Getting more by asking less: justifying and reforming tax law's offer-in-compromise procedure.

• Author: Oei, Shu-Yi

The Offer in Compromise (OIC) is a procedure by which the IRS may agree to forgive a portion of the tax liabilities of certain taxpayers. This Article suggests a framework for evaluating the effectiveness of any proposed reforms to this procedure. It presents three arguments that support forgiving tax debts through devices such as the OIC. These arguments are rooted in revenue-raising, fairness, rehabilitative, and socioeconomic considerations. Unfortunately, an analysis of the OIC's recent history shows that its current structure tends to undermine its effectiveness. The power to effectuate the procedure is dispersed among four stakeholders with divergent interests: Congress, the IRS, the taxpayer, and financial and other supporters of the taxpayer. Each of these players has conflicting and contradictory interests in OIC-procedure outcomes. Over time, the actions and decisions of each of these players can lead to conflicting and counterproductive behaviors and responses by other players, and this undermines the program's overall effectiveness. Given this dynamic among stakeholders, reforms that would minimize or eliminate such downward-spiraling interactions of divergent interests should be adopted. Conversely, reforms likely to provoke or exacerbate such interactions should be avoided. This Article provides examples of each type of reform.

INTRODUCTION I. THE OFFER IN COMPROMISE: WHAT IT IS AND WHY IT MATTERS A. The OIC Procedure: A Brief Description 1. Doubt as to Collectibility 2. Doubt as to Liability 3. Effective Tax Administration B. A Preliminary Case for a Robust Offer-in-Compromise Procedure 1. Revenue Benefits 2. Interrogating the Finality of the Assessed Tax Liability--Toward a Broader Conception of Distributive Justice 3. Negotiating a Reality Where People Sometimes Cannot Pay: Tax Policy Considerations in Dialogue with Debtor-Creditor Policy Considerations II. THE PROCEDURE IN ACTION: TWO PROBLEMATIC TRENDS IN HISTORICAL CONTEXT A. Watershed Moments in the Procedure's Recent History 1. 1992 Changes 2. 1995 Introduction of Nationalized Standards 3. 1998 IRS Restructuring and Reform Act 4. 2001 Introduction of Centralized Processing 5. 2003 Introduction of User Fee Requirements 6. 2005-2006 Legislative Changes B. Two Problematic Trends in Historical Context 1. 1997-2001: Increased Inventory Backlog and Longer Processing Times 2. 2000-2009: Decline in the Number of Received and Accepted Offers and Increase in "Repeat Offers" III. EXPLAINING WEAKNESS: A STAKEHOLDER DYNAMICS FRAMEWORK A. Four Stakeholders with Divergent Interests 1. Congress and Other Legislative Actors 2. The IRS 3. The Taxpayer 4. Other Stakeholders B. Power Dispersal and Interest Divergence in Action--Two Turning Points 1. 1998 Restructuring Act Changes and IRS Responses 2. Taxpayer and Other Stakeholder Reactions to the Partial Payment Requirement, User Fees, and Frivolity Penalties IV. EVALUATING PROPOSALS FOR REFORM UNDER THE FRAMEWORK A. Reforms That Might Work 1. Creation of a Non-Stakeholder Initial Adjudicator of Offers 2. Rethinking Implementation of User Fees and the Partial Payment Requirement B. One Reform That Probably Will Not Work CONCLUSION INTRODUCTION

What should happen when a taxpayer cannot pay her taxes? Should the taxpayer, who may be experiencing financial hardship or facing exceptional personal circumstances, always be compelled to pay the full amount of her tax liability, no matter the consequences? And what measures can or should the taxing authority take against a taxpayer who cannot pay? Under what circumstances should tax debts be forgiven in order to further greater societal and revenue goals? The answers to these and other questions are of vital importance in analyzing the law of tax collections. With a few notable exceptions, (1) however, the academic literature tends to treat these collections issues as an afterthought, secondary in importance to more substantive or theoretical issues such as the tax base, tax rates, tax expenditures, and even tax penalties. These tax collections issues therefore tend to be understudied and underanalyzed. (2) Yet these issues have great policy significance because the ways in which we collect taxes that have been assessed and are owed implicate important tax policy concerns, including efficiency, equity, administrability, and distributive justice.

