TREASURY INSPECTOR GENERAL
FOR TAX ADMINISTRATION
The Internal Revenue Service Needs to Consistently Use Special Circumstances in the Offer in Compromise Program
Reference No. 2001-30-096
The Collecting Mission of the Internal Revenue Service (IRS) is to collect promptly the proper amount of federal tax from all persons who have not filed returns and/or paid tax as required by law and to encourage future compliance with the law. At times, the IRS encounters situations where the taxes owed cannot be collected in full or where there is a dispute as to what is owed.
Internal Revenue Code § 7122 gives the IRS the authority to "compromise" a tax liability. An offer in compromise (OIC) allows the taxpayer to settle unpaid tax accounts for less than the full amount of the assessed balance due. Under this Code section, there are two bases on which an offer can be made: doubt as to liability for the amount owed and doubt as to collectibility (when it is unlikely that the liability can be paid in full). Generally, taxpayers must offer an amount equal to the net value of their assets plus the amount that could be obtained from their future income. However, the IRS can accept a lesser amount under special circumstances, such as advanced age or serious illness of the taxpayer. These OICs are called doubt as to collectibility with special circumstances (DCSC).
The Congress expanded the OIC Program in Section 3462 of the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 98). This section provides for compromise when collection of the tax would create an economic hardship or such an inequity as to be detrimental to voluntary compliance. This type of offer is called an effective tax administration (ETA) offer. The RRA 98 also requires the IRS to establish procedures for an independent administrative review of any rejection of a proposed OIC and allows the taxpayer to appeal any rejection of an offer.
Our overall objective was to determine if procedures for accepting OICs based on special circumstances were being consistently, uniformly, and appropriately applied. The audit was requested by the Deputy Commissioner.
The IRS has taken many actions to implement changes required by the RRA 98. Specifically, the IRS issued temporary Treasury regulations and revised the Internal Revenue Manual (IRM) to provide additional guidance regarding the compromise of federal taxes. The offer specialist training course was revised to include ETA offers and to re-emphasize the DCSC offers, and the course was given to specialists who work offer cases. To ensure procedures are consistently applied and to identify trends for improvement, the IRS initiated a 100 percent review of all offers with special circumstances. In addition, it initiated a separate review of a sample of offers as part of the Collection Quality Measurement System (CQMS).
The use of special circumstance provisions, however, varies significantly depending upon which specialist works the case and where the taxpayer lives. This is due in part to the subjectivity of the factors involved in each case. In addition, the IRS’ policy of allowing taxpayers to withdraw their offers, rather than having the IRS reject them after the investigations determine more can be collected than was offered, bypasses the independent review provided for by the Congress.
The Internal Revenue Service Provided the Necessary Training on the Changes to the Offer in Compromise Program
The IRS revised its offer specialist training course to increase the emphasis on, and to help ensure consistency in, the application of special circumstance criteria. The material covered the various standards and factors to be considered as special circumstances and provided examples of each.
Special Circumstance Criteria Were Not Always Considered and Consistently Applied to Offer in Compromise Cases
Offer specialists did not always consider special circumstance provisions while working offers filed for doubt as to collectibility. Special circumstances were present in 11 of the 114 doubt as to collectibility offers we reviewed that the IRS rejected or the taxpayers withdrew. These cases could have been accepted under the special circumstance provisions.
IRS managers in the three offices we visited had different attitudes about accepting offers with special circumstances. Managers in one office were aggressive in implementing the program and advised the taxpayers they may qualify for special circumstances, even if the taxpayers did not raise the issue. On the other hand, managers in another office did not appear to be strong proponents of the use of these procedures and stated it was not the offer specialists’ responsibility to advise the taxpayer of special circumstance options. Managers’ attitudes towards offers in the third office were in the middle of the other two.
Some offices have expanded the factors that can be considered in determining whether to accept an offer based on special circumstances. Some offices are accepting special circumstance offers based on the decision that the amount offered was more than they thought the IRS would reasonably collect from the taxpayer through normal collection activities. Not all offices applied this expanded interpretation.
The subjectivity of the factors involved in each case and the differing management views is evidenced by the variance in the number of special circumstance offers worked nationally. The number of special circumstances offers worked in Fiscal Year (FY) 2000 ranged from a low of 10 in 1 office (which represented .55 percent of the total offers worked in that office) to a high of 253 in another office (which represented 6.67 percent of the total offers worked in that office).
The issue of not always considering special circumstances was also raised in the National Taxpayer Advocate’s FY 2000 Annual Report to Congress (issued in December 2000), which outlined the 20 most serious problems encountered by taxpayers. The report stated that, "Sustained effort is needed to change the mindsets of those working offer cases. While the implementation of the temporary regulations and provisions in the RRA 98 provided flexibility, some field personnel continue to…ignore special circumstances that would allow consideration or acceptance."
Not All Special Circumstance Offers Are Properly Accounted for on the Management Information System
In a June 2000 audit report on the implementation of the RRA 98 concerning the OIC Program, the Treasury Inspector General for Tax Administration (TIGTA) recommended the IRS establish a management information system (MIS) to monitor, summarize, and report on special circumstance offers on a national level. The IRS agreed with this recommendation and implemented the necessary changes.
