TAX PRACTICE FINAL COPYRIGHT 2017 LGUTEF. Learning Objectives. Introduction

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1 TAX PRACTICE 14 Issue 1: Substitute for Returns and Superseding Returns Issue 2: Nonfilers Issue 3: Collection Statute of Limitations Issue 4: Transferees, Nominees, and Alter Egos Issue 5: Offer in Compromise Learning Objectives After completing this session, participants will be able to do the following: Understand a substitute for return and know how to correct the return Assist a nonfiler to determine which returns have not yet been filed, and determine which returns to file first Reconstruct a taxpayer s records to establish income, expenses, and itemized deductions Determine the original collection statute expiration date for an assessment Identify the events that will cause a suspension of the running of the collection statute of limitations period Recognize when a third party may have transferee liability for a tax debt Recognize when the IRS can collect against assets titled to a third party as a nominee or alter ego of the taxpayer Determine if a taxpayer may be eligible for an offer in compromise Describe the three types of offers in compromise Apply for an offer in compromise and calculate the minimum offer Introduction This chapter discusses the substitute for a return and when and how a taxpayer should file a superseding return to replace a previously filed return. This chapter also explains how to help a nonfiler to file past-due returns, and how to reconstruct the records that are necessary to file the delinquent returns Land Grant University Tax Education Foundation, Inc. 505

2 This chapter covers three important collection issues: It examines the collection statute of limitations and the events that suspend the running of the statute. It explains who is a transferee, nominee, or alter ego of the taxpayer, and when such third parties (or their assets) are liable for another person s tax liability. Finally, it reviews the three types of offers in compromise, the requirements to submit an offer, the forms that are used to submit an offer, and how the taxpayer calculates the minimum offer amount. ISSUE 1: SUBSTITUTE FOR RETURNS AND SUPERSEDING RETURNS This section discusses substitute returns prepared by the IRS and superseding returns filed by the taxpayer. This section discusses a substitute for return (SFR), which the IRS prepares if the taxpayer fails to file a return. This section also discusses a superseding return, which is a return that a taxpayer files before the due date of the return to change or add items to a previously filed return. Substitute for Return If a taxpayer has not filed a return and does not respond to IRS requests for a return, the IRS will create an SFR for the taxpayer [I.R.C. 6020(b)]. IRS Campus personnel, a revenue officer, or a revenue agent in a local office may prepare an SFR. The IRS prepares an SFR based on information that the IRS has available. Typically, it is based on income-reporting documents, without any deductions for expenses. The IRS uses only the taxpayer s personal exemption and the standard deduction. If the taxpayer s last-filed return was a joint return, the IRS will use married filing separately status. Alternatively, the IRS will use single filing status. Thus, the SFR may overstate tax liability. SFR Assessment and Collection The IRS initially sends a 30-day letter, Notice 2566 (IRS Campus or Collection) or Letter 950 (Examination), that shows a calculation of the proposed tax and penalties, a schedule of the income that was used to determine taxable income, and an explanation of the penalties. The taxpayer can 1. consent to the assessment, 2. file a signed and complete tax return by a specified date (usually within 30 days of the letter), 3. send in a statement explaining why the taxpayer believes he or she is not required to file a return, or 4. send in any other information the taxpayer would like the IRS to consider. Statute of Limitations on Assessment Only filing a return signed by the taxpayer will start the 3-year statute of limitations on assessment. Signing the agreement form sent with the 30-day letter does not constitute filing a return; it is only a consent to assessment of the tax. If the taxpayer files a return, the IRS generally will process the return and adjust the account accordingly. Processing the delinquent return may take 6 weeks or more, but the IRS will stay collection activity during that time. The assessment statute of limitations starts on the date the taxpayer files the delinquent return. See the later discussion of nonfilers for information about how to reconstruct records to file a past-due return. If the taxpayer does not respond to the 30-day letter, the IRS sends a statutory notice of deficiency (Letter 3219-B for Campus or Collection, or Letter 531 for Examination) by certified mail. The taxpayer has 90 days to petition the Tax Court, file an original tax return, file a consent to assessment and collection (agreeing to the IRS tax), or 506 INTRODUCTION

3 explain why the taxpayer believes he or she is not required to file a tax return. If the taxpayer does not respond to the statutory notice, the IRS assesses the tax and starts the collection process. The IRS may levy wages or bank accounts or file a federal tax lien against the taxpayer s property. The assessment of the deficiency starts the 10-year collection statute of limitations. It will not, however, start the statute of limitations on assessments that runs from the later of the due date of the return or the date the taxpayer files a return, as the SFR is not considered a return filed by the taxpayer. Limitation on Refunds I.R.C provides time frames for the limitation period for refunds. If a return is filed, the taxpayer may file for a refund within 3 years of the date the return was filed, or 2 years from the time that the tax was paid, whichever is later. If no return was filed, the claim must be filed within 2 years from the time the tax was paid. The amount of refund or credit cannot exceed the portion of the tax paid within the period immediately preceding the filing of the claim, equal to 3 years plus the period of any extension of time for filing the return. If the claim was not filed within the 3-year period, the amount of the refund cannot exceed the portion of the tax paid during the 2 years immediately preceding the filing of the claim. Under I.R.C. 6513(a), payments (e.g., withholding or estimated tax) made prior to the due date for filing (without extensions) are deemed paid on the due date. For taxes paid through withholding or estimated tax, the taxpayer has 3 years from the due date of the original return (without extensions) to file for a refund. After the 3 years have passed, the IRS cannot refund any overpayment, use it to offset an unpaid tax in another year, or apply the overpayment to a future estimated tax payment. Filing More Than 3 Years after Due Date Even though a refund is no longer available 3 years beyond the return s due date, the taxpayer should consider filing a return after the IRS has processed an SFR. The return can reduce or eliminate the deficiency shown on the SFR and minimize or eliminate collection activity. Other Limitation Periods The following other deadlines and limitation periods may impact filing a return: 1. The taxpayer cannot claim certain credits, such as the earned income tax credit, more than 3 years after the return due date. 2. The election to file a joint return (if allowed) can only be made within 3 years of the original due date of the return [I.R.C. 6013(a) (2)(A)]. 3. Taxpayers can revoke a joint filing only if the taxpayers file separate returns by the original due date of the return, without extensions. 4. Special limitation periods apply to certain credit carrybacks, net operating loss carrybacks, and capital loss carrybacks. Audit Reconsideration If the IRS filed an SFR and assessed tax, and the taxpayer disagrees with the original determination, he or she can still file an original return to request audit reconsideration. The Internal Revenue Code does not explicitly authorize the IRS to offer audit reconsideration, but it does authorize the IRS to abate the unpaid portion of the assessment of any liability that is excessive in amount [I.RC. 6404(a)]. The IRS will reconsider an unpaid assessment if the taxpayer files an original return following an assessment arising from an SFR. The IRS will not reconsider the assessment if the assessment was due to 1. an executed Appeals settlement agreement (Form 870-AD), 2. an executed closing agreement (Form 906), 14 Audit Reconsideration 507

4 3. an offer in compromise, or 4. a final order of the Tax Court or other court. The IRS will also deny a request for reconsideration if the taxpayer has already been granted audit reconsideration and did not provide any additional information or requested documentation that would change the original assessment. Superseding Returns If a taxpayer files a second return before the due date (including extensions) for the return, the second return is a superseding return. The filing of a superseding return allows a taxpayer to revoke irrevocable elections or to make changes to the income or deductions on the previously filed return without the addition of interest or potential penalties. A superseding return is generally treated as the taxpayer s original return, and the superseding return is in effect incorporated into and treated as relating back to, and modifying or superseding, the earlier return [Haggar Co. v. Helvering, 308 U.S. 389 (1940)]. Amended Return An amended return filed within the time for filing the original return, with extensions, is also a superseding return. Each return filed prior to the due date of the return supersedes the preceding return. An amended return filed after the due date (including extensions) does not incorporate anything into the original return. Statute of Limitations on Assessment Under I.R.C. 6501(a), the IRS must assess tax within 3 years after the taxpayer filed the returnregardless of whether the taxpayer filed the return on or after the due date of the return. If the taxpayer files the return before the due date (without extensions), it is deemed filed on the due date. A return filed during an extension period is treated as filed on the day it is received, if received on or before the extended due date, or on the postmark date if filed before but received after the extended due date. There is no time limit on assessing tax if the taxpayer does not file a return. If the taxpayer files a superseding return, the statute of limitations for assessment follows these same rules. A return filed before an extended due date does not revoke the remaining extension period. Another return filed before the extended due date will be a superseding return. The second filing will begin the running of the statute of limitations for assessment [C.C.A ( June 26, 2006)]. Example 14.1 Date of Assessment Clarence Cautious timely filed for an extension of time to file his 2016 return (to October 16, 2017). On June 4, 2017, he filed his 2016 return. He discovered in early August that he had made an error on the return, and he filed Form 1040X on August 26, The return filed on August 26 is a superseding return. The statute of limitations for assessment begins running on August 26, If instead Clarence filed Form 1040X on October 26, 2017, the return would be an amended return because he filed the return after the extended due date. The statute of limitations would begin running on June 4, 2017, when he filed his original return. 508 ISSUE 1: SUBSTITUTE FOR RETURNS AND SUPERSEDING RETURNS

5 Return Elections and Superseding Returns Certain elections are irrevocable, but the taxpayer can withdraw the election by filing a superseding return. For example, the election by a real estate professional to group all rentals as one activity under I.R.C. 469(c)(7) can be withdrawn if the taxpayer files a superseding return by the due date of the return. Taxpayers that have filed a joint return may revoke the joint election by filing superseding separate returns by the original due date. Also, a taxpayer may file a superseding return to ensure that an election that was not made on the original return is made timely. For example, a taxpayer with a current-year net operating loss (NOL) could file a superseding return to waive the NOL carryback under I.R.C. 172(b) (1). Treas. Reg (b) provides a similar right to take corrective action for elections made within the 6-month extension period. Filing for Extensions Even if a taxpayer intends to file by the original due date, it may be beneficial to file for an extension. Taxpayers with an interest in a passthrough entity that issues Schedule K-1 (Form 1120S or Form 1065) after April 15 may include the information on a superseding return that will constitute the original filing if the taxpayer has an extension to file. Filing a Superseding Return There are no written instructions on to how to file a superseding individual income tax return, only when it must be filed to become the taxpayer s return for the year. If additional tax is owed and the due date of the return has not passed, the taxpayer should file Form 1040X and pay the tax by the due date (without extensions) to avoid penalties and interest. If the taxpayer finds an error on the original return, the IRS advises the taxpayer to wait until the original has been processed before amending the return. Some tax practitioners advise the taxpayer to file a superseding return in the format of the original return and to write SUPERSEDING RETURN across the top of the first page. As one return has already been filed and processed, the IRS may post the second return as a duplicate filing, which may delay the processing of the return. For this reason, filing Form 1040X appears to be preferable. Superseding returns for a corporation can be filed electronically (and must be filed electronically if the original return had to be filed electronically). A superseding return for a corporation must be a complete filing of the entire return, with all required forms, schedules, and attachments. The filer must indicate that the return is a superseding return by selecting the superseded return box. If the corporation fails to check the box, the IRS may reject the return as a duplicate filing. There is no checkbox if the taxpayer files a paper return (and there is no such checkbox for individual returns). 14 ISSUE 2: NONFILERS This section discusses how to help a taxpayer with past-due returns become compliant. A taxpayer that has not filed tax returns for many years should file the past-due returns. This section discusses filing past-due returns and how to reconstruct records. Criminal Liability Failure to file returns and pay amounts owed are typically civil matters. However, if there are firm indications of fraud or willfulness and the taxpayer meets certain criminal criteria, the IRS may refer the case to the IRS Criminal Investigation. See the Ethics, Part 1 chapter in this book for a list of indicators of fraud. Issue 2: Nonfilers 509

6 Filing Past-Due Returns A taxpayer must first determine which returns the taxpayer has not filed and whether the IRS processed any SFRs. The taxpayer or his or her agent should order an account transcript for at least the preceding 6 years. Securing Transcripts should not ignore the older years, as the IRS may have assessed tax based on an SFR that included only income and no expenses. Reconstructing Records The records that are necessary to prepare delinquent returns may be lost or missing. This section explains how to reconstruct records of income, expenses, and itemized deductions. See pages in the 2016 National Income Tax Workbook for the details on available transcripts and how to obtain them. The tax account transcript will show if a return was filed and any transactions posted to the tax account. If the IRS initiated an SFR, TC 150SFR will show on the account. If the process has reached the defaulted 90-day letter status, the TC 150SFR will be followed by an assessment code (see Figure 14.2, later). Enforcement of Delinquent Returns Under IRS Policy Statement (Delinquent returns), the IRS will not enforce delinquency procedures for more than 6 years. However, enforcement beyond 6 years is possible based on the taxpayer s prior history of noncompliance, existence of income from illegal sources, effect upon voluntary compliance, anticipated revenue, and collectibility in relation to the time and effort required to determine the tax due. Enforcement beyond 6 years requires managerial approval. It may be helpful to have copies of prioryear returns, particularly if the taxpayer is selfemployed. If the taxpayer does not have copies of these returns, the taxpayer or his or her agent can request a copy of the most recently filed return from the IRS using Form 4506, Request for Copy of Tax Return. A taxpayer who has been delinquent in filing returns should consider the limitation periods (e.g., the limitations on claiming credits and refunds, discussed earlier) when deciding which returns to prepare first. However, the taxpayer Income Direct Methods Direct sources of information for reconstructing income include the following: 1. IRS wage and income transcript to show taxpayer income from Form W-2, Wage and Tax Statement; Forms 1099; and other information returns State Tax Withholding If the taxpayer is also delinquent in state filings, the taxpayer must obtain a copy of the actual W-2 from the issuer because the IRS transcript does not show state withholding. 2. State sales tax returns 3. Receipt books 4. Cash register receipts 5. Invoices 6. Credit card charge slips 7. Any document (calendar, income ledger) that the taxpayer maintained to record receipts 8. Bank statements for all taxpayer accounts [Deposits to bank accounts, adjusted for nontaxable income such as loans or account transfers, should be a reasonable approximation of the self-employed taxpayer s gross receipts if the taxpayer deposited all business income. If the taxpayer received income received in cash (retail establishments, for example) additional analysis may be necessary to establish gross receipts).] 510 ISSUE 2: NONFILERS

