Today’s lesson is about dogs and tails. Tax practitioners often work hard to get their clients into some kind of Offer In Compromise (OIC) or Installment Agreement (IA) with the IRS. Those are the dogs. But a successful IA or OIC involves more than just making timely payments on the deals. It involves an ongoing commitment to properly file returns and pay taxes for up to five years. That’s the long tail. And, to mix metaphors, that long tail can come back to bite a taxpayer who falls out of compliance. That’s the lesson we learn from two recent opinions: (1) Edward F. Sadjadi and Cynthia M. Sadjadi, T.C. Memo. 2019-58 (May 29, 2019) (Judge Cohen) (IRS can collect original liability against taxpayers who fully paid their OIC); (2) Kevin Scott Millen v. Commissioner, T.C. Memo. 2019-60 (May 30, 2019) (Judge Lauber) (taxpayer had his IA terminated even though he never missed a payment).
The Law: Offer In Compromise (OIC).
The OIC is a tool that not only helps the government collect some tax, but also helps the government improve taxpayer compliance.
Section 7122 authorizes the IRS to compromise taxes, allowing certain taxpayers to pay less than they owe. Treas. Reg. 301.7122-1 provides that the IRS will compromise taxes when: (1) there is doubt as to the taxpayer’s actual liability; (2) there is doubt as to whether the taxpayer can actually fully pay the liability; or (3) the compromise will further effective tax administration.
To get an OIC, taxpayers submit Form 656. The 7-page Form contains a bunch of terms that the taxpayer must agree to follow. One term is this: “I will comply with all provisions of the internal revenue laws, including requirements to timely file tax returns and timely pay taxes for the five year period beginning with the date of acceptance of this offer and ending through the fifth year, including any extensions to file and pay.”
OICs are win-win for taxpayer and the government. Taxpayers get relief from enforced collection of a legally due and owing obligation. The government gets some money now rather than nothing later and, more importantly, brings non-compliant taxpayers back into compliance....at least for five years...at least in theory. The National Taxpayer Advocate’s 2018 Annual Report to Congress sums up the mutual benefit this way on page 266:“The taxpayer benefits by reaching finality with his or her tax debt sooner in the collection process and paying what he or she can afford to pay, while the IRS benefits by creating a segment of noncompliant taxpayers who become more compliant.”
If the taxpayer becomes noncompliant during the five years after the OIC's effective date, the IRM instructs employees to first try and work out the new noncompliance. It that is not possible, they will then default the OIC. See IRM 220.127.116.11 (“Potential Default Cases”). One tax lawyer’s blog suggests that the IRS will try to work with taxpayer to prevent default because “[t]he IRS does not want the compromise to default any more than you do.” The NTA 2018 Report says that about 70% of individual taxpayers in fact stay good for five years.
Bad stuff happens to the 30% of taxpayers who fail to keep compliant for the five year period. The IRS can default the OIC and kick the case back into the ACS collection machine.
The Law: The Installment Agreement (IA).
Like the OIC, the IA is best seen as both a collection tool and a compliance tool.
Section 6159 authorizes, and in some cases requires, the IRS to allow taxpayers to pay their tax liabilities in installments. There are a variety of IAs available depending on the amount owed. A great resource on IAs (and OICs too) is Chapter 10 (“Handling Tax Collection Matters—Procedures and Strategies”), in Effectively Representing Your Client Before the IRS (7th Ed.). That chapter is written by W. Edward Afield, Tameka E. Lester, and Willard N. Timm, Jr.
There are a variety of IAs taxpayer can work out with the IRS. But all types of IAs give taxpayers the same advantages: (1) time to pay off the tax debt; (2) suspension of IRS enforced collection action, including a prohibition on levies and (usually) no filing of a Notice of Federal Tax Lien (NFTL), which protects a taxpayer’s credit score; and (3) flexibility to add later tax liabilities to the installments. See §6159(f); IRM 5.14.5.
To get these advantages taxpayers must demonstrate compliance as follows. First, all types of IAs require taxpayers to be in compliance with all their filing requirements at the time they enter into an IA. IRM 18.104.22.168.2 (07-16-2018). Second, taxpayers are subject to several ongoing obligations related to the IA, including timely payment of installments, staying current on later tax obligations, and providing financial information upon request. See Treas. Reg. 301.6159-1(e)(2)(ii). Finally, Treas. Reg. 301.6159-1(c)(3)(iii)(A) provides that IAs may “contain terms that protect the interest of the government.” One of those terms is that taxpayers keep current on their filing obligations. Form 433-D (“Installment Agreement”) provides that “While this agreement is in effect, you must file all federal tax returns and pay any (federal) taxes you owe on time.”
