IRS Can Revoke Your Offer in Compromise if it Does Not Like You – Houston Tax Attorneys

Imagine working for years to resolve your tax problems and finally reaching an agreement with the IRS to settle your tax debt. You make all the required payments, fulfilling your part of the bargain.

You think you are in the clear, but say the IRS employees who worked on your case do not like you. Say that they send you a letter saying the IRS has decided to void the agreement entirely. When you ask why, the IRS refuses to provide specifics or allow you an opportunity to challenge its decision. Could a case like this ever happen? This question brings us to the Novoselsky v. United States, Case No. 24-cv-387-bhl (E.D. Wis. 2024) case.

Facts & Procedural History

The taxpayers in this case had negotiated and entered into an offer-in-compromise with the IRS for the 2009 to 2014 tax years. According to the court opinion, the taxpayers fulfilled all their obligations under the offer. As with the comment in the intro for this post, in May 2023, the IRS sent the taxpayers a letter revoking the offer and informing them it would restart tax collection proceedings.

The court opinion indicates that the taxpayers made various efforts to understand the basis for the revocation. The IRS’s response included only vague allegations about misrepresentations the taxpayers supposedly made concerning their home, including unclear claims about ownership interests and property values. When the taxpayers requested specific details about these alleged misrepresentations so they could attempt to address them, the IRS flatly refused. Instead of providing specifics or allowing any opportunity to cure potential issues, the IRS simply informed the taxpayers they had no right to even seek an internal review of the revocation decision.

The taxpayers then filed a civil action against the IRS, asserting that the IRS had revoked the offer based on “personal animus” against them. This dispute resulted in the court opinion at issue in this post. This case does not say who at the IRS would have had the personal animus, but it could have been any number of IRS employees. For example, if the case originated with a revenue officer, it could have been the revenue officer. The revenue officer generally does have the ability to influence the offer acceptance when they have the case prior to the offer being submitted.

About the Offer in Compromise

An offer-in-compromise allows taxpayers to settle their tax debt for less than the full amount owed. Congress granted the IRS authority to settle tax balances. The term “offer-in-compromise” is the name the IRS gave to the program it created under this authority.

The offer-in-compromise can be a great way to get a fresh start and to come into compliance. It brings in elements of bankruptcy discharge, without some of the negative aspects of bankruptcy. As with any government program providing relief, there are numerous requirements that one must meet to qualify. There are also drawbacks, such as an extension of the time the IRS has to collect.

Most offers are submitted by taxpayers based on doubt as to collectibility. With these offers, there is no challenge to whether the underlying liability is owed. Rather, the challenge centers on the taxpayer’s inability to pay the liability (there are other types of offers that can be made for the liability).

The taxpayer must submit a detailed application with comprehensive financial documentation and offer at least what the IRS calculates as their “reasonable collection potential.” The IRS evaluates offers based on the taxpayer’s ability to pay, income, household expenses, and asset equity. The IRS applies its collection rules to determine whether a taxpayer can pay the liability.

These requirements exist in addition to other standard qualifications, such as being current with all filing and payment requirements and not having an open bankruptcy proceeding.

When a taxpayer submits an offer, they must provide detailed financial information under penalties of perjury. But what obligation does the IRS have to verify this information before accepting the offer? And if the IRS fails to verify information it could have easily checked during the offer process, should it be able to later void the agreement based on that same information?

Contract Law Applies

The offer-in-compromise is fundamentally a contract. The courts have consistently held that contract law applies in resolving disputes related to offers.

Under basic contract law principles, a contract can be voided for fraudulent inducement when one party makes material misrepresentations that lead the other party to enter into the agreement. However, the party seeking to void the contract typically must show they reasonably relied on the misrepresentation and could not have discovered the truth through ordinary diligence.

The IRS’s actions in this case—claiming misrepresentation about readily verifiable property records without showing they actually verified anything—seem to fall short of this standard. But this raises an important question: can taxpayers actually sue the IRS for breach of contract?

Limited Remedies for Taxpayers

This case involved a claim under the Declaratory Judgment Act and the IRS’s defense citing the Tax Anti-Injunction Act.

The Declaratory Judgment Act allows courts to issue declarations about parties’ legal rights in many situations. However, the Act specifically excludes cases “with respect to Federal taxes.” This tax exception is interpreted broadly and generally prevents courts from issuing declaratory judgments about tax matters.