7 9. If the taxpayer is in the business of selling and income is not reflected on 1099s of any type, information from the buyer(s) of the taxpayer s products about the total the buyer paid to the taxpayer for the year(s) Income Indirect Methods The taxpayer may be able to use other indirect methods to establish income. Bank Deposit and Cash Expenditure Method The bank deposits and cash expenditures method calculates income by showing what happened to a taxpayer s funds. It is based on the theory that if a taxpayer receives money, only two things can happen: the taxpayer can deposit the funds or spend the funds [I.R.M and Exhibit ]. Source and Application of Funds Method The source and application of funds method is an analysis of a taxpayer s cash flow. The taxpayer s taxable receipts are calculated by comparing the taxpayer s application of funds (expenses, increase in bank balances, increase in cash on hand, increase in assets, decrease in liabilities) with the total nontaxable receipts for the year (increase in liabilities, inheritances, decrease in bank balances, decrease in cash on hand) [I.R.M and Exhibit ]. Net Worth Method The net worth method for determining the actual tax liability is based on the theory that increases in a taxpayer s net worth during a tax year, adjusted for nondeductible expenditures and nontaxable income, must result from taxable income. The theory is based on the fact that for any given year, a taxpayer s income is applied or expended on items that are either deductible or nondeductible, including increases to the taxpayer s net worth through the purchase of assets and/or reduction of liabilities [I.R.M and Exhibit ]. Other Indirect Methods See page 138 in the 2012 Income Tax Workbook for a discussion of other indirect methods included in the Cash Intensive Businesses audit technique guide. Business Expenses A taxpayer may establish good-faith estimates of expenses based on the taxpayer s expense habits. If the taxpayer can determine the existence of an expense, the precise amount can be estimated for most expenses [Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930)]. There must be a rational basis for the estimate. Expenses can be established by a combination of what the taxpayer has on hand, bank and credit card statements, and contact with third parties. A prior-year return that the taxpayer filed based on actual records can serve as guide for what is a reasonable range of expenses. Travel and Entertainment The taxpayer cannot use reasonable estimates to support a deduction for travel and entertainment expenses. For travel expenses, the taxpayer must substantiate the amount, time, place, and business purpose of the travel. For entertainment expenses, the taxpayer must be able to substantiate the amount, time, place, business purposes, and business relationship with the person entertained. Figure 14.1 shows how to use existing records to reconstruct business expenses. 14 Reconstructing Records 511

8 FIGURE 14.1 Reconstructing Records of Business Expenses Example Source How to Use to Reconstruct Records Appointment books or calendars Online map tools IRS standard allowances Checkbook, canceled checks, bank statements, or credit card statements List of regular clients Partial receipts or sales tax records Cell phone records and call history or computer logs Prior-year returns An appointment book could be used to develop: Where a taxpayer traveled to provide services, and how many trips How many people received services How many of each type of service were rendered; for example, how many haircut appointments, how many manicure appointments Using summary counts of the number of each kind of service rendered, the taxpayer could apply an average or standard cost to come up with an estimate of total receipts. The number of trips made and the locations traveled to could be combined with online map data to support total business miles driven. Online map tools can be used to reconstruct mileage calculations. The IRS provides standard expense allowances including per diem expenses for truck drivers and standard mileage rates. These documents can be used to gain information about expenses incurred and what types of services were performed for clients. Using summary counts of the number of each kind of service rendered, the taxpayer could apply an average or standard cost to come up with an estimate of total costs and receipts. Using a list of regular clients, a taxpayer could reconstruct a reasonable calendar of services. Regular expenses could be extrapolated from that information. The taxpayer could apply an average or standard cost to come up with an estimate of total receipts. Partial receipts can provide information regarding what expenses were incurred for services. The taxpayer could apply an average or standard cost to come up with an estimate of total receipts. Cell phone records and call history can be used to develop a list of clients served during specific time frames. Prior-year returns can provide the basis for records if activities are similar from year to year. Source: Schedule C and Record Reconstruction Training, prepared by the IRS/EITC Software Developers Working Group [ Additional ways to substantiate purchases and other business expenses include the following: 1. Obtain cash register receipts. 2. Obtain invoices. 3. Contact supplier(s) for amount purchased during the year. 4. Contact payees (e.g., utility company, cell phone company, insurance company, advertisers, and other professionals) to establish amounts that the taxpayer paid. 5. Contact lenders for interest paid. 6. Review Forms 941, Employer s Quarterly Federal Tax Return, for salary and the employer s share of FICA paid. 7. Review Form 940, Employer s Annual Federal Unemployment (FUTA) Tax Return, for FUTA paid. 512 ISSUE 2: NONFILERS Additional ways to substantiate transportation expenses include the following: 1. To establish mileage, obtain receipts from the oil change company, dealership, or local garage where work was performed. 2. Reconstruct trips taken by discussion with the taxpayer. 3. Establish whether there was a weekly routine for travel. 4. Use credit card statements to establish overnight trips. 5. If the taxpayer is currently in the same line of work, detailed records for current mileage may establish a basis for the prior-year driving. If the taxpayer is only missing a portion of a year s records and the business is similar all year, the taxpayer can use the documented portion

9 of the year to estimate the full year s expenses. This estimate of a full year s expenses along with a prior-year return filed based on substantiating records can help establish that the estimates or reconstruction made for another tax year are reasonable. Itemized Deductions The taxpayer can reconstruct itemized deductions in the same way that the taxpayer reconstructs business expenses. Mortgage interest reported on Form 1098, Mortgage Interest Statement, will appear on a wage and income transcript. Many lenders have the statements available online as well. Local townships, cities, or counties can provide documentation of real property taxes paid and the payments may be accessible through an online website. To establish state income tax paid through withholding, the taxpayer must contact his or her employer for a copy of Form W-2. A taxpayer can establish cash charitable contributions by canceled checks, but certain donations require contemporaneous written substantiation. Charitable Contributions See the Individual Issues chapter in this book for a discussion of the charitable contribution substantiation requirements. Penalties on Late-Filed Returns See pages in the 2016 National Income Tax Workbook for a discussion of penalties that may apply to late-filed individual and business returns, and pages in the 2016 National Income Tax Workbook for a discussion of defenses and relief that may apply for certain individual and business penalties. 14 ISSUE 3: COLLECTION STATUTE OF LIMITATIONS The time that the IRS has to collect assessed tax is limited by the collection statute of limitations. I.R.C. 6502(a) provides the general rule that the IRS may collect taxes within 10 years after the assessment. The IRS must commence collection by levy or court proceeding before the statute of limitations expires. The expiration of the collection statute ends the government s right to pursue collection of a liability. The statute can be extended by agreement between the IRS and the taxpayer only under limited circumstances (discussed later in this section). In addition, there are certain events that suspend the running of the statute, which results in a limitation period that is longer than 10 years from the assessment date. If the IRS commences a timely court proceeding to collect assessed tax, the period during which such tax may be collected by levy is extended and will not expire until the liability for the tax (or a judgment against the taxpayer arising from such liability) is satisfied or becomes unenforceable. The collection statute of limitations applies to the tax and any penalties and interest. However, specific penalty and interest assessments may have a different collection limitation period. If the IRS files an SFR, the collection statute of limitations begins to run when the assessment is processed for the SFR. Determining the Collection Statute Expiration Date The collection statute expiration date (CSED) is based on the date a tax was assessed. The most accurate way to determine the CSED is to obtain a transcript of the taxpayer s account. A tax account transcript will show the date of assessment, date of filing, the tax liability, and any payments and additions to the tax. Determining the Collection Statute Expiration Date 513

10 The IRS enters the assessment at the time of filing under transaction code (TC) 150. The IRS enters an additional assessment resulting from an audit under TC 300. Figure 14.2 shows transaction codes that have their own CSED. FIGURE 14.2 Transaction Codes with Their Own CSED Transaction Code Definition 160 Manually computed delinquency penalty 166 Computer-generated delinquency penalty 170 Estimated tax penalty 176 Computer-generated estimated tax penalty 180 Manually assessed failure-to-deposit penalty (FTD) 186 Computer-generated FTD penalty 234 Daily delinquency penalty (if it is the only CSED in the module) 238 Daily delinquency penalty 240 Miscellaneous civil penalty (except for reference codes 697 and 699) 246 Form 8752 (S corporation or partnership with I.R.C. 444 election) or Form 1065 penalty 290 Additional tax assessment 294 Tentative carryback disallowance with interest computation date 298 Additional tax assessment with interest computation date 300 Additional tax or deficiency assessment by Examination or Appeals 304 Tentative carryback disallowance by Examination with interest computation date 308 Additional tax or deficiency assessment by Examination or Appeals with interest computation date 320 Fraud penalty 340 Restricted interest [only document codes 47 (exam adjustment) or 51 (prompt/manual/ quick assessment)] 350 Negligence penalty Source: I.R.M IRS Document 6209 is a reference guide that provides definitions of the TC entries [ An account may have multiple CSEDs for one year. Each tax assessment may have its own CSED. Adding 10 years to the date of the assessment code will give the original CSED for the tax and penalties entered for that date (but see the later discussion of suspended or extended CSEDs that may change the original CSED). If there was a lien filed, the original CSED can be determined by adding 10 years to the Date of Assessment found under column (d) of Form 668(Y), Notice of Federal Tax Lien, as shown in Figure The taxpayer can also request the CSED from the IRS. 514 ISSUE 3: COLLECTION STATUE OF LIMITATIONS

11 FIGURE 14.3 Notice of Federal Tax Lien 14 Example 14.2 Calculating the CSED Karen Careful filed her 2014 return on April 15, The return showed a $4,200 tax liability. On July 6, 2016, the IRS concluded an examination of Karen s 2014 return. On July 30, 2016, the IRS assessed an additional $1,200. The CSED for the $4,200 tax assessment is April 15, 2025, while the CSED for the additional $1,200 is July 30, Any penalties assessed at the time of the tax assessments will be subject to the same CSED as the related tax liability. Extending the CSED by Written Agreement Prior to January 1, 2000, the IRS could enter into an agreement with a taxpayer to extend the period of limitations on collection at any time prior to the expiration of the limitation period. Historically, the IRS conditioned consideration of an offer in compromise on the execution of a collection extension agreement or waiver. Section 3461 of the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No , amended I.R.C to allow the IRS to enter into collection extension agreements only in the following two situations: 1. When the taxpayer enters into an installment agreement 2. Prior to release of a levy pursuant to I.R.C. 6343, if the release occurs after the expiration of the original 10-year period of limitations on collection An extension agreement entered into before the expiration of the CSED in connection with an installment agreement extends the statute to the eighty-ninth day after the date agreed upon in the written agreement. While the statute allows for extending the collection statute in connection with granting installment agreements, it is the IRS s policy that CSED extensions are allowed only in conjunction with a partial payment installment agreement (discussed later), and then only in certain situations. An extension agreement entered into prior to the release of a levy made within the statute of limitations will extend the period of limitation on collection to the date stated in the agreement. The date of the levy is the date that the IRS gives the I.R.C. 6335(a) notice of seizure. Under Treas. Reg (a), notice must be given to the owner of the property (or, in the case of personal property, to the possessor of the property). If the taxpayer cannot make full payment by the CSED, and the taxpayer has some ability to pay, the IRS may enter into a partial payment installment agreement (PPIA). Before the IRS grants a PPIA, the IRS reviews the taxpayer s equity in assets, and if appropriate, the taxpayer must sell those assets and make a partial payment. If the taxpayer has significant equity in assets and enforcement action is appropriate, the IRS will not approve a PPIA. To obtain a PPIA, the taxpayer must complete Forms 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, and/or Form 433-B, Collection Information Statement for Businesses, to determine the taxpayer s ability to pay. The IRS will compare current-year income information that the taxpayer provides to the income on the last-filed return. Extending the CSED by Written Agreement 515

12 In addition, the IRS will compare assets included on the financial statement to information on prior returns and information obtained from other sources (e.g., real property records). If the taxpayer s current-year income has decreased 20% or more from the last filed return, or if the IRS identifies income or assets that the taxpayer did not disclose on the financial statement, the IRS will ask the taxpayer to explain the discrepancy. A taxpayer must agree to pay the maximum monthly payment based on the taxpayer s ability to pay. If the taxpayer has defaulted on an installment agreement in the past 24 months, he or she will be required to make monthly payments by direct debit or payroll deduction. The IRS may grant a PPIA if a taxpayer has no assets or equity in assets, or has liquidated available assets to make a partial tax payment. If the taxpayer has equity in assets, the IRS may grant a PPIA even if the taxpayer does not sell or cannot borrow against the assets with equity because of the following: 1. The assets have minimal equity or the equity is insufficient to allow a creditor to loan funds. 2. The taxpayer is unable to use equity (e.g., a nonliable spouse will not agree to borrow against property held as tenants by the entirety). 3. The asset has some value, but the taxpayer is unable to sell it because the asset is currently unmarketable. 4. The asset is necessary to generate income for the PPIA, and the government will receive more from the future income generated by the asset than from the sale of the asset. 5. It would impose an economic hardship on the taxpayer to sell the property, borrow on the equity in the property, or use a liquid asset to pay the taxes. 6. The taxpayer s loan payment would exceed the taxpayer s disposable income, and he or she would not qualify for a loan. If the IRS determines that enforcement action is not appropriate, the IRS may grant a PPIA. If there is an asset that will come into the possession of a taxpayer after the CSED and liquidation of that asset offers the best resolution (in lieu of liquidating existing assets to partially pay the liability), the IRS will consider securing a waiver with the PPIA. The extension can only be secured 516 ISSUE 3: COLLECTION STATUTE OF LIMITATIONS at the start of the PPIA. The length of the extension must be based on the time that it will take to make payments and cannot exceed 5 years plus 1 year to provide for other administrative actions. Example 14.3 Asset Available after CSED May Flowers owes individual income tax and is the beneficiary of a trust. She will receive a monthly distribution from the trust that could be used to fund the PPIA. May is not entitled to the principal of the trust for 2 more years. The CSED expires in 1 year. May s only other asset is her primary residence. She cannot obtain a loan on the residence because she has insufficient income and bad credit. May and the IRS can agree to extend the statute and to liquidate the trust in 2 years. The IRS would grant a waiver for 2 additional years (1 year after the CSED expiration to secure payment from the trust, and 1 additional year for administrative purposes). Suspension of the Collection Statute of Limitations Under I.R.C. 6503, certain events will suspend (or toll) the collection statute, and the CSED date will exceed 10 years from the assessment date. Suspension means that that statute does not run during specified periods and the 10-year period that was stopped continues to run the remainder of its term following the end of the suspension. The reason for extending the collection statute is to make up for time periods during which the IRS is prohibited from taking collection action. I.R.C. 6015(e)(2) suspends the collection statute of limitations for some innocent spouse claims. I.R.C. 7811(d) suspends the collection statute when the taxpayer files Form 911, Request for Taxpayer Advocate Service Assistance (And Application for Taxpayer Assistance Order). I.R.C. 6331(k) suspends the collection statute for taxpayers who have requested an installment agreement or submitted an offer in compromise. Request for Innocent Spouse Relief Collection activity is suspended for the requesting spouse when he or she submits a qualifying request for innocent spouse relief; separation of

