New Offer-In-Compromise Policy v. Bankruptcy
Written 6/07/12
By Curt Harrington


It has been years since the IRS freely compromised taxpayer liability routinely for fractions of what was owed based upon a temporary financial setback for the taxpayer. For the past decade the IRS has been tough and unyielding in seeking to reject offers from taxpayers were surely not in a position of having a low "Reasonable Collection Potential" (RCP). I have quipped from time to time that the ideal Offer-In-Compromise ( OIC) candidate of 2011 would be an 85 year old, unemployed, permanently hospitalized individual. However, on May 21, 2012 the IRS announced "new and improved" OIC guidelines. "What does this mean" and how will this affect the decision to try and discharge taxes owed in bankruptcy versus going the "New" OIC route?

Bankruptcy has been the measuring stick against which an OIC potential is measured. It is known that taxes can be discharged in bankruptcy if a number of requirements are met. Generally there are three time periods which must be exceeded at the time of the bankruptcy filing in order to obtain dischargeability.

The first time period requires, the tax year's due date must have occurred at least three years before the bankruptcy filing date. The second time period requires the tax return must have been actually filed two years before the the bankruptcy filing date. The third time period requires the tax to have been assessed 240 days before the the bankruptcy filing date. In addition, where returns were filed late, they still must have been filed before the government had a chance to create a Substitute For Return (SFR). Another prohibition on discharge is that the tax must not have been a payroll trust fund tax or other trust-type tax. Specific other types of taxes may require a more intense analysis.

The tax bankruptcy discharge versus Offer-In-Compromise has another nasty twist. The filing of an Offer-In-Compromise Tolls the third and possibly the first one of the due dates. An offer when made during the 240 day period after assessment tolls it for the time that the offer is pending plus 30 days.

When reconsideration of the OIC is requested or when a Collection Due Process (CDP) hearing is requested, the tolling time for the first (3 year) period is for the time that any request is on appeal and for 90 days thereafter. This is an important reason why any Offer-In-Compromise or Collection Due Process rights hearing should be carefully considered and compared to the bankruptcy option.

This is not to say that other, even more pressing considerations will not come into play in deciding whether or not to file bankruptcy. However the bankruptcy option is severely impacted by the tax practitioner who moves ahead with an OIC or CDP application.

In general, a taxpayer who owes a great deal of tax has a choice to try and survive the IRS collection attempts for a period sufficient for the taxes to be discharged, and compares this option to making an OIC or CDP application. Can the taxpayer survive for the requisite time period to be able to discharge the tax? Or will loss of other assets via the levy and lien process prove too much to bear?

Ignoring non-tax debts, if at the time the taxpayer decides to file an OIC or CDP application, the three time periods bankruptcy have not passed (the tax year is too recent), the filing of the an OIC or CDP application will generally temporarily forestall the passage of time to reach the first and third of those three time periods. A taxpayer often asks themselves if stopping the collection activities through an OIC or CDP application will allow them to actively manage and "catch up" their tax arrearages.

Temporary suspension of collection activity only delays the inevitable restart of the collection process, but with added interest. The chances for OIC or CDP to provide a lasting solution for the typical taxpayer have been small. A taxpayer may be better off to weather the IRS collection process for years and keep the option for discharge of their taxes.

The May 21, 2012 IRS pronouncements about the "new OIC" were made via IR-2012-53 and changes to the Internal Revenue Manual's section 5.8.5. It seems to telegraphs a belief that the economy is not expected to improve in the near term. This at least states a contrast with the IRS previous OIC rules which seemed to operate a policy of "waiting the taxpayer out." The policy seemed to bet that the economy would eventually improve enough that future IRS collections would improve by foreclosing taxpayer's ability to reduce the debt through compromise. The real policy behind the "New OIC" announcement is still subject to speculation. At a recent tax conference only four days after the May 21, 2012 announcement, a territory manager responsible for offers in compromise said nothing other than a mere mention of the new guidelines.

A few of the more significant changes in the announcement are stated as:
(1) If the offer will be paid in 5 or fewer installments in 5 months or less, the computation will use the realizable value of assets plus the amount that could be collected in 12 months;

(2) if the offer will be paid in more than 5 installments or more than 5 months up to a maximum of 24 months, the computation will use the realizable value of assets plus the amount that could be collected in 24 months;


(3) the new computation will eliminate the value of the income producing asset from the calculation of "Reasonable Collection Potential" (to thus not force taxpayers to lose income producing assets responsible for what little income they have); and


(4) the new computation will eliminate "dissipated assets" from the Reasonable Collection Potential, where "dissipated assets" includes assets which "disappeared" through negligence, or spent in disregard of the existence of tax liabilities or spent on "nonessential debts".


Reading these four provisions together, it seems as if the IRS is realizing (1) that liquidating a taxpayers source of self employment income will hurt the economy and do long term damage, (2) that if assets were dissipated that using them to punish the taxpayer by treating them as existing when they do not exist is no longer good policy to pretend their existence to punish the taxpayer, and that (3) offers discounts will be unavailable where there are assets that can drive the value of the offer despite a cash flow which may only slightly cause a positive contribution to ability to pay. Thus, offers which will bear a deep discount with respect to taxes owed will now be available to taxpayers who have no significant assets. It remains to be seen whether the floodgates will open and actually begin taking strict mathematical qualifiers for the guidelines stated off the collection rolls with complete forgiveness.

