Refund delayed? Our ability to help may be limited.
The IRS has the discretion to accept an offer in compromise (OIC) or to release refunds it would otherwise apply against taxpayers’ tax debts through an offset bypass refund (OBR). To help taxpayers experiencing hardships TAS collaborated with the IRS to remove barriers for taxpayers considering the OIC program. Effective November 1, 2021, IRS changed its policy allowing taxpayers to keep their tax refunds once the IRS accepts their OICs and enables certain taxpayers to seek OBRs while their OICs are pending the IRS’s consideration.
An OIC allows taxpayers to settle their tax debt for less than the full amount owed. An OIC based on doubt as to collectability, one of the three types of OICs, enables taxpayers who are unable to fully pay their liabilities to pay a lesser amount, after the IRS conducts a financial analysis, (ability to pay; income; expenses; and asset equity) and determines if the taxpayer has offered the reasonable collection potential. Being in a financially precarious position a reduced tax liability with finality is a welcome relief and for many it is the ability to start over.
TAS and the IRS collaborated on two significant changes to the OIC refund offset policy. First, for offers accepted on or after November 1, 2021, the offer in compromise refund recoupment process, explained below, will no longer be applicable for tax periods included on the Form 656. And second, while refunds may still be offset during the time an OIC is pending, the IRS agrees that taxpayers may seek an OBR during this period, where warranted, by contacting the IRS at 800-829-1040.
Taxpayers submit an executed Form 656, Offer in Compromise, for the IRS to consider their OIC. Once acceptance by the IRS, it becomes a legal agreement binding the taxpayer and the government to a settlement for an amount less than what is legally owed. A TC 780 is placed on the taxpayer’s account on the IRS records to show the date the offer was accepted. Currently, page 5, section 7(e) contains the following recoupment provision:
The IRS will keep any refund, including interest, that I might be due for tax periods extending through the calendar year in which the IRS accepts my offer. I cannot designate that the refund be applied to estimated tax payments for the following year or the accepted offer amount. If I receive a refund after I submit this offer for any tax period extending through the calendar year in which the IRS accepts my offer, I will return the refund within 30 days of notification. (emphasis added)
However, effective November 1, 2021, the IRS will no longer offset, or recoup refunds for the calendar year in which the OIC was accepted. It will no longer apply that refund to the outstanding tax liability for the year(s) included in the OIC agreement, Form 656. For example, assume the IRS accepts a taxpayer’s OIC to settle liabilities for tax years (TYs) 2017 and 2018 on December 15, 2021. Under the new guidance, the IRS will no longer offset the refund shown on the taxpayer’s TY 2021 return and apply as a payment to the TYs 2017 and 2018 liabilities subject to the OIC agreement. For many taxpayers, this one change could be the difference of even applying for an OIC.
For taxpayers facing an economic hardship, the anticipation of a refund may be the safety pin holding together a family’s ability to meet basic living expenses, especially for taxpayers relying on the Earned Income Tax Credit (EITC) or the Additional Child Tax Credit (ACTC) that Congress intended for subsistence of low-income taxpayers. For those facing an unanticipated detrimental change in their financial situation or whose lives spiraled due to COVID-19, natural disaster, or other reasons, losing a tax refund may fuel financial chaos and leave the taxpayer unable to meet basic living expenses. An accepted OIC may lead to financial security. TAS Research shows that of OIC submitters in fiscal year (FY) 2019, close to 13 percent had claimed EITC the previous year, and approximately 40 percent had the low-income indicator (LII) on their account. In FY 2020, close to 11 percent had claimed EITC the previous year, and approximately 40 percent had the LII on their account. Taxpayers who are ineligible for EITC may nonetheless receive a refund of their excess wage withholding. Approximately 48 percent of TY 2019’s OICs showed only W-2 income, and almost 44 percent of TY 2020’s OICs showed only W-2 income.
Until the Form 656 is updated removing the recoupment provision for the year of offer acceptance and modifies it to reflect that offset will continue under IRC § 6402(a) prior to offer acceptance, the IRS will provide the taxpayer a notice of this modification to the offer terms.
As part of its update to Form 656, it is anticipated that the IRS will require taxpayers to agree that they will not file an amended return for tax years included on the Form 656 and return any refunds they receive if an amended return is filed for tax years before OIC acceptance. In addition, any refunds related to an amended return filed for a tax year which has an ending date prior to offer acceptance will be offset to the tax liability. If taxpayers receive a refund prior to offer acceptance or based on an amended return for any tax periods extending to the date my offer is accepted, taxpayers will return the refund within 30 days of receiving the refund.