The requirement to timely file future tax returns is critical to compliance. Section 6159(b)(3) authorizes the IRS to modify existing IAs if it determines that the taxpayer’s financial situation has changed. And the IRS is statutorily required to review one kind of IA, called the Partial Payment IA, every two years. §6159(d). As a practical matter, reviewing later-filed tax returns is how the IRS performs the monitoring function. See IRM 22.214.171.124 (“IDRS Monitoring”) (08-05-2010). So the failure to file a later return will trigger a proposed termination of an IA.
The OIC Lesson in Sadjadi
Mr. and Ms. Sadjadi timely filed tax returns for the years 2008 and 2009, reporting a small balance due, but not enclosing payment. On audit, the IRS determined deficiencies in both years and the taxpayers agreed to additional assessments of those deficiencies, plus penalties.
In 2013, the taxpayers entered into a deferred payment OIC for their 2008 and 2009 tax liabilities. It appears that they had paid off the OIC in full by September 2016. Unfortunately, after they paid off, they filed their 2015 return really late (after October 15, 2016) and did not pay their self-reported liability.
In 2017 the IRS sent the Sadjadis a notice of intent to levy for various tax years, including the years had been subject to the OIC. The Sadjadis timely sought a CDP hearing, where they asked for an IA for the 2015 liability and argued that the IRS could not collect the 2008-2009 liabilities because of the completed OIC.
The CDP Appeals officer approved collection, in part, because the taxpayers had only offered to pay $350 on the later liability and the CDP Appeals officer thought they had a much larger reasonable collection potential, finding they had monthly disposable income of almost $6,500. Oh, and they had filed late and failed to pay that liability in the first place.
In 2018 the Sadjadis petitioned the Tax Court for review, and Judge Cohen focused on the latter reason for the CDP Appeals officer's decision. Judge Cohen explained that the Sadjadis' failure to comply with the five-year timely filing and payment requirements of the OIC meant that the IRS was entitled to now try and collect on the entire assessed amount for 2008 and 2009.
Lesson: OICs en“tail” a five year commitment to compliance. OICs are not satisfied simply by full payment.
The IA Lesson in Millen
Mr. Millen was a little late and a little short on his 2014 tax return. He filed it on April 30, 2015, reporting but not paying a liability of about $3,083. In October 2015 he got into an IA for $40 per month.
In April 2017 Mr. Millen filed his 2016 tax return and again reported but did not pay a liability. The IRS terminated the IA in June 2017 and resumed collection of the 2014 liability, which at that point had a balance due of $3,002. As part of that resumed collection the IRS sent Mr. Millen a CDP notice in September 2017 and he asked for a CDP hearing.
Mr. Millen got his CDP hearing in 2018. It seems to have gone the way one would expect. The Appeals officer told Mr. Millen that he could ask for a new IA but only if he submitted the Collection Information Statement Form 433-A. She also asked that he give her signed copies of his 2015 and 2017 returns, setting a deadline of May 3, 2018. Mr. Millen was not able to do any of that to the Appeals officer’s satisfaction, and after some testy telephone calls between them, she ended up sustaining the collection of his 2014 liability in August 2018.
Mr. Millen timely petitioned the Tax Court for review and Judge Lauber had no difficulty sustaining the CDP determination. The IA was properly terminated because Mr. Millen failed to stay in compliance with his filing and payment obligations. Mr. Millen’s defense to the IA termination was that he had never missed a payment. But, as Judge Lauber points out, that misses the point: even if he had properly made every monthly $40 payment on his IA, he blew his compliance obligations when he failed to pay the self-reported liabilities on his 2016 return.
Lesson: IA’s en“tail” an ongoing commitment to compliance. Proper payment is not the only obligation a taxpayer has under an IA.
Coda: Notice again how the CDP process can help taxpayers at the administrative level but not so much at the judicial level. For example, it gave Mr. Millen a chance to rework his IA. Normally, the IRS will try to work out later non-compliance and can modify an existing IA to include a later liability. See IRM 126.96.36.199.2 and IRM 188.8.131.52. It gave the Sadjadis another shot at another OIC. Getting taxpayers into workable IAs and OICs adds value to tax administration. But judicial review adds little to the process, except delay. Delay is never good for tax collection. And, for taxpayers with few assets, delay is not their friend. The ever-accumulating interest and penalties are relatively large to them but add relatively little to the Treasury, even if collectable. So delay hurts them much more than it helps the Treasury. I sometimes hear practitioners claim that simply the potential for judicial review makes Appeals pay more attention to the taxpayer and so judicial review leads to better decisions by Appeals. I think that unlikely except on the margin but it is an interesting hypothesis that could be studied if anyone in TIGTA or TAS had the time or inclination.
Bryan Camp is the George Mahon Professor of Law at Texas Tech University School of Law