The courts reviewed the position that taxpayers who are in bankruptcy and cannot afford to pay their tax bill can use the offer-in-compromise procedure to reduce the amount of the bill. Charles Peterson, who owed $102,000 in payroll taxes, filed for chapter 13 bankruptcy protection. He then filed an offer in compromise, which the IRS refused to consider. When the bankruptcy court ordered it to consider the offer, the IRS appealed.
Result. For the taxpayer. Section 7122 provides that the Treasury “may compromise any civil or criminal case arising under the internal revenue laws.” The grounds for compromising (that is, reducing) taxes are doubt as to liability, doubt as to collectibility and promoting effective tax administration. Although the regulations do not mention bankruptcy filing, the Internal Revenue Manual does not allow the IRS to consider any offer in compromise from a taxpayer who has filed for bankruptcy protection because of the potential legal and administrative problems. However, there is precedent for such consideration.
In the Matter of William K. Holmes, 298 BR 477 (2003), the bankruptcy court required the government to consider an offer in compromise for two reasons: The Internal Revenue Manual is not binding, and it conflicts with congressional intent in allowing offers in compromise and the rules of bankruptcy. In Holmes, the taxpayer filed for bankruptcy under chapter 11; Peterson filed under chapter 13. Ignoring this difference, the bankruptcy court in Peterson reaffirmed its order that the IRS consider the taxpayer’s offer, stressing that revenue procedures (including those in the manual) were not mandatory. In addition since prior courts had required the IRS to consider offers in compromise from taxpayers in bankruptcy, the IRS had to consider the offer in this case.
Taxpayers who have an outstanding tax liability and are filing for bankruptcy protection under chapter 11 or 13 should consider an offer in compromise under section 7122.
In the Matter of Charles Peterson, 2004 Bankr LEXIS 1765.
Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.