Actor Wesley Snipes has had his share of tax troubles. When he completed his jail time in 2013 for failing to file tax returns, he was left to the matter of paying his tax balance to the IRS. The tax bill: $23.5 million for tax years 2001 to 2006.
In 2013, Snipes and his advisors were dealing with IRS collection efforts. After receiving a Notice of Federal Tax Lien from the IRS, Snipes decided he would offer the IRS an amount to settle his tax bill. This settlement is commonly referred to as an offer in compromise – doubt as to collectability, or OIC.
Snipes offered 4 percent of the tax balance he owed — $842,061 — to settle his $23.5 million debt. As with all OICs, the IRS investigated the offer to understand Snipes’ “reasonable collection potential” — that is, the amount that the IRS could reasonably collect from his assets and future income before the statute for collection expires (generally 10 years from when the tax is assessed).
The IRS found some shenanigans — and an argument ensued between the IRS and Snipes on the proper amount that Snipes should pay to settle his taxes. In the end, the IRS won because Snipes and his advisors failed to properly consider the dissipated asset rule.
Settling a tax bill with an OIC is not an arbitrary process
There are rules to determine whether taxpayers qualify and what amount they should offer the IRS to settle. It’s a two-step process:
1. Does the taxpayer qualify?
2. How much to offer?
A common misunderstanding about the OIC is that taxpayers can just offer an amount and see whether the IRS will accept it as a settlement. That is far from reality.
All taxpayers submitting an OIC must review their assets, liabilities, income and expenses to determine whether they qualify, and, if so, what amount they should offer. The rules to help determine an OIC are in the IRS Internal Revenue Manual, or IRM. These rules are the standard taxpayers can use to argue that they should be allowed an OIC.
All taxpayers should closely examine the IRM before they submit an OIC.
Step 1: Do you qualify?
The first step is to use a formula to determine whether a taxpayer qualifies. The formula for an OIC doubt as to collectability is net equity in assets plus monthly payments for the remaining time left on the collection statute must be less than the amount of tax owed.
For example, a taxpayer who has $10,000 net equity in assets can make $100 in monthly payments for 84 months and owes $100,000. This person would qualify for an OIC because the amount he could pay before the statute expires ($10,000 in assets plus $8,400 in monthly payments – $18,400) is less than the $100,000 tax bill.
If taxpayers qualify, they’ll move on to the next step.
Step 2: What’s the offer amount?
The only difference in calculating the offer amount is that the IRS will accept only 12 or 24 months of monthly payments in an offer amount. The number of months depends on whether the taxpayer selects the lump-sum payment option (12 months) or the periodic payment option (24 months). In our example, the offer amount for the lump-sum payment option would be $11,200 ($10,000 in assets plus 12 months of $100 payments).
If the taxpayer follows the IRS OIC rules for determining the correct amount of assets, liabilities, income and expenses, the IRS should accept the OIC. However, in Snipes’ case, he failed to properly value his assets — including assets he disposed of while he owed taxes. These are called dissipated assets.
The IRS dissipated asset rule makes sense — you can’t dispose of assets before an OIC to avoid paying the government.
The IRS rejected Snipes’ OIC because of dissipated assets
In Snipes’ OIC, the IRS claimed that he didn’t include numerous assets and real estate holdings that were held in multiple entities. Apparently, Snipes didn’t disclose these assets to the IRS in his OIC application. The IRS took considerable efforts to verify Snipes’ assets and found property transfers that couldn’t be explained.
When the IRS asked Snipes and his advisors about the assets, the IRS didn’t get satisfactory answers. Snipes claimed his financial advisor mishandled the assets. His financial advisor took out loans and disposed of assets and income on Snipes’ behalf — without Snipes’ knowledge or benefit. When Snipes couldn’t produce any evidence of the asset diversion, the IRS became more suspicious.
The IRS rejected his 4 percent OIC amount and a court battle ensued. Snipes tried to argue that the IRS should go after his financial advisor (called transferee liability). But the court rejected that argument because IRS rules don’t require the IRS to do so in an OIC.
In the end, the judge agreed with the IRS that Snipes should have included his dissipated assets in the OIC.
Dissipated asset rules: What you should know
Snipes’ OIC may have looked suspicious because of his history with the IRS. But the Snipes case highlights one reason that the IRS accepts only 40 percent of all OIC applications: taxpayers often fail to include dissipated assets in their OICs.
The general rule for dissipated assets requires taxpayers to include the value of these assets in their OIC if they owed tax when they dissipated the asset.
The IRS states: “Inclusion of dissipated assets in the calculation of the OIC reasonable collection potential (RCP) is no longer applicable, except in situations where it can be shown the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary, or other income) for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or during a period of up to six months prior to or after the tax assessment.”
In recent years, the IRS has applied a three-year lookback rule. In IRM 5.8.5.18 (March 23, 2018), the IRS states that a three-year timeframe will be used to determine whether it’s appropriate to include a dissipated asset in the calculation of an OIC. For example, if a taxpayer submits an OIC in 2018, any asset dissipated in 2015 or prior shouldn’t be included.
The IRS has special rules when it comes to late filers and people under audit. The IRS states: “Situations may occur in which the transfer happened over 3 years prior to the offer submission, yet because of the timing of the transfer (within six months prior to or six months after the tax assessment (like a late filed return) or after notification of an examination), the inclusion of the asset in RCP (OIC) may be appropriate.”
The IRS provides an example for late filers: “The taxpayer filed tax returns for five years (2007 - 2011) in February of 2013, which were assessed in March 2013. In January of 2013, the taxpayer transferred real property to a family member for no consideration. An offer was submitted in January 2017. In this instance, since the transfer was within six months of the tax assessments, it may be appropriate to include the value of the real property in RCP (for the OIC).”
It’s not clear if the IRS applied these bright-line dissipated asset rules in Snipes’ case. We do know that Snipes didn’t provide an adequate, documented explanation of how he lost or transferred his properties. In the end, failing to properly apply the dissipated asset rules was fatal to Snipes’ OIC, and he is back to dealing with his $23.5 million tax liability.
OIC applicants: Investigate any dissipated assets before applying
For taxpayers and advisors considering an OIC doubt as to collectability, you should always do a complete asset review before submitting the OIC application. You can find prior assets and investigate more through some of these sources:
- Prior tax returns for asset sales
- IRS wage and income transcripts for sales of property (1099-S), IRA balances (5498 and 1099-R), and bank accounts (1099-INT)
- Credit reports for evidence of prior properties
- Public property records
You can also interview the taxpayer and go through his or her finances for the past three years.
In an OIC investigation, the IRS usually pulls taxpayers’ credit reports if they owe more than $100,000. The IRS will always give taxpayers an opportunity to explain any dissipated assets in question. Be prepared to explain why an asset isn’t a dissipated asset, according to the IRM.
Also, avoid Snipes’ error and be prepared to support your explanation with documentation.
Properly investigating and applying the dissipated asset rules is critical to determining whether a taxpayer qualifies for an OIC and what the OIC offer amount will be. If you miss these rules, you could get the same conclusion as Snipes.
