New OIC Requirement Poses a Hardship • Valuable IRS Website Resources • Tax Prepayments May Be Advance Payments or Deposits

Editor:
John L. Miller, CPA
Faculty Instructor
Metropolitan Community College
Omaha, NE

Editor’s note: Mr. Miller is a member of the AICPA Tax Division’s IRS Practice and Procedures Committee. Messrs. Caplan and Snow and Ms. Gansler are members of that Committee. For further information about this column, contact Mr. Miller at jmiller@mccneb.edu.

New OIC 20% Partial Payment Requirement Could Backfire

The IRS,Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) amended Sec. 7122(c) (1) to require most taxpayers to make a 20% partial payment with an offer-in-compromise (OIC) application, effective July 16, 2006. The legislation was passed despite opposition from the AICPA, the American Bar Association’s Section of Taxation and other stakeholders.

The change applies to lump-sum OICs. “Lump sum” is defined by Sec. 7122(c)(1)(A)(ii) as an offer to make payments in five or fewer installments. Any applicable OIC that does not include a partial payment may be returned to the taxpayer as unprocessable; see Sec. 7122(d)(3)(C).

The $150 user fee imposed on OIC applicants since Nov. 1, 2003, is still in effect; see Notice 2006-68.

Under Sec. 7122(f), the IRS will consider any properly submitted OIC to be acceptable if it has not made a determination within 24 months of the submission date. However, a tax liability covered under the OIC that involves any judicial proceeding will suspend the 24-month period. Taxpayers must be current with their filings and any payments subsequent to the period covered by the OIC while they are waiting a resolution.

A Break with Tradition

Since the 1860s, taxpayers have had the ability to compromise and settle deficiencies as a last resort. Historically, this has been good business for the government. In testimony before the House Small Business Committee on April 5, 2006, Nina Olsen, the IRS Taxpayer Advocate, said that, on average, accepted OICs have resulted in the Service collecting 16 cents on every dollar owed. This is a better return than 13 cents on the dollar, which is what the IRS has typically collected on debts two or more years old. According to Ms. Olsen, in cases in which OIC applications are rejected, the IRS collects less than 80% of what it might have collected under an initial taxpayer offer. In over 20% of those cases, the Service recoups nothing at all.

Despite the success, and even before the current legislation, recent statistics show an overall decline in the OIC program. A General Accounting Office study noted that taxpayers applied for about 123,000 OICs in fiscal-year 2002. By fiscal-year 2005, the number was closer to 73,000. The number of OICs accepted has declined as well. OIC acceptances for fiscal-year 2002 were approximately 28,000. Fiscal-year 2005 saw only about 15,000 offers accepted; see “IRS Offers In Compromise: Performance Has Been Mixed; Better Management Information and Simplification Could Improve the Program” (GAO-06-525, 5/23/06), available at www.gao.gov/htext/d06525.html.

Due to impediments introduced with the TIPRA, many practitioners and advocates have expressed concern that the new legislation will effectively kill the OIC program. How many taxpayers will be willing to incur the emotional and financial costs of providing a partial payment, knowing their chances of having an offer accepted are slim? The most common means of financing an OIC payment are:

1. Cashing in an IRA and paying tax and penalties;

2. Refinancing real estate with a loan; and

3. Obtaining funds from parents or friends.

Is There Any Relief?

As a way to avoid the 20% initial payment, some commentators propose structuring an OIC to include more than five installments. Under this scenario, taxpayers would make monthly installments while awaiting IRS approval. However, as final approval may take several years, this approach may be impractical.

Another alternative is a hardship waiver. New Sec. 7122(c)(2)(C) gives the Secretary authority to issue regulations allowing waivers for certain classes of taxpayers. Ms. Olsen has requested examples from the AICPA Tax Division’s IRS Practice and Procedures Committee, which can form the basis of as broad a hardship waiver as practical. The Committee is in the process of submitting examples.

Conclusion

The Joint Committee on Taxation has estimated that revenue will increase by almost $2 billion from this provision. On the contrary, many practitioners predict that the 20% partial payment is a significant barrier that will encourage taxpayers not to apply for an OIC and will result in an overall decrease in revenue.

