Offers-in-compromise in Bankruptcy
Offers-in-compromise (OIC) have become a useful tool for taxpayers in paying heavy tax burdens where the taxpayer has limited distributable assets or income. As such, a taxpayer can propose to pay taxes on the basis of an ability to pay or on the basis of the Internal Revenue Service's (IRS's) ability to collect the taxes, thereby relieving the taxpayer of a tax burden that otherwise could not be paid. More importantly, the IRS has encouraged the use of OICs as an alternative to bankruptcy for the payment of taxes where the Bankruptcy Code imposes a payment scheme for which the taxpayer does not have the resources to pay the taxes in accordance with the Code. The IRS has not, however, embraced the use of OICs as a means to pay taxes through bankruptcy. Consequently, in the IRS's opinion, bankruptcy and OICs remain mutually exclusive methods of tax payment.
The IRS's authority to compromise tax liabilities is provided for in I.R.C. §7122(a).2 26 U.S.C. §7122(a) provides in relevant part that "The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense, and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense." The decision to compromise, including whether to consider a compromise and how much to accept, is within the IRS's discretion. See Treas. Reg. §301.7122-1(a). Further, the IRS's position on all OICs is to compromise cases only when settlement furthers the best interests of the taxpayer and the United States.
The IRS also has certain threshold requirements that govern the processing and acceptance of OICs. For example, the IRS will not process or consider OICs where the OIC does not contain sufficient information, where the OIC was submitted in an attempt to delay tax collection or where the OIC is "otherwise non-processable." The IRS has determined that certain omissions or situations render an OIC non-processable: (1) The OIC is not submitted on a proper form; (2) the taxpayer has not complied with all filing and payment requirements—i.e., is not current on making estimated individual income or business taxes for a requisite period of time or that the taxpayer has unfiled returns; (3) the required processing fee is not paid; (4) the taxpayer is in bankruptcy; and (5) the taxpayer has failed to meet any other minimum requirement that the IRS has established.
As a practical matter, the IRS should be reluctant to accept a payment proposal that is less than what the Bankruptcy Code would require.
In addition, the IRS's Internal Revenue Manual (IRM) prescribes certain thresholds and conditions3 that the IRS may consider in determining whether or not to accept an OIC. Although the IRM does not have the force and effect of law, it nonetheless regulates how the IRS is to function regarding a host of activities, including consideration of OICs See In re Holmes, 298 B.R. 477, 484 (Bankr. M.D. Ga. 2003) (provisions of the IRM are directory, rather than mandatory, and do not have the force and effect of law) (citation omitted); Nader v. United States of America (In re Nader), 1999 WL 627394, *4 (Bankr. E.D. Pa. 1999) (the IRS may prescribe guidelines [the IRM] for IRS personnel to use in evaluating whether IRS personnel are to accept an OIC, and establish procedures that allow a taxpayer to appeal any rejection of an OIC).
Must the IRS Consider and Process an OIC in Bankruptcy?
It is the criteria that the taxpayer may not be in bankruptcy in order for the IRS to accept an OIC that has sparked some consideration by bankruptcy courts. Courts that have considered the question of whether the IRS must consider and process an OIC in bankruptcy have for the most part concluded that the IRS's failure to do so would run afoul of the anti-discrimination provisions of §525.4 See, e.g., Holmes, 298 B.R. at 481; Mills v. United States of America, (In re Mills), 240 B.R. 689 (Bankr. D. W.Va. 1999) (IRS's failure to consider OIC in bankruptcy is in conflict with the anti-discrimination provision of §525); Chapman v. United States (In re Chapman), 1999 WL 550793 (Bankr. W.D. Va., June 23, 1999). These courts conclude that to deny the taxpayer/debtor the right to submit an OIC in bankruptcy denies the debtor a remedy under the I.R.C. and is discriminatory as to debtors.
