The last article in this series on dealing with the Collection Division addressed Installment Agreements — arrangements through which tax debts can be resolved by means of monthly payments. Some folks, however, owe so much that an installment agreement is not a practical solution. Interest and penalties can accrue so quickly that the liability actually increases, despite the monthly payments. For such clients, one option often considered is an “Offer in Compromise.”

Statutory authority.

The IRS’s authority to accept compromises in full settlement of tax debts is found in IRC sec. 7122. There are only two statutory grounds for such compromises — “doubt as to liability” and “doubt as to collectibility.” Compromises premised on doubt as to whether the underlying tax is properly owed are handled by the Examination Division. We will focus on offers based on doubt as to collectibility, which are presented to and investigated by the IRS Collection Division.

The IRS’s reasons for entertaining and accepting Offers in Compromise are explained succinctly in Policy Statement P?5?100:

The Service will accept an Offer In Compromise when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects collection potential. An Offer in Compromise is a legitimate alternative to declaring a case as currently not collectible or to a protracted installment agreement. The goal is to achieve collection of what is potentially collectible at the earliest possible time and at the least cost to the government.

This statement of policy provides a frame of reference by which the Service’s procedures and standards for evaluating offers can be more readily understood.

A history lesson.

There have been radical shifts in the Service’s attitude toward Offers in Compromise over the years. Prior to 1992, it was nearly impossible to convince the IRS to exercise its statutory authority to compromise tax liabilities. The Service was roundly criticized by Congress and taxpayer advocates for its refusal to enter into reasonable compromises, and for its inability to control the ever growing number and magnitude of delinquent accounts.

As a result of this criticism, on February 26, 1992, the IRS issued a new Internal Revenue Manual section dealing with offers. This signaled the start of what would turn out to be the Gold Age of the Offer in Compromise. Under the old rules, Collection Division personnel were discouraged even from informing hard-pressed taxpayers of the Service’s authority to compromise tax debts. But under the new IRM provisions, employees were directed to “discuss the compromise alternative with the taxpayer and, when necessary, assist in preparing the required forms.” As a result of the new liberalized attitude, acceptance rates and the number of offers filed both increased.
Unfortunately, however, there were wide variances in the administration of the Offer in Compromise program in different parts of the country. Some practitioners, aware of these disparities, lobbied the IRS for more uniformity. At the same time, the system was being overwhelmed by the increasing number of offers. For these reasons the Service wanted to bring more efficiency and uniformity to the offer evaluation process. The result was yet another major change in policies and procedures. On August 29, 1995, the IRS adopted a system of local and national “standards” for the evaluation of a taxpayer’s “ability to pay,” and dividing expenditures into categories of “necessary expenses” and “conditional expenses.” This was discussed in detail in my last article on the subject of negotiating installment agreements because the standards used for determining ability to pay are the same. I explained in that article that these new expenditure classification and allowance standards make it more difficult to negotiate reasonable installment agreements. And they have the same effect on Offers in Compromise, often pushing the amount the IRS will accept beyond the reach of many taxpayers who might have fared better under the old procedures. These standards, however, represent the current environment. Thus, in drafting Offers in Compromise for our clients, we must deal with the rules as the IRS has defined them.

Inclusion of all tax liabilities.

As a preliminary matter, note that an Offer in Compromise must include all of the taxpayer’s liabilities. Thus, it is often necessary to bring about the assessment of any taxes which could otherwise be assessed in the future. For income taxes, any unfiled returns must be prepared and filed so that the full liability is known. And for withholding taxes or trust fund recovery penalties, assessments must be made for all quarters for which the client is potentially liable. Furthermore, if there are unfiled returns the IRS typically will not consider the offer anyway because the taxpayer is not in “current compliance.”

Forms to be submitted.

An Offer in Compromise is filed using IRS Form 656, accompanied by Form 433-A and/or 433-B. Guidance for properly completing these forms can be found in the instructions, in IRS Pub. 1854, and in IRM 57(10)6.1. If a computer generated Form 656 is used, the taxpayer must initial each page certifying that it is a verbatim duplicate of the official form.

The IRS is currently working on a new version of Form 656. A controversial draft of the new form would have required the preparer to sign along with the taxpayer, certifying under penalties of perjury that he or she had “examined” the Offer and related documents, and that the information presented therein was true and correct to the best of the preparer’s knowledge and belief. When presented at the AICPA Tax Division Annual Conference in late October, this draft produced a storm of protest, and in response the IRS quickly abandoned the idea of requiring the signature of anyone other than the taxpayer.

Cash versus deferred payment offers.

The Service prefers cash offers. A “Future Income Collateral Agreement” (Form 2261) was once required for most Offers in Compromise, but is now rarely used. Today, the IRS only wants cash on the barrelhead. If the taxpayer can’t fund a lump sum offer, and must by necessity deal with the taxes through monthly payments, the Service may permit an Installment Agreement, but generally will not agree to an Offer in Compromise. A cash offer means anything up to paying 90 days after notification that the offer has been accepted. Deposits are encouraged, but not required.

