Episode 309: Offers in Compromise: Options, Benefits and the Process

Offers in Compromise: Options, Benefits and the Process

Offers in Compromise: Options, Benefits and the Process

Taxpayers unable to satisfy an outstanding tax debt may reduce their tax liabilities through an offer in compromise (OIC). OICs are offered through the IRS and are similar to other debt settlement programs. The taxpayer, assuming they qualify, may settle their tax liability for a fraction of what they owe. Offers in compromise may also be used to dispute an outstanding tax debt and, if successful, discharge the liability completely. A reputable Houston tax attorney can help.

Offers in compromise are not automatically accepted by the IRS. Far from it, in fact. The majority of OIC applications are rejected by the agency, so it’s critically important for applicants to provide accurate, detailed information to the IRS to support an OIC case.

Why Should Taxpayers Consider Making an Offer in Compromise?

Although the IRS rejects most OIC applications, it’s still worth pursuing for taxpayers who cannot afford their tax bill or are facing financial hardship. Here is why:

  • An OIC can reduce tax burdens – Clearly, the main reason why taxpayers apply for an OIC is because they cannot afford their outstanding taxes. If the taxpayer’s circumstances are such that the IRS doesn’t believe it can recoup the full tax bill, an offer in compromise provides taxpayers a relatively quick way to resolve their debts. For some, the reduction can be massive, but again, most OIC applications are rejected. This high rejection rate is a good reason to partner with a tax professional beforehand.

  • An OIC gives taxpayers additional payment options – When submitting an OIC, taxpayers may elect to pay their offer in a lump sum arrangement or with a monthly installment agreement. Lump sums must be paid within five months (paid monthly) while monthly plans are paid out over 24 months. If paying in a lump sum, monthly payments will be considerably higher (the IRS applies a multiplier to lump sum monthly payments), so for applicants, it’s a matter of paying more over a short period of time, or less over a longer stretch. The optimal decision will vary with the situation.

  • An OIC allows taxpayers to move on with their life – It’s not exactly pleasant embarking on an IRS payment plan, but it does resolve any tax-related anxieties. It also allows taxpayers to make major life decisions without worrying about the tax implications. Marriage, for example, may be put off to avoid exposing the future spouse to tax liability. By working with the IRS on an OIC, taxpayers can focus on important areas of their life without worry.

Three Options for Filing an Offer in Compromise

An OIC may be submitted for one of three reasons, and all three require completion of some version of Form 656. The options include:

  • Inability to pay outstanding tax liabilities – The most common reason for filing an OIC is because the applicant does not have the income or assets to resolve their tax bill. The taxpayer agrees that they owe the tax but asserts that they do not have the ability to pay.

    The IRS will accept this reason if it doubts that it can recoup the full amount. However, this is not completely subjective. The IRS will review the applicant’s financial information to verify that, indeed, the applicant is highly unlikely to resolve their account in full. This is confirmed through supplemental worksheets (either Form 433-A or Form 433-B) used to calculate payments, along with supporting documentation.

  • Doubt as to whether a tax liability is valid – An OIC may also be filed if the taxpayer believes they do not owe the tax, or that the tax is not theirs to pay. To submit an offer in compromise for this reason, the applicant must complete Form 656-L. Form 433-A or 433-B are not required with 656-L, but supporting tax documentation (tax returns, typically) and a written statement describing why the tax shouldn’t apply must be included.

  • Undue hardship making collection unacceptably difficult – In rare cases, taxpayers may claim special hardship in their OIC application. This hardship should be such that it is not in the interest of the IRS to pursue collection. For example, if the taxpayer has been diagnosed with a terminal illness and is using assets to pay for medical care, it may be prohibitively difficult to recoup outstanding taxes. This option is only available in a vanishingly small number of circumstances, and commonplace financial hardship does not qualify.

Along with Form 656 and supplemental forms, the applicant must send a $205 application fee along with their application. This fee may be waived for low-income taxpayers. Also, the first OIC payment must be sent as well if the OIC isn’t disputing a tax liability. This initial payment must be calculated relative to what the taxpayer owes and whether they plan on paying a lump sum or in monthly installments.

What to Expect While Filing for an Offer in Compromise

There’s a good deal of information gathering and waiting when putting together an OIC application. If you’re considering an offer in compromise, here’s how the process usually unfolds:

  • Ensuring all qualifications are met – Before an OIC application can be submitted, the applicant must meet several criteria. To qualify, the applicant must be current on their tax returns (no outstanding returns). They must also have received a tax bill from the IRS, must have made all estimated tax payments for the current tax year, and must not be involved in bankruptcy proceedings. If any of the above are not true, the OIC will be rejected without review and the application fee (and initial payment) will not be returned.

