ROBERT E. MCKENZIE, ESQ.

ARNSTEIN & LEHR

120 SOUTH RIVERSIDE PLAZA, SUITE 1200
CHICAGO, IL 60606
312-876-6927
312-876-7318 fax

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OFFER IN COMPROMISE
Robert E. McKenzie

Background

1.110 An offer in compromise is a settlement of a delinquent tax account for less than the full amount
due. Sec. 7122 states that the IRS may compromise any civil or criminal case arising under the
Internal Revenue Laws prior to reference to the Department of Justice for prosecution or defense. In
the past very few offers were accepted because the standards were almost impossible to meet and
the IRS really did not encourage them. But in 1992, the IRS decided that they had a major problem
with accounts receivable inventory and a growing number of cases reported as currently not
collectible.@ The new policy espoused by the IRS was that they would accept an OIC when it was
unlikely that the tax liability could be collected in full and the amount offered reasonably reflected
collection potential.

New Offer In Compromise Procedures

1.120 The IRS released a new Form 656 in July 2004. The form also requires that the taxpayer
submit new forms 433A and 433B. All OIC's will now be processed centrally at two Service Centers:
Memphis for taxpayers most western states and Brookhaven for eastern states. All but the most
complex offers will be worked from the centers.

More Supporting Documents

1.130 The new financial statements require the proponent to supply documentation for each item on the forms,
i.e. pay stubs, car payment book, mortgages, pay stubs, charge account statements, and bank statements. The
IRS contemplates considering many offers without conducting a field investigation, therefore it is requiring the
proponent to supply all the info to make a decision without field verification.

New Addresses

1.140 All new offers from taxpayers living in Alaska, Alabama, Arizona, California, Colorado, Hawaii, Idaho,
Kentucky, Louisiana, Mississippi, Montana, Nevada, New Mexico, Oregon, Tennessee, Texas, Utah,
Washington, Wisconsin, or Wyoming must be filed as follows:

Wage earner or self employed without employees Other than wage earner or self employed without employees
Then mail to: Then mail to:
Memphis Internal Revenue Service Memphis Internal Revenue Service

Center COIC Unit Center COIC Unit

PO Box 30803, AMC PO Box 30804, AMC

Memphis, TN 38130-0803 Memphis, TN 38130-0804

All other states will submit offers as follows:

Wage earner or self employed without employees Other than wage earner or self employed without employees
Then mail to: Then mail to:
Brookhaven Internal Revenue Service Brookhaven Internal Revenue Service

Center COIC Unit Center COIC Unit

PO Box 9007 PO Box 9008

Holtsville, NY 11742-9007 Holtsville, NY 11742-9008

Offers already assigned to the field will continue to be worked by the local territory office.

Return of an Offer

1.150 The former procedures required the at least 2 attempts to request information from a taxpayer prior to the
return of an offer for failure to provide requested financial information/verification. This procedure has been
reduced to require only one request during the offer investigation.

An OIC may now be returned , or rejected, based on the following criteria:

Taxpayer resubmits an offer that is not materially different from a previous offer that was either previously
rejected with appeal rights or returned. The resubmission reflects an amount that is substantially similar to , the
same, or less than the prior offer without a material difference in the taxpayer's financial situation or appearance
of special circumstances.

Taxpayer resubmits an offer within one year of having defaulted and received a termination letter. The taxpayer
has failed to resolve the previous default situation and the new submission is substantially similar to, the same, or
less than the prior offer without a material difference in the taxpayer's financial situation or appearance of
special circumstances.

An offer is filed solely to delay enforcement actions after a collection employee has determined and
communicated to the taxpayer the intent to enforce collection through levy or seizure. The taxpayer has a clear
and present ability to pay substantially more than the offer amount and special circumstances do not exist.

An offer will be returned during the investigation if the taxpayer does not demonstrate compliance with
estimated tax payments and fails and/or neglects to make the required estimated tax payment(s).

Offers that are returned based on resubmission after a prior reject, return, or default situation, or for failure to
make estimated payments, will not be subject to independent review. Offers that are returned based on a
determination that the offer was submitted solely to delay enforcement will be subject to independent review.

Processing Center Review

1.160 Upon receipt of an Offer in Compromise in the appropriate processing center, it will be reviewed by a
staff member to determine if field investigation is necessary. If the Offer involves great complexity, including
self-employed individuals or individuals with substantial property, it is likely to be transmitted to the local area
offices for investigation. Other Offers which involve less complex matters will be reviewed and considered in the
processing center.

Offers Increasing

1.170 During fiscal 2005 the Internal Revenue Service received over 74,000 offers in compromise.(1) That
number represented a decrease from 106,000 offers in compromise received in fiscal year 2004. The Internal
Revenue Service has a huge backlog of offers and has been devoting more and more of its limited collection
resources to processing them. In an effort to reduce its backlog the IRS now requires that all offers be submitted
to either its Holtsville or Memphis Compliance Centers. It also has implemented strict processing rules.

Unnavigable Roadblocks

1.180 The new centralized system has created unnavigable roadblocks for submitting offers. Even experienced
practitioners are frustrated by the maze faced by prospective offers. New IRS rules require that all
documentation be transmitted upon submission of an offer. Poorly trained clerical workers then review each
offer to assure all documentation is present. If even a small portion of the documentation is deemed to be missing
by the IRS reviewer, a form letter setting a short deadline for response is sent out to the taxpayer or her
representative. The new system appears to be designed to reduce the number of offers in compromise
backlogged at the IRS by making it almost impossible to receive substantive consideration of compromises.