Nevertheless, despite the Service’s strong preference for cash offers, if your client simply can’t come up with the money, you should know that the Internal Revenue Manual does permit the acceptance of offers with deferred payment periods of up to two years:

(3) A deferred payment offer is one where any part of the amount offered is to be paid at any date(s) more than 90 days after acceptance of the offer. As a general rule, deferred payment should not be extended beyond two years. . .

(a) A longer or shorter period of time may be acceptable if extraordinary circumstances exist and are documented in the case file. However, regions or districts may not establish a general rule to require payment within a specific time frame.

(b) If the amount of the offer is acceptable and will be paid within two years, an offer will not be rejected unless exceptional circumstances are clearly documented which establish why a shorter period of time for payment is appropriate. . .

(4) The terms of a deferred payment offer should be precisely stated so there can be no doubt as to the taxpayer’s intent if the offer is accepted.

A deferred payment offer is much harder to sell than a cash offer. But if the taxpayer’s circumstances require, you may be able to use the above-quoted IRM provision to good advantage.

The “processability” determination.

After submitting the required forms, the first obstacle is the “processability” determination. To control the workload of the few Revenue Officers in each district trained as “offer examiners,” an offer package is given an initial screening to determine if it warrants further consideration. The large number of offers which the IRS sends back as unprocessable has been a source of great frustration. The IRS asserts that many offers are not presented in processable condition because taxpayers don’t understand the offer process, or don’t fill out the required forms in accordance with the instructions, or don’t provide the necessary supporting documentation. Some practitioners suspect, however, that the Service uses “processability” as a cover to reject offers on their merits, while keeping acceptance statistics artificially high (i.e. by excluding many offers from the “rejected” column by asserting they were incomplete or in some other way deficient.)
IRM 57(10)9.1 outlines the circumstances in which an offer will be considered unprocessable. They include the following:

(a) The taxpayer is not identified.
(b) The liabilities are not identified.
(c) No amount is offered.
(d) Appropriate signatures are not present.
(e) Financial statement is not provided.
(f) The offer “does not reasonably reflect net equity in assets” and the amount “recoverable from future income sources.”
(g) An obsolete version of Form 656 has been used.
(h) Terms have been altered or deleted.

In theory, local IRS offices are not permitted to deviate from the published processability criteria without National Office approval.

One advantage of this initial screening is that it provides an opportunity for the correction of any real defects in the offer package. There is also, however, a less obvious benefit. The fine print on the Form 656 points out that the normal ten year statute of limitations on collections is extended for the period the offer is pending, plus one year. However, this suspension does not begin until an IRS employee signs the offer and fills in the date on the “waiver” portion of the Form 656. If the offer is unprocessable, it is returned before the waiver is signed. Accordingly, an unprocessable offer does not extend the statute of limitations.

On the other hand, when an Offer in Compromise is returned as unprocessable, the taxpayer is denied the opportunity to plead his case to the IRS Appeals Office. If the offer package is incomplete or deficient, it is appropriate that there be a mechanism for its correction so that determinations are only made on the basis of complete and proper documents. However, when the processability determination is used as a back door way to reject an Offer in Compromise on its merits without giving the troublesome taxpayer the right to appeal, it is an odious and pernicious abuse of power.

Determining the amount to offer.

Obviously, the key question in an Offer in Compromise is the amount the taxpayer will have to pay. Procedural shortcomings in the documents can be overcome. But if the amount offered is not enough, nothing you can say will cause the IRS to accept it. Simply stated, to be acceptable the amount must represent the present value of the Service’s maximum reasonable collection potential. Again, the Manual (at IRM 57(10)(10).1) provides invaluable information about how the Service approaches this determination:

(1) An offer is adequate if it reasonably reflects collection potential. An acceptable offer is made up of the following components: (a) the amount collectible from the taxpayer’s assets; (b) the amount collectible from the taxpayer’s present and future income; (c) the amount collectible from third parties, e.g., trust fund recovery penalty and transferee; and (d) the amount the taxpayer should reasonably be expected to raise from assets in which he or she has an interest but the interest is beyond the reach of the government. For example, property located outside the U.S. or property owned by tenancy by the entirety.

(2) The starting point in the consideration of an offer submitted based on doubt as to collectibility is the value of the taxpayer’s assets less encumbrances which have priority over the federal tax lien. Ordinarily, the liquidating or quick sale value of assets should be used.

Quick sale value is defined as a value greater than forced sale value. In turn, forced sale value may be no less than 75% of fair market value. Nevertheless, any discount you can support with cogent evidence should be claimed, and the computation explained in the Form 433-A and supporting documents. The “minimum bid” amount may be used to approximate quick sale value. The minimum bid amount can be determined with IRS Form 4585 (Minimum Bid Worksheet).