While changes were made to the OIC MIS, it still does not accurately account for special circumstance offers. The OIC MIS showed there were 1,016 special circumstance offers closed during FY 2000. However, we identified another 316 special circumstance offers that were closed during FY 2000 and incorrectly recorded on the MIS as doubt as to collectibility offers. Managers in one office advised us they were unaware of the changes to the MIS system, while managers in another office stated they were confused as to how ETA and DCSC offers were to be recorded. Managers in all three offices indicated that some offers were incorrectly recorded due to an oversight.
Permitting Taxpayers to Withdraw Their Offers Instead of Rejecting Them May Be Contrary to Congressional Intent for an Independent Review
The RRA 98 requires the IRS to perform an independent review of any rejection of a proposed OIC and allows a taxpayer to appeal any rejection. Withdrawn offers are not subjected to the independent review process. The IRS procedures provide that if the offer cannot be given favorable consideration, the taxpayer should be given the opportunity to withdraw the offer and be advised that by withdrawing the offer he/she loses any appeal rights on that offer.
In 23 of the 60 withdrawn doubt as to collectibility offers we reviewed, the IRS’ offer investigation concluded that more money could be collected than was offered and, therefore, the offer could not be accepted. The taxpayers were either told to withdraw their offer or given the option to withdraw or have it rejected. Since these offers were closed as being withdrawn, they were not subjected to the independent administrative review process. The Congress’ intent in the RRA 98 was that rejected offers receive an independent review and the taxpayers be offered appeal rights to the rejections. The policy of permitting taxpayers to withdraw their offers in these situations eliminates the independent review and, therefore, may be contrary to the Congress’ intent. In addition, in 15 of the 23 offers, the taxpayers were not advised they forfeited their appeal rights if they withdrew their offers.
This issue was also discussed in the June 2000 TIGTA audit report on the IRS’ implementation of the RRA 98 concerning the OIC Program. The TIGTA recommended the OIC guidelines be changed to discontinue the withdrawal request option. IRS management did not agree with the recommendation and stated, "…allowing the taxpayer to withdraw the offer provides an uncomplicated way to close the offer investigation…." However, we still believe that, in most situations, the taxpayers’ rights would be better served by subjecting the decision not to accept the offer to the independent administrative review process and allowing the taxpayer to appeal the proposed rejection.
The Review Process to Identify Trends or Inconsistencies in the Application of Special Circumstances Can Be Improved
While the IRS has set up review procedures to help ensure consistency in the application of special circumstance provisions, the review process can be improved. Independent administrative reviewers in the field offices did not always receive results of the 100 percent review process. Further, field managers did not use CQMS review results because they were not aware that the results were available on the IRS intranet.
In addition, not all the closed special circumstance offers were included in the 100 percent review program. According to the OIC MIS, there were 839 special circumstance offers closed between October 1, 1999, and August 31, 2000. We determined that 404 of these were not reviewed by the 100 percent review team.
Summary of Recommendations
The Commissioner, Small Business/Self-Employed (SB/SE) Division, needs to improve the communication of quality review results to help ensure consistency in the application of the special circumstance provisions. In addition, detailed instructions in accounting for special circumstance offers on the OIC MIS should be issued to the field, and the procedures for submitting special circumstance offers for the 100 percent review program should be re-emphasized. Finally, the Commissioner should seek clarification from the Congress as to whether the practice of permitting a taxpayer to withdraw his/her offer, after a decision has been made that the offer cannot be accepted, is contrary to the RRA 98 requirement for an independent review of rejected offers.
Management’s Response: SB/SE Division management agreed with all of our recommendations except one. They plan on revising the IRM to address the need to discuss with taxpayers potential special circumstance situations early in the OIC investigation; to emphasize how special circumstance offers should be accounted for on the OIC MIS; and to emphasize taxpayers must be advised that by withdrawing their offers they will forfeit any appeal rights.
In addition, they plan to explore a process to provide direct feedback to field managers on specific cases where quality review disagrees with the conclusion reached in the offer investigation. SB/SE Division management discontinued issuance of the 100 percent review process digest summaries and will provide the field periodic trend analyses of special circumstance reviews. They will also issue memoranda to the field regarding where and how to access the quality review results and re-emphasizing procedures for submitting special circumstance offers to quality review. In addition, they will explore the use of a process that would periodically generate a list of offers from the OIC MIS to compare to the quality review database.
However, SB/SE Division management did not agree to seek clarification from the Congress as to whether the IRS’ policy permitting taxpayers to withdraw offers in those instances where the investigation concluded the offer could not be accepted was contrary to the Congress’ intent in the RRA 98. SB/SE Division management believes allowing for withdrawals serves the interest of both the government and taxpayer by avoiding unnecessary costs to both parties.
Office of Audit Comment: We continue to believe that some withdrawals are very similar to rejects and that these offers are not subject to an independent review. While we agree that the withdrawal option can be advantageous to both the taxpayer and the IRS, we do not believe that the IRS should tell or otherwise encourage taxpayers to withdraw their offers. This causes the taxpayers to be removed from the independent review process.