13 liability relief; or equitable relief under I.R.C. 6015(b), (c), or (f) [I.R.C. 6015(e)(2)]. The collection period is suspended from the date the taxpayer files the claim until 60 days after 1. the taxpayer files a waiver, 2. the 90-day period for petitioning the Tax Court to appeal a determination expires, or 3. the Tax Court decision becomes final under I.R.C Although the IRS may resume collection activity on the date the requesting spouse files a notice of appeal of an adverse Tax Court decision (if the taxpayer does not file an appeal bond), the IRS will not resume collection activity before the appeal is completed unless the CSED is imminent or the delay will jeopardize collection [I.R.M ]. A request for a reconsideration is not a qualifying request for relief for purposes of Treas. Reg (h)(5) and does not trigger the collection restrictions under I.R.C. 6015(e)(1)(B) or suspension of the collection period of limitations. Request for Taxpayer Advocate Service Assistance Under I.R.C. 7811(d), the collection statute of limitations is suspended if a taxpayer files Form 911, Request for Taxpayer Advocate Service Assistance (And Application for Taxpayer Assistance Order). The request for relief must involve an action to release property of the taxpayer levied upon or to cease any action, take any action as permitted by law, or refrain from taking any action, with respect to the taxpayer under chapter 64 (relating to collection), subchapter B of chapter 70 (relating to bankruptcy and receivership), chapter 78 (relating to discovery of liability and enforcement of title), and any other provision of law specified by the National Taxpayer Advocate. [I.R.C. 7811(b)] The collection statute suspension begins on the date of the taxpayer s application for assistance [the taxpayer advocate received date (TARD)] and ends on the date of the taxpayer advocate services (TAS) decision with respect to the application (the TAS decision date) and any period specified by the TAS in a taxpayer assistance order (TAO) issued pursuant to the application. I.R.M (Taxpayer Advocate Procedures) provides that the TAS decision date will be 1. the date the Form 911 is denied, 2. the date an agreement is reached as to what should be done with the operations assistance request (OAR); 3. the date the TAS issues the TAO; or 4. the date the review is completed by the parties who could modify or rescind the TAO. For the suspension to apply, the taxpayer or authorized representative must submit a signed Form 911 or a signed written statement that contains the following: Taxpayer s name, TIN, and current mailing address Type of tax and tax periods involved Description of IRS action or proposed action causing or about to cause a significant hardship IRS office and personnel involved, if known Type of relief requested When the TAS receives a written request for assistance, the TAS must mail a statute of limitations suspension notification letter to the taxpayer and his or her authorized representative within 7 calendar days of the TARD. The notice informs the taxpayer of the statute suspension action. A Form 911 or written statement filed to request TAS assistance or to document assistance provided to a taxpayer for record keeping purposes does not suspend the collection statute (e.g., congressional inquiries or functional referrals). Filing Form 911 suspends the running of limitations periods for assessment or collection of tax but it does not suspend the period of limitations for filing refund claims. The collection statute is suspended for the tax periods to which the Form 911 or written statement relates or the tax periods specified on Form 911 or the written statement. The suspension period includes all calendar days except the date the application is received. The statute is not suspended when the applicable 14 Suspension of the Collection Statute of Limitations 517

14 limitation period is suspended by another provision of the law and the initial suspension protects the IRS s interest [I.R.M ]. Example 14.4 Form 911 Suspends the CSED Tony Taxpro was the designated representative for Terrance and Tina Timely. Tony tried to negotiate an installment agreement for Terrance and Tina. Tony spoke to the IRS on October 21, 2015, and the IRS told Tony to provide the Timelys financial information on Form 433-A by December 14, Tony called the IRS on December 14 and found that a levy was issued on November 21, The IRS had no record of the October conversation and refused to release the levy. Terrance and Tina were trying to secure a home equity loan to pay their tax liability. On January 15, 2016, Tony helped the Timelys file Form 911, Request for Taxpayer Advocate Service Assistance, to request release of the levy. Tony included a letter from the bank stating the taxpayers were closing on their loan soon. The IRS released the levy on January 22, The CSED was extended for 7 days, which is the number of calendar days (excluding the day received) from the January 15, 2016, TARD to the January 22, 2016, levy release. Offer in Compromise FINAL COPYRIGHT 2017 LGUTEF I.R.C. 6331(k)(1) and (3) prohibit the IRS from levying while an offer in compromise (OIC) is pending. A pending OIC suspends the collection statute for the number of days the offer is pending with the IRS, the 30 days immediately following rejection of the offer, and the period that Appeals is considering a timely filed appeal of a rejection. An offer is pending when the IRS accepts the offer for processing [Treas. Reg (d) (2)]. If only one party to a joint assessment files an OIC, then the CSED is suspended just for that person. 518 ISSUE 3: COLLECTION STATUTE OF LIMITATIONS OIC to Delay Collection Submission of an OIC does not automatically stay collection if there is any indication that the taxpayer filed the offer solely to delay collection of the liability or if the delay would jeopardize the government s interest [IRS Policy Statement 5-97]. OICs and OICs filed for delay are discussed in greater detail later. Installment Agreements The provisions of I.R.C. 6331(k) also apply to installment agreements. The IRS cannot take levy or seizure action while an installment agreement is under consideration, for 30 days after denial or termination of an installment agreement, or during the time an appeal of a denied or terminated installment agreement is pending. The collection statute is suspended during these periods. Collection Due Process I.R.C. 6330(e) suspends the collection statute for the period during which a timely filed collection due process (CDP) hearing and appeal are pending. The suspension begins on the date the IRS receives a timely filed request for a CDP hearing and ends on the date the taxpayer withdraws his or her request or the date the determination of Appeals becomes final, including any court appeals. If the period remaining on the statute is less than 90 days when the determination is made final, the statute of limitations is extended to 90 days. An Appeals determination becomes final when the 30-day period within which the taxpayer could appeal to the Tax Court expires or when the judicial review (including any appeals to higher courts) is completed. If the taxpayer does not exercise his or her right to appeal to a higher-level court, the 90 days allowed for appeal is included in the suspension. This suspension only applies to a timely filed request for a CDP hearing. A timely filed request is one that is filed with the IRS within 30 days after the IRS sends a final notice of intent to levy.

15 If the taxpayer requests a CDP hearing after the 30 days, the taxpayer can request an administrative hearing with Appeals (an equivalency hearing). The CSED is not suspended during an equivalency hearing. Military Tax Issues See the Individual Issues chapter in this book for a discussion of additional tax rules that apply to members of the US Armed Forces. CDP vs. Equivalency Hearing Taxes may be discharged in a bankruptcy proceeding if the taxes were assessed more than 240 days before the bankruptcy petition date (and the taxpayer meets other requirements). This 240-day period is tolled while a timely CDP appeal is pending, plus 90 days [11 U.S.C. 507(a)]. The 240-day period is not tolled for an equivalency hearing. Thus, if the taxpayer is considering bankruptcy, an equivalency hearing may be preferable. Military Deferment/Military in Combat Under I.R.C. 7508(a), the collection statute is suspended while a taxpayer is in a combat zone, plus 180 days. Under the Servicemembers Civil Relief Act (SCRA) of 2003, Pub. L. No , the collection of any income tax due from a person in the military service, whether the tax is due before or during military service, may be deferred up to 180 days after termination of or release from military service if ability to pay the tax is materially affected because of the person s military service. The running of a statute of limitations against the collection of tax deferred under the SCRA, by seizure or otherwise, is suspended for the period of military service of the servicemember and for an additional period of 270 days thereafter. If the taxpayer s current monthly income (military income) is less than the monthly income immediately prior to active duty, his or her ability to pay the balance due is materially affected by active military status. A taxpayer is eligible for military deferment only for the initial period of military service. Military deferments are granted only upon the written request by the taxpayer. These provisions apply to spouses of military personnel as well if the spouses file jointly. Issuance of a Statutory Notice of Deficiency I.R.C. 6503(a) suspends the collection statute of limitations on collection of an I.R.C deficiency by levy or court proceeding. The statute is suspended for 90 days (150 days if addressed to a taxpayer outside the United States) after the IRS mails a notice of deficiency. If a proceeding in respect of the deficiency is placed on the docket of the Tax Court, the suspension runs until the decision of the Tax Court becomes final and for 60 days thereafter. An income, estate, gift, or excise tax deficiency is defined as the amount by which the tax imposed exceeds the excess of the amount shown on the return; increased by the amount previously assessed (or collected without assessment); and reduced by rebates (abatement, credit, refund, or other repayment) [I.R.C. 6211(a)]. Taxpayer s Assets in Control or Custody of Court I.R.C. 6503(b) suspends the collection statute while the taxpayer s assets are in the control or custody of the court in any proceeding before any court of the United States, any state, or of the District of Columbia. The statute is suspended for the period that the assets are in the control or custody of the court, plus 6 months. To suspend the statute, all or substantially all of the assets of a taxpayer must be in the custody or control of the court [Treas. Reg (b)-1]. Taxpayer outside the United States I.R.C. 6503(c) suspends the collection statute for the period during which the taxpayer is outside the United States if the period of absence is for a continuous period of at least 6 months. If the taxpayer returns to the United States and the remaining time on the statute is less than 6 months, the collection period cannot expire Suspension of the Collection Statute of Limitations

16 earlier than 6 months after the date of return. Under Treas. Reg (c)-1(b), a taxpayer will be deemed to be absent from the United States if he or she is generally and substantially absent from the United States, even though he or she makes casual temporary visits during the period of absence. Statute Suspension Procedures As the suspension of the CSED while a taxpayer is absent from the United States can result in very long CSED extensions, I.R.M outlines IRS policies regarding suspension of the statute. The recalculated period for the CSED is more limited for taxpayers who have cooperated with the IRS to resolve their liabilities, or taxpayers with whom the IRS has maximized its ability to collect. The taxpayer is cooperative if the taxpayer fully responded to the IRS and provided full information with respect to collection of the assessment. In such instances, the case may be resolved by a formal installment agreement, by a valid OIC, or by designating the case currently not collectible for hardship reasons. If the taxpayer is not cooperative, the IRS will recalculate and update the CSED for the maximum amount of time allowed by I.R.C. 6503(c) if the IRS determines that there is significant potential for collection. For taxpayers currently residing outside the United States who have installment agreements or periodic payment OICs with payments up to 24 months, the maximum length of the CSED recalculation is 16 years from the date of assessment. If an international taxpayer has been designated as currently not collectible for hardship reasons, generally the IRS will not recalculate the CSED. For taxpayers with significant collection potential that have been out of the United States for a lengthy period, the IRS will recalculate the CSED as necessary for the time anticipated to collect the liability, up to the maximum allowed under the law. The IRS will count assets located outside the United States as significant collection potential (see I.R.M , Collection Tools for International Cases). Assets located in a country with which the United States has a mutual collection agreement may be seized or levied by the mutual collection country for the benefit of the United States. These mutual collection income tax treaty partners 520 ISSUE 3: COLLECTION STATUTE OF LIMITATIONS include Canada, Denmark, France, The Netherlands, and Sweden [I.R.M ]. In January 2013, the United States and Japan agreed to provide mutual collection assistance, but as of June 2017, the treaty protocol had not been ratified. Reasons to Recalculate the CSED I.R.M provides reasons that will allow the recalculation of the CSED (but only to the extent that the policies described earlier apply). Recalculation may be based on the following criteria: 1. A signed Form 433-A, Collection Information Statement for Wage Earners and Self- Employed Individuals, that states the dates of residence outside the United States and Commonwealth Territories 2. Any other written information from the taxpayer or his or her agent stating that the taxpayer was outside the United States and Commonwealth Territories 3. Oral statements by the taxpayer or his or her agent stating the dates the taxpayer was outside the United States and Commonwealth Territories if such information is clearly documented in the case history 4. Tax returns that were consistently filed since the year of tax assessment with a foreign address (with recalculation and update of the CSED up to the date the taxpayer signed the return) The IRS will use data sources such as Accurint, credit reports, the information returns processing system, and third-party testimony to determine whether the taxpayer has been outside the country for a long period of time. However, these sources cannot be the sole reason to justify updating the CSED. If the IRS cannot contact the taxpayer or his or her agent to confirm that the taxpayer is out of the country, information may be available through a government resource such as TECS Historical Travel Records or the Department of State records of registration. If a case has significant collection potential and the preponderance of information assembled indicates that the taxpayer is outside the United States, the IRS will recalculate and update the CSED without any contact or discussion with the taxpayer or his or her agent.

