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More on Offers in Compromise • Tax Court's "Zero Tolerance" for Curbing Undesirable Conduct • Limited-Time Offer: Voluntary Compliance on Alien Withholding Program • Information Reporting Update
Editor:
Editor's note: Mr. Ely is former chair of the AICPA Relations with the IRS Committee. Ms. Pflieger is the current chair. Professor Blair, Ms. Corbet and Ms. Gervie are committee members.
Offers in Compromise: "Doubt as to Collectibility" Sec. 7122 authorizes the IRS to accept compromises to fully settle tax debts. The Service may compromise a civil or criminal liability in three circumstances. An offer in compromise for "doubt as to collectibility" is an option available to taxpayers when (1) the likelihood of collecting the liability in full is small, (2) the amount offered reasonably reflects collection potential and (3) an installment agreement is not sufficient to cover the tax liability. The IRS's Collection Division administers offers for "doubt as to collectibility" and "effective tax administration." In the second situation, an offer submitted because of effective tax administration is a compromise in which there is no doubt the tax is correct and the amount owed can be collected, but the collection would create an economic hardship or would be unfair and inequitable. Internal Revenue Manual (IRM) 5.8.2.4.1 provides examples of situations in which such exceptional circumstances exist. Finally, an offer can be submitted for doubt as to liability, when the correctness of the assessed tax is in question. The Service's Examination Division handles these types of offers. Financial information is not required.
Offers for Doubt as to Collectibility The IRS liberalized its Offer-in-Compromise Program in 1995 by agreeing to accept most offers for processing. There are only two reasons why the Service will not process an offer: a taxpayer is (1) in bankruptcy or (2) not currently in compliance. The system is now overwhelmed by offers and there is a backlog in the processing pipeline. The Service has stepped up efforts for training employees as offer specialists and has made enormous strides in improving the program. It is continually implementing changes. Currently, the IRS has two programs: 1. Online Offer-in-Compromise Program for tax, penalties and interest of $50,000 or less; and 2. Offers for penalties and interest of more than $50,000. Online Offer-in-Compromise Program or "streamlined" offer. Taxpayers can use the Online Offer-in-Compromise (i.e., streamlined offer) by accessing the Service's Website at www.irs.gov/ind_info/index.html . A five-step program is available for eligible taxpayers with information necessary to complete the online forms. To be eligible, an individual must (1) agree with the tax liability, (2) have no unfiled past-due tax returns and (3) not be in bankruptcy. The liability can be for individual income taxes, penalties (e.g., trust fund recovery penalties) or employment taxes for an out-of-business sole proprietor. The online forms include 656-P, Offer In Compromise; 433-OIC, Financial Statement for Wage Earners and Self-Employed; and supplemental information (a complete list of items to be submitted is found in the directions). One convenient section on this Website is the "Optional Interactive Worksheet." The worksheet assists in determining a monthly income and expense analysis based on Local and National Standards, used on the Form 433-OIC. The questions on this worksheet are easy to follow (e.g., state of residence, county of residence, family size, number of cars). Taxpayers can download and complete the forms and submit them (along with the supplemental information) to a local IRS collection office. To try to reduce the backlog from the increased number of offers, the IRS will soon route all offers in which the total liability (including tax, interest and penalties) is $50,000 or less through one Service Center. Specially trained individuals will screen the Forms 656 and supplemental forms for missing information, and contact taxpayers (or their representatives) by telephone, letter or both for this information. The Service Center will process simple cases; the Service hopes that the streamlined process will lessen the burden of the number of offers revenue officers in the Collection Division must currently handle. Offers of more than $50,000 or complex issues. Revenue officers in the Collection Division will continue to handle offers of $50,000 or more and complex issues. For these offers, taxpayers must complete Forms 656, Offer in Compromise; 433-A, Financial Information for Individuals; 433-B, Financial Information for Businesses; and supplemental information. IRS Publication 1854, "How to Prepare a Collection Information Statement (Form 433-A)" and IRM 5.8, "Offer in Compromise," provide guidance for properly completing these forms. Form 656-A, An Explanation of Circumstances, should accompany Form 656 when there is an additional basis for compromise involving effective tax administration. Cash or Deferred-Payment Offers The IRS now has provision for three payment arrangements (see Form 656): 1. Cash offer: the offered amount to be paid within 90 days after the IRS accepts the offer. 2. Short-term deferred-payment offer: the offered amount to be paid in more than 90 days but within 24 months. 3. Deferred-payment offer: the offered amount to be paid over the life of the collection statute. Amount to offer. The minimum offer is generally equal to the realizable value of assets plus future income. For a cash offer, the future income calculation is projected future income less necessary living expenses over four years. Five years of income is required when computing an offer using one of the deferred-payment arrangements. Necessary living expenses vary, depending on the taxpayer's state of residence and locality. The IRS publishes the following "necessary living expense" standards on its Website:
