A common scenario faced by tax and insolvency attorneys is the client who has incurred substantial tax liability to the Internal Revenue Service. The client very often is a small entrepreneur who is operating a business at a loss. The business person, unable to pay all creditors, determines not to pay Uncle Sam, hoping to catch up next quarter, when business improves. But business does not improve, and the client, faced with a significant tax debt, engages an attorney hoping to erase the liability by liquidating the business, and thus move on with
This hope cannot be realized because trust fund tax liabilities do not disappear, even when a corporation is liquidated. (Trust fund taxes generally are meals, sales and withholding taxes.) When the corporation is unable to pay them, the IRS will assess these taxes against the individual who is the responsible officer
The client, even after liquidating the remaining assets of the business, is left with limited assets and income and is unable to pay the IRS. Therefore, unless the IRS is willing to accept less than the full amount owed, it will pursue the client for at least the next 10 years, filing liens, levying bank accounts, possibly garnishing wages, and applying future refunds to the liability. Plus, interest and penalties will continue to accrue on the liability. The goal of the client to get a "fresh start" will not be realized.
Although the taxpayer cannot erase the entire liability, an avenue does exist that permits negotiation for a reduction in payment requirements. The Internal Revenue Service, since at least 1906, has accepted offers and compromises. The original process involved completing complex paperwork and navigating a maze of bureaucracy for both the taxpayer and the IRS. Such difficulty resulted in fewer than 9,000 offers in compromise in 1991, and the acceptance of less than 25% of those.
The reason for the paucity of the offers was the common knowledge that it was nearly impossible for the IRS to settle tax bill for less than the full amount owed. The taxpayer thus had little incentive to negotiate, and often determined that it was more prudent to attempt to hide assets from the reaches of the IRS. Both the taxpayer and the IRS suffered from this failure to compromise the claim.
The IRS eventually came to the conclusion that it made more sense to collect something, rather than nothing. And approximately one year ago, the IRS made significant changes to its offer and compromise program, with the intent that this program would be used more frequently as a viable alternative in resolving the collection of liabilities. The changes included giving local managers more authority to accept offers and streamline the forms on which to apply for an offer. This accelerated the process of getting an offer and compromise evaluated.
The objective of increasing the number of offers in compromise has come to fruition in the first year of the program. According to IRS statistics, in 1991 the agency received only 8,711 offers in compromise and accepted 1,995 (23%). In 1992, it received 17,749 offers and accepted 4,356 (25%), greatly enhancing revenue from this program in the very first year of the modifications.
The key inquiry made by the IRS is whether the offer proposed by the taxpayer is the most money the agency will receive from a liability that cannot be fully realized. If the amount offered in compromise is an adequate reflection of the actual collection potential, the IRS will entertain acceptance. The agency seeks to receive payment expeditiously and at minimal cost.
The procedure to make an offer and compromise involves filing a complete financial statement that shows the taxpayer's assets, liabilities and income. The equity that the taxpayer has in assets must be included in the offer, which must evidence the taxpayer's maximum ability to pay.
Collection activity will be stayed if the IRS determines that the offer merits consideration and that there is no reason to believe that collection of the amount offered in settlement of the tax liability will be jeopardized. It is also a requirement that the taxpayer making an offer must agree to comply with all tax filing and payment requirements for five years after the offer and compromise is accepted.