17 Extensions of the Time for Payment I.R.C. 6503(d) suspends the collection limitation period for the period of any extension of time for payment granted under the provisions of I.R.C. 6161(a)(2) or (b)(2), 6163, or I.R.C allows an extension of the time for payment of the amount of tax shown, or required to be shown for a reasonable period not to exceed 6 months (12 months in the case of estate tax) from the payment due date. The IRS can grant multiple extensions of time to pay estate tax for a total period of up to 10 years. I.R.C grants an extension of time for payment of estate tax on the value of reversionary or remainder interests in property. I.R.C grants an extension of time for payment of estate tax where the estate consists largely of an interest in a closely held business. It generally allows for a 5-year deferral and annual installment payments over a 10-year period. The suspension applies only to the amount of the assessment equal to the amount of money or the value of specific property returned. Wrongful Lien I.R.C. 6503(f)(2) provides a similar suspension of the running of the collection statute for a wrongful lien. The collection statute is suspended beginning with the date any person becomes entitled to a certificate of discharge of lien under I.R.C. 6325(b)(4), and it ends on the earlier of the earliest date on which the IRS no longer holds any amount as a deposit or bond under I.R.C. 6325(b)(4), or the date that a judgment under I.R.C. 7426(b)(5) becomes final. The suspension is only for the assessment equal to the value of the interest of the IRS in the property plus interest penalties, additions to tax, and any additional amounts attributable to these items. 14 Tax Liens Liens for estate tax under I.R.C. 6324(a) expire exactly 10 years from the date of the decedent s death regardless of whether the CSED has expired. Wrongful Seizure of or Lien on Property of Third Party I.R.C. 6503(f)(1) suspends the running of the collection statute for a period equal to the period beginning with the date the IRS wrongfully seized or received property (including money) of a third-party. Example 14.5 Wrongful Seizure On June 1, 2016, Allen Albertson had 10 months remaining on his CSED, which was set to expire on April 1, The IRS wrongfully seized $1,000 from Bob Brown s bank account and applied it to Allen s tax liability. The IRS determined that the $1,000 was wrongfully seized, and on March 1, 2017, the IRS returned the $1,000 to Bob. The running of the period of limitations on collection was suspended for 9 months (beginning June 1, 2016, to March 1, 2017) plus 30 days. Therefore, the period of limitations on collection after assessment will not expire until February 1, 2018, which is 9 months plus 30 days after the original April 1, 2017, CSED [Treas. Reg (f)-1(a)]. Wrongful Seizure The limitation period is suspended until the date the IRS returns the property pursuant to I.R.C. 6343(b) (authority to release levy and return property); or the date on which a judgment secured pursuant to I.R.C (civil actions by persons other than the taxpayer) with respect to such property becomes final, and for 30 days thereafter. Bankruptcy I.R.C. 6503(h) suspends the collection statute during the period the IRS cannot collect because of an automatic stay in a bankruptcy proceeding, plus 6 months. Typically, the automatic stay is in effect until the court grants a discharge. To calculate the extended period for collection, the taxpayer adds 6 months to the unexpired time remaining on the original statute as of the petition date. The taxpayer then adds the time remaining Suspension of the Collection Statute of Limitations 521

18 to the discharge or dismissal date. Thus, the IRS will never receive less than the original statute plus 6 months. The suspension of the collection statute applies to only those assessments that are not subject to discharge in the bankruptcy. Some income taxes can be discharged in bankruptcy, and the suspension of the CSED does not apply to those taxes. If one spouse files bankruptcy, and the spouses file a joint return, the collection statute is suspended only for the petitioning spouse. If both spouses file a joint bankruptcy, the same CSED suspension applies to both spouses. If each spouse files an individual bankruptcy and the spouses file a joint return, the CSED is suspended individually for each debtor. The extension depends on the duration of the stay in each bankruptcy case. Further Suspension after Discharge After the suspension under I.R.C. 6503(h) no longer applies, the CSED may still be suspended if substantially all the debtor s assets remain in the custody or control of the bankruptcy court [I.R.C. 6503(b)]. Other Suspensions under Section 6503 I.R.C. 6503(e) suspends the collection statute of limitations for the period of any extension of time for payment of tax attributable to recoveries of foreign expropriation losses under I.R.C. 6167(a) or (b). I.R.C. 6503(g) suspends the collection statute for a pending extension to correct certain items related to private foundations. I.R.C. 6503(i) suspends the collection statute for the collection of any undistributed passive foreign investment company (PFIC) earnings tax liability for the period of any extension of time to pay such tax under I.R.C Multiple Suspensions FINAL COPYRIGHT 2017 LGUTEF If suspensions overlap, the taxpayer must count the period of overlap only once. If there are multiple events affecting the CSED, the CSED must be recalculated for each event. 522 ISSUE 3: COLLECTION STATUTE OF LIMITATIONS Example 14.6 Overlapping Suspension Periods George Smith owes income taxes for the tax year ending December 31, The tax assessment date was June 1, 2009, and the original CSED was June 1, George is in the Army Reserves. He was called for combat duty and entered a combat zone on May 10, He left the combat zone on March 1, George submitted an OIC on April 20, The IRS rejected the OIC on October 17, 2015, and George did not appeal the rejection. Entering a combat zone and submitting an OIC both suspend the CSED. The combat duty suspended the CSED from May 10, 2014, through March 1, 2015, plus 180 days (through August 28, 2015). Consideration of the OIC suspended the CSED from April 20, 2015, through October 17, 2015, plus an additional 30 days for the appeal period (through November 16, 2015). Because these actions overlapped, the CSED was suspended only from the date George entered the combat zone (May 10, 2014) through the date the OIC was rejected and the appeal period ended (November 16, 2015). The overlapping of the two suspending events, from April 20, 2015, to August 28, 2015, is considered in the extension only once. The CSED is extended 555 days (May 10, 2014, to November 16, 2015) from the original June 1, 2019, CSED. The new CSED is December 7, 2020 [I.R.M ]. Example 14.7 Multiple Events On June 3, 2002, the IRS assessed tax against Joe Hopeful. The CSED was June 3, 2012 (10 years from the date of the assessment). On November 19, 2002, Joe appealed a notice of federal tax lien. On July 10, 2003, the rejection of the appeal became final. The CSED was suspended from the date that Joe timely filed the request for a CDP hearing to the date the determination became final (233 days). The new CSED was January 22, 2013 (June 3, days). On February 23, 2004, Joe filed bankruptcy, and on August 11, 2004, the bankruptcy was dismissed. The CSED was suspended from the date bankruptcy was filed to the date it was dismissed plus 6 months. The new CSED is January 11, 2014 (January 22, days + 6 months).

19 On September 2, 2006, Joe joined the US Armed Forces and entered a combat zone. He left the combat zone on June 8, The CSED was suspended from date Joe entered the combat zone to the date he left the combat zone (279 days) plus 180 days. Absent any other suspending events, the new CSED would have been April 15, 2015 (January 11, days). During the time that he was in the combat zone, Joe submitted an OIC, which caused an overlap in suspension periods. The IRS accepted the OIC for processing on May 22, 2007, and rejected the offer on March 5, The CSED was suspended while the offer was pending plus 30 days. The overlapping suspension days are counted only once. As a result, the total suspension period is September 2, 2006 (when Joe entered the combat zone) to April 4, 2008 (the final rejection of the OIC + 30 days). The CSED was suspended 580 days, and the new CSED was August 14, 2015 (January 11, days). Suit for Judgment To extend the statute of limitations for collection, the government may bring a lawsuit to reduce the tax liability to a judgment. The government will file a suit if the collection statute is expiring, all administrative remedies have been exhausted, and there is reason to believe that the government can collect in the future (e.g., if the taxpayer acquires assets or has substantial earnings). If the suit is successful, the period for collection by levy does not expire until the tax liability is satisfied or becomes unenforceable. Before initiating a suit, the government will consider the size of the tax liability, potential sources of collection, and the time and expense of a suit. Although the collection statute of limitations is extended indefinitely when a tax assessment is reduced to judgment, if there is no collection potential after 20 years from the date of the judgment, the IRS will not maintain the account on its active system. However, if the IRS later identifies collection sources, it may reinstate the account and resume collection. 14 Recalculating a CSED ACA and Judgments The easiest way to recalculate a CSED is using the Julian dates. A Julian date is the date expressed as a single number out of 365 or 366 days (e.g., February 20 is days of January + 20). Julian date calendars for both leap and nonleap years can be found at /fepp/julian-calendar.pdf. The Affordable Care Act s individual shared responsibility payment (ISRP) is not subject to lien or levy, and the IRS cannot include an ISRP in a suit for a judgment [I.R.C. 5000A(g)(2)(B)]. However, the employer shared responsibility payment (ESRP) is subject to the same collection actions as an assessed penalty, and the IRS can include an ESRP in a suit for judgment [I.R.C. 4980H(d)(1)]. Suspension of the Collection Statute of Limitations 523

20 ISSUE 4: TRANSFEREES, NOMINEES, AND ALTER EGOS When a taxpayer transfers assets to third parties, transferees, nominees, or alter egos, the IRS has several ways to collect against the transferred assets. There are a variety of situations where the IRS can hold a third party liable for the tax liability of another taxpayer. Different legal theories for third-party liability include transferee liability, or liability of a nominee or alter ego. Transferee Liabilities Under I.R.C the IRS can assess a taxpayer s tax liability against a person/entity who received the taxpayer-transferor s assets for less than full, fair, and adequate consideration. The IRS can also collect the liability from the person/ entity who is legally responsible for paying the taxpayer-transferor s liability. Transferee liability can arise from the transfer of property by a taxpayer (income tax), a decedent (estate tax), or a donor (gift tax). A transferee liability can arise for other taxes (e.g., excise tax or employment taxes) if there was a liquidation of a corporation or a partnership, or a corporate reorganization under I.R.C There are two types of transferee liability: transferee at law and transferee in equity. Transferee at law arises when a person or entity is responsible for the transferor s tax liability because of an existing law or because of a contractual agreement with the transferor (i.e., an assumption or guarantee agreement). To pursue a transferee liability at law, the IRS must show that the transferee assumed the liability under a valid contract or that the transferee is liable under a specific state or federal statute. Transferee in equity is the most common form of transferee liability. This situation arises when a person/entity receives the transferor s assets for less than full, fair, and adequate consideration, leaving the transferor insolvent and unable to pay the tax liability. Transferee in equity cases are based on the state or federal fraudulent conveyance statutes. In these cases, the transferee liability is limited to the value of the assets received from the transferor. This section primarily discusses transferee in equity cases. To pursue a transferee liability in equity, the IRS must establish the following: 1. The transferor was insolvent when the asset transfer occurred or was rendered insolvent because of the asset transfer(s) (some states do not require insolvency for an in-equity liability). 2. The value of the asset transferred on the transfer date. 3. The consideration, if any, paid for the asset(s), and who received the asset(s). 4. That the asset transfer occurred after the transferor s liability accrued. 5. That the IRS made a reasonable attempt to collect the tax from the transferor or that it would be futile to pursue collection from the transferor (e.g., a dissolved corporation). Statute of Limitations The administrative procedures under I.R.C are not available to the IRS if the statute of limitations for assessment against the transferee has expired. If the statute is expired, the government may only impose a transferee liability by filing suit. See the later discussion of the transferee s assessment statute of limitations. Transferee A transferee under I.R.C can be anyone who receives property for inadequate consideration from a taxpayer who has an unpaid tax liability or a person who receives property or other distributions from a corporation or partnership if the entity has an unpaid tax liability. The definition of a transferee under Treas. Reg (b) includes the following: 1. An heir, legatee, devisee, or distributee, of an estate of a deceased person 2. The shareholder of a dissolved corporation 3. The assignee or donee of an insolvent person 524 ISSUE 4: TRANSFEREES, NOMINEES, AND ALTER EGOS

21 4. The successor of a corporation 5. A party to a reorganization as defined in I.R.C All other classes of distributees 7. With respect to gift tax, a donee (without regard to the solvency of the donor) 8. With respect to estate tax, any person who under I.R.C. 6324(a)(2) is personally liable for any part of such tax Property Transfers FINAL COPYRIGHT 2017 LGUTEF The transfer of property must occur after the accrual of a tax liability (not the actual assessment). If the transfer occurs during the year that the liability accrues, IRS Area Counsel determines when the liability accrued [I.R.M ]. Example 14.8 Accrual vs. Assessment Bob Broke filed his 2014 tax return on April 15, In 2015 Bob gifted stock to his brother, Bill. In June 2017, the IRS determined that Bob had $10,000 unreported income in 2014, and assessed additional tax. The IRS can assess a transferee liability against Bill if Bob cannot pay the tax. The tax liability related to the $10,000 income accrued in 2014 before the stock transfer. The transfer of property must be for less than adequate consideration. Often, such transfers occur because of a close relationship between the parties involved. A preferential transfer occurs if the transfer was made to an insider because of a prior debt, the transfer was made at a time the transferor was insolvent, and the insider had reason to believe that the transferor was insolvent at the time the transfer was made. Example 14.9 Transfers Between Corporation and Shareholder Upon dissolution, CT Corporation paid a debt it owed to its majority shareholder but failed to pay an outstanding tax liability. The repayment of the loan may be a preferential transfer to an insider, thus making the shareholder a transferee. Similarly, an unreasonable bonus or salary paid to an employee/shareholder may also be treated as the equivalent of a distribution of the corporate assets and result in a transferee liability. A property transfer can be direct or indirect, and includes the following: The disposition of an asset or an interest in an asset The payment of money The payoff of debt The release of a debt or claim The granting of a lease The creation of a lien or other encumbrance Excessive compensation paid to corporate officers The distribution of sales proceeds or other corporate assets to shareholders [I.R.M ] Example Encumbrance of Debtor s Asset Arnie Wilson took out a mortgage on property owned by his mother, who was liable for unpaid taxes. Arnie used the borrowed funds to improve his own property. Arnie can be held liable for the decrease in value of the property attributable to the mortgage. [See United States v. Bushlow, 832 F.Supp. 574 (E.D.N.Y. 1993).] Source of Liability The existence and the extent of a transferee s liability is based on either law or equity. An atlaw liability is directly imposed by federal or state law. It can also arise from an express or an implied agreement. For example, a purchaser of a business may agree to purchase the assets and assume all liabilities of the business. An in-equity liability is a transferee liability based on equity or fairness principles. It generally arises from the Federal Debt Collection Procedures Act (FDCPA) or state fraudulent conveyance statutes that prohibit a debtor from transferring assets for less than adequate consideration if he or she is unable to meet his or her obligations. 14 Transferee Liabilities 525

