The realities about the IRS offer in compromise program

OIC acceptance is rare. Here’s why.

April 28, 2014
by Jim Buttonow, CPA/CITP

Television and radio are filled with ads claiming that taxpayers can settle their tax balances owed to the IRS. This settlement program is known as the IRS offer in compromise (OIC). Clients who can’t pay their taxes may inquire about this overhyped settlement option; however, according to IRS statistics, it is highly unlikely that most taxpayers who have outstanding balances will have an OIC accepted.

The Government Accountability Office reported that in 2010 more than 16 million taxpayers owed taxes to the IRS, and these numbers have continued to increase. In 2013, despite the millions of taxpayers with debt, the IRS approved only 31,000 OIC applications. In contrast, the IRS had almost 4 million installment agreements in effect in 2013 for taxpayers to repay their balances.

OIC acceptance is rare for two main reasons: Either the taxpayer does not qualify for an OIC or, if the taxpayer does qualify, he or she can’t pay the offer amount.

Does your client qualify for an OIC?
The reality is, OIC qualification is based on a computation of the taxpayer’s ability to pay his or her tax debt before the IRS runs out of time to collect the debt (called the collection statute expiration date). Contrary to popular perception, the IRS decision is not largely subjective and is instead based on computational formulas. That is why IRS.gov features an OIC Pre-qualifier tool.

To qualify for an OIC, your client must prove that he or she can’t pay the total balances owed before the collection statute expires, using net equity in assets plus any future income. The IRS calculates future income as the amount it can collect on a monthly basis (monthly disposable income) before the collection statute expires.

Although the qualification formula is objective, the components of the computation of net equity in assets and monthly disposable income are often the subject of much debate and confusion. However, once the ability to pay amount is determined, the computation results are clear:  Either your client cannot pay the taxes owed and qualifies for an OIC, or your client can pay the taxes owed and does not qualify.

However, qualifying for an OIC does not mean your client will obtain an OIC. To obtain an OIC, your client must be able to pay the offer amount, which is the computed amount required to be paid to the IRS to settle the debt.

Can your client pay the OIC offer amount?
The formula used to compute the offer amount differs from the formula used to determine qualification. The qualification formula and offer amount formulas use the same computation for net equity in assets. However, the offer amount formula requires only 12 or 24 months of future income, rather than the full amount that the IRS could collect before the collection statute expires.

When calculating the offer amount, it is imperative to conduct complete due diligence. In taxpayers’ initial calculations, they often find that the offer amount is too high to consider an OIC as a viable option. In addition, during the IRS’s OIC investigation process, taxpayers may discover that they incorrectly computed net equity in assets and monthly disposable income, resulting in an offer amount that is much larger than expected and too much to pay to settle the taxes owed. Tax professionals should exercise great care and diligence in properly computing the OIC’s financial components to avoid a potentially costly, long investigation process when there might be a better alternative, such as currently not collectible status or an installment agreement.

Qualification and offer amount illustrated
To illustrate how the OIC qualification and offer amounts are computed, let’s assume the following facts:

  • The taxpayer owes $50,000 on April 15, 2014, and submits an OIC application on that date.
  • The collection statute expiration date is April 15, 2020 (six years, or 72 months, remain on the collection statute).
  • The taxpayer has net equity in assets amounting to $5,000 and monthly disposable income of $500.

In this example, the taxpayer chooses the lump-sum OIC payment option, which uses a future income multiplier of 12 months. (There is also a periodic payment option that uses a future income multiplier of 24 months.) For this example, the qualification and offer amount are computed as follows:

In this example, the taxpayer qualifies for an OIC, because the amount that the taxpayer can pay before the collection statute expires ($41,000) is less than the tax owed ($50,000). The offer amount that would be required to be paid to settle all liabilities is $11,000. This example illustrates the benefits of the OIC program for taxpayers who qualify. To provide the taxpayer with a fresh start, the Treasury Department would accept $30,000 less in payments than it could otherwise receive.

2011 IRS Fresh Start Initiative
While the number of OICs accepted is small compared with the number of taxpayers who have outstanding balances, more taxpayers are qualifying for and obtaining OICs due to the 2011 IRS Fresh Start Initiative, which softened qualification criteria and allowed for lower offer amounts.

Prior to Fresh Start, the offer amount calculation generally produced a larger settlement payment because the future income multiplier was significantly larger. In our example above, the taxpayer’s offer amount was $11,000 under Fresh Start rules. Under pre-Fresh Start rules, the same taxpayer would have had an offer amount of $29,000 – $18,000 more – because the future income multiplier would have been 48 months, instead of 12 months.