The court held that determining whether the IRS properly revoked an offer falls squarely within this tax exception. Even though the taxpayers framed their argument in contract terms, the court found that the fundamental nature of the dispute involved federal taxes. Because reinstating the offer would effectively declare the taxpayers’ rights regarding their tax obligations, the court concluded it lacked jurisdiction under the DJA. The stark conclusion: you cannot sue the IRS for breach of contract. The IRS is free to breach as it sees fit.

The Tax Anti-Injunction Act provides another barrier. It generally prohibits suits that would restrain the assessment or collection of taxes. Congress enacted this law to ensure the government could collect taxes without judicial interference disrupting the flow of revenue. The Act essentially requires taxpayers to pay first and litigate later, with only a few narrow statutory exceptions.

In this case, the court found that the taxpayers’ attempt to reinstate their offer would effectively restrain the IRS’s ability to collect taxes. Even though the taxpayers argued they were merely seeking to enforce a contract, the court viewed this as an indirect attempt to stop tax collection. The court reasoned that because an offer by definition allows for payment of less than the full tax liability, forcing the IRS to honor the offer would interfere with its ability to collect the full tax amount.

Remedies After Collection Attempts

Absent these remedies, taxpayers who contract with the IRS are in a difficult position. They cannot preemptively challenge the IRS’s revocation of their contract through normal judicial channels. However, taxpayers may have alternative remedies once the IRS attempts collection.

A wrongful levy action under I.R.C. § 7426 could provide an opportunity to challenge the underlying validity of the tax debt and the offer revocation. This would require waiting until the IRS actually seizes property, but it might offer a path for judicial review that isn’t barred by the Anti-Injunction Act.

Taxpayers might also consider a Collection Due Process hearing, though the scope of review may be limited. In some cases, taxpayers might be able to file a refund suit if they can fully pay the liability for at least one tax period. None of these options are ideal, but they may provide some avenue for challenging an improper offer revocation.

The Takeaway

This case highlights a fundamental unfairness in tax administration. When taxpayers enter into offers, they must provide extensive financial documentation and make specific representations about their assets and income. The IRS scrutinizes this information before accepting an offer. Yet after acceptance, the IRS can apparently revoke the agreement based on vague allegations of misrepresentation, without having to prove or even clearly articulate what those misrepresentations were.

The practical implications are serious. Taxpayers who have fulfilled their obligations under an offer and moved forward with their lives can suddenly find themselves back at square one, facing their original tax liability plus additional interest and penalties. The lack of meaningful review or appeal rights makes the IRS’s revocation power nearly absolute.

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Stephan Dorsey

Stephan is the sports journalist for the Maple Grove Report.

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Tax Refunds Lost to Timing Rules: Lesson, File Early, Pay Late – Houston Tax Attorneys

You should always pay your taxes on time, right? After all, early payment avoids tax penalties and interest, and shows good faith compliance with tax obligations.

This is not always the best approach. Why? Taxpayers who pay early or even on time may be precluded from getting money back from the IRS if they overpaid their tax liability. In some cases, taxpayers who delay making payments to the IRS may have more refund rights than those who pay on time.

This issue typically arises in two scenarios where taxpayers make advance payments to the IRS. First, when taxpayers make payments but fail to file timely returns. Second, when taxpayers make payments and the IRS conducts an audit or makes an adjustment that results in a statutory notice of deficiency. In both cases, the taxpayer may later discover they not only don’t owe additional tax—they actually overpaid and are due a refund. This problem lies with payments made before either the late-filed tax return or the IRS’s notice of deficiency–which taxpayers may not be able to get back from the IRS. The recent Applegarth v. Commissioner, T.C. Memo. 2024-107, provides an opportunity to consider these timing issues.

Note: there are other rules that come into play for refunds in collection due process hearings, which are similar but different than when you have an IRS adjustment or notice of deficiency as we are addressing in this article.

Facts & Procedural History

The taxpayer in this case made estimated tax payments to the IRS for 2014 and 2015. The payments were all made on or before the extended due dates for the tax returns for 2014 and 2015.

The taxpayer then filed his 2014 return in June 2019 and never filed his 2015 return.

In November 2019, the IRS issued notices of deficiency to the taxpayer for both years. The taxpayer filed a petition with the U.S. Tax Court to challenge the IRS’s determinations.

The taxpayer provided an amended return to the IRS attorney during the tax litigation. The parties ultimately agreed that there were significant overpayments–$78,472 for 2014 and $9,603 for 2015. So not only did the taxpayer not owe the amounts asserted by the IRS in its notice, the taxpayer was actually owed money back from the IRS.