Other allowable expenses used in the calculation of future income include childcare, court-ordered payments, term life insurance, medical expenses and other expenses that might fall within the category of health and welfare or the production of income or both. The standards are based on an individual's income and family size. When calculating the net realizable value of assets, the Service uses "quick sale value" (QSV) (80% of fair market value). Secured liabilities reduce the QSV to determine the net realizable value in more assets; the IRS does not consider unsecured liabilities. There are exceptions for accounts receivable and other assets. IRM 5.8 includes information on asset valuations, secured and unsecured debt, collateral agreements and other complex issues. Compromising employment taxes. Before the Service will even consider discussing an offer, a taxpayer must be current with payroll taxes for at least two quarters. Normally, the IRS does not accept less than the tax due, unless the taxpayer can convince the Service that the offer is in the government's best interest. An offer for less might be accepted, as long as it reasonably reflects collection potential.
IRS Appeals Division In rejecting offers, the IRS issues a written notice to taxpayers. The notice includes the reason(s) for the rejection and informs the taxpayer about rights to an appeal. If the Collection Division rejects an offer in compromise, the taxpayer has the right to an independent review by the IRS Appeals Division. The taxpayer must submit a written protest to the Service within 30 days of the rejection.
Effect of Acceptance An offer is a contract that a taxpayer agrees to stay in full compliance with all tax obligations for five years. The taxpayer also agrees to the offset of any refunds due for prior years and the tax year during which he accepts the offer. If the taxpayer fails to comply with any of these terms, the IRS can retroactively terminate the offer and resurrect the tax liabilities. Policy Statement P-5-100 states "[a]n Offer in Compromise is a legitimate alternative to declaring a case as 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." This policy statement provides a frame of reference by which the Service's procedures and standards for evaluating offers can be more readily understood. From Mary Lou Gervie, CPA, CFE, Watkins, Meegan, Drury & Company, L.L.C., Bethesda, MD
Tax Court Flexes Its Muscles—Imposes Sanctions and Issues a Warning Recently, the Tax Court issued several opinions that reflect its intolerance of taxpayers' and practitioners' (both private and governmental) actions that the court determined to be dilatory or improper. To clearly communicate its message, the court drew on Sec. 6673, a rather infrequently used (but very potent) Code provision that permits the Tax Court, in its discretion, to impose monetary sanctions or penalties if it determines that (1) proceedings have been instituted or maintained by a taxpayer primarily for delay, (2) the taxpayer's position is frivolous or groundless or (3) the taxpayer unreasonably failed to pursue available administrative remedies. In addition, if the court determines that a practitioner has multiplied the proceedings unreasonably or vexatiously, it may require the payment of excess costs (including attorneys' fees) reasonably incurred because of such conduct. In Nis Family Trust, 115 TC No. 37 (2000), the court imposed monetary sanctions (the maximum $25,000 in one docket) against the taxpayers and also required their attorney to pay $10,600 to the IRS, representing excess attorneys' fees that the Service incurred on account of the attorney's conduct in unreasonably delaying the proceedings. The case involved three separate dockets. In each petition filed in response to the statutory deficiency notices, the taxpayers (appearing pro se) failed to address any of the adjustments that the IRS proposed; rather, the petitions contained nothing but frivolous, tax-protester-like positions. The court entered judgment against the taxpayers based on the pleadings, imposed accuracy-related penalties and further found that the taxpayers both instituted and maintained the proceedings primarily for delay. This latter finding was based on the taxpayers' noncooperation and nonresponsiveness throughout the audit and during the court proceedings, including the discovery process. Sometime during the pendency of the proceeding (as often occurs), the taxpayers retained an attorney who entered an appearance on their behalf. The attorney continued to raise the same type of arguments that the taxpayers had previously advanced. Based on the record, the court held that the taxpayers were subject to penalties under Sec. 6673(a)(1), and their attorney was required to pay costs under Sec. 6673(a)(2). The court found that both the taxpayers and their attorney attempted to unreasonably and unduly multiply the proceedings and that the attorney's actions were undertaken in bad faith. Shortly thereafter, the Tax Court issued its opinion in Pierson, 115 TC No. 39 (2000), involving a taxpayer's appeal under the newly enacted "collection due-process procedures" of Secs. 6320 and 6330. Once again, rather than addressing the merits of the matters in issue, the taxpayer's petition raised only frivolous tax-protester arguments. The court concluded that the taxpayer instituted the proceeding