To prevent potential gaming of this favorable change, the IRS’s Interim Guidance on Refund Recoupments has an exception to its revised offset procedures. If a taxpayer and the IRS execute the OIC based upon information known at the time of the settlement and the taxpayer subsequently files an amended return requesting a refund for a year not covered by Form 656, the IRS may nevertheless offset that refund. I believe the logic is the IRS was not aware of the refund or that asset at the time it negotiated the settlement, and that asset should have been considered, and as such will be applied toward the taxpayer’s liability. The guidance provides the following example:
“An offer in compromise is accepted November 15, 2021 for tax periods 2017 and 2018. The taxpayer timely filed a return for tax year 2020 with a balance due of $500 that was full paid with the return. The return was assessed (TC 150) on October 15, 2021. On January 15, 2022, the taxpayer files an amended 2020 tax return showing a refund of $10,000. In this instance, since the refund is attributable to an amended return for a tax year not included on the Form 656, the refund offset may still take place.”
The IRS may offset a taxpayer’s refund and apply it to a federal tax liability, per IRC § 6402. While this authority is discretionary, the IRS must offset refunds when the taxpayer owes any other federal debt or state tax liability. However, the IRS can forego the offset and issue the refund if the taxpayer only has a federal tax liability and is experiencing economic hardship, which is why the IRS refers to the refund as an OBR (for offset bypass refund). An OBR generally is possible only before the IRS applies the current refund to a prior liability tax and is based upon establishing hardship (for example, if the individual needs to pay a utility bill to avoid disconnection). Once the amount of the hardship is established the IRS will only bypass enough of the offset to alleviate the hardship amount. For example, if a taxpayer has a refund of $4,000 and outstanding tax liabilities in excess of the $4,000, under normal procedures the IRS will apply the total refund towards the prior liability leaving the individual without any available refund to be issued. The OBR procedures are an exception to that refund offset and provides immediate relief to those taxpayers experiencing a financial hardship. If the taxpayer established a hardship of $1,000. The IRS will issue a $1,000 payment to the taxpayer and offset the balance, $3,000, and apply to prior liabilities. The OBR procedure is not a well-known option and there is a very limited time in which the taxpayers can request the OBR and establish their hardship amount.
For taxpayers who had submitted an OIC, the OBR remedy was unavailable to them, as was the ability to retain refunds shown on their tax returns for the calendar year the IRS accepted the OIC. Under the new procedures the IRS is allowing qualifying taxpayers experiencing financial hardship to seek OBRs while their OICs are pending the IRS’s consideration. These individuals would be able to retain their tax refunds as long as they meet the criteria in the Internal Revenue Manual.
Time is of the essence when requesting an OBR as the request must be received by the IRS prior to the posting date of the offset. Taxpayers should contact the IRS immediately upon the filing of their return if they want to explore whether they are eligible for an OBR and provide supporting documents showing the hardship. Once an offset occurs, it generally cannot be “undone” requiring immediate action by the IRS.
Presently, the IRS has no form to request an OBR. And a search of the IRS’s website will not find any direct references to either “OBR” or “Offset Bypass.” And while the Internal Revenue Manual (IRM) provides guidance to employees on processing OBRs, most taxpayers are unlikely to stumble across the benefits or requirements of the OBR program. The IRM directs taxpayers to the IRS, which taxpayers may reach by calling 800-829-1040. Assistance may also be available from TAS.
My hope is these change in policy will encourage more taxpayers to seek OICs, which can improve their financial health and tax compliance going forward by putting their past liabilities behind them and I applaud the IRS for its recent policy change assisting taxpayers facing financial difficulties. We continue to encourage the IRS to provide educational material on IRS.gov explaining the benefits of OBRs, the economic hardship requirements, and what taxpayers need to do to timely request an OBR. With the upcoming filing season, we encourage the IRS to get the OBR message out by leveraging its relationships with the public through the Stakeholder Partnerships, Education, and Communication organization. Additionally, the IRS should include details of the OBR program on its webpage including the time urgency of the request and the information necessary to demonstrate the financial hardship in its training materials for the volunteers who prepare tax returns through the Volunteer Income Tax Assistance and Tax Counseling for the Elderly programs. These volunteers could educate taxpayers and share information on the OBR program during return preparation or submission.
The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.