Horror Stories

1.190 Horror stories abound. As I have gone about the country lecturing over the past 10 months, I have heard
one story after another from experienced practitioners who have found it extremely difficult to receive adequate
consideration of their offers. Even the most experienced practitioners have faced prolific barriers to
consideration of their clients' offers. Once an offer is under consideration, the IRS now inflexibly applies
allowable expense standards.

Compliance Centers Hinder Substantive Consideration of Offers

1.200 On one occasion I submitted an offer in compromise for a liability of about $1 million dollars.
Accompanying that offer was a 600 page notebook indexed with all appropriate documentation supporting the
offer. The IRS Holtsville Compliance Center promptly managed to separate the documentation from the offer in
compromise. I received a letter from the IRS stating the offer would be rejected because it was not accompanied
by documentation. I re-transmitted the documentation. Upon receipt of the new documentation, the Service
issued letters stating that the offer was not processible because we had failed to provide one of the last three
months bank statements. (The taxpayer had misplaced that statement.) Apparently common sense is not a job
requirement for review of offers in compromise. It was clear upon submission of over 600 pages of
documentation that the taxpayer was prepared to fully comply with all IRS requests. We subsequently
transmitted the offending bank statement only to have the IRS improperly transmit the offer to the wrong area
office. Six weeks later the offer was finally transmitted to the proper office and we have begun negotiations.
Although this story may seem to be an exception, I have yet to have an offer properly and promptly processed
by a Compliance Center. My conversations with Enrolled Agents, attorneys and accountants from across the
country confirm that the Compliance Centers hinder substantive consideration of offers.

Creates Many Barriers to Compromise

1.210 The IRS's goal for centralization was to reduce its backlog of offers in compromise. It is clear that the new
system is designed to do exactly that. Unfortunately, the method chosen to reduce the backlog is to create so
many barriers to compromise that most taxpayers could not possibly be successful. As a practitioner who has
spent a 30 year career either representing people before the IRS or working for the IRS Collection Division, I
have yet to have an offer go through the new system without delays, dumb inquiries and major bureaucratic
screw ups. If an experienced practitioner cannot navigate the new system, then the average taxpayer has no
hope of ever receiving a fair consideration of his or her offer in compromise. The IRS has constructed a Berlin
Wall with low paid clerical workers performing the function of East German Border Guards preventing fair
consideration of offers. Over time, most taxpayers will give up on offers in compromise simply because they
cannot find a way to scale that wall. To paraphrase Ronald Reagan, "Mr. Rossotti, tear down this wall."

A Better Way to Process Offers

1.220 The IRS's new process appears to be in direct contravention of directions from Congress and RRA98 to
ease offer standards. Many deserving taxpayers will not receive an offer in compromise, not because their offers
lack merit, but because they are unable to navigate the system. There is a better way to process offers. My
suggestions are:

1. Return to a local system of processing offers in compromise.

2. Assign experienced/seasoned Revenue Officers to review each incoming Offer in Compromise.

3. Instead of requiring huge levels of documentation prior to consideration of an offer, after review of financial
data, request only that documentation that common sense and best practices require to make a reasoned
decision.

4. If an offer is frivolous, it should be returned to the taxpayer for re-submission for an appropriate amount.

5. Offers for liabilities less than $75,000 should be assigned to lower paid IRS tax examiners for prompt review
and response to the taxpayer. Most of these offers could be considered without field investigation.

6. Offers for tax liabilities in excess of $75,000 should be classified as to complexity and assigned to IRS
employees with appropriate experience levels.

7. The IRS should comply with the requirements of Section 7122 requiring review of individual facts and
circumstances instead of rotely applying its allowable expense standards.

1998 Revisions

1.230 The Internal Revenue Service Restructuring Act expands the authority for the IRS to accept
offers in compromise. The Act requires the IRS to develop and publish schedules of national and
local allowances that will provide taxpayers entering into an offer in compromise with adequate
means to provide for basic living expenses. The IRS is required to consider the facts and
circumstances of a particular taxpayer's case in determining whether the national and local
schedules are adequate for that particular taxpayer. The Act prohibits the IRS from rejecting an offer
in compromise from a low-income taxpayer solely on the basis of the amount of the offer. [Act 3462]
[IRC 7122]

Prohibition of Levy

1.240 The Act prohibits the IRS from collecting a tax liability by levy (1) during any period that a
taxpayer's offer in compromise for that liability is being processed, (2) during the 30 days following
rejection of an offer, (3) during any period in which an appeal of the rejection of an offer is being
considered, and (4) while an installment agreement is pending. [2462(b)] [IRC 6331(k)]

Rejections
1.250 The Act required that the IRS implement procedures to review all proposed IRS rejections of
taxpayer offers in compromise and requests for installment agreements prior to the rejection being
communicated to the taxpayer. The Act provides that the IRS will adopt a liberal acceptance policy
for offers in compromise to provide an incentive for taxpayers to continue to file tax returns and
continue to pay their taxes.

More Liberal Policies

1.260 Section 3462 imposes a duty upon the Internal Revenue Service to exercise much more
flexibility in the use of its allowable expense standards. Revenue Officers and employees of the
Collection Division may not use the schedules to the extent that such use would result in the
taxpayer not having adequate means to provide for basic living expenses. This provision is
particularly important with respect to housing. Because the IRS uses the average cost of housing in a
particular county in determining its current allowable expense standards, any taxpayer who recently
purchased a home probably has housing expenses that exceed the IRS standard. The IRS should
look at the actual expenses of the taxpayer as opposed to its arbitrary determination of appropriate
housing standards. Although the Code mandates flexibility many IRS employees have failed to
exercise that authority to allow individual taxpayers to reach reasonable compromises.