primarily for delay and, therefore, imposed a penalty under Sec. 6673(a)(1). However, noting that its jurisdiction over the collection due-process procedure is relatively new, the court opted not to impose a penalty in this case. However, it did make its intentions clear for future similar cases, by unequivocally stating that it regarded "this case as fair warning to those taxpayers who, in the future, institute or maintain a lien or levy action primarily for delay or whose position in such a proceeding is frivolous or groundless." Lest one is led to believe that Sec. 6673 is applicable only to taxpayers and their representatives, consider Dixon, TC Memo 2000-116. In this case, the Tax Court imposed sanctions and costs under Sec. 6673(a)(2)(B) against the Service due to the misconduct of IRS district counsel during a court proceeding. The court noted that this case represented the first time it had the occasion to apply Sec. 6673 to misconduct of a government attorney. The court examined its relatively few opinions when it had imposed sanctions or costs or both on taxpayers' representatives and concluded that a finding of bad faith was a prerequisite. In this case, although the Service had brought the misconduct to the court's attention, after considering all the facts and circumstances, the court held that the attorneys intentionally misled the court before, during and after the trial, and these actions were deliberate attempts by government attorneys to manipulate and abuse the trial process and thus were undertaken and carried out in bad faith. Perhaps a more instructive reflection of the Tax Court's intensity regarding its "zero tolerance" approach to curbing abuses of the court's (and the IRS's) time and resources can be gleaned from its opinion in Universal Trust 06-15-90, TC Memo 2000-390. This case involved whether an individual who filed a petition on behalf of a trust in fact possessed the legal capacity to do so. The Service moved to dismiss the case for lack of jurisdiction. The individual had also been involved in other cases before the Tax Court in which similar arguments had been made. The court concluded that the individual did not possess the requisite capacity to institute the proceeding, and therefore dismissed the case. However, the court did not stop at that. After noting that the IRS did not seek Sec. 6673 sanctions against the individual, the court gratuitously suggested that perhaps the Service should consider imposing other penalties and/or sanctions (i.e., Secs. 67006701 (tax shelter promoter)) or that a criminal investigation should be initiated against the individual: "the expenditures of time and resources of the Court and the Commissioner in this and other cases in which [the individual] has acted...have been so substantial as to raise the question whether some other sanction might be appropriate." The issuance of these opinions within a relatively short period is indicative of what the Tax Court may perceive as an increasing problem. While zealous advocacy of a client's (be it a taxpayer or the IRS) position should never be discouraged, practitioners must conduct thoughtful and careful analyses to properly evaluate whether the permissible line has been (or is about to be) crossed. This is especially true when the practitioner has not been an active participant from the inception. Obviously, when this happens, the practitioner should make every effort to ascertain and evaluate all prior activity, and whether some damage control is necessary before proceeding with the representation. As noted, each case is fact-intensive; whether the court concludes that sanctions are appropriate depends on its particular facts and circumstances. Certainly, the Tax Court has spoken loud and clear on bad faith, and will not hesitate to use the ammunition provided by Sec. 6673 in the future. From Matthew Magnone, J.D., LL.M., and Rene M. Corbet, CPA, Ernst & Young LLP, New York, NY
Withholdings on Aliens by Educational Institutions In an effort to get colleges and universities to better comply with employment tax requirements, on Jan. 29, 2001, the IRS issued Rev. Proc. 2001-20, which is an offer to waive penalties on underpayments or deficiencies due to reasonable causes. This limited-time experimental offer, called Voluntary Compliance on Alien Withholding Program, is for public and other nonprofit educational institutions that want to resolve tax, withholding and reporting compliance issues for income and FICA tax on aliens. Exempt Sec. 501(a) colleges and universities and their affiliates are eligible. Rev. Proc. 2001-20 is an effort to improve voluntary compliance among the targeted institutions in withholding and reporting on wages, grants, scholarships and other income to alien individuals. "Targeted defects" are failures to pay and to withhold and pay the correct taxes under Secs. 3111 (Social Security), 3101 (Medicare excise), 3402 (income taxes on employers and employees) and 14411464 (income tax on scholarships, fellowships and grants, independent personal services and royalties). The general tax rate applied to nonresident aliens is 30% (Sec. 871), but there are many exceptions for reduced rates. The Service and Treasury have concluded that it is desirable to allow the benefit of reduced withholding at the source rate, rather than a refund procedure. Doing so, however, depends on whether withholding agents perform important compliance functions (i.e., properly withholding). Regs. Sec. 1.1441-7(b)(1) (the withholding's due diligence standard) imposes the responsibility on the withholding agent to ascertain whether withholding is applicable, as well as the appropriate withholding rate.