From Robert M. Caplan, CPA, Foster City, CA

IRS Help Is Just a Click Away

Tax advisers tired of the IRS’s automated telephone service and willing to let their fingers do the walking, can use its website (www.irs.gov/taxpros/index.html). Unlike days of old, it is fast, easy and extremely user-friendly. Some of the site’s content is discussed here and can be added to an online favorites list. However, the list should not be limited to these few highlighted resources. It is a mere sample. If tax practitioners still prefer to use the phone, the exhibit contains a handy list of IRS contact numbers.

E-Newsletters

The Service’s newsletters provide breaking tax news. Subscriptions to newsletters and the IRS’s newswire service are available at www.irs.gov/newsroom, under “e-News Subscriptions.” When practitioners sign up for Newswire, they will receive regular explanations of new regulations and laws. There are also direct links to hot topics. Newsletters offered include Tax Tips; Qualified Intermediaries News; Federal, State, and Local Governments Newsletter; IRS GuideWire, which notifies subscribers of IRS issues and provides advance copies of tax guidance; Employee Plans News; Retirement News for Employers; a Small Business/Self-Employed Division mailing list for IRS outreach products and programs; and several other offerings. This service is free; tax advisers need only provide their e-mail address.

Also available in the “Tax Professionals” section of the IRS’s website is “E-news for tax professionals”; to join, click on Subscription Services, then Join “e-News For Tax Professionals.” This electronic mail service provides a plethora of information and useful bulletins covering general news, as well as local news and events. It is a gateway to other resources on the website.

Tax Talk Today

Another useful link found under the “Tax Professionals” section is “Tax Talk Today,” a weekly webcast. It is privately owned and provides continuing education. Each webcast is 60 minutes and covers current issues. Practitioners can join the webcast live or review the archived programs.

Basic Tools for Tax Professionals

This link provides information tax advisers need to file returns. It is also a portal to a wealth of other useful information, such as tax practitioner responsibilities, which includes links to Treasury Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, and Appraisers Before the Internal Revenue Service; Standards of Practice for Tax Professionals; an archive of Internal Revenue Bulletins; reference materials; and information on representing clients before the IRS, collection tools, client rights and the IRS’s Criminal Investigation Division and enforcement initiatives.

Feedback

From the Commissioner down, the IRS is trying to maintain an open line of communication with practitioners. IRS staff values practitioners’ opinions and ideas on how to improve the services it provides to tax professionals and their clients. Tax advisers are uniquely aware of the IRS resources that need to be improved. The Issue Management Resolution System (IMRS), for example, serves as an early warning system for identifying and resolving significant issues regarding IRS policies and practices; see www.irs.gov/business/small/article/0,,id=158507,00.html. When practitioners need assistance with the IMRS, they can contact their local stakeholder liaison; see www.irs.gov/localcontacts. A liaison’s job is one of gatekeeper—the first line of contact for issue resolution. Liaisons will immediately forward an issue to appropriate personnel and will follow up to ensure that the practitioner receives a timely and accurate response.

From Jill Gansler, CPA, Regional Management Inc., Baltimore, MD         

Tax Prepayments—Advance Payments or Deposits under Blom?

As the interest rate on Federal tax underpayments increases (8% for the calendar quarter beginning July 1, 2006), taxpayers facing a tax liability dispute with the IRS are even more likely to consider making voluntary prepayments to obviate the effects of any interest and penalties. Taxpayers can make prepayments in one of two ways, as long as the IRS has not already assessed tax. They can designate them either as a deposit or an advance payment of tax. There is an important distinction between the two, which was highlighted in a recent court decision.

A deposit made under Sec. 6603 that is in accordance with Rev. Proc. 2005-18 will be returned if the taxpayer simply submits a written request to the IRS. A prepayment made as an “advance payment of tax,” however, will be returned only if the taxpayer follows the Service’s procedures for claiming a refund. Consequently, a request for a return of an advance payment is subject to the strict statute of limitations (SOL) on refund claims. According to Sec. 6511, for the IRS to consider a refund claim, it must be filed within three years of filing the return or within two years of paying the tax, whichever is later. Taxpayers that do not file a return must file a refund claim within two years of paying the tax.