Minimum Offer Standards

1.270 Some districts had imposed minimum offer standards for taxpayers. Therefore, a low income
taxpayer who offered a minimum amount might have had the offer rejected even though it
represented her maximum ability to pay. The Internal Revenue Service is now required to consider
each offer submitted by a taxpayer on its individual merits not based upon some minimal offer
amount.

Appeal Rights

1.280 Although the Internal Revenue Service had previously provided for administrative review of
Offers in Compromise by the Appeals Division there was no specific statutory requirement for such
review. Section RRA 3462(d) now enacts into law specific rights of independent review of Offers in
Compromise by the Internal Revenue Service Office of Appeals.

Joint Offer - Default by One Spouse

1.290 Offers in Compromise contain within their terms the requirement that the taxpayer remain
current during the 5 years subsequent to approval of an Offer in Compromise. One problem which
has arisen is that married taxpayers who later divorce may face the possibility where one of the
spouses fails to meet all of his or her tax obligation. As a result the Internal Revenue Service has
occasionally attempted to default the Offer in Compromise with respect to both spouses. Section
3462 of RRA contains specific protections for an innocent spouse who has complied with all of his or
her tax obligations notwithstanding any default by a spouse.

Doubt as to Liability Offers

1.300 Another protection provided by Section 3462 of RRA is with respect for Offers in Compromise
based on doubt as to liability. In the past the Internal Revenue Service has occasionally rejected
offers with respect to doubt as to liability solely because it could not find its administrative file. The
Internal Revenue Service is now prohibited from taking such action. The Internal Revenue Service
has imposed additional duties upon taxpayers seeking compromise liabilities solely on the basis of
doubt as to liability by requiring those taxpayers to submit financial statements. Many in the
practitioner community believe the taxpayers with substantial means were prejudiced by this
requirement because the Internal Revenue Service would consider the taxpayers substantial
economic means when reviewing the underlying liability. The Internal Revenue Service is now
specifically prohibited from requiring financial statements when offers are submitted based solely on
doubt as to liability.

Accepted Offers

1.305 As a result, the number of offers received by the IRS has gone up dramatically as has the
acceptance rate. However, in recent years, the number has decreased while the acceptance rate
has increased.

In 1992, the year the policy changed, the IRS received 12,102 offers and accepted 36%.

In 1996, the IRS received 133,598 and accepted 48% of those determined to be processable.

In 1998, the IRS received 105,255 and accepted only 25,052; leading to the collection of $290 million
out of $1.9 billion in outstanding tax bills.

In 2000, the IRS received 109,000 and accepted 33,000.

In 2001, the IRS received 125,000 and accepted Unknown number.

In 2002, 124,000 received and 29,000 accepted,

In 2003, 128,000 received and 22,000 accepted.

In 2004, 106,000 received and 20,000 accepted.

In 2005, 74,000 received and 19,000 accepted.

Deferred Offer

1.320 In March, 1999 the IRS created a new offer called a deferred payment offer which allows the
taxpayer to propose paying the discounted value of her assets plus monthly payments for the
remainder of the statute of limitations for collection.

Computation of Offer Amount

1.330 The IRS uses three different methods for determining the adequacy of an offer depending on
the period of time the taxpayer proposes for payment of the offer amount. The methods are:

1. Cash (paid in 90 days or less), or

2. Short-Term Deferred Payment (more than 90 days, up to 24 months), or

3. Deferred Payment (offers with payment terms over the remaining statutory period for collecting the
tax.).

Note: In all three cases, the IRS will release any filed Notice of Federal Tax Lien once you have fully
paid the offer amount and any interest that has accrued.

Cash Offer

1.340 You must pay cash offers within 90 days of acceptance. You should offer the realizable value
of your assets (quick sale value) plus the total amount the IRS could collect over forty-eight months
of payments (present value of income). When the ten-year statutory period for collection expires in
less than forty-eight months, you must use the Deferred Payment Chart shown in the instructions to
Form 656. The IRS will charge interest on the offer amount from the acceptance date until it receives
full payment. The Internal Revenue Service's method of determining the adequacy of an offer could
be best expressed by:

Quick Sale Value Plus Present Value of Income Equals Offer In Compromise (QSV + PVI = OIC)

In applying this formula, the IRS determines the Quick Sale Value of all of the client's assets and
then adds the amount of the present value of the taxpayer's ability to pay. It aggregates the two
numbers to arrive at an Offer in Compromise amount. The following paragraphs will discuss the
Internal Revenue Service's methodology for determining quick sale value and the present value of
income.

Short-Term Deferred Payment Offer

1.350 This payment option requires you to pay the offer within two years of acceptance. The offer
must include the realizable value of your assets in addition to the total amount the IRS could secure
over sixty months (or the remainder of the ten-year statutory period for collection, whichever is less)
through monthly payments. The IRS may file a Notice of Federal Tax Lien on tax liabilities
compromised under short-term payment offers.

