When a taxpayer can’t afford to pay a tax liability in full, Internal Revenue Code (IRC) § 7122 authorizes the IRS to accept less than the full amount due in the form of an offer in compromise (OIC). As a condition of acceptance for an OIC, the taxpayer must agree to remain compliant with his or her filing and paying requirements for the five years following the acceptance of the OIC. So, although the IRS agrees to settle a tax debt for less than the full amount due, the IRS secures future filing and payment compliance for the next five years, hopefully developing better taxpayer habits, while also collecting an amount that it is unlikely to collect otherwise. On the other hand, the taxpayer is no longer saddled with a debt that cannot be satisfied in full.

According to Internal Revenue Manual (IRM) 5.8.1.2.3, unless special circumstances exist, OICs based on doubt as to collectibility will not be accepted if the IRS believes the liability can be paid in full as a lump sum, or by installment payments extending through the remaining statutory period for collection, or through other means of collection. Once the IRS confirms that the taxpayer will not be able to pay the debt in full, the IRS then determines the reasonable collection potential (RCP) for the taxpayer. Generally, the RCP will serve as the basis for an acceptable OIC amount. The IRS defines RCP in IRM 5.8.4.3.1 as the amount that can be collected from all available means. Thus, RCP plays a major role in OIC acceptance.

IRC § 7122 requires two things before an OIC can be deemed processable. First, an OIC submission must include a partial payment – referred to as a “TIPRA payment.” Second, the taxpayer must pay any applicable user fee (unless he or she qualifies for a low income waiver). Additionally, Treas. Reg. § 301.7122-1(d)(1) requires that the OIC be made in writing, be signed by the taxpayer under penalty of perjury, and contain all of the information “prescribed or requested by the Secretary.”

Despite all of the benefits of OICs, I have two concerns with the IRS’s administration of this important program:

The IRS does not always calculate the RCP accurately, sometimes overestimating what it can collect, leading to rejected OICs and lost opportunities to collect revenue; and
The IRS has made recent policy changes which prevent some taxpayers from successfully submitting OICs.

First, I’ve reported here, here, and here that the IRS often focuses on how much it can collect from taxpayers in the OIC program instead of how it can best utilize the OIC program to meet all of its objectives. In 2017, TAS Research analyzed several aspects of the OIC program. Data analyzed by TAS show the IRS secures at least as much (often more) than the offered amount in 60 percent of the OICs it returns or rejects.  However, on average, in the remaining 40 percent of returned or rejected OICs, the IRS only collected a third of the amount offered through subsequent payments. And of those taxpayers who had an OIC returned or rejected from 2009 through 2013, only 30 percent satisfied their tax liabilities.

Additionally, over 40 percent of taxpayers with a returned or rejected OIC between 2009 and 2013 have been deemed by the IRS to be currently not collectible – hardship (CNC), meaning collection of the liability would create a hardship for taxpayers by leaving them unable to meet necessary living expenses. The average OIC amount for a taxpayer in this population was $10,378, whereas the average amount of payment collected by the IRS totaled $2,659.

Clearly, further study of this OIC population is warranted. Perhaps these taxpayers were funding their OICs with money given to them by a friend or family member, otherwise not reachable by the IRS. And even if these taxpayers can only afford “low-dollar” OICs, Congress encourages this. IRC 7122(d)(3)(A) mandates that “an officer or employee of the Internal Revenue Service shall not reject an offer-in-compromise from a low-income taxpayer solely on the basis of the amount of the offer.” The IRS would save resources and provide finality to taxpayers if it worked with taxpayers to perfect OICs instead of rejecting or returning an OIC and then classifying the taxpayer as CNC.

Certainly, some OICs submitted by taxpayers are not sufficient. However, TAS research also shows that if the IRS invests some time and resources into working with a taxpayer to get a successful OIC, the IRS will save resources downstream with its collection efforts. In fact, future filing compliance improves for taxpayers with accepted OICs. TAS research shows taxpayers with an accepted OIC were 16 percent more likely to timely file their tax return than taxpayers who did not have their OIC accepted. Timely filed tax returns conserve IRS resources that otherwise would have to go to the collection of these returns. Similarly, taxpayers who have an OIC accepted by the IRS are more likely to pay their subsequent income taxes. Seventy-two percent of taxpayers with an accepted OIC pay their subsequent income taxes for the five years after the OIC is accepted compared to 52 percent of taxpayers who do not have an OIC accepted. Again, the IRS saves resources if it doesn’t have to pursue a taxpayer for debt collection, not to mention the taxpayer learning good tax habits of filing and payment compliance.

My second area of concern arose in 2016, when the IRS announced that OICs submitted by a taxpayer who had not filed all necessary tax returns (based on internal research) would be returned to the taxpayer as not processable. It used to be that taxpayers would be given a brief window of time to file returns. Furthermore, the IRS now keeps the payments sent with OICs that are returned for lack of filing compliance.

These policy decisions go against the analysis seen in TAS’s recent research. TAS saw that a small number of taxpayers don’t get their OICs done right the first time. Fewer than ten percent of taxpayers “churn,” which means they submit multiple OICs within a six-month period. However, nearly half of the taxpayers who churn ultimately receive an accepted OIC, suggesting that taxpayers are not trying to game the system, but are legitimately seeking an acceptable OIC. When the IRS returns or rejects an OIC and the taxpayer subsequently submits a new OIC, the IRS expends additional resources to rework the OIC when it could have just worked with the taxpayer to avoid the initial return or rejection. This problem is compounded by the fact that the IRS now keeps the payments sent with returned OICs determined to be unprocessable. Yet, if taxpayers lose their payment with a returned OIC, it’s possible they can’t afford to submit a second OIC. Recently introduced legislation will waive the OIC user fee for low income taxpayers, defined as an individual with an adjusted gross income which does not exceed 250 percent of the applicable poverty level.

Given the positive benefits that can result from an accepted OIC, the IRS should study a sample of returned and rejected OICs to figure out what indicators are present to show that the IRS won’t be able to collect more than the offered amount. In particular, this study should look at rejected or returned OICs where the RIS collected less than the amount offered to determine how it overstated its RCP projections. Considering the downstream IRS resources that can be saved, recent changes made to the OIC program make little sense. Instead, the IRS should rethink its current policy changes and instead devote more resources into the OIC program to encourage acceptable OICs, even if it takes some upfront work with taxpayers. Such an approach furthers the taxpayer’s rights to finality, to privacy, and to a fair and just tax system.

Have a question? Contact Nina Olson and the National Taxpayer Advocate Team.

Your comments are always welcome!