One-Year Rule Confusion

I read with great interest the article “Easier Offers in Compromise” (JofA, Dec.97). The article says that the IRS made a major improvementwhen it established a one-year rule for changes in a taxpayer’s life-style after it accepts an offer. Previously, the IRS expected taxpayers to change their life-styles immediately to live within the confines of what it allowed as necessary living expenses. This was not always practical or even possible.

This appeared to be a very welcome improvement in the OIC program as it would reduce the present value of future income computation. The present value of future income is the capitalization of available cash (excess of income over expenses as computed on section V of form 433-A) over a five-year period. This amount is then discounted to its present value. This present value figure can escalate dramatically as income over expense amounts increase and, based on my experience, is by far the most common reason for offer rejection.

This all sounds great. However, according to the interpretation of the district counsel of the IRS North-South Carolina District, the one-year rule, per Internal Revenue Manual 5323.5, applies only to installment agreements, not to offers in compromise. Could you have the authors clarify this issue?

Louis C. Arthur, Enrolled Agent
Retired IRS OIC Specialist
Cary, North Carolina

Authors’ Reply: In our article, we incorrectly stated that a one-year rule for modifying life-styles to eliminate unnecessary expenses applies to offers in compromise.

At the time we wrote the article, there was significant confusion both within and outside the IRS as to how the new OIC rules would be interpreted. This confusion was compounded by the wording in Internal Revenue Manual 5323, which does not specify that the one-year rule applies only to installment agreements.

IRM 5323.12(3) provides a blanket definition of the one-year rule as applying to those taxpayers whose tax liability cannot be fully paid within three years but does not say specifically whether it applies to installment agreements or OICs. However, IRM 5323.5(1) says, Taxpayers who cannot fully pay their accounts within three years may be given up to one year to modify [their life-style] expenses, and IRM 5323.5(2) provides guidelines for the use of the one-year rule in conjunction with installment agreements.

In the manual on whether the one-year rule can be used with OICs, the IRS interprets the IRM’s omission as restricting the one-year rule to installment agreements only. It could have interpreted the definition in IRM 5323.12(3) as applying to OICs as well, because taxpayers who submit such offers cannot fully pay their tax liabilities within three years either.

The IRS justifies its interpretation by stating that OICs normally take about six months to process, and this should give taxpayers time to adjust their life-style expenses downward. However, this would force taxpayers to make often significant life-style changes before an OIC is acceptedwhich many are not likely to do.

The IRS may be defeating its own collection efforts by its unduly restrictive interpretation. Perhaps the IRS needs to rethink its interpretation.

The IRS, recognizing that there still are many problems within the OIC program, created a task force in January 1998 to develop policies for dealing with OIC problems that have become apparent since the 1995 revisions were made.

Some of the task force’s recommended changes went into effect October 1others are still in the pipeline. Significant changes may be forthcoming.

Terri Gutierrez, CPA, PhD
Associate Professor
University of Northern Colorado
Greeley, Colorado

Myron Hulen, PhD
Associate Professor
Colorado State University
Fort Collins, Colorado