The IRS requires that all assets be considered in determining collectibility. Importantly, this includes even assets against which the Service could not take enforcement action. A source of frequent problems is the demand that where only one spouse is liable for the tax at issue, the amount to be offered must include the value of tenants by the entireties real estate, even though the Service readily concedes it could not reach such property through levy and distraint action. IRM 57(10)(13).92 provides the IRS’s justification for this position, as well as guidelines for its application:

(1) . . . It is reasonable to expect that if a taxpayer wishes to compromise a tax liability, the taxpayer should be asked to include in the amount offered at least a portion of the amount accessible to the taxpayer but unavailable to the Service for collection action.

(2) In the consideration of real estate and other related property held by tenancy by the entirety, where the assessment for the liability is made against only one spouse, the starting point for negotiations will be 50% of the net equity in the property. The revenue officer or offer examiner must apply the facts of the specific case to determine whether a lesser percentage is appropriate. In any case, a minimum of 20 percent and a maximum of 50 percent of the equity must be included in arriving at an acceptable offer in compromise.

You may be told that district policy requires including at least 50% of the value of jointly held real estate. To respond, point out that 50% is merely a suggested starting point, that the Manual provides authority for including as little as 20% in appropriate circumstances, and that local office deviations from these standards are prohibited without National Office approval.

As indicated above, the Service also considers the amount collectible from the taxpayer’s future income. The Manual requires that in evaluating future income, “the taxpayer’s education, profession or trade, age and experience, health, past and present income will be considered,” and that in determining necessary living expenses,” the procedures in IRM 5323 will be used.” Since these standards were extensively discussed in my previous article, they will not be presented in detail here. Suffice it to say, however, that determining “allowable” living expenses in the manner most favorable to your client requires the preparation of Form 433-A in strict yet creative compliance with the IRM 5323 standards.

Once the taxpayer’s ability to make monthly payments is determined, the present value of those potential future payments must be ascertained. Remember, what we’re looking for is the total present value of the IRS’s collection potential, both from assets and from future income. If the amount offered exceeds this figure, the offer has at least a chance of being accepted. But if it doesn’t exceed this amount, the offer will be rejected. To translate future monthly payments into a present value figure, the IRS starts with what the taxpayer could pay over 60 months, and then discounts this stream of payments to present value. The interest rate to be used in making this discount computation is the rate charged by the Service on tax delinquencies as of the date the computation is made. This multiplier effect underscores the importance of carefully computing and negotiating the monthly ability to pay. A reduction of $100 per month in ability to pay translates into a reduction of approximately $5,000 in the amount the taxpayer would have to offer in order for his compromise proposal to be favorably considered.

Compromising employment taxes.

Compromising employment taxes presents special problems. Offers in Compromise are frequently considered in these cases for two reasons: First, the magnitude of the liability, even for a small employer, can be staggering. Second, unlike income taxes, employment taxes, and the related trust fund recovery penalty, cannot be discharged in bankruptcy, and thus bankruptcy is not an option.
Unfortunately, the Service’s policies often make it hard to compromise tax liabilities of this nature. If the business in question is still operating, the IRS normally will not accept an offer for an amount less than the tax, exclusive of penalties and interest. Nevertheless, if the taxpayer shows an ability to stay current, and the IRS can be convinced that the offer is in the best interest of the government, an Offer in Compromise for an amount less than the tax can be accepted, as long as it reasonably reflects collection potential.

Public policy considerations.

Some situations raise special “public policy” considerations. Unlike everything else the IRS does, the acceptance of offers is subject to public disclosure. The IRS believes that voluntary compliance with the tax laws could be adversely impacted by accepting Offers in Compromise from certain taxpayers in certain situations. IRM 57(10)1.3 explains the IRS’s position that offers may be rejected as contrary to public policy, “even though it is shown conclusively that the amounts offered are greater than could reasonably be collected in any other manner.” The Manual also states, however, that “a decision to reject an offer for public policy considerations should be extremely rare,” and that it should be made “only where a clear and convincing case can be made that public reaction to the acceptance would be so negative that future voluntary compliance by the public would be diminished.”

One such situation often encountered involves tax liabilities arising due to fraud. Revenue Officers will sometimes assert that such liabilities may not be compromised. The Internal Revenue Manual, however, states that “an offer will not be rejected solely because a taxpayer was criminally prosecuted for a tax or non?tax violation.” Nevertheless, an offer may be rejected “when it is suspected that the financial benefits of the criminal activity are concealed or the criminal activity is continuing.”

For similar reasons, the Service routinely rejects Offers in Compromise from taxpayers who work for the federal government. Again, there is no flat prohibition on acceptance of such offers, but the Manual states that “based upon public policy considerations, acceptances should be rare.” This is a particularly important consideration for practitioners here in the Washington metropolitan area with its large number of federal employees.

Recourse to the Appeals Office.