Deferred Payment Offers

1.360 This payment option requires you to pay the offer amount within the remaining statutory period
for collecting the tax. The offer must include the realizable value of your assets plus the amount the
IRS could collect through monthly payments during the remaining life of the collection statute. The
deferred payment option itself has three payment options:

1) Option One is: Full payment of the realizable value of your assets within 90 days from the date
the IRS accepts your offer and Your future income in monthly payments during the remaining life of
the collection statute;

2) Option Two is: Cash payment for a portion of the realizable value of your assets within 90 days
from the date the IRS accepts your offer and Monthly payments during the remaining life of the
collection statute for both the balance of the realizable value and your future income;

3) Option Three is: The entire offer amount in monthly payments over the life of the collection
statute. Just as with short-term deferred payment offers, the IRS may file a Notice of Federal Tax
Lien.

TIPRA, section 509, amends Internal Revenue Code section 7122 by adding a new subsection (c)
“Rules for Submission of Offers in Compromise" which establishes the following:

A taxpayer filing a lump-sum offer must pay 20 percent of the offer amount with the application
(IRC 7122(c)(1)(A)). A lump-sum offer means any offer of payments made in five or fewer
installments.
A taxpayer filing a periodic-payment offer must pay the first proposed installment payment with
the application and pay additional installments while the IRS is evaluating the offer (IRC section
7122(c)(1)(B)). A periodic-payment offer means any offer of payments made in six or more
installments.

The IRS considers the 20 percent payment for a lump sum offer, and the installment payment on a
periodic payment offer, as "payments on tax" and are not refundable deposits regardless of whether
the offer is later returned, withdrawn, rejected or terminated by the IRS.

Allowable Expenses

1.361 As of August 29,1995, the Internal Revenue Service adopted new policies with respect to expenses which
would be allowed for taxpayers on Forms 433-A and 433-F. The new allowable expenses created two categories:
Necessary Expenses and Conditional Expenses. Taxpayers who establish necessary expenses based on national
and local standards are allowed these expenses for consideration of any installment agreement or Offer in
Compromise. Conditional expenses would be those expenses that the IRS did not consider to meet the necessary
tests, but which it would allow if the taxpayer can pay the outstanding taxes with an installment agreement
within the three years. If the taxpayer could not pay within three years, she would be allowed one year to adjust
her conditional expenses.

Necessary Expenses

1.362 The new IRS procedures provide that a necessary expense will be allowable if it meets the necessary
expense test: "Provide for a taxpayer's and his or her family's health and welfare and/or the production of
income." The Internal Revenue Service requires that the expense must be reasonable. The IRS believes that the
total necessary expenses establish the minimum a taxpayer and family need to live. The IRS has created three
necessary expense categories:

(1) National Standards. These provisions establish standards for reasonable amounts for five necessary
expenses. For four of them the standard comes from the Bureau of Labor Statistics (BLS) Consumer
Expenditure Survey: food, housekeeping supplies, apparel and services, and personal care products and service.
For the remaining one, the standard has been established by the Service: miscellaneous. Any amount above the
national standards may be considered excessive necessary expenses. Alaska and Hawaii have been allowed some
upward adjustment because of their high cost of living.

(2) Local Standards. Local standards have been established for two necessary expenses: housing and
transportation. All utilities are included in the housing category. The IRS has established a housing category for
each county in the United States. Housing standards are extremely parsimonious. The transportation standards
are established for regions with additional amounts allowed for particular metropolitan areas.

(3) Other. Other expenses may be allowed if the IRS believes they meet the necessary expense test. All such
expenses must be reasonable in amount in the eyes of the IRS. Since there are no national or locally established
standards for determining reasonable amounts, the Service employee is given discretion to determine whether an
expense is necessary and the amount is reasonable. The practitioner obviously may aggressively represent his
client's interest with respect to other necessary expenses.

Conditional Expenses

1.363 The second category of expenses which the IRS may choose to allow are those which do not meet the IRS
Necessary Expense Test. However, conditional expenses are allowable if the taxpayer has the ability to pay the
tax liability, including projected accruals, within five years. The requirements for conditional expenses are as
follows:

(1) Five-Year Rule. This rule establishes a time limit for any expense determined to be excessive, necessary,
and/or conditional expenses. They will be allowed if the tax liability, including projected accruals, can be paid in
full within five years.

(2) One-Year Rule. This rule establishes a time limit. It provides the taxpayer up to one year to modify or
eliminate excessive necessary or not allowable conditional expenses if the tax liability, including projected
accruals, cannot be fully paid within five years.

(3) Reasonable Amount. For certain specified expenses where reasonable amounts are not provided by the
national standards and by the local standards, an IRS employee has discretion. If the reasonable amount is not
provided by one of these two standards, then the Service employee responsible for the case is allowed to
determine it. If the tax liability, including projected accruals, can be fully paid within five years, the Internal
Revenue Service may allow a taxpayer's claimed expenses if substantiated.

Expenses Which Will Not Require Substantiation

1.364 The IRS will no longer require substantiation of those expenses specified in the national standards. The
IRS will allow the total national standards amount for the taxpayer's income level. Taxpayers making more than
the highest income level shown in the national standards will be limited to the maximum amount allowed by the
national standards unless they can substantiate and justify a larger amount. [IRM 5.15.1.3] The manner in
which the taxpayer chooses to spend the national standards is up to the taxpayer. For example, the IRS manual
specifies that the taxpayer could allocate less for clothing and spend more for entertainment; or more for food
and less for clothing. If the taxpayer spends more than the total amount allowed by the national standards, the
taxpayer will be required to justify that expense. For example, a taxpayer with special dietary needs will be
required to establish the justification for additional food expense. In summary, if the taxpayer claims more than
the national standards, she will be required to submit substantiation and justification, but if she claims an amount
equal to the national standards, no substantiation will be required by the Internal Revenue Service.