  • Gathering all financial information – For most applicants, a wealth of information will need to be provided with the offer in compromise application. This should include information about income, assets, investments, expenses and debts. Additional information about your household income and expenses – utilities, food, rent, insurance – must also be provided. The IRS will use this information to determine the applicant’s share of household expenses and their disposable income.

  • Completing the relevant forms – Form 656 or 656-L are OIC application forms and are required to begin the process. If the outstanding tax liability is acknowledged by the applicant, they must also submit either Form 433-A (for individuals) or Form 433-B (for businesses) for payment calculation purposes. If the outstanding liability concerns the taxpayer’s individual return and a business return (for a business they own), both forms must be provided, along with separate application fees and initial payments.

  • Submitting the application and waiting for a response – The IRS is not known for speed, and that’s the case with offers in compromise applications, too. It typically takes several months before the IRS will make its decision. During this time, the taxpayer must continue submitting monthly tax payments to the IRS.

  • (Potentially) appealing if the application is rejected – If the OIC is rejected, applicants have 30 days from the date specified on the rejection letter to file an appeal. This is done through Form 13711, or the taxpayer may mail a letter to the agency explaining their situation in greater detail.

If the OIC is accepted, you’ll need to continue making payments under the agreement set forth in the compromise. Depending on your choice of payment structure, this means satisfying the reduced payment amount within five months (lump sum option) or in monthly installments within 24 months.

How a Houston Tax Law Expert Can Help with Offers in Compromise

Working with the IRS over an existing tax debt is understandably intimidating for most people. If the process isn’t managed properly, applicants may be disqualified from the program before they are considered, and they will lose their initial payment in the process.

The stakes are high, and confusion is common with offers in compromise, but a tax lawyer can make sense of it for their clients. A Houston tax attorney, for example, can provide expert guidance regarding how to maximize approval chances, what information to provide (and how to attain it), and proper form completion. If the liability is to be disputed, a tax lawyer can also help their client gather evidence to that fact and represent it effectively to the IRS.

If approved, offers in compromise can provide major tax relief to people. Attaining approval, though, can be a challenge. A Houston tax attorney can help their clients take on this challenge and maximize their chances of securing an OIC.

Episode 308: Wills, Powers of Attorney, Directives and Guardianship

Wills, Powers of Attorney, Directives and Guardianship

Wills, Powers of Attorney, Directives and More: How Estate Planning Tools Can Help with Final Arrangements

Life is anything but certain, but various legal instruments can make the unpredictable easier to manage. Wills, powers of attorney and directives are a few of these tools, and when combined, they can provide direction for end-of-life decisions.

Here, we’ll review some of the most common legal tools and maneuvers available to those setting up their final arrangements. For most people, the best approach is to combine several of these instruments to cover every situation.

Wills: Articulating Final Wishes and Naming Beneficiaries

Wills are Law 101 for attorneys, as they’re the most popular instrument for estate planning purposes. With a will in place, people can do the following:

  • Name beneficiaries and distribute assets among them
  • Set up a trust and name a beneficiary for the trust
  • Name a guardian for any minor children (or pets)
  • Specify end-of-life arrangements, such as deciding between burial or cremation
  • Donate to charities or other preferred causes
  • Name an executor who will oversee the will’s administration

In short, wills articulate the testator’s final wishes, providing peace of mind to the testator and their family. As wills are generally used to provide for family following death, it’s important that they are created while adhering to state requirements. In Texas, for example, a will must satisfy the following:

  • The will was written or typed out.
  • The will must be signed by the testator.
  • The testator must be at least 18 years old.
  • The testator must be of sound mind. In other words, they must have been capable of making sound decisions for themselves when writing the will.
  • The will must have a clear testamentary “intent.” This means the testator must confirm that the document they are writing is a will and that the purpose is to leave assets for named beneficiaries.
  • There must be at least two witnesses present when the testator signed their will.
  • The witnesses must sign an attestation, typically in the testator’s presence.

Assets named in a will must pass through probate before they are allocated to beneficiaries. During probate, a court makes final determinations regarding who receives what, using the will as the guide. Probate can be a lengthy, expensive – and public – process, but it can be expedited if the will is accompanied with a “self-proving affidavit.” This is a document that confirms that the testator signed the will, that the witnesses saw the testator sign the will, and that everyone involved was of minimum age (18 for the testator, 14 for witnesses in Texas).