As noted above, if an Offer in Compromise is rejected (after being deemed processable and investigated), the taxpayer has the right to an independent review by the IRS Appeals Office. The IRS Pattern Letter used to communicate the rejection of the offer explains that a review by the Appeals Office may be sought by filing a written protest within 30 days. New information presented with the protest will be evaluated initially by the offer examiner. This may result in the examiner agreeing to accept the offer. Usually, however, the protest and the case file are simply forwarded to the Appeals Office.

In addition to preparing the rejection letter, for all rejected offers the examiner is required to prepare a Form 1271 (Rejection or Withdrawal Memorandum) and an accompanying narrative report explaining the reasons for the rejection:

A brief report outlining the reasons for rejection must accompany Form 1271. If the offer was based on doubt as to collectibility, the facts as to collectibility must be set out in sufficient detail including the amounts and term determined to be acceptable, so that the information can be used both for further collection action and as a basis for discussion of the case in the event the rejection is appealed. IRM 57(10)(17).3(1).

The IRS does not routinely send this report to the taxpayer. However, given its obvious value in preparing for an appeals conference or fashioning a new offer, every effort should be made to secure a copy, either directly from the offer examiner or through a Freedom of Information Act request.

If a deposit was made with the offer, upon rejection it will be refunded (without interest) unless the taxpayer authorizes it to be applied to the tax liability. A Form 3040 (Authorization to Apply Offer in Compromise Deposit to Liability) must be signed by the taxpayer in cases where the deposit is to be applied.

Effect of acceptance.

An Offer in Compromise is a contract. It is conclusive and binding on both the IRS and the taxpayer, and precludes further inquiry into the matters it covers. In the absence of fraud or mutual mistake, the courts have denied either party recovery of any part of the consideration given. However, an offer which was accepted under a mutual mistake as to a material fact, or because of false representations about a material fact, may be set aside.

In addition to the main terms of the offer — the taxpayer’s agreement to pay the amount offered and the IRS’s agreement to accept it in full settlement of the tax liability and to release any previously filed liens — the Offer in Compromise contains other boilerplate promises. The most important of these is the promise to stay in full compliance with all tax obligations for five years. Failure to file tax returns or pay tax can result in the retroactive termination of the offer, and the resurrection of the tax liabilities. In addition, the taxpayer agrees to the offset of any refunds due for prior years and for the tax year during which the offer is accepted. If the IRS computer mistakenly sends out a refund check, the taxpayer must return it. Failure to do so is a violation of the terms of the offer, and may result in its revocation.

Renegotiating accepted offers.

Sadly, it is not unusual to push an offer through to acceptance, only to find that the client can’t come up with the money to pay the amount offered. Why? Sometimes through negotiation the IRS increases the amount beyond what the taxpayer can afford. And sometimes the Service takes so long to evaluate the offer that circumstances have changed and the taxpayer can no longer raise the money through borrowing or selling assets. In these situations, it is possible to renegotiate an accepted offer. No special form is required. Instead, a proposal to renegotiate an accepted offer is made by letter explaining the circumstances requiring the change. The renegotiated amount must be paid in full before the proposal will be accepted. The standards applied by the IRS in evaluating a renegotiation proposal are similar to those applied to the initial evaluation of an offer.

IRS Restructuring and Reform Act.

Among its many new taxpayer protection provisions, the IRS Restructuring and Reform Act of 1998 makes several changes applicable to Offers in Compromise (some merely codifying existing IRS practice). The more important changes are the following:

First, the Act prohibits levies while an offer is pending, and for 30 days following rejection. Furthermore, this prohibition continues during the period an appeal is pending. Prior to the Act, the IRS usually withheld collection action while an offer was pending, but was not required to do so.

Second, the IRS is directed to develop guidelines and publish schedules of national and local allowances providing adequate means to cover basic living expenses. This, of course, was done in 1995. But the Act also directs the Service to develop guidelines for Revenue Officers to use in determining whether the published national and local schedules are adequate for the particular taxpayer. Congress was concerned that the rigid application of the local and national standards inappropriately made offers unavailable in some cases. It is hoped that this will restore some of the flexibility which was taken away by the imposition of the local and national standards.

Third, the IRS is directed to conduct an independent internal administrative review of any rejected Offer in Compromise before the taxpayer is informed that the offer is to be rejected. Whether this will make any practical difference depends on how the IRS implements this new procedural requirement.

Fourth, the Act protects one spouse from having an accepted offer rescinded because of the subsequent noncompliance of the other spouse. As noted above, one condition of an offer is that the taxpayer stay in full compliance for five years after acceptance. The Act provides a mechanism for the reinstatement of an offer as to the spouse who remains in compliance.

Fifth, in the accompanying Committee Report, the Congress expressed its desire that the IRS adopt a liberal acceptance policy for Offers in Compromise to provide an incentive for taxpayers to continue to file tax returns and pay their taxes. No standards are given, so we will have to await the IRS’s response to this statement of Congressional intent to see the extent to which it causes an increase in the offer acceptance rate.