The question before the court was whether the U.S. Tax Court could order refunds of the overpayments given the statutory time limitations.

The Refund Claim Framework

This is probably not a surprise, but there are a number of deadlines set out in the tax code. For this case, there are two key provisions to consider, i.e., Section 6511(b)(2) and 6512(b)(3).

Section 6511(b)(2) establishes the “lookback” periods for refund claims. For taxpayers who file a tax return, they can recover payments made within three years plus any extension period before the refund claim. For taxpayers who don’t file a return, they can only recover payments made within two years of their refund claim.

Section 6512(b)(3) applies specifically to cases brought in the U.S. Tax Court. It limits the Tax Court’s ability to order refunds to: (1) payments made after the IRS issues its notice of deficiency, (2) payments that would be refundable if a refund claim had been filed on the notice date, or (3) payments covered by an actual refund claim filed before the notice date.

This creates a connection between the notice date and refund rights. Taken together, these code sections limit refund rights based on when payments were made relative to when refund claims are filed or deemed filed. This is why a taxpayer who files a petition with the U.S. Tax Court in response to a notice of deficiency has to focus on the date of the IRS’s notice of deficiency. The code treats this date as a hypothetical refund claim date and only allows recovery of payments made within specific “lookback” periods measured from this date. For taxpayers who haven’t filed returns, this lookback period is generally just two years before the date of the IRS notice. That is the issue in the Applegarth case.

In Applegarth, the taxpayer’s payments were all made more than two years before the November 2019 notice of deficiency. Because he hadn’t filed returns within the proper timeframe, the two-year lookback period applied. As a result, the U.S. Tax Court could not order refunds of the overpayments, even though everyone agreed that the taxpayer was otherwise entitled to the refunds.

Understanding the Lookback Periods

IIt is helpful to consider an example here. Imagine a taxpayer who paid $10,000 in taxes on April 15, 2020, but later discovers they only owed $5,000. Their ability to get back the $5,000 overpayment depends on when they take action.

If they file a tax return (which serves as a refund claim), they can recover payments made within 3 years plus any extension period before filing the refund claim. So if they file the tax return on April 15, 2023, they can get back the April 2020 payment. The 3-year lookback period protects their refund rights.

The situation is quite different if they never file a return and the IRS sends a notice of deficiency. In this case, they can only recover payments made within 2 years before the notice date. So if the IRS sends a notice on April 15, 2023, they can only get back payments made after April 15, 2021. Their April 2020 payment falls outside this 2-year window and is lost.

This is why the Applegarth case turned out the way it did. Since the taxpayer hadn’t filed returns within the proper timeframe, he was stuck with the shorter 2-year lookback period. His payments were made too early to fall within this window.

Planning Around the Timing Rules

These refund rules create some counterintuitive results. A taxpayer who files their return late but within three years of payment has more refund rights than a taxpayer who doesn’t file at all and waits for an IRS notice. And a taxpayer who pays at the last minute (but within two years of an IRS notice) may have more refund rights than one who paid years earlier.

This doesn’t mean taxpayers should delay payments to the IRS. Late payment penalties and interest usually outweigh any theoretical benefit from preserving refund rights. However, it does mean that taxpayers who have made payments should prioritize filing their returns, even if late. A late-filed return is far better than no return when it comes to preserving refund rights.

Given these concepts, there are a few issues that you may be thinking about. One is situations in which a taxpayer is required to file a return with an estimate, and has to true up the return later? There are situations like this built into our tax laws. We covered that topic here as to fixing estimates.

The other question is whether the taxpayer can argue that they did file a timely tax return, even though they technically did not. If the taxpayer has no other arguments, one argument might be that they did file a tax return as a refund claim, it was just an informal refund claim. There is some chance that something the taxpayer provided to the IRS could count as a refund claim–even if it was just a letter or other correspondence the taxpayer sent to the IRS.

Takeaway

The lesson from this case isn’t that taxpayers should delay paying their taxes. Rather, it highlights the critical importance of filing tax returns, even if they’re late. While timely tax payments are important, they must be paired with a filed return to preserve refund rights. Taxpayers who have made significant payments should file returns or protective claims if they discover potential overpayments. Otherwise, as Applegarth shows, the taxpayers could permanently lose their right to substantial refunds due to timing rules alone.