In this Article, I analyze one of the tools in the IRS's collections toolkit--its power to compromise a tax liability via the Offer-in-Compromise (OIC) procedure (3)--and propose an analytical framework through which the procedure should be understood and ultimately reformed. Generally speaking, the OIC procedure is a collections procedure by which the IRS may forgive a portion of the debts owed by certain taxpayers who are having difficulty paying the full amount owed. Such a taxpayer may offer to settle her tax liability by paying only a portion of the total taxes due. The taxpayer must meet certain requirements and conditions in order to qualify, and the IRS has the discretion to accept or deny the offer. The OIC procedure is therefore an important way in which the tax system copes with the problem of taxpayers who are unable to pay their taxes. However, there is almost no academic literature on the subject. (4)

My study of the OIC procedure has both programmatic and philosophical goals: I examine the procedure in the interest of program specific reform and also as a gateway to the consideration of broader issues of when, why, and to what extent a tax liability should be forgiven. I argue that important revenue-raising, fairness-based, rehabilitative, and socioeconomic arguments weigh in favor of having a systematic and effective "escape valve" for tax-debt forgiveness. Most pertinently, IRS collections data show that the IRS ultimately collects more per dollar of outstanding tax liability through accepted offers in compromise than it does from offers it has rejected. (5) OICs also yield more cents on the dollar than do regular collections methods with respect to certain categories of delinquent tax debts. (6) But despite these encouraging numbers, an analysis of the procedure's recent history reveals problematic trends that suggest that it is not operating as effectively as it could be.

I argue that the OIC procedure is structured in a way that systematically undermines its effectiveness. Problematically, the power to effectuate the OIC procedure is dispersed among four stakeholders with divergent interests: (1) Congress, (2) the IRS, (3) the taxpayer, and (4) financial and other supporters of the taxpayer. Each of these players has conflicting and contradictory interests in how tax forgiveness should operate in general, and in how the OIC procedure should function in particular. Moreover, the actions and decisions of each of the players may provoke counterproductive responses from other players, such that, over time, the program's effectiveness is weakened. I therefore suggest that reforms likely to provoke or exacerbate these undesirable stakeholder dynamics should be disregarded. Conversely, reforms likely to minimize the effects of power dispersal and interest divergence should be adopted.

In Part I, I describe the basic features of the OIC procedure and explain its importance. I first describe the procedure as it currently exists on paper. I then defend the need for a robust but tailored debt-forgiveness procedure by arguing that such a procedure (1) enables the IRS to collect more revenue, (2) reflects a rich conception of distributive justice that looks beyond assessed tax liabilities, and (3) comports with the realities of a world in which debtors sometimes cannot repay their debts. Such a system serves society's interests in debtor rehabilitation as well as social and economic stabilization.

I then turn to a discussion of how OIC has functioned over time. In Part II, I discuss two observable trends in the OIC procedure's recent history that give rise to concerns that the procedure is ineffective, and I provide some background regarding the historical context in which these two trends arose. I then present, in Part III, a power-dispersal and interest-divergence analysis of the OIC procedure's functioning, showing that the dynamics between the four stakeholders have caused the procedure to perform less well over time than one might have hoped. I argue that the OIC procedure must be reformed to counteract these problematic stakeholder dynamics. This can happen by either (1) centralizing power among fewer stakeholders or (2) adopting proposals that eliminate or minimize the likelihood of downward-spiraling interactions among stakeholders with divergent interests. The second of these strategies is the more promising simply because it is difficult to change the realities underlying the relationships and dynamics among the stakeholders.

Finally, in Part IV, I describe two concrete proposals that align with my suggested framework: (1) empowering an independent decision-maker to consider offer proposals and (2) making user fees and the required partial down payments on offers refundable. I further argue that an alternative reform suggested by the Treasury Inspector General for Tax Administration--the introduction by the IRS of more aggressive follow-up collection tactics for rejected OICs--is unlikely to succeed because such a move would result in unproductive and dissonant responses on the part of taxpayers.

The OIC procedure is just one discrete tool at the IRS's disposal, but the implications of my analysis are broad. Thinking analytically about whether and how to operate and improve such a program demonstrates how stakeholder dynamics can impact tax administration. It also opens a window to the consideration of broader philosophical issues and tensions in the area of tax collections, including whether a taxing authority can act as an altruistic creditor toward tax debtors, how much flexibility is...