With a properly formed will, that is accompanied by a self-proving affidavit, the will’s witnesses will not need to be tracked down during probate, speeding up the process.

Physician Directives: Inform Doctors of Your Medical Decisions in Advance

Physician directives, also termed advance directives, inform physicians of your medical wishes should you become incapacitated and incapable of making treatment decisions yourself. Alternatively, an advance directive can also be used to name a person who may make medical decisions for you.

An advance directive kicks in when the directive’s author becomes a “qualified patient.” To be considered a qualified patient, the following must be true:

  • The person named in the directive is diagnosed with an irreversible, terminal condition.
  • The diagnosis must be rendered by an attending physician.
  • The physician must certify their diagnosis in writing.

If the above are all true, life-saving measures may be withdrawn as per the directive’s conditions. Using a directive, individuals may specify what conditions are relevant to the directive and what measures may be deployed to rescue the patient.

In Texas, an advance directive is only official if the following are true:

  • The directive’s author is at least 18 years old.
  • They are of sound mind and acting of their own free will when executing the directive.
  • The directive is signed in the presence of two competent, adult witnesses.
  • The author’s physician, if any, is notified as soon as the directive is created.

One of the two witnesses must not be:

  • Related to the directive’s author.
  • A beneficiary of the author’s estate.
  • The author’s physician or one of the physician’s employees.
  • Someone authorized to make medical decision on the author’s behalf.
  • An employee of the health care facility in which the author subsides.

With an advance directive in place, individuals can determine how their medical affairs are handled, and how they are allowed to pass.

Powers of Attorney: Empower Another Person to Make Decisions on Your Behalf

Powers of attorney (POAs) grant other people, called agents, the right to make legal, medical or financial decisions on behalf of an authorizing party, the principal. POAs cover a wide range of powers. Depending on the POA, agents may make the following decisions:

  • What forms of medical treatment may be used
  • Managing decisions for a business
  • Submitting payments to creditors or for other financial obligations
  • Filing tax returns
  • Overseeing bank account activity
  • Making beneficiary designations
  • Selling property and managing other assets

POAs can either be temporary or “durable,” in that they remain in effect even when the principal becomes incapacitated or otherwise unable to make their own decisions. They can also be set to activate in response to specified conditions. Referred to as a “springing” POA, these powers of attorney describe which conditions would cause the POA to be put into effect. This could be the onset of a particular medical condition or when the principal dies.

We recommend developing POAs so that they take effect immediately. That way, if the principal is suddenly incapacitated, there’s no delay in confirming the POAs conditions and ensuring financial and medical decisions can be made without interruption.

HIPPA Release: Allow Others Access to Your Medical Information

A HIPPA release or authorization form gives medical institutions permission to provide relevant medical information to people named in the release. A HIPPA release does not allow those people to make medical decisions, but it does provide critical information that can assist in the decision-making process. A release also entitles the named individuals to receive updates about the patient’s condition.

HIPPA releases are also used to demonstrate incapacitation for trust or POA purposes and are therefore essential for preventing delays when enacting these legal instruments.

Guardianship: Expansive Powers Backed By Court Orders

Legal guardianship is similar to a POA, though typically more expansive in scope. The guardian is usually the one with authority to make medical and financial decisions for their ward, so they have major influence over their ward’s day-to-day decision making.

Guardians may be named in a will (such as when designating who will care for minor children), but they must be approved and overseen by a court. In some instances, it is the court that will make the final decision regarding guardianship.

The benefit of attaining legal guardianship is the additional power that a court order conveys. Though uncommon, some medical or financial institutions may resist responding to a POA and make it difficult for agents to act on the principal’s behalf. Those institutions will not resist a court order.

Work with an Estate Planning Attorney to Determine Which Estate Planning Tools Are Right for You

If you’re concerned about providing for family after passing, or are concerned about how certain medical, financial or legal decisions will be made, there’s a legal document for that. Whether it’s a will, a POA, a directive, a release, or guardianship, an Houston estate planning attorney can use all of the available legal instruments to ensure your final wishes are observed.

Episode 307: Qualified Settlement Funds Trusts

Episode 307: Qualified Settlement Funds Trusts

Qualified Settlement Funds: Their Purpose and Their Advantage

Qualified settlement funds (QSFs), or 468B trusts, are a tool for businesses to use to deduct the cost of any payments made to settle lawsuit or bankruptcy claims, even if the claims and amounts owed are contested. QSFs are an alternative to an escrow account and are employed for strategic reasons. We will address what QSFs are and why businesses might want to use them.