Taxpayers with no assets and who are marginally employed were the ones most likely to be able to hang on for bankruptcy tax discharge relief. Apartment dwellers with low bank balances or no bank accounts were much less reachable than homeowners with an average magnitude income. If taxpayers with this profile were being culled from the system. Taxpayers with reachable assets would not receive much of an OIC discount and don't have as much more incentive (or chance to qualify) under the new guidelines than they did under the old.

How will the new OIC policies affect taxpayers willingness to use these "new" policies, versus planning toward discharge of delinquent taxes in bankruptcy? Well, taxpayers who are hiding assets will probably come no closer to risking the enhanced scrutiny of the bankruptcy process than simply the regular collection scrutiny of the IRS. Bankruptcy fraud is prosecuted to a much greater extent than tax evasion in part because an application for bankruptcy requires an extremely detailed listing of assets, creditors, and income. In general, the bankruptcy system is more primed to identify and deal with abuse and fraud. Taxpayers with "difficult-to-trace" personal property assets and big tax liabilities are less likely to declare bankruptcy for fear of losing their assets and would not be expected to take advantage of a more "liberalized" OIC system.

However, for taxpayers with (1) no assets, (2) a minimalist income, (3) some ability to make a lump sum settlement and (4) who want to avoid bankruptcy for other reasons, the new guidelines offer some hope. But the taxpayers most likely to pursue the OIC route believe that their fortunes will improve in the short term. An accepted lump sum offer puts them in a position to start afresh very quickly, if they can afford it.

But for those who are uncertain as to whether they will keep their job and/or their ability to remain financially afloat may continue to plan for and continuously evaluate a future bankruptcy that has the capability to simply discharge their taxes. This long range planning coupled with avoidance of bankruptcy tolling the time periods for discharge eligibility of the older tax years will leave the "no-asset taxpayer" in better control of their destiny because it extends and more importantly "expands" the option period to choose between bankruptcy and the IRS options.

From a systems standpoint, rather than dissuade taxpayers prone to tax discharge in bankruptcy, the new IRS guidelines seem to be providing an early "out" to taxpayers who would likely not use the tax discharge in bankruptcy anyway. However, electing the IRS administered OIC and CDP routes will delay a taxpayer's ability to choose the tax discharge in bankruptcy option by prolonging the wait for each tax year in which the OIC is elected. The prolongation is for the third time period when the OIC is pending plus 30 days (240 day assessment time period). Further, if the taxpayer asks for reconsideration of an OIC rejection (very tempting), it constitutes "an appeal" of sorts and the further time tolls both the 240 day assessment time period and also the 3-year third time period (tax year's due date must have occurred at least three years before the bankruptcy filing date) during the pendency of the "appeal" and 90 days thereafter. A taxpayer could thus easily add two years to the minimum 3 years for the 3-year third time period.

Assuming that the IRS is serious about offering and quickly processing offers, the advantage of the IRS administered OIC and CDP routes involves an ability to get rid of recent years' tax liability, which can be difficult using bankruptcy. Why? One who plans for a complete tax "fresh start" must keep current with more recent tax years and continue to move forward in time while making voluntary contributions which are designated to pay down more recent tax years (while avoiding IRS collection procedures in which the IRS uses its discretion to satisfy the oldest tax liabilities first). Put another way, when a taxpayer voluntarily makes spot payments to the IRS, the taxpayer can elect to have those payment designated to more recent tax years which are nondischargeable when the payments are made, and preferentially avoid paying down the older tax year bills which are dischargeable .

This last piece of the puzzle enables a more complete snapshot of the taxpayer with a heavy tax debt experiencing a "wait and see" management of his tax debt as the taxpayer moves into the future. The first priority is to try to keep current on new tax years while the older tax years are allowed to move, by passage of time, into the past and beyond the three year threshold in order that they become dischargeable in bankruptcy. The second priority is to apply any excess money payments to the IRS explicitly toward the most recent tax year in which taxes are owed so that the oldest tax years will not be paid down as they slip into the dischargeable past. A third priority is to make regular small payments on these recent tax years to help blunt any realistic charge of tax evasion. Finally, the taxpayer will periodically evaluate each month: (1) how much is needed to live, (2) how much is owed for older tax years which can be discharged in bankruptcy, (3) how much is owed for the more recent years' tax which cannot be discharge in bankruptcy, (4) how much of their earnings can be committed to paying down the more recent tax years' tax, (5) how much other, non-tax related, debt needs to be discharged in bankruptcy, & (6) whether the taxpayer is eligible for, and can afford the cost of, a chapter 7 or 13 or 11 bankruptcy.

There are many other factors which can dictate the whether a given taxpayer needs the relief of bankruptcy much sooner than a time before all of the tax debt is dischargeable in bankruptcy. If this is the case, and if bankruptcy is declared prematurely the more recent years of taxes owed will become permanently nondischargeable. This makes the decision analysis much more complicated, and exploration of various cases is beyond the scope of this simple comparison. However, where tax is the only debt owed and where the taxpayer can survive until all the tax debt becomes dischargeable is highly dependent upon on personal circumstances.

Further, a taxpayer's mix of additional non-tax debt can cause a taxpayer to file early to get rid of such debt as a benefit, and against the liability of leaving a nondischargeable tax debt which must be paid off over time, typically after the bankruptcy discharge is granted. But a good analysis is an often revisited one, and the tax-debtor should look at the rewards of struggling to make it to the deadline which moves, over time, each most recent year's taxes owed from the nondischargeable status and into a dischargeable status. Successful planning can make the difference between a "fresh start" with a "clean slate" versus merely a "timeout" and a further period of "being behind". 

 

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