Offer in Compromise: Settlement of IRS Tax Liabilities

Acceptance of an offer in compromise by the IRS results in a taxpayer paying less than the full amount of the asserted liability and closes the taxpayer's entire tax liability for the covered period. Compromises are governed by the rules applicable to contracts.

Internal Revenue Code ("IRC") Section 7122 authorizes the Internal Revenue Service to compromise any civil or criminal case arising under the Internal Revenue laws, unless the matter has been referred to the Department of Justice for prosecution or defense.

The IRS has complete discretion whether to enter into a compromise and will generally entertain an offer in compromise only if it is based on one or all of the following grounds:

doubt as to the taxpayer's liability for the tax;
doubt as to the ability of IRS to collect the tax due to the taxpayer’s current and anticipated future financial circumstances; and
a determination that collection of the tax would cause an undue hardship on the taxpayer.

Because a compromise is generally not limited to one issue or transaction, a compromise is deemed to close the taxpayer's entire tax liability for the period covered, including liability for taxes, penalties, and interest. Thus, compromise as to part of a tax liability (a penalty, for example) may have the result of foreclosing the right to dispute other parts of the tax liability

Procedure. An offer to enter into a compromise agreement is submitted on a Form 656. In addition to the form, a written position statement is usually included to bolster the taxpayer's arguments. As part of the offer in compromise, taxpayers are required to waive the benefit of the statute of limitations on assessment or collection of the tax, thereby affording the IRS time to review the offer. Generally, it is an advisable to submit a deposit or the amount offered along with the offer. If the offer is not accepted, IRS must return the amount deposited or sent with the offer.

For offers based on inability to pay, taxpayers must submit a statement of financial condition (Form 433A - individuals or Form 433B - businesses) to enable IRS to analyze the taxpayer's ability to pay. IRS will require that the amount offered reflect the maximum amount collectible from the taxpayer's current income and assets, and may also require, as additional consideration, that the taxpayer enter into a collateral agreement to secure additional payment from the taxpayer's future income or to provide that the taxpayer forgo certain other tax benefits.

After an offer is accepted by IRS, the agreement is binding and is enforceable as a contract, according to its terms. Neither party may reopen a compromised case. The only grounds upon which a compromise can be set aside are: (a) mutual mistake of fact as to the agreement; falsification or concealment of assets by the taxpayer; or (b) grounds sufficient to set aside a contract generally.

An additional requirement of an accepted compromise is that the taxpayer timely file and timely pay all required tax returns for a period of five years after the compromise is entered into. If the taxpayer files late or pays late, the IRS can void the compromise agreement.

Although there are certainly limitations on the ability of a taxpayer to reach an acceptable offer in compromise with IRS, this opportunity to settle tax claims by payment of less than the full amount due can be extremely beneficial in the right circumstances.

Hoopes, Adams & Alexander, PLC, is a Chandler, Arizona, law firm offering services to Phoenix-area clients in the areas of estate planning, entity formation, commercial and real estate transactions, and civil litigation.