What is a Qualified Settlement Funds Trust and When Are They Needed?

Qualified settlement funds are termed such because they must meet certain qualifications to be recognized by the IRS as a vehicle for deducting the costs of settling certain legal claims. According to IRC 468B(2), there are three criteria to meet in order to qualify as a QSF.

  1. The trust must be formed pursuant to a court order or the authority of a governmental agency, and the trust must remain under that court or agency’s jurisdiction. In other words, a QSF cannot be established and funded without court or agency oversight.
  2. The trust must be established to resolve certain civil claims against the defendant, such as torts and breach of contract.
  3. The trust must satisfy state laws governing trusts in the state that the QSF is formed.

QSFs are often used to pay off a company’s creditors during bankruptcy or pay off mass tort claims. If a company needs a QSF, it has likely determined that future settlement payments will be necessary. If done properly, any transfers of payments to the fund will be deductible as expenses paid in the course of business.

It’s important to note, though, that transfers to QSFs must be non-reversionary. Once funds are placed in the QSF, they cannot be returned to the business under any circumstance – even if it is later determined that the business is not liable for the claims. In order to effectively claim a deduction for money paid to the trust, the company must give up any right to a refund of the money.

One might wonder why should a business irrevocably transfer funds if there is a possibility there will be no financial liability pending the outcome of a trial or appeal? In some cases, setting up a simple escrow account might be the more logical option, until the dispute has been settled. There are, however, specific reasons why a business might want to employ a QSF.

The Advantages of Setting up a Qualified Settlement Fund Trust

When a business faces civil claims or files bankruptcy, it must consider possibilities for paying creditors and judgment holders. Forming a QSF as a payment vehicle is an option to consider for a few reasons.

  • A QSF provides a tax deduction for any funds transferred to the trust – In order for a business to claim a tax deduction, it must meet the “all events test” under IRC 461. In order to meet this test, there must be “economic performance”, meaning the costs have actually been paid. Treasury Regulation 1.468B-3(c) states that any money transferred to a QSF for the purpose of satisfying a liability meets the economic performance test and is therefore a deductible business cost.

  • A QSF releases the defendant from continuing liability as to those payments – A QSF assumes responsibility for a defendants’ payments to creditors and judgment holders related to the claims the trust was specifically created for. If the defendant satisfies payment requirements to a QSF, the Trust Agreement that creates the QSF can call for the defendant to be released from further liability for the claims the payments are intended to satisfy. Once a QSF is created, it releases the defendant from the responsibility of paying claimants directly, and judgment holders and creditors must take up any further grievances relating to payments of their claims with the Trust. The Trustee in charge of the Trust would then be the one to handle those issues. The Trust and the Trustee would also be in charge of allocating payments to multiple claimants, even if the claimants are all owed differing amounts or the amounts owed are contingent, uncertain, or unverified.
  • A QSF allows companies to organize their finances in the wake of litigation – Litigation can take months, even years to resolve. QSFs allow businesses to quickly and precisely allocate funds to potential judgment holders and creditors. When facing the costs of paying innumerable judgement holders and creditors, there can be budget and logistical concerns. How many claimants will there ultimately be? What amounts must they be paid? How is the company going to manage that uncertainty? The creation of a QSF is a way to manage the concerns. Once a QSF trust is created and funded, the company can write off any transfers as an expense. Decision makers won’t have to worry about who all will be paid or how much each person must ultimately be paid. All that matters for the business is the year end amount that is transferred to the fund, regardless of the total judgment award or claim value each creditor may have.

  • A QSF trust can help companies recover their reputation – Along with monetary damages, mass tort claims may bring reputational harm as well. By establishing a QSF, businesses demonstrate good faith and can rightly claim to be a cooperative party during settlement. Further, once payments are made to plaintiffs, any leftover funds may then paid out to a charity of the company’s choice. This can provide a reputation boost to the company if it’s framed and communicated properly.

Together, these advantages make a compelling case for using QSF trusts to pay legal claims.

If your business is facing litigation and considering a QSF trust for settlement purposes, it’s worth consulting with a Houston tax and accounting expert first. Taxation laws and timelines related to QSF trusts are complex, governed by treasury codes that dictate rates, reporting, and how distributions are treated. A Houston tax professional can forecast these details for their clients and help advantageously position businesses facing settlement proceedings.