IRS data show much of the impact of Fresh Start changes: In 2013, the IRS received 30% more OIC applications compared with 2010, and the acceptance rate for OICs increased to 42%, up from 25% in 2010.

Do your due diligence first
An OIC should be considered when your client clearly has a financial hardship and there is no possibility that he or she will be able to pay the taxes in full before the collection statute expires. The qualification and offer amount computations are fairly straightforward and can easily answer your client’s questions about whether he or she should pursue an OIC.

However, determining your clients’ net equity in assets and ability to pay can be complicated. Closely examine your client’s financial situation before you conclude that he or she qualifies and can obtain an OIC.  Your client may be better off with a more suitable collection alternative, such as currently not collectible status or an installment agreement.

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IRS Offers Tax Filing Delay to Washington Mudslide Victims

MICHAEL COHN

The Internal Revenue Service said Friday that victims of last month’s mudslides and flooding in Washington state will have until Oct. 15 to file their returns and pay any taxes due.

After this week’s disaster declaration for individual assistance from the Federal Emergency Management Agency, the IRS said that affected taxpayers in Snohomish County, including the Sauk-Suiattle, Stillaguamish and Tulalip tribes, will receive this and other special tax relief.

The tax relief postpones various tax filing and payment deadlines that occurred starting on March 22, 2014. As a result, affected individuals and businesses will have until Oct. 15, 2014 to file these returns and pay any taxes due.

Also included are the April 15, June 16 and Sept. 15 deadlines for making quarterly estimated tax payments. A variety of business tax deadlines are also affected including the April 30 and July 31 deadlines for quarterly payroll and excise tax returns.

The IRS also said it would abate any interest, late-payment or late-filing penalty that would otherwise apply. The agency automatically provides this relief to any taxpayer with an IRS address of record located in the disaster area. Taxpayers do not need to contact the IRS to get this relief.

Beyond the relief provided to taxpayers in the FEMA-designated localities, the IRS will work with any taxpayer who lives outside the disaster area but whose records necessary to meet a deadline occurring during the postponement period are located in the affected area. All workers assisting the relief activities who are affiliated with a recognized government or philanthropic organization also qualify for relief. Taxpayers qualifying for relief who live outside the disaster area need to contact the IRS at (866) 562-5227.

Individuals and businesses who suffered uninsured or unreimbursed disaster-related losses can choose to claim them on either last year’s or this year’s return. Claiming these casualty loss deductions on either an original or amended 2013 return will get the taxpayer an earlier refund but waiting to claim them on a 2014 return could result in greater tax savings depending upon other income factors.

In addition, the IRS said it is waiving late deposit penalties for federal payroll and excise tax deposits normally due on or after March 22 and before April 7 if the deposits are made by April 7, 2014. Details on available relief can be found on the disaster relief page on IRS.gov.

The tax relief is part of a coordinated federal response to the damage caused by mudslides and flooding and is based on local damage assessments by FEMA. For information on disaster recovery, visit disasterassistance.gov.

The IRS said it is actively monitoring the situation and will provide additional relief if needed.

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IRS Warns of Email Scam Impersonating Taxpayer Advocate Service

BY MICHAEL COHN

The Internal Revenue Service is warning consumers to beware of a new email phishing scam in which fraudulent emails purport to come from the IRS Taxpayer Advocate Service, complete with a bogus case number.

The fake emails may include the following message: “Your reported 2013 income is flagged for review due to a document processing error. Your case has been forwarded to the Taxpayer Advocate Service for resolution assistance. To avoid delays processing your 2013 filing contact the Taxpayer Advocate Service for resolution assistance.”

Recipients are directed to click on links that claim to provide information about the “advocate” assigned to the taxpayer’s case or that let them “review reported income.” The links then lead to Web pages that solicit personal information from the recipient.

Taxpayers who get these messages should not respond to the email or click on the links, the IRS warned. Instead, they should forward the scam emails to the IRS at phishing@irs.gov. For more information, visit the IRS’s Report Phishing web page.

The Taxpayer Advocate Service is a legitimate IRS organization that helps taxpayers resolve federal tax issues that have not been resolved through the normal IRS channels. The IRS, including the TAS, does not initiate contact with taxpayers by email, texting or any social media, the IRS cautioned.
Last week, the Treasury Inspector General for Tax Administration warned of another scam involving phone calls claiming to originate from the IRS (see Taxpayers Warned of ‘Largest Ever’ Phone Fraud Scam from IRS Impostors).