Finally, the most important aspect of the IRS Restructuring and Reform Act as it affects Offers in Compromise is increased taxpayer access to appeals consideration in the face of threatened collection action. Effective 180 days after enactment, the Act prohibits levy and distraint action unless the Service has first issued a “Notice of Intent to Levy,” similar to that currently required by IRC ƒu6331(d). For 30 days thereafter, the taxpayer may demand a “pre-levy hearing” with the IRS Appeals Office. At this hearing the taxpayer may challenge the appropriateness of threatened collection actions and present “alternatives,” including an offer in compromise. Accordingly, one approach in representing a taxpayer faced with threatened levy action will be to propose an Offer in Compromise at a pre-levy appeals hearing. This will undoubtedly have the effect of increasing the number of offers filed.
Conclusion.

More than 40 years ago the Offer in Compromise was authorized by Congress to give taxpayers a “fresh start,” but for most of this time relatively few taxpayers seeking to invoke this procedure have actually obtained relief. Congress has now expressed its desire that acceptance policies be liberalized, and has given taxpayers increased opportunities to thwart more aggressive collection actions on the part of the Service. Thus, we can anticipate greater use of Offers in Compromise in the future. A detailed knowledge of the process may prove extremely useful in representing clients who find themselves saddled with tax liabilities exceeding their ability to pay.
About the Author: Mr. Haynes is an attorney with offices in Burke, VA, and Burtonsville, MD. Until 1981 he was a Special Agent with the IRS Criminal Investigation Division, and in 1980 was named “Criminal Investigator of the Year” by the Association of Federal Investigators. He specializes in civil and criminal tax disputes, tax collection matters, and the tax aspects of bankruptcy and divorce.

He is on the Editorial Board of the Maryland Society of Accountants, and writes a series of articles for “The Freestate Accountant” on dealing with the IRS Collection Division. Many of Mr. Haynes’ articles are in the Author’s Row section of the tax website unclefed.com. These include articles in IRS liens, installment agreements, innocent spouse issues, offers in compromise, IRS appeals, the ability of the IRS to reach pension assets and jointly owned real estate, and using bankruptcy to discharge tax debts.

Mr. Haynes has taught accounting, tax and business law as an adjunct faculty member at Towson State University and the University of Maryland. He lectures frequently to professional groups on various aspects of dealing with the IRS. He can be reached by email at bjhaynes@erols.com

One of the tasks most frequently faced in representing clients before the IRS Collection Division is negotiating an “installment agreement” — an arrangement under which the taxpayer makes monthly payments against the outstanding tax debt, free of the threat of levy and distraint action. Despite the Service’s imposition of a system of miserly national and local expense “standards” in August 1995, there is still considerable room for effective advocacy. Furthermore, the new IRS Restructuring and Reform Act of 1998 will make changes to the negotiation and legal consequences of installment agreements, and place greater emphasis on their use. In this article we will explore the present rules for installment agreements, as well as the changes we can expect as the IRS digests and implements the new law.

Identifying the objective.

As Revenue Officers are fond of saying, the IRS is not a bank. And unless there is no reasonable alternative, the Collection Division will not accept a monthly payment agreement. In many cases, however, there simply is no reasonable alternative. The task then becomes one of getting the client the best possible deal. This requires an understanding of the client’s objectives.

For some clients, the goal is the full payment of the taxes as quickly as possible to minimize interest and late payment penalties. Other clients, however, have managed to create tax liabilities so large that full payment is simply not in the cards. These poor souls must look toward the expiration of the statute of limitations, the resolution of the liabilities through the offer in compromise process, or the discharge of the taxes in bankruptcy. For them, an installment agreement is only an interim solution, and the objective is usually negotiating the smallest monthly payment the IRS will accept. Not surprisingly, the IRS’s goal is exactly the opposite — the Revenue Officer wants the largest monthly payment the taxpayer can afford.
Current compliance.

A prerequisite to any installment agreement is “current compliance.” This is IRS jargon meaning that all required returns have been filed, and that the taxpayer is on a pay-as-you-go basis for current period taxes. For business taxpayers, the Service will demand proof that current payroll tax deposits are being made on a timely basis. For individuals, there must be evidence of adequate withholding from the taxpayer’s wages or compliance with the obligation to make adequate estimated tax payments. A taxpayer who is piling new liabilities on top of old ones is said to be “pyramiding” in IRS-speak. A Revenue Officer will more likely be thinking about putting such a taxpayer out of his misery, rather than allowing him to make monthly payments against the delinquency. Particularly for business taxpayers, the pyramiding of withholding taxes precludes any relief from the onslaught of levies and seizures. You will get much farther on your client’s behalf in discussions with a Revenue Officer by focusing first on current compliance. Indeed, by using the IRS’s own terminology and showing that you understand the importance of current compliance, you will demonstrate that you know what you’re doing, and that you are trying to make the Revenue Officer’s task easier. Revenue Officers have the worst job in the IRS, and most appreciate working with a courteous and professional representative who understands the demands and standards the system imposes upon them.