Facts

In Blom, ED PA, 5/31/06, the taxpayer prevailed in convincing a district court that a payment made by an estate was a “deposit in the nature of a cash bond.” (Prior to the American Jobs Creation Act of 2004’s enactment of Sec. 6603, a prepayment made as a deposit was referred to as a deposit in the nature of a cash bond.) While the taxpayer was successful, the case serves as a reminder that for a prepayment of a disputable tax to be considered a deposit, taxpayers must closely follow Rev. Proc. 2005-18’s requirements.

In Blom, an executrix visited an IRS office to inquire about an extension to file the decedent’s Federal estate tax return. The decedent had died on March 1, 1996. The executrix believed assets held in trust from the decedent’s late husband’s estate were supposed to be included in the decedent’s taxable estate. The estate eventually became involved in litigation with the trustee.

As a result of her visit to the IRS, the executrix filed Form 4768, Application for Extension of Time To File a Return and/or pay U.S. Estate (and Generation-Skipping Transfer) Taxes, on Nov. 22, 1996. At the same time, she submitted two checks to the Service, totaling $140,000. Neither of the payments was designated as a deposit. One check included the reference “Federal Estate Tax” and the decedent’s name, while the other carried no notation. The IRS accepted these payments and approved the extension request. However, the executrix failed to file the estate tax return by the extended due date, June 1, 1997. When the return was finally filed on Sept. 9, 2002, there was no tax liability noted.

The IRS had posted the payments as advance payments of tax. As a result, it treated the estate tax return as a refund claim, which it then proceeded to deny on the basis that the three-year SOL had expired. The executrix filed suit to recover the $140,000, contending that she intended the payments to be a deposit in the nature of a cash bond, not a payment.

Analysis

Both Rev. Proc. 2005-18 and its predecessor, Rev. Proc. 84-58 (applicable in Blom), state that a payment made before the IRS mails a deficiency notice can be considered a deposit only if the taxpayer designates it as such in writing. As previously noted, the executrix in Blom did not designate either check as a deposit. However, because the payments were made prior to the issuance of a deficiency notice (and, in fact, no taxes were due), the district court used the Third Circuit’s “facts and circumstances” analysis to resolve the issue. It believed the facts supported the executrix’s assertion that she intended the payments to be deposits. The executrix testified that she did not consult a tax professional to estimate the taxes and made the payments to avoid a penalty assessment against the estate for filing or paying late. According to the court, her intent was supported by correspondence she sent to the IRS before she filed the estate tax return. In that correspondence, she explained that the estate was involved in litigation and that she would not file the return until it was concluded.

Importantly, different courts treat a remittance that accompanies a request for a filing extension differently. Some courts have held, like Blom, that such payments are deposits, not advance payments of tax; see, e.g., Hill, 263 F2d 885 (3d Cir. 1959). Others have held the opposite; see, e.g., Deaton, 440 F3d 223 (5th Cir. 2006), aff’g TC Memo 2005-1, and Harrigill,  410 F3d 786 (5th Cir. 2005).

In footnote 4 of Blom, the court noted, “there is a body of law in other Circuits finding that an estimated payment filed with a Request for Extension is a ‘payment’ for purposes of tolling the statute of limitations.” However, the court found such cases distinguishable. Of consequence is the fact that these cases predate Sec. 6603 and Rev. Proc. 2005-18. For that reason, taxpayers may not want to rely on previous decisions holding such payments to be deposits.

Conclusion

Taxpayers contemplating making a payment when there might be a potential tax dispute with the IRS should review and follow the requirements of Sec. 6603 and Rev. Proc. 2005-18. In particular, they should always closely monitor and adhere to the deadlines under Sec. 6511 for claiming refunds, in case they end up in a court that does not agree with Blom.

From Danny Snow, CPA, Thompson Dunavant PLC, Memphis, TN