Housing Expense

1.365 When applying the local housing standards the IRS employee is allowed to consider other factors which
might justify an expense in excess of the local housing standard. For example, the IRS employee can consider
the following factors:

(1) The increased cost of transportation to work and school which would result from moving to a lower cost
housing;

(2) The tax consequences which would result from selling a home;

(3) Someone moving from an owned home to a rented home would lose tax advantages of itemized deductions;
there would also be the possibility of a capital gain liability; and

(4) The cost of moving to a new residence. [IRM 5.15.1.7]

Transportation

1.366 The transportation amount established in the IRS Tables set the standards for amounts to be allowed for
car purchase and lease, repairs, maintenance and fuel. The Internal Revenue Service takes the position that in
some metropolitan areas public transportation would be an appropriate means for transportation to and from
work for the taxpayer and therefore, it could choose to disallow an automobile as a personal convenience for the
taxpayer.

Necessary Expenses (Other)

1.367 The Internal Revenue Service has set forth the following standards for Other Necessary Expenses:
(1) In addition to those listed under the National and Local Standards, certain other expenses are usually
considered to be necessary.

Expense Item Expense is Notes/Tips

Necessary if:
Accounting and Representation Disallow any
legal fees. before the Service other accounting
is needed or meets or legal fees.
the necessary Disallow costs not
expense tests. related to solving
Amount must be current liability.
reasonable.
Charitable If it is a condition Disallow any
contributions of employment or other charitable
(Donations to tax meets the necessary contributions that
exempt expense tests. are not
organizations) Example: A considered
minister is required necessary.
to tithe according to Example: Review
his employment the employment
contract. contract.
Child Care(Baby- It meets the Cost of child care
sitting, day care, necessary expense can vary greatly.
nursery and test. Only Do not allow
preschool) reasonable amounts unusually large
are allowed. child care
expense if more
reasonable
alternatives are
available.
Consider the age
of the child and if
both parents
work.
Court-Ordered If court ordered and Review the court
Payments(Alimony, being paid, they are order.
child support, allowable. If
including orders payments are not
made by the state, being made, do not
and other court allow the expense.
ordered payments) Child support
payments for
natural children or
legally adopted
dependents may be
allowed.
Dependent If there is no
Care(For the care alternative to the
of the elderly, taxpayer paying the
invalid, or expense.
handicapped.)
Education It is required for a Example: An
physically or attorney must
mentally challenged take so many
child and no public education credits
education providing each year or they
similar services is will not be
available. Also accredited and
allowed only for the could eventually
taxpayer and only if lose their license
required as to practice before
condition of the State Bar. A
employment. teacher could lose
their position or
in some States
their pay is
commensurate
with their
education credits.
Health Care Required for the To determine
health and welfare monthly
of the family. expenses, the
Elective surgery total out of
would not be pocket expenses
allowed such as would be divided
plastic surgery or by 12. The
elective dental Schedule A may
work. The taxpayer also be used to
must provide proof determine the
of excessive out of yearly expense.
pocket medical Ensure that the
expenses. amount used is
out of pocket
after insurance
claims are paid.
Substantiate that
payments are
being made.
Involuntary If it is a To determine
Deductions requirement of the monthly
job; i.e. union dues, expenses, the
uniforms, work total out of
shoes. pocket expenses
would be divided
by 12.
Life Insurance If it is a term policy If there are whole
on the life of the life policies, these
taxpayer only. should be
reviewed as an
asset for
borrowing against
or liquidating.
 Life insurance
used as an
investment is not
a necessary
expense.
Secured or legally If it meets the Taxpayer must
perfected debts necessary expense substantiate that
test. the payments are
being made.
Unsecured Debts If the taxpayer Examples of
substantiates and unsecured debts
justifies the which may be
expense, the necessary
minimum payment expenses include:
may be allowed. Payments
The necessary required for the
expense test of production of
health and welfare income such as
and/or production payments to
of income must be suppliers and
met. Except for payments on lines
payments required of credit needed
for the production for business and
of income, payment of debts
payments on incurred in order
unsecured debts to pay a federal
will not be allowed tax liability.
if the tax liability,
including projected
accruals, can be
paid in full within
90 days.
Taxes It is for current Current taxes are
federal, FICA, allowed
Medicare, state and regardless of
local taxes. whether the
taxpayer made
them in the past
or not. Delinquent
state and local
taxes are
allowable
depending on the
priority of the
FTL and/or
Service
agreement with
the state and local
taxing agencies.
Optional Telephones It must meet the
and Telephone necessary expense
Services (Cell test.
phone, pager, Call
waiting, caller
identification or
long distance)
Student Loans If it is secured by Taxpayer must
the federal substantiate that
government and the payments are
only for the being made.
taxpayer's
education.
Internet If it meets the
Provider/E-mail necessary expense
test - generally for
production of
income.
Repayment of loans If the loan is
made for payment of secured by the
Federal Taxes taxpayer's assets
when those assets
are of reasonable
value and are
necessary to
provide for the
health and welfare
of the family.

(2) Depending upon individual circumstances, other expenses may meet the necessary expense test: health and
welfare and/or production of income.