Collection Information Statements.

Being a bureaucracy, the IRS naturally has its own forms for everything. In dealing with a Revenue Officer the Rosetta Stone is the “Collection Information Statement.” There are two versions: Form 433-A for individuals, and Form 433-B for businesses. The single best way to help a client with a tax collection problem is to assist him in completing these forms accurately and with full substantiating documentation. Every number shown must be correct and substantiated, not only because the form is signed under penalties of perjury, but because an incomplete or inaccurate form will destroy your credibility with the Revenue Officer.

Sources of information.

Because of the need for complete accuracy in preparing Forms 433-A and 433-B, for new clients it is helpful to obtain copies of any such forms previously filed. You can make this request (after filing the required Power of Attorney form) directly with the Revenue Officer handling the case. If no Revenue Officer is assigned, consider filing a Freedom of Information Act request with the District Disclosure Officer.

While we’re on the subject, in all new cases you should also obtain from the IRS complete IMF or BMF “transcripts” for all relevant tax periods. These transcripts will give you details on every transaction for each tax period, including assessments of tax, penalties, and interest, payments, refunds and refund offsets, lien filing dates, statute of limitations extensions, and a host of other invaluable information. Knowledge is power, and you need to know at least as much about your client’s accounts as the Revenue Officer with whom you are dealing.

Selling or borrowing against assets.

Forms 433-A and 433-B include balance sheets, requiring a taxpayer to list all assets and liabilities. Before discussing a client’s ability to make monthly payments from future income, the Revenue Officer will want to talk about selling or borrowing against assets. An installment agreement is allowed only if the taxpayer has no ability to liquidate or borrow against assets to pay or reduce the liability. The IRS “Collecting Contact Handbook” gives explicit instructions to Revenue Officers about how to approach these issues:

Analyze income and assets to determine ways of liquidating the account. Your goal is to collect the tax liability as quickly as possible. Follow these steps:

1. If the taxpayer has cash equal to the tax liability, demand immediate payment.

2. Otherwise, consider other assets which may be pledged or readily converted to cash.

3. Consider unencumbered assets, equity in encumbered assets, interests in estates and trusts, lines of credit from which money may be borrowed, and the taxpayer’s ability to get an unsecured loan.

4. If there are assets with value and a taxpayer is unwilling to raise money from them, consider enforcement.

5. If there appears to be no borrowing ability, ask the taxpayer to defer payment of other debts to pay the tax.

By being aware of what the IRS expects the Revenue Officer to do, you can be prepared to meet these questions in a manner designed to achieve the most favorable result for your client.

With respect to assets, there are two critical issues: ownership and valuation. Form of ownership is particularly important in a case where the assets are jointly owned, and yet only one spouse is liable for the tax. Maryland, D.C. and Virginia follow the majority rule in offering a high degree of protection for “tenants by the entireties” property. No creditor, not even the IRS, can reach tenants by the entireties property to satisfy one spouse’s separate debt. Similarly, partnership property cannot be reached to satisfy the personal tax debts of a partner. Most Revenue Officers understand these rules, but some do not.

Valuation offers many opportunities for creative advocacy. It is important that the Form 433-A or 433-B and accompanying materials adequately and fairly present the net amount which could be realized from a sale of the client’s assets. Thus, the sale of investment securities might result in a current period tax, which would reduce the net after-tax proceeds. A premature withdrawal from an IRA or qualified pension plan could result in a penalty in addition to a current period tax. A sale of the client’s house could require closing and brokerage costs, again reducing the realizable value. All of this can and should be explained in the Collection Information Statement. For a large asset, such as a residence, it may be quite helpful to obtain an appraisal. (Explain to the appraiser that you are looking for a forced or distress sale value, since that more closely reflects what the IRS itself would get if it seized and sold the property.) The costs attendant to moving and securing new housing are also relevant in presenting the net amount realizable from residential property.

Income and expenses.

Having demonstrated current compliance, and addressed the question of ability to pay by selling or borrowing against assets, you will finally be in a position to talk about the client’s monthly income and expenses in an effort to determine the required monthly installment payment. This discussion, however, will be very much constrained by the standardized expenditure allowances which the IRS imposed in August 1995 to force more uniform analysis of financial information in collection cases. Under this system, expenditures are divided into “necessary expenses” and “conditional expenses.” The IRS publishes tables, based on income level and family size, for three categories of necessary expenditures: “national standard” expenses, housing expenses, and transportation expenses. In computing ability to pay, necessary expenses are allowed whether or not the proposed installment agreement would result in full payment in three years. Conditional expenses, however, are allowed only if the tax liability, including projected appeals, can be paid within three years. The IRS Collecting Contact Handbook contains the following discussion of these expense categories:

Necessary expenses. These must meet the necessary expense test: provide for a taxpayer’s and his or her family’s health and welfare and/or the production of income. The expenses must be reasonable. The total necessary expenses establish the minimum a taxpayer and family need to live. Three types of necessary expenses are:

A. National Standards. These establish standards for reasonable amounts for five necessary expenses. Four of them come from the Bureau of Labor Statistics Consumer Expenditure Survey: food, housekeeping supplies, apparel and services, and personal care products and services. The Service has established standards for the fifth category, Miscellaneous.