Conversely, many of those same courts also hold that the IRS has the sole discretion5 of accepting or rejecting OICs and that the IRS cannot be compelled to accept an OIC. See, e.g., In re Holmes, 301 B.R. 911, 913 (Bankr. M.D. Ga. 2003) ("the decision to accept or reject a compromise offer is discretionary and cannot be compelled by any action"); Mills, 240 B.R. at 695-96 (IRS cannot be compelled to accept an OIC); Chapman, 1999 WL 550793, *7 (Bankr. W.D. Va. 1999) (IRS is correct that it cannot be compelled to accept an OIC). As such, while a court could direct the IRS to consider an OIC, it could not direct the IRS to accept an OIC.
The IRS's Rationale in Not Accepting OICs in Bankruptcy
As a practical matter, the IRS should be reluctant to accept a payment proposal that is less than what the Bankruptcy Code would require. In situations where the debtor owes taxes entitled to priority under the Code, the IRS can insist on full payment (§§1129 (a)(9)(C), 1222(a)(2) and 1322(a)(2)). In situations where the debtor wishes to retain property, the IRS can insist that its lien value (inclusive of exempt assets) be paid plus interest. Because business taxes are non-dischargeable, it does a debtor little good to file bankruptcy and not to pay the tax in full because the IRS generally will not compromise the tax liability owed. If less than the full amount of the business taxes are paid, the IRS can pursue collection of the unpaid tax and statutory penalties and interest.
Additionally, there is the practical matter of how the IRS should evaluate an OIC in bankruptcy. Feasibility considerations in bankruptcy are first evaluated under schedules "I" and "J," which give an initial snapshot of excess income to pay plan debts. How much is allowed per a particular expenditure on schedule "J" is subject to local practice. Further, in business cases the secured parties can dictate an appropriate budget for the debtor on the basis of the use of cash collateral. Under an OIC scenario, the IRS will utilize IRS schedules to evaluate an OIC. Allowances for expenses in bankruptcy (i.e., a private school, a mortgage for a luxury home, entertainment) may be disallowed for purposes of calculating an acceptable OIC with the IRS. Further, the length of an acceptable OIC with the IRS (three to five years) may be significantly less in duration than a chapter 11 or 13 plan.
Additionally, what if the IRS does not accept an OIC in bankruptcy? The bankruptcy court could review the IRS's discretion in disallowing the OIC. As noted, courts have been fairly uniform in stating that the IRS cannot be compelled to accept an OIC. Nonetheless, §505(a) allows the court to adjudicate any tax dispute whether or not previously adjudicated. As such, bankruptcy courts could become the refuge for contesting the denial of OICs in bankruptcy on good-faith grounds.
Possibly a better approach to this conundrum would be for the debtor to enter into an OIC with the IRS before bankruptcy and then to pursue bankruptcy relief for reasons other than tax debts such as the protection of a homestead from foreclosure. The debtor could attempt to continue the OIC in bankruptcy or possibly assume it through bankruptcy. Of course, this remedy is available to a limited number of debtors simply because under the current Code many debtors are eligible for either liquidation or reorganization. In sum, debtors can expect the IRS not to accept OICs where the debtor has the ability to pay tax debts in accordance with the Code.
3 I.R.C. §§7122(c)(1) and (2) state that the Secretary shall develop schedules of national and local allowances for basic living expenses and guidelines as to how IRS employees should evaluate OICs. Return to article
4 Section 525(a) states in relevant part that "a governmental unit may not...refuse to renew a license, permit, charter, franchise or similar grant to...or discriminate [against]...a person that has been a debtor...solely because such debtor is or has been a debtor...." Courts that have found that a taxpayer's ability to have the IRS consider an OIC in bankruptcy a "license"—the ability to do an act such as to negotiate a lower amount of taxes paid. Holmes, 298 B.R. at 482-83. Moreover, a number of courts have concluded that §525 is not exhaustive in scope as written and that Congress intended to make §5252 as expansive as possible to protect debtors from discrimination. See Mills, 240 B.R. at 698. Return to article