Tax Payoff Plan Leads to More Bankruptcies
The IRS’ much-touted plan for settling tax debts--a key result of congressional investigations of taxpayer abuses three years ago--is so overwhelmed with applications that the agency is unable to cope.
The “offer in compromise” process sometimes takes so long that some tax preparers are advising their clients to file for bankruptcy rather than to attempt to pay any of their tax debt--exactly the result Congress was trying to avoid when it ordered the Internal Revenue Service to reform the program.
“The offer process is broken,” Dale Hart, an IRS deputy commissioner, told a group of tax practitioners in Los Angeles last week, adding that the service has been overwhelmed trying to deal with more than 100,000 compromise requests.
At the direction of Congress, the IRS loosened its criteria last year for accepting offers in compromise, which are formal pleas from cash-strapped taxpayers to pay less than they owe--typically 12 cents to 13 cents on the dollar.
The idea was for the IRS to settle up and allow taxpayers who had been hounded for years by collection agents to start over with a clean slate. The taxpayers could regain their financial stability, and the IRS could stop worrying about uncollectable taxes.
But the agency failed to add staff to meet the surge in demand, and IRS officials say most offers aren’t being handled within the agency’s target time frame of six months. Only 40% of offers nationwide are processed that fast, and the rate is probably even lower in Southern California, where the process is particularly popular, IRS spokeswoman Michelle Lamishau said.
Attrition and a tight budget have prevented the IRS from hiring more agents to handle the deluge, she said. The agency got more money from Congress for the new fiscal year, but has no specific plans to boost staffing for the program, Lamishau said.
IRS procedures for handling offers in compromise worked fine when only a few cases were considered each year, said Hart, who made her remarks to the UCLA Extension Tax Controversy Institute. But the procedures “don’t work when you have a whole lot of [cases]. This huge inventory mushroomed out of nowhere.”
For years, the IRS rejected far more applications for offers in compromise than it accepted. The agency typically OKd requests only if it was unlikely that the full amount could ever be collected.
But after a series of highly publicized hearings in 1997 and 1998 that detailed a raft of IRS abuses, Congress decided the agency should be more flexible in dealing with taxpayers who were sincerely trying to pay their tax debts.
In the 1998 hearings, the Senate Finance Committee heard testimony that IRS collection agents browbeat some taxpayers for years in cases in which the families had no hope of ever paying off their tax bills.
Lawmakers hoped that a more lenient compromise process would prevent some taxpayers from seeking protection in bankruptcy, in which some tax debts can be erased. Congress also hoped that leniency would result in the government collecting more money. The IRS estimates it was owed $34 billion in back taxes, penalties and interest in 1998, the last year for which figures are available.
The resulting IRS Restructuring and Reform Act of 1998 was designed to make it easier for taxpayers to qualify for relief. The act required the agency to consider the taxpayer’s financial situation and ability to pay, as well as the odds of collecting the entire bill.
The new law found a ready audience among beleaguered taxpayers. More than 109,000 requests for relief were received nationwide in the fiscal year that ended Sept. 30, up 13% from the year before. IRS officials say the actual increase in taxpayers applying was probably even greater, because in past years many taxpayers applied repeatedly after getting their forms returned to them because of minor errors.
For example, Ernest Howard, head of the California Society of Certified Public Accountants’ Beverly Hills chapter, said he once had a signed offer rejected because the signature was in black ink and the IRS claimed the form was a photocopy rather than an original.
As part of the agency’s reform program, IRS agents are now required to call taxpayers or their preparers or request written information to try to complete the process.
Since the new procedures went into effect, the number of requests actually being considered by the IRS has risen 58%. There has also been a rise in the percentage of offers that are accepted--about 30% of the applications received this year, compared with 22% in 1997. About one in five offers is rejected as an inadequate settlement--about the same as four years ago.
However, the amount of money being collected is up only slightly. The IRS accepted offers to repay $316 million of tax debt this year, up 7% from 1997.
The number of offers that are withdrawn before the agency can act on them is up to 11%, from 6% four years ago. Taxpayers often withdraw their offers when they’ve decided to file for bankruptcy instead.
Some tax preparers refer their clients to bankruptcy attorneys rather than have them spend time and money pursuing a settlement with the IRS, Howard said. Some clients, already stressed by debt and financial problems, simply don’t have the emotional resources to wait, he said.
“That’s a sad thing,” Howard said. “It’s not good public policy to force people into bankruptcy because of their taxes.”
Some tax preparers suspect their peers are to blame for at least part of the overload. So-called offer mills have sprung up that promise to help people negotiate better deals, regardless of whether the taxpayers actually qualify for the program, said John Knight, a former IRS revenue officer now in private practice in Woodland Hills.
“These offer mills just crank ‘em out,” Knight said. “It plugs up the system.”
Other experts say the IRS still hasn’t liberalized its procedures enough to comply with Congress’ original intention.
Bruce Strauss, a former IRS division chief who criticized the agency during the Senate finance hearings, said the process of submitting and reviewing offers in compromise is still far too time-consuming.
“It’s the typical mind-set of the IRS to beat everything to death,” said Strauss, who after 31 years with the agency is now an enrolled agent in Jacksonville, Fla.
“The objective should be to get people back into the tax system and paying taxes.”
Not all tax preparers are irritated by the delays. Robert Leonard, an Encino CPA and tax attorney who submits 50 to 75 offers in compromise each year, said the extra time can be helpful. The IRS’ collection efforts stop while an offer is being considered, giving taxpayers breathing room and allowing them to decide what to do next, Leonard said.
“The backlog gives us time to prepare the client, to help them adjust to lifestyle changes and to prepare for bankruptcy, if necessary,” Leonard said.
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Settling Tax Debts
The IRS changed its rules for settling tax debts in May 1999, leading to a surge in applications for “offers in compromise.” Figures shown are for fiscal years ended Sept. 30.
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1997 1998 1999 2000 Offers considered* 52,054 55,768 74,220 82,047 Offers accepted 25,330 25,052 30,542 33,114 Amount pledged $295 $290 $312 $316 in accepted offers (in millions) Average size 15% 15% 13% 12% of settlement (as % of tax bill)
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*Figure derived by subtracting the number of offers rejected for technical reasons from the total number of offers received.
Source: Internal Revenue Service; Times research
