Tax Court Backs IRS Offer In Compromise Rejection

The Tax Court recently upheld the IRS’s rejection of an attorney’s “offer in compromise” (OIC) as it was seen as an unreasonably low offer.

For a quick review, an OIC is an agreement between a taxpayer and the IRS settling the taxpayer’s tax liability for less than the full amount owed. If the liability can be fully paid through an installment agreement or other means, the taxpayer generally isn’t eligible for an OIC.

To qualify under the IRS’ OIC program, the taxpayer must have filed all tax returns, made all required estimated tax payments for the current year and deposited payroll taxes for the current quarter if he or she is a business owner.

Here’s the catch: Generally, the IRS won’t accept an OIC unless the amount offered by the taxpayer is equal to or greater than the “reasonable collection potential” (RCP). The RCP includes the value that may be realized from the taxpayer’s assets—including real estate, automobiles, bank accounts and other property—as well as expected future income (less certain amounts allowed for basic living expenses). This is the requirement that tripped up the taxpayer in the new case.

Key facts: The taxpayer is a successful tax attorney in Michigan and a partner in the law firm he founded in 1995. His firm, and the taxpayer himself, was known for helping clients avoid significant tax liabilities and it specialized in negotiating settlements with the IRS for delinquent taxpayers.

For 2012 through 2016, the taxpayer filed tax returns, but did not pay all the taxes due. Eventually, the IRS issued a notice of deficiency of about $214,000 in 2019. Relying on his own expertise, the taxpayer made an OIC of $50,000.

Accordingly, the taxpayer provided although the official documentation required for an assessment. Nevertheless, the IRS rejected the OIC and countered that the RCP indicated that the taxpayer could actually afford to pay the full tax liability in a little more than 33 months.

Specifically, the IRS looked at the compensation the taxpayer received from his law firm, which showed a monthly income of more than $31,000. Allowing for monthly expenses of $17,000, the IRS said the taxpayer would receive about $14,000 a month left over to pay taxes. It also cited personal assets owned by the taxpayer totaling more than $200,000.

Base on its numbers, the IRS offered to settle the tax liability with an installment agreement of about $2,900 per month spanning six years. The taxpayer turned it down and proceeded to Tax Court.

At trial, the taxpayer disputed the IRS’ numbers and said it should have counted expenses of the four children living with him (although only two qualified as dependents). He also cited vague expenses for religious school. And he said the IRS was supposed to deduct $61,000 from the RCP that was needed to pay off other tax liabilities.

Finally, the taxpayer claimed he should be granted more leeway due to special circumstances, including his advanced age of 63 and a lack of retirement savings. But the Tax Court refused to budge and agreed with the IRS action. It also refuted any notion that special circumstances warranted a lower OIC. After all, age 63 is not that old!

Bottom line: Strictly adhere to the rules for OIC when representing clients (or yourself, for that matter, if you choose to go that route). Usually, the IRS is willing to work out a reasonable deal.