22 State Law Fraudulent Conveyance Currently, 43 states and the District of Columbia have adopted the Uniform Fraudulent Conveyance Act (UFCA) or its successor, the Uniform Fraudulent Transfers Act (UFTA). Alaska, Virginia, South Carolina, Georgia, Mississippi, Kentucky, and Louisiana have not adopted either. See The government can file suit to have the fraudulent transfer set aside or it can pursue the holder of the property under the transferee liability provisions. Constructive fraud is sufficient to set aside a transfer that occurs after the debt accrues. Actual fraud will defeat a transfer even if the debt accrued after the transfer. Fraudulent Conveyance A fraudulent conveyance can involve constructive or actual fraud. Constructive fraud exists if the transferor transfers property for inadequate consideration and the transferor either is insolvent when the transfer occurs or is made insolvent by the transfer. The transferor s intent is immaterial. When a taxpayer transfers property with the intent to hinder, delay, or defraud a creditor, actual fraud exists. Actual fraud may be established through circumstantial evidence (known as the badges of fraud), which include the following: 1. Transfer lacks fair consideration 2. Transferor and transferee are closely related 3. Transferor retains the enjoyment, possession, and control of the property after the transfer 4. Transfer is concealed, or not recorded 5. Transferor was sued or threatened with suit prior to the transfer 6. Transferor transferred substantially all the transferor s assets 7. Transferor secretly left the jurisdiction 8. Transferor removed or concealed assets 9. Transferor was insolvent prior to the transfer or became insolvent shortly thereafter 10. Transfer occurred shortly before or after transferor incurred a substantial debt 11. Transferor transferred an essential asset of a business to a lienholder, who then transferred the asset to an insider For a transfer to be a good-faith exchange at fair consideration, the purchaser must have exchanged property for the transfer. A promise to pay or payment with a non-negotiable note is not sufficient. Trust Fund Doctrine Transferee liability may also exist based on the trust fund doctrine, a judicially created equitable doctrine. The theory of the doctrine is that when a transfer leaves the transferor without enough assets to pay debts, the transferee holds the transferred property in trust for the benefit of the transferor s creditors. The trust fund doctrine is most commonly used to impose transferee liability on a shareholder for a corporation s taxes when the shareholder receives assets from a corporation prior to its dissolution. Recovery under this doctrine is limited to the value of the transferred property. To apply the trust fund doctrine, the IRS must establish the value of the transferred property and show the following: 1. The alleged transferee received property of the transferor. 2. The transfer was made without consideration or for less than adequate consideration. 3. The transfer was made during or after the period for which the tax liability of the transferor accrued. 4. The transferor was insolvent prior to or because of the transfer (or series of transfers). 5. The IRS made all reasonable efforts to collect from the transferor, and further efforts would be futile. Assessing Transferee Liability A transferee s liability for the transferor s federal tax liability includes any additions to tax, penalties, and interest that have been assessed with respect to the tax. Transferee liability is several and the IRS may proceed against one or more of any number of potential transferees [Phillips v. Commissioner, 283 U.S. 589 (1931)]. In addition, 526 ISSUE 4: TRANSFEREES, NOMINEES, AND ALTER EGOS

23 the government is not bound by any agreements among the transferees as to how the liability is apportioned. Multiple Transferees Typically, the IRS pursues the transferee that the IRS can reach the easiest a transferee whose whereabouts are known and who is located closest to the IRS office pursuing collection. If the IRS successfully collects the full liability from one transferee, it will not pursue any others. Assessment Procedure The procedures for establishing transferee and fiduciary liability under section 6901 are similar to the deficiency procedures. 1. The IRS must mail a notice of transferee or fiduciary liability to the transferee or fiduciary (30-day letter). 2. The transferee or fiduciary may request an Appeals hearing. 3. If the transferee or fiduciary does not request an Appeals hearing, or there is no agreement reached at Appeals, the IRS issues a statutory notice of deficiency to the lastknown address of the transferee or fiduciary. 4. The transferee or fiduciary may petition the Tax Court within 90 days. 5. The IRS will assess the liability against the transferee or fiduciary if the Tax Court enters a decision against the transferee or fiduciary, the transferee or fiduciary defaults on the notice of liability, or the transferee or fiduciary agrees to an assessment of the liability. 6. Once the liability is assessed, and after notice and demand and a refusal to pay, a lien is created that attaches to all property of the transferee or fiduciary. The IRS must file a notice of federal tax lien to protect its interests under I.R.C The IRS can collect the assessment administratively from all property and rights to property of the transferee or fiduciary. 8. The period for collection of the assessment against the transferee is the I.R.C collection statute of limitations (10 years from the assessment against the transferee). Accrued Interest The IRS calculates interest in transferee liability cases for two separate periods: the prenotice period and the postnotice period. Depending on the facts, the two periods may have different rates. Prenotice interest will run either from the due date of the transferor s return generating the liability to the date of the liability notice to the transferee or from the date of the asset transfer to the date of the liability notice. Prenotice interest is based on state or federal rates. Postnotice interest begins on the date when the IRS issues the liability notice to the transferee and ends on the date when the liability is fully paid. It is calculated under I.R.C and For prenotice interest, whether state or federal rules and rates apply depends on the value of the transferred assets relative to the transferor s total liability (including interest). If the value of the assets transferred exceeds the transferor s total tax liability, including penalties and interest, the transferee is liable for the entire amount of the deficiency and interest as determined under federal law. If the value is less than the transferor s tax liability, state law determines the calculation of interest and the applicable rate. Statute of Limitations on Assessment Generally, the IRS must assess liability for the initial transferee within 1 year of the expiration of the statute of limitations for assessment against the transferor [I.R.C. 6901(c)]. If there is a transferee of a transferee, the related assessment must be made within 1 year after the expiration of the statute of limitations for assessment against the preceding transferee, but not more than 3 years after the statute expiration for assessment against the initial transferor. However, if there is a timely initiated court proceeding for assessment or collection against the transferor or the preceding transferee, the period for assessment against the transferee will expire 1 year after the court proceeding is final. If the transferor is deceased or is a terminated corporation, the period of limitation is the period that would have been in effect had death or termination not occurred. For fiduciary liability (discussed later), the IRS must assess the liability 1 year after the fiduciary liability arises or the period for collection of the tax ends, whichever is later. Transferee Liabilities

24 Example Terminated Corporation Great Business, Inc., a C corporation, closed its business and was fully liquidated by February 28, The final tax return for the corporation is due June 15, 2017 (the fifteenth day of the fourth month following the end of the tax year). If a transferee liability arises for unpaid tax related to this final return, the statute of limitations for assessment against the transferee will be April 15, 2022, which is 1 year after what would have been the expiration of the statute of limitations if Great Business, Inc. had operated all year and had an April 15, 2018, return due date and an April 15, 2021, assessment statute of limitations date. The running of the statute of limitations on assessment of income, and on estate or gift taxes, against a transferee is suspended after the mailing to the transferee of the notice provided for in I.R.C (statutory notice of deficiency) for the period during which the IRS is prohibited from making the assessment: 90 days (150 days if the taxpayer is outside the United States) plus 60 days. If the transferee initiates a proceeding in Tax Court, the assessment period is suspended until the Tax Court decision becomes final plus 60 days. Estate and Gift Tax Transfers I.R.C. 6324(a)(2) and (b) impose liability on the transferee for unpaid estate and gift tax. Liability is generally limited to the extent of the FMV of the property received from the estate or the property transferred by gift. I.R.C. 3713(b) imposes personal liability on a representative of a person or an estate paying any part of a debt of the person or estate before paying a debt due to the United States. The fiduciary is liable to the extent of the payment for unpaid claims if the fiduciary knows or should have known that an obligation was due to the United States. Personal liability only applies when the person or estate is insolvent. The liability is limited to the value of the assets that the fiduciary distributes in violation of the federal priority. The procedure to assess fiduciary liability is the same as the procedure to assess transferee liability (discussed earlier). Defenses against Transferee Liability Defenses against transferee liability could include the following: 1. Proof the transferor paid the tax (or another transferee paid the tax) 2. Proof that the transferor does not owe the amount of tax 3. Expiration of the statute of limitations 4. Return of the transferred property 5. Proof that the IRS has not exhausted all remedies against the transferor 6. Documentation of a different asset value and that fair value was paid [I.R.M ] Successor Liability Many state corporate merger and consolidation statutes provide that a surviving corporation is liable for the debts of a predecessor corporation when the surviving corporation is the result of a formal merger or consolidation of two corporations. In these cases, the surviving corporation is primarily liable for the tax debts of the predecessor corporation as a successor in interest. The successor in interest becomes the taxpayer and is primarily liable for the predecessor s tax liability. Nominee and Alter Ego Liability The IRS can collect a taxpayer s liabilities against the taxpayer s property held by nominees or alter egos. A nominee is someone designated to act for another. For example, if a taxpayer titles assets in the name of another person or entity but retains control of the assets and other incidents of ownership, the transfer is in name only. An alter ego means a second self. An alter ego is an entity with a separate legal identity, but because of the unity of ownership and interest between the taxpayer and the entity, the entity is not considered separate from the taxpayer. 528 ISSUE 4: TRANSFEREES, NOMINEES, AND ALTER EGOS

25 For reporting purposes, a nominee is also a taxpayer who receives an information return that reports income payable to more than one taxpayer. Nominee Generally, a nominee holds specific property for the exclusive use and enjoyment of the taxpayer. The IRS may collect a taxpayer s liability from assets held by the third party as the taxpayer s nominee. A nominee situation generally involves one or more of the following: The taxpayer previously owned the property The nominee paid little or no consideration for the property The taxpayer retains possession or control of the property The taxpayer continues to use and enjoy the property conveyed just as before the transfer The taxpayer pays all or most of the expenses of the property The conveyance was for tax-avoidance purposes [I.R.M ] The IRS will issue a nominee Notice of Federal Tax Lien with the name of the taxpayer listed as Nominee Name, Nominee of Taxpayer. Alter Ego FINAL COPYRIGHT 2017 LGUTEF An alter ego is an entity that is legally distinct from the taxpayer but is so intermixed with the affairs and assets of the taxpayer that they are not readily separable. The IRS treats the entity and the individual as one for collection purposes. A corporation may be the alter ego of an individual making the assets in the corporation available to satisfy individual debts, or the individual may be the alter ego of a corporation, making the individual s assets available to satisfy corporate debts. Factors that indicate an alter ego situation include one or more of the following: Commingling of corporate and personal finances and use of corporate funds to pay personal expenses Unsecured interest-free loans between the corporation and the shareholder The taxpayer is a shareholder, director, or officer of the corporation or otherwise exerts substantial control over the corporation The corporation is undercapitalized relative to its reasonable anticipated risks of business A failure to observe corporation formalities, such as issuance of stock, payment of dividends, director and shareholder meetings, or the maintenance of corporate records A failure to disregard the corporate fiction presents an element of injustice or fundamental unfairness [I.R.M ] The IRS will issue an alter ego Notice of Federal Tax Lien with the name of the taxpayer listed as Corporate Name, as alter ego of Taxpayer Name. Collection by Lawsuit In some cases, the IRS will file suit in federal district court to establish that the property is held by the taxpayer s nominee or that the legally separate entity is an alter ego of the taxpayer. Filing suit is most common in situations where 1. the IRS wants to clear title to maximize the sale price of property, 2. there is dispute as to the priority of a lien or security interest in encumbered property, 3. the property is a principal residence (judicial approval is required for seizure), 4. the 10-year section 6502 collection statute is close to expiration, or 5. there is some uncertainty about whether there was a fraudulent transfer or a nominee situation. Nominees for Reporting Purposes Banks and other institutions usually issue only one income document for each account or transaction. Thus, a taxpayer may receive an information document (i.e., Form 1099) that includes income reportable by more than one taxpayer. The recipient is a nominee recipient. The nominee, not the original payer, is responsible for filing subsequent Forms 1099 to show the amount allocable to each owner. The taxpayer must file the same type of Form 1099 with the IRS for each of the other owners showing the amounts allocable 14 Nominee and Alter Ego Liability 529

26 to each, and provide a copy to each of the other owners. The taxpayer is listed as the payer, and the other owner is the recipient. The taxpayer must report the full amount shown on the information document. For interest and dividends, the taxpayer reports the gross amount on Schedule B (Form 1040), Interest and Ordinary Dividends, and makes an additional negative entry as a nominee distribution reflecting the amount on the information return sent to the other owner(s). For a sale of property, the taxpayer reports the full sale price and basis on Form 8949, Sales and Other Dispositions of Capital Assets. The taxpayer reports an adjustment for the portion of gain or loss allocable to another owner in column (g) with code N in column (f), signifying nominee. The taxpayer reports only his or her share of capital gains on Schedule D (Form 1040), Capital Gains and Losses, line 13, and must attach a statement showing the full amount received and the amount received as a nominee. Example Nominee Reporting Stock Sale George Lane and his two brothers, John and Jim, jointly purchased 100 shares of QRS Corporation stock in 2000 for $21,000. They sold the stock 7 years later for $117,000. QRS issued Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, in George s name and social security number. George filed Forms 1099-B for John and Jim reflecting George as the payer and each brother as the recipient of $32,000 [($117,000 $21,000) 3)]. He furnished copies to John and Jim. George reports the full $117,000 proceeds from Form 1099-B on his Form 8949, and he includes an adjustment for the $32,000 reported to John and $32,000 reported to Jim. George reports the $64,000 ($32,000 + $32,000) adjustment in column (g) and enters code N in column (f) to show that it is an adjustment for a nominee. Figure 14.4 shows the Form 8949 entry. FIGURE 14.4 Nominee Reporting Form 8949 Example Nominee Reporting Property Sale George, John, and Jim from Example also sold real estate. The closing agent did not know how to allocate the sale proceeds, so the agent issued a Form 1099-S, Proceeds From Real Estate Transactions, reporting 100% of the gross sale proceeds to George, to John, and to Jim. Each must report the full amount on Form 8949 (as George did in Example 14.12) and make a corresponding adjustment with code O. Each brother should submit an attachment to his return to explain the adjustment. A taxpayer may receive a Form 1099-MISC, Miscellaneous Income, that reflects income of others. This often happens in the entertainment industry when a club or concert venue issues one Form 1099-MISC to one member of the band for the full amount of the appearance fee. The member receiving the form must issue Forms 1099-MISC to the other band members for the portion he or she paid to them. The recipient of the Form 1099-MISC includes the full payment as gross receipts on Schedule C (Form 1040). He or she reports the amount paid to the others as an expense. 530 ISSUE 4: TRANSFERESS, NOMINEES, AND ALTER EGOS

