IRS Must Provide Taxpayer a Chance to Cure Offer in Compromise Default

Eli Noff, Esq., Partner
Mary F. Lundstedt, Esq., Associate

A successful offer in compromise (OIC) allows a taxpayer to settle unpaid tax accounts for less than the full amount owed. However, if an OIC is ultimately granted, a taxpayer also agrees to certain terms and conditions going forward in order not to default the OIC. Interestingly, in a recent case, Moore v. Commissioner,[1] clarified that even where the taxpayer has clearly failed to hold up his end of the bargain, the Internal Revenue Service's (IRS) failure to allow the taxpayer to cure the defects is an abuse of discretion. Specifically, the court ruled that the IRS must send a default letter before terminating an OIC.

Background

In 2003 and 2004, Taxpayer served as president and chief executive officer of a company (C). During that time, Taxpayer neglected to pay employment and trust fund taxes for multiple periods. The investigation of these unpaid taxes confirmed that Taxpayer had signatory authority over the company bank accounts and was a "responsible officer" liable for the payment of these taxes. Subsequently, in 2004 and 2006, the IRS assessed trust fund recovery penalties (TFRP) against Taxpayer.

In 2008, Taxpayer submitted Form 656, Offer in Compromise, based on doubt as to collectability of the TFRP liabilities accrued for C and another company. In 2010, the OIC was amended to address only those liabilities at issue for C.

Both the original and amended OICs were signed by Taxpayer, affirming that he would comply with all Internal Revenue Code (IRC) provisions pertaining to filing his individual returns and paying his corresponding taxes for 5 years, or until the offer amount is fully paid (whichever was longer). Additionally, Taxpayer affirmed that failing to meet any of the OIC terms and conditions would result in default on the offer, and the IRS could begin collection activities.

In 2010, the IRS accepted Taxpayer's OIC, reminding Taxpayer of the terms and conditions that Taxpayer would need to comply with to prevent default.

Subsequently, Taxpayer and his wife filed a late return for 2010 and were late paying their 2010 and 2012 tax liabilities. In 2014, the Brookhaven Appeals Office sent letters to Taxpayer and Taxpayer's representative, stating that the OIC was terminated and the TFRP liabilities (less payments already received) were reinstated. Significantly, the administrative record lacked any "written communication addressed to petitioner informing him of a default in the OIC, requesting that he contact respondent, or setting a January 2, 2014, deadline to respond or pay the amounts due."[2]

Eventually, after receiving IRS Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing, Taxpayer timely requested a Collection Due Process hearing (CDP hearing) and stipulated, among other things, that the IRS should reinstate the OIC and abate the reinstated TFRP assessments.

The settlement officer conducting the CDP hearing sustained the proposed levy and issued a notice of determination based upon his reading of Internal Revenue Manual (IRM):

The taxpayer may contend that the termination was improper because the default was insignificant or not a "material breach." The only relevant question is whether there was a default of an express condition. Whether the taxpayer "materially breached" the OIC or "substantially complied" with the OIC is irrelevant.[3]

Taxpayer's representative requested another (supplemental) CDP hearing in October of 2017. Prior to the hearing, Taxpayer's representative faxed a letter to the settlement officer arguing that the OIC should be reinstated, because Taxpayer was not provided with the opportunity to cure the default-and that termination under those circumstances was an abuse of discretion. However, the settlement officer concluded that Brookhaven Appeals properly terminated the OIC.

In both the original and supplemental notices of determination, the settlement officer refused to reconsider the termination of the OIC.

Analysis and Decision

The court considered it "clear" that the Taxpayer and his wife were noncompliant, and thus, subject to potential OIC default. Specifically, the court stated that, "[a]ny noncompliance, even one that is immaterial, is sufficient to terminate an OIC."[4] However, the court noted that a breach of OIC terms and conditions is not determinative; rather, the court determined the central issue to be whether the settlement officer's refusal to reconsider the OIC's termination was an abuse of discretion.

The court noted that per the Form 656 terms, termination for noncompliance is "authorized but not automatic."[5] The court also clarified that the IRM provides the procedures to be followed when terminating an OIC for noncompliance. According to the IRM, explained the court, a "default letter" is sent upon default.[6] Furthermore, the court emphasized that the taxpayer should be given a 60-day grace period to comply before the OIC is terminated.

Ultimately, the court agreed that the default was entirely due to Taxpayer's poor management of income tax liabilities and filing obligations, but those failures did not excuse the settlement officer's failure to follow administrative procedures for OIC termination. The court ruled that the settlement officer's actions were an abuse of discretion and remanded the case, suggesting the assignment of a new settlement officer.

Conclusion

Typically, achieving a successful OIC is a complicated process, involving careful attention to the abundance of guidelines in place for the IRS. As this case demonstrates, preventing the default of an OIC can be equally dependent on a knowledge of the applicable rules. A taxpayer is well-advised to seek advice from a tax professional at any stage of the process when an issue arises.

If you have questions or concerns about an offer in compromise call Frost & Associates, LLC today at 410-497-5947.


[1] T. C. Memo 2019- 129 (Sept. 30, 2019).

[2] Id. at 8.

[3] Former IRM 8.22.7.10.11(4) (Sept. 23, 2014). See IRM 8.22.7.10.8 (Aug. 2017).

[4] Moore, at 19.

[5] Id. at 20.

[6] Former IRM 5.8.9.3 (Apr. 15, 2011). See IRM 5.19.7.2.20(4) (10-30-2018), which provides: Often taxpayers will comply (take the actions requested of them in the potential default letter) soon after receiving the default letter. Allow 15 days following the issuance of the default letter before taking default actions. If the taxpayer complies within this time frame, do not default the offer. When more than one breach of contract condition exists, the taxpayer must comply with all to avoid termination of the offer. It is in the Service's best interest to allow the taxpayer a full 60 days before defaulting (30 days for the POTENTIAL default letter with a 15-day grace = 45 days + 15 days after the default letter = 60 days).

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