Offer's Advantages If, after review, the IRS agrees with an institution's proposed procedures, it:
Caveats. While an offer is attractive, the Service does not guarantee that it will not impose penalties or initiate an examination. Further, the Service does not offer to waive any kind of tax (which is not unusual in an offer of this nature).
Procedures To request consideration under Rev. Proc. 2001-20, an institution must:
Impact Generally, nonresident aliens pay a 30% tax rate on income (including salaries, wages and compensation). However, Sec. 871(b) excepts income effectively connected with a trade or business within the U.S. Salaries, wages and compensation earned within the U.S. generally qualify as personal service income (Sec. 864(b)) that is effectively connected with a trade or business within the U.S. (Sec. 871(b)(1)). The result is that this income is subject to a graduated tax under Sec. 1 or 55, and withholding under Sec. 3402. Another significant exception is income subject to a treaty agreement, in which case the educational institution as withholding agent may rely on the treaty agreement terms if the alien individual has furnished the required documentation; see Regs. Sec. 1.1441-4. An "alien individual" is a person that is not a U.S. citizen or national. A "resident alien," simply stated, is an alien who is a lawful permanent U.S. resident at any time during the calendar year, or has been present in the U.S. at least 31 calendar days of the calendar year and 183 days during the current year and the two preceding calendar years (substantial presence test); see Sec. 7701(b)(1). Therefore, a "nonresident alien," by exception, is an alien that is not a resident alien.
Timing and Exclusions The offer to resolve issues arising from tax, withholding and reporting obligations began on Feb. 26, 2001 and is available for submissions made before March 1, 2002. The procedure is not offered, however, to institutions under examination on the date that the procedure was published, or to those that come under examination before they submit the required information. Also excluded were institutions that had issues involving the targeted defects pending in the IRS Appeals Division or in litigation. From Ronald J. Blair, CPA, MBA, University of Texas at Dallas, Dallas, TX
Latest Developments in Information Reporting In October 2000, Treasury issued its long-awaited proposed "middleman" regulations (REG-246249-96) under Sec. 6041, addressing information reporting requirements for certain payments made on behalf of persons other than the payor, and payments made to joint payees.
Payments on Behalf of Others Under Prop. Regs. Sec. 1.6041-1(e)(1), a person who makes a reportable payment on behalf of another person, and either performs a management or oversight function in connection with the payment or has a significant economic interest in the payment, must report under Sec. 6041. The regulations define a "management or oversight function" as an activity that is more than merely administrative or ministerial. A "significant economic interest" in a payment is deemed to be an economic interest that would be compromised if the payment were not made. Thus, a person who exercises discretion or supervision in connection with a reportable payment is performing a management or oversight function and must issue a Form 1099 for that payment. Likewise, a bank has a significant economic interest in a reportable payment to a contractor performing repairs when damage occurs to property secured by a mortgage held by the bank, and therefore the bank must issue a Form 1099-MISC for the payment.
Joint Payments The proposed regulations state that a payment made jointly to two or more payees may be fixed and determinable income, and thus reportable to one payee, even though it is not reportable to the other payee. As a result, when a health insurance company makes a payment jointly to a doctor and the patient for services rendered, it must issue an information return to the doctor for whom the income is fixed and determinable, even though the payment is not reportable to the patient.