27 Responsible Party Nominee for Partner To apply for an employer identification number (EIN), the applicant must disclose the name of a responsible party. The responsible party is typically an officer (corporation), general partner (partnership), owner (disregarded entity), or grantor (trust). A nominee may be a person who has limited authority to act on behalf of an entity, usually for a limited period (typically during formation). A nominee is not a responsible party. If a nominee holds an interest in a partnership, the nominee must provide the partnership information about the actual owner by the last day of the first month following the close of the partnership s tax year. The written statement must include the nominee s name, address, and taxpayer identification number (TIN); the actual owner s name, address, and TIN; whether the owner is not a US person, is a foreign government, or is a tax-exempt entity; a description of the interest held at the beginning of the year and any interest acquired for the actual owner during the year; and a description of any interest transferred for that owner during the year and the transfer date and proceeds [Temp. Treas. Reg (c)-1T]. 14 ISSUE 5: OFFER IN COMPROMISE An offer in compromise may reduce the required payment on an assessed tax liability, interest, and penalties. I.R.C authorizes the IRS to compromise any civil or criminal liability for taxes, interest, or penalties prior to a referral to the Department of Justice for prosecution or defense. This section discusses the requirements to file an offer in compromise (OIC), how to file the OIC, and how to calculate the offer amount. IRS Policy Statement IRS policy states that the IRS will accept an OIC when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects collection potential. An OIC is a legitimate alternative to declaring a case 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. The IRS will assist the taxpayer to prepare the required forms and make reasonable and prompt decisions. It is the taxpayer s responsibility to make an adequate proposal and to provide reasonable documentation [I.R.M ]. Issue 5: Offer in Compromise 531

28 Eligibility for an OIC A taxpayer is eligible for an OIC if he or she received a bill for at least one tax debt to be included in the offer, filed all currently due tax returns, made all required estimated tax payments for the current year, and made all required federal tax deposits for the current quarter if the taxpayer is a business owner with employees. If the IRS determines that a taxpayer did not file all tax returns, the IRS will apply any initial payment sent with the OIC to the tax debt and will return the OIC and the application fee to the taxpayer. Section 6 of Form 656, Offer in Compromise, requires the taxpayer to indicate that the taxpayer has either filed all returns and made all required payments or that there was no filing or payment requirement for certain years. The IRS will not accept an OIC if the taxpayer is currently in an open bankruptcy proceeding. In most cases, the IRS will not accept an OIC unless the amount that the taxpayer offers is equal to or greater than the reasonable collection potential (RCP). The IRS uses RCP to measure the taxpayer s ability to pay (discussed later). The IRS will not consider an OIC filed for liabilities that the taxpayer can pay through an installment agreement or by other means prior to the expiration of the collection statute of limitations (unless the OIC is based on promoting effective tax administration). OIC Prequalifier Tool The IRS provides an OIC prequalifier tool that the taxpayer can use to confirm eligibility and to prepare a preliminary proposal. See ISSUE 5: OFFER IN COMPROMISE Basis for OIC The IRS may accept an OIC that is filed for the following three reasons: 1. Doubt as to liability 2. Doubt as to collectibility 3. Effective tax administration Doubt as to Liability Doubt as to liability (DATL) exists where there is a genuine dispute about the existence or amount of the correct tax liability under the law [Treas. Reg (b)(1)]. DATL cannot exist if a final court decision or judgment has established the existence of or the amount of the liability. The IRS cannot reject an offer based on DATL solely because the IRS is unable to locate the taxpayer s return or return information to verify the liability [Treas. Reg (f)(4)]. DATL may be the basis for an OIC in the following situations: The tax was discharged fully in bankruptcy. The tax was incorrectly or erroneously assessed. The IRS misplaced an amended return. Doubt as to Collectibility Doubt as to collectibility (DATC) exists if the taxpayer s assets and income are less than the full amount of the liability [Treas. Reg (b)(2)]. The IRS uses the RCP (discussed later) to determine the taxpayer s collectibility. If the RCP does not represent collection potential due to special circumstances, the taxpayer can file an OIC based on effective tax administration. Effective Tax Administration A compromise will promote effective tax administration (ETA) if collection of the tax would create an economic hardship for the taxpayer or if there is a compelling public policy or equity reason for the compromise. [The I.R.M. also refers to such offers as doubt as to collectibility with special circumstances (DCSC)]. The IRS cannot enter into a compromise to promote ETA if compromise of the liability would undermine taxpayers compliance with the tax law [Treas. Reg (b)(3)].

29 Undermining Compliance The following factors may show that the compromise would undermine compliance with the tax law: The taxpayer has a history of noncompliance with the filing and payment requirements of the Internal Revenue Code. The taxpayer took deliberate actions to avoid the payment of taxes. The taxpayer encouraged others to refuse to comply with tax laws. [Treas. Reg (c)(3)(ii)] Economic Hardship The IRS can compromise a tax liability to promote ETA even if the IRS could collect the full tax. Collection of the full liability must cause the taxpayer economic hardship within the meaning of Treas. Reg [Treas. Reg (b)(3)]. Economic hardship under Treas. Reg (b)(4) exists if payment of the tax would cause an individual taxpayer to be unable to pay his or her reasonable basic living expenses. The determination of a reasonable amount for basic living expenses is made according to the unique circumstances of the taxpayer, but does not include the maintenance of an affluent or luxurious standard of living. In determining a reasonable amount, the IRS will consider any information that the taxpayer provides, including the following: 1. The taxpayer s age, employment status and history, ability to earn, number of dependents, and status as a dependent of someone else 2. The amount reasonably necessary for food, clothing, housing (including utilities, homeowners dues, and similar expenses), medical expenses (including health insurance), transportation, current tax payments (including federal, state, and local), alimony, child support, other court-ordered payments, and expenses necessary for the taxpayer to produce income (such as dues for a trade union or professional organization or child care payments that allow the taxpayer to be gainfully employed) 3. The cost of living in the geographic area where the taxpayer lives 4. The amount of property that is exempt from levy and is available to pay the taxpayer s expenses 5. Any extraordinary circumstances such as special-education expenses, a medical catastrophe, or natural disaster 6. Any other factor that demonstrates economic hardship The following factors support a determination that collection would cause economic hardship: The taxpayer is incapable of earning a living because of a long-term illness, medical condition, or disability, and it is reasonably foreseeable that the taxpayer s financial resources will be exhausted providing for his or her care and support. The taxpayer s monthly income is exhausted each month in providing care for dependents with no other means of support. The taxpayer has assets but is unable to borrow against the equity in those assets, and liquidation of the assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses. [Treas. Reg (c)(3)(i)] Example Hardship Because of Illness Jean Windsor has assets sufficient to satisfy her tax liability. Jean provides full-time care and assistance to her dependent child, who has a serious long-term illness. It is expected that Jean will need to use the equity in her assets to provide for adequate basic living expenses and medical care for her child. Jean s overall compliance history does not weigh against compromise. The IRS may compromise Jean s liability under the economic hardship provisions [Treas. Reg (c) (3)(iii), Example 1]. 14 Basis for OIC 533

30 Example Inability to Liquidate Asset John Richards is retired and receives only pension income. His only asset is a retirement account that holds funds sufficient to pay the full liability. Liquidation of the retirement account would leave John without an adequate means to provide for basic living expenses. John s overall compliance history does not weigh against compromise. The IRS may compromise John s liability under the economic hardship provisions [Treas. Reg (c)(3)(iii), Example 2]. Example Inability to Borrow against Asset Miles Lundgren is disabled and lives on a fixed income. After allowance for basic living expenses, his remaining income does not permit full payment of his tax liability under an installment agreement. Miles owns a modest home that has been adapted to accommodate his disability. Equity in the house is sufficient for payment of the tax liability. However, due to his disability and limited earning potential, Miles is unable to borrow against this equity. As this home has been specially equipped to accommodate his disability, forced sale would create severe adverse consequences for Miles. His overall compliance history does not weigh against compromise. The IRS may compromise his liability under the economic hardship provisions [Treas. Reg (c)(3)(iii), Example 3]. Example Compliance Undermined Jeff Allen submitted an ETA offer based on economic hardship. The financial statement appeared to support the offer. When the IRS researched the county property records, the IRS found that Jeff had transferred his home to his daughter for $100 plus love and affection. Jeff transferred the home after the IRS assessed the tax. Jeff did not provide any information or documentation to demonstrate that the transfer of property was an arm s-length transaction. It appears that the transfer was to avoid the payment of tax, and therefore, the IRS will not accept Jeff s offer [I.R.M (8)]. For an offer based on economic hardship, the IRS will determine an acceptable offer amount by analyzing the financial information and the hardship that would be created if the taxpayer used certain assets, or a portion of certain assets, to pay the liability [I.R.M (1)]. Example Hardship Acceptable Offer Amount Casey Milner has a $100,000 liability and a RCP of $125,000. To avoid economic hardship, the IRS determines that Casey needs $75,000. The remaining $50,000 is an acceptable offer amount. Compelling Public Policy or Equity If there is no basis for compromise due to economic hardship, a compromise may promote ETA if there is a compelling public policy or equity consideration. The compromise is justified if, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are administered in a fair and equitable manner. The taxpayer filing for this type of compromise must clearly show circumstances that justify compromise, even though a similarly situated taxpayer may have paid his or her liability in full. All nonhardship ETA offers must meet the following requirements: The taxpayer has remained in compliance since incurring the liability, and overall his or her compliance history does not weigh against compromise. The taxpayer must have acted reasonably and responsibly in the situation giving rise to the liabilities. The compromise must not place the taxpayer in a better position than he or she would have been in had the taxpayer timely and fully met his or her obligations, unless there are special circumstances justifying the compromise. [I.R.M ] 534 ISSUE 5: OFFER IN COMPROMISE

31 Examples of Compelling Public Policy or Equity A compromise may promote ETA based on compelling public policy or equity in the following situations: 1. An IRS processing error directly caused the taxpayer s liability, and it would otherwise have been avoided. 2. The taxpayer incurred the liability having followed erroneous advice or instructions from the IRS. The advice or instructions caused the taxpayer to incur a tax lability that he or she would not otherwise have incurred. The taxpayer must be able to show, through some form of documentation, the name of the IRS employee who provided the advice and when he or she did so. 3. If actions or inaction of the IRS unreasonably delayed resolution of the taxpayer s case and interest or penalty abatement is not available, compromise may be warranted if the circumstances are sufficiently compelling. (The IRS will not accept an OIC under ETA when abatement under I.R.C is appropriate.) 4. The taxpayer demonstrates that the criminal or fraudulent act of a third party is directly responsible for the tax liability. This includes actions of a payroll service provider (PSP). This section does not apply to Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) liabilities. (See Example later.) 5. There is clear and convincing evidence that rejecting the OIC and pursuing other collection alternatives would have a significant negative impact on the community in which the taxpayer lives or does business (i.e., the taxpayer provides essential services to the community and those services would be lost if the IRS collects the tax liability in full). Businesses that typically qualify under this provision are nonprofit, charitable, or tax-exempt organizations. 6. The taxpayer was incapacitated and unable to comply with the tax laws. The IRS will give the taxpayer a chance to withdraw the offer, and to work with the IRS to get returns filed, and the IRS will adjust the taxpayer s account accordingly. An offer may then be appropriate. However, it would not promote ETA to compromise if the taxpayer was able to attend to other financial matters (paying all other bills, successfully operating a business) during the time of his or her illness. 7. Other circumstances may lead a reasonable third party to conclude that acceptance of the OIC would be fair, equitable, and promote ETA. Offers recommended for acceptance in this category must be routed through the national OIC program manager to obtain concurrence of the director of collection. [I.R.M ] Example Incapacitated Taxpayer In October 2012, Robert Rhodes developed a serious illness that resulted in almost continuous hospitalizations for a number of years. During this period, he was unable to manage any of his financial affairs. Robert has not filed any returns since he became ill. When Robert s health improved, he promptly began to attend to his tax affairs. He discovered that the IRS had prepared a substitute for return for 2012 based solely on information returns it received, and had assessed a deficiency. The liability with interest and penalties had tripled by the time Robert discovered it. Robert s overall compliance history does not weigh against compromise, and he may be eligible for a compromise to promote ETA [Treas. Reg (c)(3)(iv), Example 1]. Example Erroneous IRS Advice Robert Johnson is a salaried sales manager at a department store. He contributed $2,000 to a tax-deductible IRA for each of the last 2 years. He learned that he can earn a higher rate of interest at a different financial institution. Prior to moving the funds, Robert submitted an inquiry to the IRS, requesting information about the steps to take to preserve the tax benefits and to avoid penalties. The IRS responded in an that Robert may withdraw his IRA funds but must redeposit them into the new IRA account within 90 days. Robert withdrew the funds and deposited them on the sixty-third day. Upon audit, Robert learned that he is liable for additional taxes, penalties, and additions to tax for not meeting the 60-day rollover deadline. 14 Basis for OIC 535

32 Robert missed the 60-day deadline because of erroneous advice. He has a copy of the IRS response to his inquiry. Robert s overall compliance history does not weigh against compromise, and he may be eligible for a compromise to promote ETA [Treas. Reg (c)(3) (iv), Example 2]. other factors weigh against acceptance of an offer. Because FDL acted in a reasonable manner, an acceptance of an offer under ETA public policy is appropriate. If instead FDL did not check the PSP s references, and did not monitor deposits, FDL s offer would not be accepted [I.R.M (4)]. Example IRS Error Bell Company is a closely held corporation. The IRS audited Bell s returns for 2010, 2011, and 2012 and determined that Bell was a personal holding company liable for personal holding company tax. Bell agreed to immediate assessment of the tax and attempted to take advantage of the I.R.C. 547 deduction for deficiency dividends. Bell made the distributions necessary to qualify for the deduction, but the IRS made several errors in executing the required agreements and other paperwork. As a result, Bell could not benefit from the section 547 deduction. Under statute, regulations, and case law, Bell cannot correct the mistakes and take the deduction. There is documentary evidence that the IRS intended to complete the processing of the agreements and that, but for the failure to do so, Bell would have qualified for the deduction. Bell has no prior history of noncompliance. The fact that the IRS error solely caused the tax liability supports the determination that collection in full would cause other taxpayers to question the fairness of the tax system. The IRS may consider accepting a compromise that would reflect the amount that Bell would have owed if the IRS had not made an error [I.R.M (1)]. Example Payroll Service Provider Inaction FDL, LLP contracted with a payroll service provider (PSP) to handle all its payroll tax matters of the business. The PSP had been in business for several years, and FDL contacted other businesses using the PSP to confirm that the PSP had acted appropriately. FDL monitored the federal tax deposits by reviewing bank account withdrawals and electronic payments. FDL later determined that the PSP may have missed deposits, and immediately started verifying federal tax deposits on their due dates. No 536 ISSUE 5: OFFER IN COMPROMISE Example Effect on Community Shepherd s Hand is a nonprofit organization that provides quality health and human services to indigent, low-income, and underserved residents in two counties. Rejecting the offer and pursuing collection action for full payment would result in forcing the organization to choose between paying its delinquent taxes or providing competent medical care. Acceptance of an offer would be appropriate [I.R.M (5)]. Example That Is Not Compelling Public Policy or Equity The IRS will not compromise tax liabilities associated with the taxpayer s participation in abusive tax-avoidance transactions. Also, compromise is not authorized if the taxpayer s offer is based solely on a belief that a provision of the tax law itself is unfair. The IRS cannot rewrite statutes through compromise. Example Unfair Tax Laws In 2010, Sandy Sutherland invested in a nationally marketed partnership, which promised her tax benefits far exceeding the amount of her investment. Sandy claimed credits that significantly reduced or eliminated her tax liabilities for several years. The IRS audited the partnership, and ultimately the Tax Court upheld the deficiencies. Sandy offered to compromise her share of the penalties and interest. She claimed that the partnership audit rules are unfair and that the liabilities were accrued in large part due to the actions of the tax matters partner (TMP) during the audit and litigation. The audit rules and the TMP s actions do not provide grounds to compromise under the equity provision. Compromise on those grounds would undermine the purpose of both the penalty and