(3) A taxpayer may be required to substantiate the amounts and justify these expenses as necessary. Unless the
tax liability will be fully paid, including projected accruals, within three years, expenses must be reasonable in
amount.

(4) If other expenses are determined to be necessary and, therefore, allowable, the case history must be
documented providing the reasons for the decision.

Excessive Necessary and Conditional Expenses Incurred after Assessment of Tax Liability

1.370 The Internal Revenue Service takes the position that it will not apply the five year rule to any new
conditional expense or excessive necessary expense which occurs after the assessment of a tax liability. The
Internal Revenue Service employees are instructed that in such instances consideration of enforcement against
the post assessment assets or not allowing the expenses in an installment agreement may be appropriate. The
Internal Revenue Service employee also has the authority, however, to make exceptions to the five year rule.
[IRM 105.1.3.3.2.4] In unusual situations the Service can choose to allow conditional expenses even if the
liability, including projected accruals, cannot be paid within three years. The employee is required to fully
explain the basis for such a decision and all expenses must be fully substantiated in all instances. Such
agreements can only be granted with the approval with the employee's manager. As this new policy is being
applied, very few IRS employees have deemed to exercise the authority granted by the authority to vary from
the three year rule.

Applications of the Standards

1.371 Allowable Expense Standards are applied in three different manners depending on whether the taxpayer
can pay in less than five years, more than five years or propounds an Offer in Compromise. If the taxpayer can
pay in less than three years, he is allowed National Standards, Regional Standards, Local Standards, expenses
necessary for production of income or health and welfare to the taxpayer and Conditional Expenses. If the
taxpayer needs more than three years to pay, she is only allowed one year of Conditional Standards. If the
taxpayer propounds an Offer in Compromise, the Service will not allow conditional expenses in any event.

Harsh Results of IRS Policies

1.372 As a result of the allowable expense standards, some taxpayers will be forced to make heart-wrenching
decisions. For example, the taxpayer paying for a child's private school or university education will be told by
the IRS that they have one year to change this expense because in one year the entire amount paid for tuition
will be considered to be available for payments to the Internal Revenue Service. The taxpayer will then face the
choice of removing his child from a university, for example, to allow payment of his tax debt, or removing his
child from a private school or parochial school in order to pay his tax debt. It should be noted, however, that if at
the end of the first year the taxpayer has not modified or eliminated an excessive necessary or not allowable
conditional expense, an IRS employee can choose to grant additional time in unusual circumstances. Once again,
any variance from the IRS standards must be approved by a Supervisor. Most IRS employees will not vary from
the IRS standards without aggressive advocacy by the representative.

Promote Effective Tax Administration

1.375 If the taxpayer does not qualify for an offer based upon doubt as to the actual underlying
liability or inability to pay the tax a compromise may be entered into to promote effective tax
administration when -

(i) Collection of the full liability will create economic hardship; or

(ii) Regardless of the taxpayer's financial circumstances, exceptional circumstances exist such that
collection of the full liability will be detrimental to voluntary compliance by taxpayers; and

(iii) Compromise of the liability will not undermine compliance by taxpayers with the tax laws.[Temp
Reg 301.7122-1T(b)(4)]

Rules for Evaluating Offers to Promote Effective Tax Administration

1.380 The determination to accept or reject an offer to compromise made on the ground that
acceptance would promote effective tax administration within the meaning of this section will be
based upon consideration of all the facts and circumstances, including the taxpayer's record of
overall compliance with the tax laws.

Economic Hardship

1.390 Factors supporting (but not conclusive of) a determination of economic hardship include :

(1) Taxpayer is incapable of earning a living because of a long term illness, medical condition, or
disability and it is reasonably foreseeable that taxpayer's financial resources will be exhausted
providing for care and support during the course of the condition;

(2) Although taxpayer has certain assets, liquidation of those assets to pay outstanding tax liabilities
would render the taxpayer unable to meet basic living expenses; and

(3) Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those
assets and disposition by seizure or sale of the assets would have sufficient adverse consequences
such that enforced collection is unlikely. Temp Reg 301.7122-1T(b)(4)(iv)(B)]

Example 1. Taxpayer has assets sufficient to satisfy the tax liability. Taxpayer provides full time care
and assistance to her dependent child, who has a serious long-term illness. It is expected that the
taxpayer will need to use the equity in her assets to provide for adequate basic living expenses and
medical care for her child. Taxpayer's overall compliance history does not weigh against compromise.

Example 2. Taxpayer is retired and his only income is from a pension. The taxpayer's only asset is a
retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of
the retirement account would leave the taxpayer without an adequate means to provide for basic
living expenses. Taxpayer's overall compliance history does not weigh against compromise.

Example 3. Taxpayer is disabled and lives on a fixed income that will not, after allowance of
adequate basic living expenses, permit full payment of his liability under an installment agreement.
Taxpayer also owns a modest house that has been specially equipped to accommodate his disability.
Taxpayer's equity in the house is sufficient to permit payment of the liability he owes. However,
because of his disability and limited earning potential, taxpayer is unable to obtain a mortgage or
otherwise borrow against this equity. In addition, because the taxpayer's home has been specially
equipped to accommodate his disability, forced sale of the taxpayer's residence would create severe
adverse consequences for the taxpayer, making such a sale unlikely. Taxpayer's overall compliance
history does not weigh against compromise.