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Supreme Court Rules Severance Pay Can Be Taxed

BY GREG STOHR
BLOOMBERG

(Bloomberg) The U.S. Supreme Court decided in favor of the Obama administration in a dispute over taxes on severance compensation, overturning a lower court decision that could have forced the IRS to refund more than $1 billion.

The court said payments to laid-off workers are subject to Social Security and Medicare taxes under the Federal Insurance Contributions Act, or FICA. It was a victory for the Internal Revenue Service, which has been fighting more than 2,400 refund claims from companies and their ex-employees.

The justices’ unanimous ruling yesterday came in the case of Quality Stores Inc., once the country’s largest agricultural specialty retailer. The defunct company fired 3,100 workers when it closed its stores in 2001 and 2002, paid the taxes on their severance and then asked a bankruptcy judge to order the IRS to refund $1 million.

Writing for the court, Justice Anthony Kennedy said the payments were subject to tax. He rejected the company’s contention that what it called supplemental unemployment compensation was exempt from the FICA.

“The severance payments here were made to employees terminated against their will, were varied based on job seniority and time served and were not linked to the receipt of state unemployment benefits,” he wrote. “Under FICA’s broad definition, these severance payments constitute taxable wages.”

Unresolved Lawsuits
Lower courts were divided on the issue. The high court ruling came in the government’s appeal of a September 2012 decision by a Cincinnati-based U.S. appeals court that said Quality Stores was entitled to a refund. The money would have gone to 1,850 ex-employees who paid their share of the taxes and authorized Muskegon, Michigan-based Quality Stores to try to recoup the payments on their behalf.

“The decision is a huge blow for employers and employees alike,” said Bob Hertzberg, the lawyer who represented Quality Stores at the Supreme Court. “In addition to the impact on Quality Stores and its former employees, this ruling has far-reaching implications for the thousands of other organizations and workers fighting for refunds.”

Kathryn Keneally, head of the Justice Department’s tax division, said the government is “pleased that the Supreme Court recognized that there should be no difference in how severance pay is taxed for social security and income tax purposes.”

Program Financing
FICA uses payroll taxes to finance Social Security and part of the Medicare health-care program for the elderly and disabled. Employers and employees each pay 6.2 percent in Social Security taxes on wages up to a cap, which is $113,700 this year, and they each pay 1.45 percent of all wages toward Medicare. High-income taxpayers are subject to additional payroll levies.

According to a brief filed by the Obama administration, the claims for refunds have been made in 11 unresolved lawsuits and 2,400 administrative cases “with a total amount at stake of more than $1 billion.”

“That figure is expected to grow,” the brief said.

The case is United States v. Quality Stores, 12-1408.

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IRS Employee Took Home Data on 20,000 Workers at Tax Agency

BY RICHARD RUBIN
BLOOMBERG

(Bloomberg) An Internal Revenue Service employee took home a computer thumb drive containing unencrypted data on 20,000 fellow workers, the agency said in a statement.

The tax agency’s systems that hold personal data on hundreds of millions of Americans weren’t breached, the statement said Tuesday.

“This incident is a powerful reminder to all of us that we must do everything we can to protect sensitive data—whether it involves our fellow employees or taxpayers,” IRS Commissioner John Koskinen said in a message to employees. “This was not a problem with our network or systems, but rather an isolated incident.

The IRS is contacting the current and former employees involved, almost all of whom worked in Pennsylvania, Delaware and New Jersey. The information dates to 2007, before the IRS started using automatic encryption.

IRS officials were told of the breach “a few days ago,” Koskinen’s message said.

The Social Security numbers, names and addresses of employees and contract workers were potentially accessible online because the thumb drive was plugged into the employee’s “unsecure home network,” Koskinen’s message said.

The IRS said it had no knowledge of the information being used to commit identity theft.

Inspector General
The IRS said it’s working with its inspector general to investigate the incident. The IRS statement didn’t say why the incident was discovered now, didn’t include the name of the employee who used the thumb drive and didn’t say whether the employee still works at the IRS.

David Barnes, a spokesman for the inspector general’s office, declined to comment.
House Ways and Means Committee Chairman Dave Camp, a Michigan Republican, said in a statement that the IRS in the past has released taxpayer information to the public and “has not been able to effectively prevent and detect identity theft.” He said the committee will look into the incident.

The IRS’s data breach is much narrower in scope than the security incident at Target Corp., where hackers stole credit- card information used by millions of shoppers.

It comes during a trying year for the tax agency, which has been under congressional investigation for its spending at conferences and its scrutiny of small-government groups.

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