Reporting Gross, Not Net The proposed regulations reemphasize the position taken in several existing revenue rulings that amounts to be reported as paid to a payee are the gross amount of the payment before fees, commissions, expenses or other amounts owed by the payee to another person that have been deducted from the payment. The proposed regulations are to be applicable for payments made on or after the beginning of the first calendar year that begins after final regulations are published.
New Form W-9, Request for Taxpayer Identification Number In December 2000, the IRS released a new version of Form W-9 on which the certification (which is signed under penalties of perjury) was modified. The new certification contains an additional statement that provides, "I am a U.S. person (including a U.S. resident alien)." This new certification may be critical, due to the new nonresident alien reporting and withholding regulations issued under Sec. 1441 (which became effective after 2000). In February 2001, the Service advised payors (in Announcement 2001-15) that use of the revised Form W-9 is optional until July 1, 2001. Payors must, however, use the revised Form W-9 for all new solicitations after June 30, 2001. Announcement 2001-15 appears to clarify that payors may continue to rely after June 30, 2001 on older versions of Forms W-9 obtained from payees before July 1, 2001.
Reporting of Gross Proceeds Paid to Attorneys Notice 2001-7 announced an additional delay in the effective date of the Sec. 6045(f) proposed regulations for reporting gross proceeds paid to attorneys. A prior delay had been announced in Notice 99-53, which had extended the effective date of the proposed regulations from Dec. 31, 1999 to Dec. 31, 2000. Sec. 6045(f) requires reporting of gross proceeds made to attorneys. The proposed regulations have been subject to sharp criticism by the payor community for a variety of reasons, including:
Notwithstanding the additional delay, payors must continue to comply in good faith with the statutory requirement to report gross proceeds paid to attorneys after Dec. 31, 1997. Such payments made in 2000 were reportable on Form 1099-MISC, in box 13, coded "A." However, the requirements imposed by the proposed regulations that are not clearly discerned from the statute need not be met until final regulations become effective. Under Notice 2001-7, those regulations will not become effective until the first calendar year that begins at least two months after their publication.
Reporting COD Income In Notice 2001-8, the Service announced that it would again extend the suspension of penalties for failure to issue Forms 1099-C, Cancellation of Debt, for those organizations that became subject to the Sec. 6050P reporting requirement as a result of a 1999 law change. A similar delay had been announced in Notice 2000-22, for cancellations of debt (COD) income in the year 2000. Notice 2001-8 provides extended relief for cancellations occurring prior to the first calendar year, beginning at least two months after the date that the IRS issues "appropriate guidance" under Sec. 6050P. Financial institutions and the Federal government have been required to report COD income under Sec. 6050P since 1994. However, in 1999, Congress expanded this reporting requirement to any organization "a significant trade or business of which is the lending of money." As a result, finance companies, credit card companies and many others are now required to issue Forms 1099-C. Many issues surround the expansion of COD income reporting and must be addressed in guidance to be issued. For example, nothing in the legislative history defines a "significant" lending activity. Further, the current Sec. 6050P regulations require reporting at the expiration of a "nonpayment testing period." This event occurs when the creditor has not received a payment on the debt during the prior 36-month period ending on Dec. 31. It is not clear when lenders now subject to reporting will be required to begin counting this 36-month period.
Reporting Income from the Exercise of Nonstatutory Stock Options Income recognized from the exercise of nonstatutory (i.e., nonqualified) stock options by employees or former employees is wages, subject to income tax withholding as well as FICA taxes. Employers are required, therefore, to report these wages on Form W-2, in box 1 (Wages), box 3 (Social Security wages, to the extent the employee has not already met the annual Social Security wage base) and box 5 (Medicare wages). In December 2000, Announcement 2000-97 informed employers that, in addition to reporting this income in boxes 1, 3 and 5, beginning for the year 2001, they would also be required to report any compensation related to the exercise of a nonstatutory stock option in box 12, using code "V." Many employers were surprised by this new (and relatively late) announcement. In response to employer concerns about their ability to timely implement this new requirement, in Announcement 2001-7, the IRS provided that this new reporting requirement will be optional for 2001 Forms W-2. From Deborah J. Pflieger, J.D., LL.M., PricewaterhouseCoopers LLP, Washington, DC |
