Terms in OIC agreement take meaning from Code, court holds

The Second Circuit Court of Appeals held on Wednesday that the terms “refund” and “overpayment” in an offer-in-compromise (OIC) agreement are specialized tax terms that take their meaning from the Internal Revenue Code and are not given their “plain English” meanings, despite the colloquial tone of the agreement (Sarmiento, No. 11-3752 (L) (2d Cir. 5/2/12), aff’g in part and rev’g in part 812 F. Supp. 2d 137 (E.D.N.Y 2011)).

In 2007, the plaintiffs, a married couple, entered into an OIC agreement with the IRS under which they would pay $2,000 to compromise their approximately $30,000 in outstanding tax liabilities. The agreement also contained a provision that, as additional consideration, the IRS would “retain any refunds or credits that you may be entitled to receive for 2007 or for earlier tax years” and any “refunds you receive in 2008 for any overpayments you made toward tax year 2007 or toward earlier years.”

On their 2007 joint tax return filed in 2008, the couple claimed a Sec. 32 earned income tax credit (EITC) of $2,831 and a Sec. 24(d) additional child tax credit (ACTC) of $864. They also claimed a $900 refund under the Economic Stimulus Act of 2008, P.L. 110-185.

The IRS withheld payment of the taxpayers’ refund under the additional consideration terms of the OIC agreement. The couple filed an administrative claim with the IRS, which was denied, and then filed suit in federal district court, which dismissed the complaint in part.

On appeal, the taxpayers argued that neither the refundable tax credits nor the Economic Stimulus Act payment were “refunds” for “overpayment” of tax within the plain-English meaning of those terms. Taxpayers who are eligible for refunds based on the EITC or ACTC do not actually “overpay” their income taxes; instead, these credits create a legal fiction that the recipients have overpaid, thereby entitling them to “refunds.”

However, the Code specifically states that amounts of refundable credits in excess of the taxpayer’s liability “shall be considered an overpayment” and the taxpayer is eligible for a “refund” (Sec. 6041(b)(1)).

The couple argued that because the OIC agreement was drafted in colloquial English, its terms should be afforded their “plain English” meaning, rather than their meaning under the Code.

The court held that “[a]ny reasonable contracting party would understand” that Form 656, Offer in Compromise, which the taxpayers used to make their offer, is “a specialized tax document whose terms and conditions take their meaning from the Internal Revenue Code” (slip op. at 10). The court decided that a reasonable taxpayer understands, from the language used in the form, that “when she enters into a contract with the IRS to compromise her outstanding tax liabilities . . . she does so against the backdrop of the definitions given to those terms in the Code” (slip op. at 11).

The court also said that “[a]dopting a ‘plain English’ interpretation of the OIC agreements . . . would have the undesirable effect of injecting unnecessary uncertainty into the judicial and administrative interpretation of IRS standard forms” (slip op. at 12).

The court held that the 2007 refund, from both the refundable credits and the Economic Stimulus Act payment, constituted refunds due because of overpayment under the terms of the OIC agreement and that the IRS correctly withheld those refunds under the terms of the agreement.

—Alistair M. Nevius (anevius@aicpa.org) is the JofA’s editor-in-chief, tax.