Example 4. Taxpayer is a business that despite the adoption of a wide array of precautions,
including the employment of outside auditors, suffered an embezzlement loss. Although the taxpayer
reviewed and signed employment tax returns and signed checks for payment of all employment tax
liabilities, the embezzling employee successfully intercepted these checks and diverted the funds. At
the time taxpayer discovers the diversions, taxpayer promptly contacts the IRS and begins
proceedings to obtain recovery from the employee and the auditor. Taxpayer is unsuccessful in
obtaining any recovery from either the employee or the auditor. While taxpayer has accounts
receivable that will satisfy the tax delinquencies, taxpayer would be unable to remain in business if
those receivables were seized by the IRS. Further, while taxpayer will continue to generate some
profit if permitted to remain in business, those profits would not be sufficient to pay the accrued
liabilities prior to the time collection of the liabilities became barred by the statute of limitations.
Taxpayer's overall compliance history does not weigh against compromise.

Undermine Compliance

1.400 Factors supporting (but not conclusive of) a determination that compromise would not
undermine compliance by taxpayers with the tax laws include:

(1) Taxpayer does not have a history of noncompliance with the filing and payment requirements of
the Internal Revenue Code;

Taxpayer has not taken deliberate actions to avoid the payment of taxes; and
 Taxpayer has not encouraged others to refuse to comply with the tax laws.[Temp Reg
301.7122-1T(b)(4)(iv)(C)]

Exceptional Circumstances

1.410 The following examples illustrate cases where exceptional circumstances exist such that
collection of the full liability will be detrimental to voluntary compliance by taxpayers; and
compromise of the liability would not undermine compliance by taxpayers with the tax laws:

Example 1. In October of 1986, taxpayer developed a serious illness that resulted in almost
continuous hospitalizations for a number of years. The taxpayer's medical condition was such that
during this period the taxpayer was unable to manage any of his financial affairs. The taxpayer has
not filed tax returns since that time. The taxpayer's health has now improved and he has promptly
begun to attend to his tax affairs. He discovers that the IRS prepared a substitute for return for the
1986 tax year on the basis of information returns it had received and had assessed a tax deficiency.
When the taxpayer discovered the liability, with penalties and interest, the tax bill is more than three
times the original tax liability. Taxpayer's overall compliance history does not weigh against
compromise.

Example 2. Taxpayer is a salaried sales manager at a department store who has been able to place
$2,000 in a tax-deductible IRA account for each of the last two years. Taxpayer learns that he can
earn a higher rate of interest on his IRA savings by moving those savings from a money management
account to a certificate of deposit at a different financial institution. Prior to transferring his savings,
taxpayer submits an E-Mail inquiry to the IRS at its Web Page, requesting information about the
steps he must take to preserve the tax benefits he has enjoyed and to avoid penalties. The IRS
responds in an answering E-Mail that the taxpayer may withdraw his IRA savings from his
neighborhood bank, but he must redeposit those savings in a new IRA account within 90 days.
Taxpayer withdraws the funds and redeposits them in a new IRA account 63 days later. Upon audit,
taxpayer learns that he has been misinformed about the required rollover period and that he is liable
for additional taxes, penalties and additions to tax for not having redeposited the amount within 60
days. Had it not been for the erroneous advice that is reflected in the taxpayer's retained copy of the
IRS E-Mail response to his inquiry, taxpayer would have redeposited the amount within the required
60-day period. Taxpayer's overall compliance history does not weigh against compromise.

PROBLEM 1

Harry Didit and Mita Didit were assessed with a Trust Fund Recovery Penalty in 1999 in the amount of
$112,000. They were the principal officers of a software company and they have no defenses to liability. He is
currently employed by Microhard, Inc. as a software specialist. She is employed as a day clerk at a Convenient
Store. Harry and Mita reside in Park Ridge, Illinois which is in Cook County. They have two children, Sally
Didit, age 14 and John Didit, age 11.

Harry and Mita have the following assets:

Assets F.M.V.

Home (Joint Tenancy) $250,000

1997 Buick 7,500

2000 Chevrolet 12,000

Household Goods 4,000

IRA 3,000

Pension at Microhard 15,000

They have the following liabilities:

Nature of Liability Amount

Home Mortgage $175,000

Loan on Buick 4,000

Loan on Chevrolet 14,000

Charge Cards 16,000

Judgment Debt from Guarantee

(Empire Business) 3,000

Loan from brother (Baldizar Didit) 7,000

State Trust Fund Penalty 10,000

The Internal Revenue Service has filed a lien with the Cook County Recorder of Deeds. The Didit's did not
respond to the CDP notice issued within 5 days of filing the lien and the 30 day protest period expired before the
arrived at you office. The IRS has not yet issued a Letter 1058.

Their income is as follows:

Harry's Pay: Gross: $ 6,000 per month

Net: 4,300 per month

Mita's Pay: Gross: $ 1,400 per month

Net: 950 per month

They tell you that they have the following monthly expenses:

Mortgage and Real Estate Taxes $ 1,750

Home Repairs and Maintenance 200

Car Payments 700

Repairs, Maintenance and Car Insurance 375

Utilities 400

Medical Expenses 100

Day Care 500

Clothing and Cleaning 400

Personal Hygiene 150

Health Club Dues 100

Payment on State Trust Fund Penalty 150

Children's Parochial School 550

Children's Recreational Activities 100

Family Entertainment and Recreation 200

Magazines, Periodicals and Newspapers 50

Cable TV 35

Charge Card Payments 200

Miscellaneous Expenses 400

The Didits have recently received a phone call from Will Levy of the IRS demanding that they submit a 433-A
and begin payments on the Trust Fund Recovery Penalty. The Didits have asked that you represent them before
the Internal Revenue Service.