33 interest provisions at issue and the consistent settlement principles of TEFRA. In addition, reducing the risks of participating in tax shelters would encourage more taxpayer to run those risks, which would undermine compliance [I.R.M (7)]. Filing an OIC FINAL COPYRIGHT 2017 LGUTEF The forms to submit an OIC and the required payments or fees vary depending on the type of offer and the taxpayer s financial status. There is no specified timeframe for the IRS to make a determination on an OIC. However, if the IRS does not make a determination within 2 years of the date that the IRS receives the offer, the offer is automatically accepted. Completing the OIC Form The taxpayer should complete every line item on every form. If the line is not applicable, the taxpayer should enter 0 or N/A. Doubt as to Liability If the OIC is based on DATL, the taxpayer files Form 656-L, Offer in Compromise (Doubt as to Liability). The taxpayer does not have to provide financial information because the determination is based on the existence or the amount of the liability, not the taxpayer s ability to pay. The taxpayer must provide a written statement and supporting documentation that shows why the tax debt or portion of the tax debt is incorrect. To qualify, the taxpayer must make an offer that is $1 or more. The offer should be based on what the taxpayer believes the correct amount of tax should be. Alternative Remedies If the taxpayer believes there is no liability, the taxpayer should typically take alternative action (instead of filing an OIC). Figure 14.5 shows other available remedies. 14 Filing an OIC 537

34 A Tax Liability Is Incorrect Because: Of an audit IRS filed a substitute for return (SFR) for the taxpayer FIGURE 14.5 Alternative Remedies Items were not reported correctly on Form 1040 or Form 1120 or because the IRS made an adjustment to the return Items were not reported correctly on a tax return other than Forms 1040 or 1120 or because the IRS made an adjustment on the return There is reasonable cause to remove or reduce penalties Additional interest charged was due to IRS error or delays Taxpayer believes he or she is not a responsible person of the business and has been assessed the trust fund portion of employment taxes or personal liability excise tax affiliated with a business reported on Form 720 Taxpayer should be considered an innocent spouse for a joint income tax return Taxpayer should be considered an injured spouse for a joint income tax return Taxpayer disputes worker classification Source: Form 656-L (Rev ), Offer in Compromise (Doubt as to Liability) Then: See IRS Publication 3598, What You Should Know About the Audit Reconsideration Process. Submit a correct signed, original tax return for processing to the appropriate processing center. See instructions for Form 1040X or Form 1120X as appropriate. See instructions for Form 843, Claim for Refund and Request for Abatement. See Notice 746, Information About Your Notice, Penalty and Interest. See instructions for Form 843, Claim for Refund and Request for Abatement. Option to file Form 656-L, or see the instructions for Form 843, Claim for Refund and Request for Abatement. See IRS Publication 971, Innocent Spouse Relief. See Form 8379, Injured Spouse Allocation. (Injured spouse claim will not be considered under DATL.) See Form SS-8, Worker Classification Determination. (An SS-8 dispute will not be considered under DATL.) Types of DATL Offers DATL offers can be filed for claims concerning bankruptcy discharges, claims involving expiration of the statutory collection period, missing payment application, and claims made after Appeals sustained a liability. Under I.R.M , the campus DATL unit can resolve some liabilities, even though other remedies are available. Examples include disagreement with assessed examination deficiencies, reasonable cause for penalties, administrative abatement of interest, and disagreement with SFR, combined annual wage reporting (CAWR), or FUTA assessments. Example Lost Records The IRS audited Jim Keyes. However, because Jim had moved, he did not receive notification of the audit. The IRS disallowed all his expenses. Jim discovered the tax assessment when he tried to borrow money. Jim lost records in the move. He cannot reconstruct his records, but he can provide an explanation that supports a reduction of the tax debt. Jim may be eligible for a DATL compromise. Example Claim for Refund Denied Sue Sunshine filed a return reporting stock options that her employer valued. The options created a large tax liability, including AMT. Sue was unable to pay the entire amount of the tax. Later she discovered that the stock options were not worth as much as she originally reported due to her employer s fraudulent acts. Sue filed a claim for a refund based on the reduced value of the stock options. The IRS responded that Sue had to pay the full amount of the tax debt before the IRS could consider the claim and denied the claim for refund. Sue may be eligible for a DATL compromise. 538 ISSUE 5: OFFER IN COMPROMISE

35 The IRS will reject any offer that it determines was submitted for the sole purpose of avoiding or delaying collection activity. The IRS considers the following in determining if an offer was filed solely to delay collection: Claims that the liability stems from the operation of a law that is unfair Claims based on a divorce decree that stipulates that the spouses each owe only a portion of a joint liability Claims that do not provide a reason for the DATL Offers that are not materially different from a previously considered offer Frivolous or patently groundless offers such as those that assert the type of tax arguments listed in IRS Notice , I.R.B. 609 [I.R.M ] Fees and Terms No payment, deposit, or application fee is required for a DATL offer. The taxpayer must agree to the terms shown in Figure FIGURE 14.6 Form 656-L Terms Filing an OIC 539

36 FIGURE 14.6 Form 656-L Terms (Continued) Doubt as to Collectibility If the offer is based on doubt as to collectibility (DATC), the taxpayer files Form 656, Offer in Compromise, and Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals, or Form 433-B (OIC), Collection Information Statement for Businesses. The taxpayer should file the most recent version of the forms. Forms 433-A (OIC) and B (OIC) The taxpayer must provide detailed financial information on Forms 433-A(OIC) and/or 433-B (OIC). The taxpayer must also submit documentation showing income sources, bank and investment accounts, open loans, and receivables. Each form contains a checklist of items to include with the offer. On each Form 433 (OIC), the taxpayer computes the reasonable collection potential (RCP) based on net asset equity and remaining monthly income after allowable expenses. Using the RCP, the taxpayer calculates the minimum offer amount under the lump sum cash method or the periodic payment method (explained later). The offer amount must equal or exceed the RCP. The calculation of RCP is discussed later. Multiple Taxpayers If one or both spouses are filing an offer on separate tax debt(s) and joint debts, each must file a separate Form 656. If one spouse does not want to file an offer, the other spouse may submit a Form 656 for the joint debt. If a taxpayer is filing an offer for both individual and business (corporate, partnership, or any business other than a sole proprietorship) tax debts, the taxpayer must file separate Forms 656. Individuals operating as a disregarded singlemember LLC taxed as a sole proprietorship must file a separate Form 656 if the offer is for employment tax debts incurred after January 1, 2009, or excise tax debts incurred after January 1, The taxpayer must submit an application fee and an initial offer payment (see the later discussion of fees) with each separate Form 656. Returned Offers The IRS will return offers for DATC if the sole purpose of filing is to delay collection. Indicators of filing for delay include the following: Filing an offer that is frivolous Filing an offer that is not materially different from a previously considered and returned or rejected offer, and not addressing the cause of return or rejection A substantial understatement of assets or asset equity Rejected and Returned Offers If the IRS rejects an offer the taxpayer has the right to appeal the rejection. The taxpayer must file an appeal within 30 days of the rejection, using Form 13711, Request for Appeal of Offer in Compromise. If the IRS returns an offer, there is no right to an appeal. The IRS will return an offer if the offer is incomplete, if requested information is not submitted timely, or if the taxpayer has fallen out of compliance during the consideration period (by not filing returns or accruing additional unpaid liabilities). 540 ISSUE 5: OFFER IN COMPROMISE

37 Fees and Terms The taxpayer must send two checks with the offer: (1) $186 for the application fee, and (2) the initial offer payment. The taxpayer may designate on Form 656 where to apply the initial offer payment. The taxpayer can submit an additional payment with the offer and designate it as a deposit. If the IRS rejects the offer, the IRS will return the deposit to the taxpayer, if the taxpayer made that request on Form 656. If the taxpayer is an individual or is operating as a sole proprietor or a disregarded entity filing as a sole proprietor and meets the low-income certification guidelines, the taxpayer does not have to submit the application fee and the initial payment. To qualify, monthly household income must be less than or equal to 250% of the current year s monthly federal poverty level income for the taxpayer s family size. A table of the qualifying monthly income amounts is included in Form 656 in the Low-Income Certification section. A taxpayer qualifying for this exception does not have to make any payment until the IRS accepts the offer. Application Fee In October 2016, the IRS proposed to increase the application fee to $300. As of the date of publication, the proposed increase has not been made final. Figure 14.7 shows the offer terms of Form FIGURE 14.7 Terms of Form 656 Filing an OIC 541

38 FIGURE 14.7 Terms of Form 656 (Continued) 542 ISSUE 5: OFFER IN COMPROMISE

39 Both DATL and DATC Offers A taxpayer that needs to make an offer for both DATL and DATC must file the offer for DATL first. Effective Tax Administration For an ETA offer, the taxpayer files the same forms as the taxpayer would file for a DATC offer (discussed earlier). The taxpayer must calculate the RCP and determine the minimum offer. The RCP will exceed the tax liability, so the taxpayer must attach a detailed statement that explains the reason for the compromise. For an OIC based on public policy/equity, the IRS expects the taxpayer to offer an amount that is fair and equitable under the circumstances. The IRS does not typically accept nominal or token offers. The IRS should determine the offer amount based on the reason for granting a compromise. The IRS considers the following: 1. In cases compromised due to examples 1, 2, or 3 (see Examples of Compelling Public Policy or Equity on page 535), an acceptable offer should result in the taxpayer being placed in the same position as if the IRS error or delay had not occurred. 2. In cases compromised due to examples 4 and 5 (see Examples of Compelling Public Policy or Equity on page 535), the taxpayer s financial condition may be a relevant consideration, after considering all other facts and circumstances. 3. In business cases compromised due to examples 4, 5, and 7 (see Examples of Compelling Public Policy or Equity on page 535), the offer amount should be reasonable based on specific facts of the case. Generally, the IRS will require an operating business to pay the full amount of the remaining tax balance, exclusive of interest and penalties. However, if the liability arose from a fraudulent act of a PSP, the IRS can accept an amount that will not jeopardize the financial viability of an otherwise compliant business. The IRS will consider how a possible payment amount would a. affect the taxpayer s ability to pay future expenses in a timely manner, b. potentially result in employee layoffs, c. negatively impact the taxpayer s ability to meet other tax obligations, d. reduce goods and or services provided to the community, e. impair the ability to remain operational, or f. negatively impact the local economy if the business fails. Any reimbursement that the taxpayer receives through a civil action, bonding company, or insurance should be included in the offer amount. The same payment rules apply to the ETA offer as apply to the DATC offer (discussed later). Form 656 Payment Under I.R.C. 7122(c), a taxpayer requesting a DATC offer or an ETA offer can make a lump sum cash payment or periodic payments. The taxpayer designates his or her choice in Section 4 of Form 656. The lump sum cash option requires the taxpayer to make a nonrefundable payment with the offer equal to 20% of the offer amount. The taxpayer must pay the balance in 5 (or fewer) consecutive months from the date the offer is approved. The monthly payments do not have to be equal. The periodic payment option requires payment over 6 to 24 months. The taxpayer must make the first installment payment with the offer. The first payment and all subsequent payments are nonrefundable. For either payment method, if the taxpayer meets the low-income certification requirement, payments begin upon approval of the offer. The taxpayer must make all payments in accordance with the accepted offer. If the taxpayer misses a payment, the IRS will contact the taxpayer and provide an opportunity to make the missing payment. If the taxpayer does not make the payment, the IRS will treat the offer as withdrawn. The IRS will not refund the application fee and will apply all payments to the tax liability. The taxpayer may designate where the initial payment and any payments made during the offer consideration are applied. After the offer is accepted, the IRS will determine where the payments are applied. The IRS also applies the user fee to the tax liability [I.R.C. 7122(c)(2)(B)]. Form 656 Payment

40 The IRS will apply all refunds in the calendar year of acceptance to the tax, but not to payment of the offer. Offer Compliance The taxpayer must file all tax returns and pay all taxes due for a 5-year period following acceptance of the offer. If the taxpayer is not in compliance, the IRS can void the offer agreement and reinstate the original remaining tax liability. If the taxpayer filed a joint offer with a spouse or ex-spouse and the spouse or ex-spouse falls out of compliance, the IRS will not void the offer for the compliant spouse. Collection Activities Suspended As discussed earlier, the CSED period is suspended while the IRS is considering the offer and for the 30-day period in which the taxpayer can file an appeal. Other collections activities are also suspended, and the taxpayer does not have to make payments on an existing installment agreement while the offer is pending. The IRS may still file a federal tax lien, and will not release the lien until the taxpayer has satisfied all terms of the offer. Reasonable Collection Potential A taxpayer s reasonable collection potential (RCP) is based on the net equity of the taxpayer s assets and his or her monthly income remaining after expenses for 1 or 2 years, depending on the payment option that the taxpayer chooses. The taxpayer uses Form 433-A (OIC) and Form 433-B (OIC) to calculate RCP. This section discusses Form 433-A (OIC). Available Equity in Assets Section 3 of Form 433-A (OIC) requests personal asset information. The taxpayer must enter the current value of all checking, savings, money market, and online accounts, plus stored value cards; investment and retirement accounts [IRAs, Keogh, 401(k) plans, stocks, bonds, mutual funds, 544 ISSUE 5: OFFER IN COMPROMISE certificates of deposit]; and life insurance policies with cash surrender values. For investment and retirement accounts, the taxpayer can use the quick sale value, which is 80% of the current value reduced by the balance of a loan against the asset. The cash value of any life insurance is 100% of the value reduced by any loan balance. The taxpayer must list all real property that the taxpayer owns, including the property address, date purchased, how title is held, and current market value. As with the investment assets, the current quick sale value is 80% of the current FMV, reduced by any outstanding loan balance. The taxpayer must list all cars, boats, motorcycles, and other vehicles that the taxpayer owns, including the make, model, year, date purchased, mileage, and current market value. Again, the current market value is multiplied by 80% and reduced by any outstanding loans. The taxpayer can also reduce the value of the first vehicle by $3,450 (but not below zero). If the taxpayers file a joint offer, they can also reduce the value of a second vehicle by $3,450. Section 3 also requires a description and value of artwork, collections, jewelry, items of value in safe deposit boxes, interests in companies or businesses that are not publicly traded, and other valuable personal property. The taxpayer does not have to include clothing, furniture, and other personal effects. Again, the value is 80% of the current market value reduced by any outstanding loan balances. Section 3, box A, reflects the total asset values listed in Section 3. Box A is the taxpayer s available individual equity in assets. In Section 5, a self-employed taxpayer lists business assets, including bank accounts, tools, books, machinery, equipment, business vehicles, and real property. The taxpayer can deduct $4,600 from the net value of business assets. If the taxpayer has notes receivable, the taxpayer must include a list of the notes, with names and amounts. The taxpayer does not have to provide a list of accounts receivable with the offer, but the IRS may request a list later. Section 5, box B, reflects the total asset values from Section 5. Box B is the taxpayer s available business equity in assets.

