attains compliance after such an OIC is returned and then submits another OIC, the new OIC will have the usual initial payment obligations.  Although the previous payment will have reduced the balance due, it will not be credited toward payment the Offer Amount in the new OIC.  As the change in the balance due should have little to no effect on the Offer Amount (see Overview), the first included payment is effectively lost.

To prevent this loss, taxpayers should be sure they are in filing compliance when making the submission and that they will be in filing compliance at the time the OIC is processed.  Processing times vary, so planning with an experienced representative aware of current OIC and return processing times is best.  This is particularly important for taxpayers considering an OIC while not currently in compliance or anticipating a new liability.

For example, consider a self-employed taxpayer with assessed liabilities for the 2015 and 2016 tax years.  In 2017 he considers an OIC to resolve those debts.   He has failed to make estimated tax payments for the first half of 2017 and does not expect to catch up.  Wildly different outcomes can result from small differences in timing:

1. If the OIC is reviewed for processability after the IRS has processed the 2017 return, the 2017 liability can be included in the OIC. If the OIC is accepted, the taxpayer will be in compliance and all debts will be resolved through the OIC.
2. If the OIC is reviewed after the 2017 return has become due but the return has not been filed, the IRS will return the OIC and keep the initial payment. None of the debts will be resolved and a new OIC with another payment will be necessary.
3. If the OIC is reviewed before the return has become due and before the 2017 tax has been assessed, more possibilities exist:
   • Depending on circumstances, the IRS may recognize that the taxpayer failed to make estimated tax payments and return the OIC for noncompliance or possibly demand the full delinquent estimated tax payments before moving forward. The current published guidance does not reflect the recent changes regarding processability and I’m aware of recent cases inconsistently addressing delinquent estimated tax payments.
   • The OIC may be processed because the 2017 return is not delinquent, but it will not compromise the 2017 liability. The taxpayer would likely experience a roller coaster of tax settlement emotions as the OIC is accepted, breached by the assessment and nonpayment of the 2017 liability, and potentially rescinded.

Under the old rules, Scenario 2 above could have achieved the same great result as Scenario 1.  Under the new rules, it would be disastrous.  Now more than ever, the timing of the OIC determines the liabilities that may be compromised.  The government’s previous policy of soliciting delinquent returns helped taxpayers come into compliance and start with clean slates.  The new processability requirements shift that burden to the taxpayer, expedite OIC processing, and prevent some abuse of the OIC process.  This new policy demands a change in strategy, particularly for taxpayers with foreseeable additional liabilities, and more careful planning.  Familiarity with this issue and other aspects of OIC processing can help develop strategies that reduce the risk of losing a large initial payment and ensure that every accepted OIC brings a fresh start as the program intended.