Arizona Tax Lawyer Blog

This short article is not the place to delve into how the oic functions line by line, an overview will suffice. It is the place to quickly explain why the oic is so unsuccessful for many taxpayers in general terms and why bankruptcy may be a better option, by laying out some pros and cons.

OIC PROBLEMS

1. The formula results in too large of a number - Taxpayers can't afford

The IRS is allowed to force each taxpayer who applies to settle their tax debt, to use a standardized budget in determining how much they have to pay.

In other words, everyone who files has to pretend that they live on the same budget as someone who possibly earns much less then them. This budget can, with the help of an experienced attorney, be planned for, added to, enlarged, but it can never match the actual budget of many with serious tax debt.

The result is that when the taxpayers actual net income is compared to this budget, there appears to be some large excess income left to pay the tax debt with each month.

The IRS then multiplies this "excess" by a pre-ordained number like 48 and then adds that number to the taxpayer's assets to arrive at a collection potential for the taxpayer.

If the "excess" number is 500 and the asset value is $5000.00, the IRS will claim that the taxpayer can afford to cough up $29,000.00

The problem is that the 500 is usually being used in real life to pay the taxpayer's ACTUAL mortgage, credit card bills, or the 20 year old son's car payment and insurance.
Items either limited or not allowed in the IRS's standard budget.

2. The process can be difficult
The IRS purposefully makes the process difficult. It initially rejects the vast majority of offers in compromise based on a cursory reviews of the facts. Many do not have the funds or desire to continue the fight.

3. Large amount paid upfront makes it more risky
The taxpayer must typically pay a large percentage of the debt with the offer or start making monthly payments equal to the offered monthly payment amount and loses those funds if the offer is unsuccessful.

4. If rejected, the debt comes back in full with interest
When rejected, the taxpayer still owes the entire debt with interest, while the statute of limitations period on the collection of the debt has been stayed.

5. Failure makes it easier for the IRS to collect
The taxpayer who has been rejected, has provided every detail about his financial life to the IRS making it easy for them to collect the debt. (In my opinion, this is why the IRS doesn’t push harder to regulate offer in compromise mills. The oic filing provides a road map of assets and income sources).

6. Full compliance is often a problem after acceptance
IF the offer is successful, the taxpayer must file tax returns and pay tax obligations for 5 years, if not, the offer is over, the money paid is lost, and the total original debt with it's accrued interest, continues to be owed, minus what has been paid.

7. Offer in Compromise is not a complete solution
More likely than not, the taxpayer proposing the offer in compromise has medical bills, credit card debt, personal loans, state tax debt etc. all of which must still be dealt with outside of the of the offer in compromise. The payments on these debts aren't typically allowed as part of the budget in calculating the reasonable collection potential of the taxpayer. The offer, at it’s best becomes only a partial solution as a result.

For these reasons and many others, the vast majority of oic’s fail. In a given year, less than 30% of offers submitted are successful. In 2007, it was closer to 25%.

There is a solution to serious tax debt, that is highly successful when attempted properly that is overlooked by most.

That solution is Bankruptcy.

A quick review of bankruptcy in relation to tax debt will help to explain why.

There are two types of bankruptcy that pertain primarily to consumers. Chapter 7 and chapter 13.

A chapter 7 bankruptcy is the more commonly filed, and is a liquidation case. In a chapter 7 bankruptcy, the debtor loses all assets not protected by statute and is forgiven his or her dischargeable debt.

Chapter 13 bankruptcy is a “reorganization” bankruptcy. The debtor attempts to keep his or her assets and pay some or all of the debt depending on income and budget amounts. The plan length varies between 3 and 5 years depending on a number of factors.

Tax debts as alluded to above, are classified in either a chapter 7 or chapter 13 as either dischargeable or non dischargeable on the date the bankruptcy petition is filed.

Non dischargeable tax debts include:
1. collected and unpaid sales tax
2. trust fund recovery penalty (employment tax unpaid by a business assessed against a “responsible party”).
3. Trust fund tax
4. Income tax related to a return that was not filed or filed but within 2 years of filing the bankruptcy.
5. Income tax related to a return that was due including extensions within the last three years
6. Income tax related to a return for which fraud was involved
7. Income tax for a tax liability that was assessed by the taxing authority within 240 days prior to the date of the bankruptcy filing.

Dischargeable tax debt includes:
1. Those income taxes that meet the following criteria:
A “return” was filed
It was filed more than two years ago
It was due more than three years ago including extensions
The tax was assessed more than 240 days ago
There was no civil or criminal fraud nor did the taxpayer willfully evade or defeat the payment of the tax debt.

In essence, a tax motivated bankruptcy is a bankruptcy case that takes into account filing issues, timing and taxpayer history in a way to take maximum advantage of bankruptcy law in relation to the tax debt.

Or in other words, what may be a nondischargeable tax debt today may become a dischargeable tax debt tomorrow.

The other benefits in comparison to an offer in compromise are as follows:

1. OIC’s factor in the taxpayer’s income while chapter 7 bankruptcies don’t. Whether the tax debt is dischargeable has nothing to do with income. In a chapter 7 if the majority of the taxpayer’s debt is tax debt, then the income is irrelevant to whether the taxpayer qualifies to file a chapter 7. The bankruptcy means testing doesn’t apply.

2. OIC’s factor in future income potential while bankruptcies don’t. It may not matter in bankruptcy that the taxpayer may be making more next year. Many offers are rejected on that basis alone.

3. OICs factor in asset equity. Bankruptcies do not. Equity in bankruptcy has little to do with ability to file or the dischargeability of the debt itself. Certain assets may be liquidated in a chapter 7, most consumer assets are safe.

4. The largest benefit of bankruptcy over the Offer in Compromise is that a bankruptcy can be crafted to deal with all of the other taxpayers debts at once. State tax, credit card, medical bill, personal loans and other consumer debt.

In my experience, most with serious tax debt need to have an experienced attorney, well versed in offer in compromise AND bankruptcy law, apply those laws to the taxpayer's facts BEFORE a decision is made to hire a sales firm to help with an offer in compromise.

The taxpayer who does so, will likely get a more straightforward answer about their oic chances, and an honest comparison between bankruptcy and the offer in compromise program.

Call Arizona Attorney Michael S. Anderson at 480-507-5985 to discuss your options.