41 Joint Assets and Separate Offers When taxpayers submit separate offers, but have jointly owned assets, they must divide the equity equally unless they can demonstrate that they own the property in some other percentage. If joint owners file joint and separate offers, the IRS will apply the equity first to the joint liability and then to the individual liabilities. Income FINAL COPYRIGHT 2017 LGUTEF Section 6 of Form 433-A (OIC) requests business income and expenses for a self-employed taxpayer. If the taxpayer provides a current profit and loss (P&L) statement with the offer, the taxpayer enters only total income and total expenses. The taxpayer can use amounts reported on the most current Schedule C (Form 1040), Profit or Loss From Business, unless the business has changed significantly within the past year. If the taxpayer does not submit a P&L, he or she must complete the line-by-line entries for income and expenses. Section 6, box C, is the net of income and expenses. Box C is the taxpayer s net business income. Section 7 requests monthly household income. The taxpayer must typically include the income of the taxpayer, spouse (even if the spouse is not liable for the tax obligation), children, and anyone else who contributes to the household income. Household income includes taxable income and nontaxable income. The taxpayer must include social security, pensions, unemployment income, interest, dividends, distributions from partnerships or S corporations, net rental income, net business income (from Section 6, box C), child support, and alimony. Section 7, box D, is the sum of all income entries. Box D is the taxpayer s total household income. Household Expenses Section 7 of Form 433-A (OIC) also requests monthly household expenses. The listed expenses must be necessary to provide for a taxpayer s (and his or her family s) health and welfare and/or production of income. The taxpayer can use the collection financial standards (discussed later) in lieu of certain actual expenses. Family size should be the same as the allowed exemptions on the taxpayer s most-recent-year income tax return. Divorced Taxpayers Divorced taxpayers may allocate exemptions to the spouse who benefits more from the exemptions. If the spouse who is not claiming the exemption otherwise meets the requirements for an exemption, that spouse may be able to include children when calculating household size. The spouse should submit a statement with the OIC regarding the dependency test, and the IRS may ask for verification (school records, medical records, etc.) that the children reside primarily in the spouse s household. National and Local Standards The standards in this section are effective on or after March 27, The taxpayer should always use the most recent version of the standards, as the 2017 standards are higher than the 2016 standards. See /businesses/small-businesses-self-employed /collection-financial-standards. National Standards for Living Expenses There are national standards for allowable living expenses. The taxpayer can use the national standard for his or her family size, regardless of the amount that the taxpayer spent. If the taxpayer claims an amount that is greater than the standard amount, the taxpayer must provide documentation to substantiate that the expenses are necessary expenses. The national standards for allowable living expenses include the following: 1. Food: This includes food at home; food from grocery stores; food away from home; meals and snacks, including tips; fast food; take-out; delivery; and full-service restaurants. 2. Housekeeping supplies: This includes laundry and cleaning supplies, stationery, postage, delivery services, miscellaneous household supplies, and lawn and garden supplies. 14 Reasonable Collection Potential 545

42 3. Apparel and services: This includes clothing, footwear, material, patterns, notions for making clothes, alterations and repairs, rental, storage, dry cleaning, sent-out laundry, watches, and jewelry. 4. Personal care products and services: This includes products for hair, oral hygiene, shaving needs, cosmetics, bath products, electric personal care appliances, and other personal care products. 5. Miscellaneous: This includes expenses not included in other categories, such as credit card payments, bank fees, reading material, and school supplies. Figure 14.8 shows the national standards for allowable living expenses. FIGURE National Standards for Allowable Living Expenses (Monthly) Expense One Person Two Persons Three Persons Four Persons* Food $ 345 $ 612 $ 737 $ 845 Housekeeping supplies Apparel & services Personal care products & services Miscellaneous Total $639 $1,132 $1,378 $1,650 *More than four persons: For each additional person, add $325 to the four-person total allowance. National Standards for Medical There are also national standards for out-ofpocket health care expenses such as medical services, prescription drugs, medical supplies, eyeglasses, and contact lenses. The taxpayer can use the monthly standard amount regardless of the taxpayer s actual expenses. The taxpayer can claim the out-of-pocket health care standard amount in addition to the amount the taxpayer pays for health insurance. The monthly amount for a person under 65 is $49, and for a person 65 and older, it is $117 per month. If the taxpayer claims an amount that is greater than the standard amount, the taxpayer must provide documentation to substantiate that the expenses are necessary expenses. Local Standards for Housing and Utilities The taxpayer can use local standards for housing and utilities expenses. The standards are listed by state and county. Figure 14.9 shows sample housing and utility standards for Michigan. The housing and utilities standards include mortgage or rent, property taxes, interest, insurance, maintenance, repairs, gas, electric, water, heating oil, garbage collection, residential telephone service, cell phone service, cable television, and Internet service. In most cases, the taxpayer is allowed the amount actually spent or the local standard, whichever is less. FIGURE Local Housing and Utilities Standards (Monthly) State County Family of 1 Family of 2 Family of 3 Family of 4 Family of 5 or More Michigan Hillsdale $1,113 $1,308 $1,378 $1,536 $1,561 Michigan Houghton $1,037 $1,219 $1,284 $1,432 $1,455 Michigan Huron $1,063 $1,248 $1,315 $1,466 $1,490 Michigan Ingham $1,278 $1,501 $1,582 $1,764 $1,792 Michigan Ionia $1,200 $1,409 $1,485 $1,656 $1, ISSUE 5: OFFER IN COMPROMISE

43 Transportation Standards The taxpayer can use collection financial standards for transportation expenses. For a taxpayer who owns or leases a vehicle, there are nationwide standards for ownership costs and local/ regional standards for operating costs. Ownership costs are the monthly lease or purchase payments. Operating costs include maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking, and tolls (personal property taxes are not included). A single taxpayer is usually allowed one automobile. The taxpayer can claim the lesser of the monthly payment on the lease or car loan or the ownership costs shown in Figure If the taxpayer has no lease or loan payment, the ownership cost is $0. FIGURE National Ownership Costs (Monthly) One Car Two Cars $485 $970 The taxpayer can claim monthly operating costs based on regional or metropolitan area costs. Taxpayers are allowed the lesser of the amount spent for operating costs or the operating costs for the taxpayer s location. The Midwest region operating costs are shown in Figure Figure is an example of the conversion chart that lists the states that comprise the Midwest census region, and the counties and cities included in each metropolitan statistical area (MSA). Once the taxpayer ascertains his or her census region, the taxpayer uses the table to see if he or she lives within an MSA. If the taxpayer is in one of the listed counties, he or she uses the amount for that MSA city. If the taxpayer is not located in one of the counties listed, he or she uses the regional amount. For example, if the taxpayer lives in Cook County, Illinois, the taxpayer uses the Chicago standard ($241 per month for one car). If the taxpayer lives in Boone County, Illinois, the taxpayer uses the Midwest Region standard ($203 per month for one car). FIGURE Operating Costs Midwest Region One Car Two Cars Midwest Region $203 $406 Chicago $241 $482 Cleveland $203 $406 Detroit $300 $600 Minneapolis-St. Paul $196 $ FIGURE MSA Definitions for Midwest Census Region: North Dakota, South Dakota, Nebraska, Kansas, Missouri, Illinois, Indiana, Ohio, Michigan, Wisconsin, Minnesota, Iowa MSA Chicago Cleveland Detroit Minneapolis-St. Paul Counties (Unless Otherwise Specified) In IL: Cook, DeKalb, DuPage, Grundy, Kane, Kankakee, Kendall, Lake, McHenry, Will In IN: Lake, Newton, Porter In WI: Kenosha In OH: Ashtabula, Cuyahoga, Geauga, Lake, Lorain, Medina, Portage, Summit In MI: Genesee, Lapeer, Lenawee, Livingston, Macomb, Monroe, Oakland, St. Clair, Washtenaw, Wayne In MN: Anoka, Benton, Carver, Chisago, Dakota, Hennepin, Isanti, Ramsey, Scott, Sherburne, Stearns, Washington, Wright In WI: Pierce, St. Croix There is a single nationwide allowance for public transportation based on Bureau of Labor Statistics for mass transit fares for a train, bus, taxi, ferry, etc. Taxpayers with no vehicle can claim $189 per month per household without regard to the amount actually spent. If a taxpayer owns a vehicle and uses public transportation, the taxpayer can claim expenses for both if they are necessary expenses. However, the taxpayer must use actual expenses for ownership costs, operating costs, and public transportation, or the standard amounts, whichever is less. Reasonable Collection Potential 547

44 Expenses Exceed Standards If the standards are inadequate to provide for basic living expenses, the taxpayer may claim actual expenses. However, the taxpayer must provide documentation that supports that national expense standards leave him or her an inadequate means of providing for basic living expenses (and must be able to document the actual expenses). FIGURE Jordan and Joy Jollys Assets and Liabilities Asset Value Liability 2007 Ford truck $ 2,500 $ Honda car $ 10,000 $ 2,000 Personal residence $ 180,000 $ 140,000 Checking account $ 500 n/a Savings account $ 2,000 n/a Jordan and Joy calculate their net equity in assets as shown in Figure Calculation of the Minimum Offer Amount Section 8 of Form 433-A (OIC) calculates the minimum offer amount based on the taxpayer s RCP (net equity in assets and future remaining income). If the taxpayer plans to pay the offer in 5 or fewer payments within 5 months or less, future remaining income is determined by multiplying the remaining monthly income by 12. If the taxpayer plans to pay the offer in 6 to 24 months, the future remaining income is determined by multiplying the remaining monthly income by 24. If the taxpayer cannot pay the calculated offer amount due to special circumstances, the taxpayer must include an explanation on Form 656. Example Calculating the Offer Jordan Jolly is currently an employee earning $65,000 per year. He is married to Joy, who does not work outside the home. They have a 4-monthold son, Jump, and they currently live in Ingham County, Michigan. Jordan and Joy have an outstanding tax debt of $28,000. Jordan and Joy want to file an OIC based on DATC. They have the assets and liabilities shown in Figure FIGURE Jordan and Joy Jollys Net Equity Calculation Asset Calculation Value 2007 Ford truck: ($2,500 80%) = $2,000 $3,450 $ Honda car: ($10,000 80%) = $8,000 $3,450 $2,000 2,550 Personal residence: ($180,000 80%) = 144,000 $140,000 4,000 Bank accounts: $2,000 + $500 2,500 Total $9,050 Jordan and Joy enter $9,050 in Section 3, box A. In Section 7, Jordan and Joy list their only monthly income, which is Jordan s $5,417-permonth ($65,000 12) salary. They also enter their monthly household expenses. For line 39, Food, clothing, and miscellaneous, and line 45, Medical expenses, they can use the collection financial standards without regard for actual costs. The national standard for a family of three for food, clothing, and miscellaneous is $1,378 (Figure 14.8). For out-of-pocket medical for three family members under age 65, the standard monthly amount is $147 ($49 3). Jordan and Joy s actual housing and utility expenses are $1,587. The local standard for a family of three in Ingham County, Michigan, is $1,582 (Figure 14.9). Jordan and Joy enter $1,582 for housing and utilities because they are limited to the lesser of the two amounts. Jordan and Joy s monthly car payment is $250, which is less than the standard $970 ownership cost for two cars car (Figure 14.10). Their 548 ISSUE 5: OFFER IN COMPROMISE

45 vehicle operating costs are $238 per month, which is less than the $406 two-car operating expense standard for the Midwest Region (Figure 14.11). Jordan and Joy include $250 for ownership costs and $238 for operating costs. Jordan and Joy have the following other monthly expenses: $300 for health insurance through Jordan s employer-sponsored plan FIGURE Remaining Monthly Income $100 for term life insurance premiums $1,026 taxes Figure shows the calculation of Jordan and Joy s $396 remaining monthly income on Form 656, Section Based on their equity in assets and their remaining monthly income, Jordan and Joy can offer a $13,802 [$9,050 + ($396 12)] lump sum cash offer. They must make a $2,760 ($13,802 20%) down payment with the submission of the offer and 5 payments after acceptance of the offer. Alternatively, Jordan and Joy can offer to make periodic payments that total $18,554 [$9,050 + ($396 24)]. They must make monthly payments over 6 to 24 months, and they must make the first payment with the offer. Jordan and Joy elect to make a lump sum cash offer. Figure shows the calculation of Jordan and Joy s minimum offer amount on Form 656, Section 8. Calculation of the Minimum Offer Amount 549

46 FIGURE Minimum Offer Amount 550 ISSUE 5: OFFER IN COMPROMISE