B. Local Standards. These establish standards for two necessary expenses: housing and transportation. Utilities are included in housing.

C. Other. Other expenses may be allowed if they meet the necessary expense test. They must be reasonable in amount. Since there are no nationally or locally established standards for determining reasonable amounts, you must determine whether the expense is necessary and the amount is reasonable.

Conditional expenses. These expenses do not meet the necessary expense test. However, they are allowable if the tax liability, including projected accruals, can be fully paid within three years.

So-called necessary expenses up to the amount of the national and local standards are always allowed in computing installment agreements, although technically the Revenue Officer could disallow those expenses which are not “reasonable.” This does not mean, however, that you should give up on necessary expenses which exceed the standards. Nor should you abandon so-called conditional expenses even if the taxes cannot be paid within three years.

First, although it is easier to just rigidly adhere to the national and local standards, Revenue Officers do have the authority under the rules to allow excess necessary or conditional expenses for the first year, even if the proposed installment agreement would not pay the liability in three years. This permits the taxpayer a reasonable “adjustment period” to alter expenditures so as to bring them within the standards:

One-year rule. A taxpayer may have up to one year to modify or eliminate excessive necessary or not-allowable conditional expenses if the tax liability including projected accruals cannot be fully paid within three years.

Revenue Officers will seldom volunteer to apply this one-year relief provision, so it is up to you as the taxpayer’s advocate to know about and argue for the application of this rule if it would be beneficial to your client.

Second, many expenses are “necessary expenses,” even though they fall outside the lists of expenditures covered by the national and local standards. While the standards are designed to achieve more uniformity, they do not constitute a rigid, mechanical cap; expenses in excess of the standards may be allowed if the taxpayer can provide substantiation and justification:

National Standards eliminate the need to require justification or substantiation for a number of recurring expenses.

A. Allow taxpayers the total National Standards amount for their income level. Taxpayers making more than the highest income level shown in the National Standards will be limited to the maximum amount allowed by the National Standards unless they can substantiate and justify a larger amount.

B. How the amount allowed for National Standards is spent is up to taxpayers. For example, they may spend less for clothing and more for entertainment (including cable TV); or they may decide to apply part of the amount to conditional unsecured debts.

C. A taxpayer who claims more than the total allowed by the National Standards must substantiate and justify as necessary each separate expense of the total.

Thus, if the client is willing to go to the trouble of substantiating and justifying the excess expenditures, the Revenue Officer can deviate from the standards. Examples of necessary expenditures which fall outside of the national and local standards are the following:
A. Child care.
B. Dependent care (for the elderly, invalid, or disabled).
C. Taxes.
D. Health care.
E. Court-ordered payments.
F. Involuntary deductions.
G. Secured or legally perfected debts (minimum payments).
H Life insurance (term only).
I. Charitable contributions (if necessary for health and welfare or required as condition of employment).
J. Education (for handicapped dependent if services are not provided by public schools, or if required as condition of employment).
K. Disability insurance (for self-employed individuals).
L. Union dues.
M. Professional association dues.
N. Accounting and legal fees (for representation before the IRS, and other fees for health and welfare and/or production of income).
O. Optional phone services (if for health and welfare and/or production of income).

The Form 433-A has lines labeled for some of these items, but others might easily be overlooked if you simply follow the form without checking the IRS’s pronouncements, including the Internal Revenue Manual and the Collecting Contact Handbook (from which the above list was drawn).

Finally, you should know that the national and local standards change periodically. Merely following the instructions issued with the Form 433-A does not insure that you have the latest numbers. Indeed, the instructions printed with the currently available version of Form 433-A refer to national standard numbers which are out of date. The same is true of IRS Publication 1854 “How to Prepare a Collection Information Statement Form 433-A.” However, you can get the current national and local standards in several ways. First, using the internet you can connect to the Service’s own web site. Second, you can use the web sites of subscription services like BNA or CCH. Third, you can refer to standard looseleaf reporter services such as the CCH Standard Federal Tax Reporter. But whichever method you choose, make sure you have the latest standards for national standard expenses, housing expenses, and transportation expenses. This will allow you to look at the income and expenditure analysis through the Revenue Officer’s eyes before actually submitting your client’s Form 433-A to the Service.

IRS Restructuring and Reform Act of 1998.

The IRS Restructuring and Reform Act of 1998, signed by President Clinton on July 22nd, has several provisions which will have an impact on the negotiation and use of installment agreements. The most important of these is a greatly expanded right to appeal threatened collection actions, thereby providing a forum in which to argue that an installment agreement should be made available to the taxpayer as an alternative to enforced collection action.