Questions

What is the most important issue to be resolved before you call Mr. Levy?
Complete page 4 of the new Form 433-A for the Didits.
Which of the expenses of the Didits would the IRS consider to be allowable expenses?
Which of the expenses of the Didits would the IRS consider to be conditional expenses?
Will the Didits be able to repay the Internal Revenue Service within five years? If not, what payments will
the Internal Revenue Service demand from the Didits during the first year of the payment arrangement and
what payments will the Didits be required to pay thereafter?
What alternatives to an installment agreement would you suggest?

Problem 2

Haddy Breakdown is 55 years old and has suffered from manic depression from 1971. If she maintains her
medicine regimen she ids able to independently function. When she fails to take her medications she falls into
severe depression. She is divorced with no children.

During 2000 Haddy's sister, Karen came to visit her at her home in Chicago. Karen discovered that Haddy had
failed to take her medications and her home was in a state of squalor. Karen hospitalized Haddy and after a
month through treatment and medications she recovered sufficiently to be discharged. During Haddy's Haddy's
hospitalization Karen hored a cleaning service to clean Haddy's home it took 2 large trucks to remove the
garbage and filth that had accumulated during her illness.

While the home was being cleaned Karen discovered Haddy's unfiled tax returns for 1997, 1998, & 1999. Upon
Haddy's recovery Karen insisted that Haddy sign and file the returns. Haddy complied with Karen's entreaty and
filed all of her returns including the 2000 return in the spring of 2001. She has now received CP-503's totaling
$55,000. She has been brought to you by Karen who will pay your fees.

During the years when she was not filing Haddy was employed in a series of low paying jobs and never had pay
exceeding $10 per hour. She had withholding taken from her pay checks. Haddy is the beneficiary of a
spendthrift trust set up by her dad's will which pays her $27,000 per year in monthly installments. During the
time from 1997 to her hospitalization she had not paid estimated taxes on her trust income. She is now timely
paying estimated taxes.

Her current in is as follows:

Joe's 6/12 Convenience Store $1,500/Month Net after w/h $1,200

Trust income $2250/month

She has the following assets & liabilities:

House $100,000 Mortgage $15,000

Savings &checking $1,000

1989 Chevrolet $1,500

Household goods & personal assets $3,000

Charge cards $1,000

Her monthly expenses are as follows:

Mortgage, taxes and home repair $500

Utilities $300

Car expenses $350

Food & personal expenses $800

Unreimbursed medical expenses $1,100

Misc. expenses $300

Estimated taxes $500

Charge card payments $75

Questions

1. Prepare page 4 of 433A.

2. What options are are available for Haddy to resolve her tax problems?

3. How much would her payments be in the first year of a payment plan?

4. What would be your first step after receipt of your retainer?

5. If you chose to submit an OIC on her behalf, what would the basis of your offer and how much would you
offer?

TABLE OF CONTENTS

OFFER IN COMPROMISE

1.110 Background 1

1.120 New Offer in Compromise Procedures 1

1.130 More Supporting Documents 1

1.140 New Addresses 1

1.150 Return of an Offer 2

1.160 Processing Center Review 3

1.170 Offers Increasing 3

1.180 Unnavigable Roadblocks 3

1.190 Horror Stories 3

1.200 Compliance Centers Hinder Substantive Consideration of Offers 3

1.210 Creates Many Barriers to Compromise 4

1.220 A Better Way to Process Offers 4

1.230 1998 Revisions 5

1.240 Prohibition of Levy 5

1.250 Rejections 5

1.260 More Liberal Policies 5

1.270 Minimum Offer Standards 6

1.280 Appeal Rights 6

1.290 Joint Offer - Default by One Spouse 6

1.300 Doubt as to Liability Offers 6

1.305 Accepted Offers 7

1.320 Deferred Offer 7

1.330 Computation of Offer Amount 7

1.340 Cash Offer 7

1.350 Short-Term Deferred Payment Offer 8

1.360 Deferred Payment Offers 8

1.361 Allowable Expense 8

1.362 Necessary Expenses 9

1.363 Conditional Expenses 9

1.364 Expenses Which Will Not Require Substantiation 10

1.365 Housing Expense 10

1.366 Transportation 11

1.367 Necessary Expenses (Other) 11

1.368 Necessary Expenses: Other Unsecured Debts 12

1.369 Necessary for Production of Income 13

1.370 Excessive Necessary and Conditional Expenses Incurred After

Assessment of Tax Liability 13

1.371 Applications of the Standards 13

1.372 Harsh Results of IRS Policies 13

1.375 Promote Effective Tax Administration 14

1.380 Rules for Evaluating Offers to Promote Effective Tax Administration 14

1.390 Economic Hardship 14

1.400 Undermine Compliance 16

1.410 Exceptional Circumstances 16

Problem 1 18

Problem 2 21

Exhibits 23-55
 PORTIONS REPRINTED WITH PERMISSION OF WEST GROUP, INC.®

FROM

BY

ROBERT E. MCKENZIE

ARNSTEIN & LEHR

120 SOUTH RIVERSIDE PLAZA

CHICAGO, IL 60606

312-876-7100

FAX: 312-876-0288

REMCKENZIE@ARNSTEIN.COM

http://www.mckenzielaw.com

©2002 but updated 2007

1. 2005 IRS Data Book

07/15/2009