Availability of installment agreements in small cases.

First, the new law in some cases “guarantees” the availability of installment agreements. Specifically, it requires the IRS to grant an installment agreement if the liability is $10,000 or less (excluding penalties and interest); in the past 5 years the taxpayer has not failed to file or to pay; financial statements are submitted and the IRS determines that the taxpayer is unable to pay the tax in full; and the agreement provides for full payment within 3 years.

Reduction in late payment penalty.

Second, the new law reduces the amount of the late payment penalty when a taxpayer has an installment agreement. Clients are often shocked to find that the IRS continues to assert interest and the 1/2% per month late payment penalty even after they have entered into installment agreements. Instead of eliminating the penalty, however, Congress merely cut it to 1/4% per month for months during which an installment agreement is in place. This modest relief applies only to individuals, and only if the original return was filed on time. It is effective for months after December 31, 1999.

Extensions of statute of limitations.

Third, changes are made with respect to extensions of the statute of limitations. Previously, entering into an installment agreement did not automatically extend the ten-year statute of limitations on collection. Often, however, the Revenue Officer demanded that the taxpayer “voluntarily” extend the statute of limitations on collections to a date far in the future before an agreement would be granted. In general, the new law eliminates the IRS’s ability to demand these voluntary statute extensions. In the case of an installment agreement, however, the IRS will continue to have the right to ask for an extension for the period of time by which the agreement would continue beyond the normal ten-year statute expiration date, plus 90 days. One would expect that for installment agreements entered into after December 31, 1999, the IRS will add an automatic statute extension provision to its Installment Agreement form (Form 433-D).

Annual statements to taxpayers.

Fourth, starting in July 2000, the IRS must send every taxpayer in an installment agreement an annual statement showing the initial balance owed, the payments made during the year, and the remaining balance. Many of us have had clients who have paid under installment agreements for years while receiving no periodic statements, only to find that their tax liabilities have actually increased despite the payments. This may still happen due to the magic of compound interest, but at least taxpayers will get annual statements showing where they stand.

Right to appeal proposed collection actions.

While the procedural changes described above will be helpful, the greatest impact on the use of installment agreements will come from the opportunities the new law gives taxpayers to appeal proposed collection actions. This will probably have the effect of forcing the IRS in many cases to abandon more aggressive collection techniques, and rely more heavily on installment agreements.

Effective 180 days after enactment, the IRS cannot levy against property unless it has given the taxpayer a “Notice of Intent to Levy,” similar to that currently required by IRC ƒu6331(d). Subject to certain exceptions, no levy could occur until 30 days thereafter. During that 30-day period, the taxpayer may demand a “pre-levy hearing” in the IRS Appeals Office. New IRC ƒu6330 lists the issues which may be raised at this appeals hearing:
(A) In general: The person may raise at the hearing any relevant issue relating to the unpaid tax or the proposed levy, including??

(i) appropriate spousal defenses,

(ii) challenges to the appropriateness of collection actions, and

(iii) offers of collection alternatives, which may include the posting of a bond, the substitution of other assets, an installment agreement, or an offer?in?compromise.

Given the ability to easily appeal proposed levy actions, it is likely that in the future we will be representing many more clients before the Appeals Office. In most of those hearings we will probably argue that installment agreements provide an effective, reasonable and appropriate alternative to seizing the client’s assets by levy.

Conclusion.

Many clients are unable to pay their tax liabilities in full, even by selling or borrowing against their assets. These folks are forced to look to future cash flow to resolve their tax problems. The IRS will go along with this, but only reluctantly. And when taxpayers do not have adequate and informed representation, the Collection Division sometimes refuses to grant installment agreements at all, or demands monthly payments which cannot be sustained or which jeopardize taxpayers’ ability to make reasonable provision for their families. By fully and creatively representing such clients, we can help them address their tax responsibilities through reasonable and appropriate installment payment agreements.
About the Author: Mr. Haynes is an attorney with offices in Burke, VA, and Burtonsville, MD. Until 1981 he was a Special Agent with the IRS Criminal Investigation Division, and in 1980 was named “Criminal Investigator of the Year” by the Association of Federal Investigators. He specializes in civil and criminal tax disputes, tax collection matters, and the tax aspects of bankruptcy and divorce.

He is on the Editorial Board of the Maryland Society of Accountants, and writes a series of articles for “The Freestate Accountant” on dealing with the IRS Collection Division. Many of Mr. Haynes’ articles are in the Author’s Row section of the tax website unclefed.com. These include articles in IRS liens, installment agreements, innocent spouse issues, offers in compromise, IRS appeals, the ability of the IRS to reach pension assets and jointly owned real estate, and using bankruptcy to discharge tax debts.

Mr. Haynes has taught accounting, tax and business law as an adjunct faculty member at Towson State University and the University of Maryland. He lectures frequently to professional groups on various aspects of dealing with the IRS. He can be reached by email at bjhaynes@erols.com