IRS Small Business/Self-Employed Division memorandum, Calculation of Reasonable Collection Potential in Certain Offers in Compromise Cases (Apr. 28, 2016)
IRS’s Small Business/Self-Employed Division (SB/SE) has instructed its Collection employees not to reject offers in compromise (OICs) by persons in the Cannabis / marijuana business, in states where marijuana sales are legal, merely on public policy grounds.
Offer in Compromise— OICs. Code Sec. 7122(a) authorizes IRS to compromise a taxpayer’s income tax liability. Code Sec. 7122(d)(1) gives IRS wide discretion to accept compromise offers and to prescribe guidelines “to determine whether an offer-in-compromise is adequate and should be accepted.” IRS will consider an OIC where: (1) the taxpayer is unable to pay the tax; (2) there is doubt as to the taxpayer’s liability for the tax; or (3) a compromise would promote effective tax administration because collection of the full amount of tax would cause economic hardship for the taxpayer, or compelling public policy or equity considerations provide a sufficient basis for compromising the liability. (Reg. § 301.7122-1(b)) There is doubt as to collectibility “in any case where the taxpayer’s assets and income are less than the full amount of the liability.” (Reg. § 301.7122-1(b)(2))
IRS will generally accept an OIC based on doubt as to collectibility when it’s unlikely that it can collect the unpaid tax liability in full and the offer reflects the taxpayer’s reasonable collection potential (RCP). A taxpayer’s RCP is the amount that IRS thinks it can get from the taxpayer’s assets and income. (Internal Revenue Manual (IRM) 18.104.22.168)
However, IRM 22.214.171.124.2, public policy Rejection, provides guidance on when it may be appropriate to reject an OIC on the basis of public policy. It references IRM 126.96.36.199.15, Policy Statement P-5-89. This policy statement was issued to clarify when rejection of an offer for public policy reasons is appropriate. The policy statement allows for rejection where acceptance of the OIC may in any way be detrimental to the interest of fair tax administration, even though it is shown conclusively that the amount offered is greater than could be collected by other means, provided no effective tax administration issues exist.
IRM 188.8.131.52.2 provides that situations that may warrant rejection based on public policy include those where “indicators exist showing that the financial benefits of a criminal activity are concealed or the criminal activity is continuing.”
The main components of a taxpayer’s RCP are his realizable net equity in his assets and his net future income.
The controversy of the Cannabis / marijuana laws. Several state legislatures have passed laws legalizing the cultivation and sale of marijuana. These laws have created a conflict between federal law and state law.
Code Sec. 280E provides that a taxpayer may not deduct any amount for a trade or business where the trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (e.g., controlled substances within the meaning of schedule I of the Controlled Substances Act — such as marijuana) which is prohibited by Federal law.
The Senate Report that accompanied the ’82 legislation that enacted Code Sec. 280E provided that “to preclude possible challenges on constitutional grounds, the adjustment to gross receipts with respect to effective costs of goods sold is not affected by this provision of the bill.” (S Rept No. 97-494) The Supreme Court has held that the Sixteenth Amendment, which authorized the income tax, precludes taxing the return of capital. (Doyle v. Mitchell Bros Co, (S Ct 1918) 3 AFTR 29793 AFTR 2979)
In Olive, (CA 9 7/09/2015) 116 AFTR 2d 2015-5150116 AFTR 2d 2015-5150, the Court of Appeals for the Ninth Circuit, affirming the Tax Court, held that a taxpayer was precluded under Code Sec. 280E from deducting expenses related to his legal medical Cannabis / marijuana dispensary business.
No rejection of marijuana business OICs on public policy grounds. IRS SB/SE has: a) set out guidelines for computing the RCP of businesses that cultivate and/or sell marijuana and that are located in states where the activity is permitted by statute; b) instructed its Collection employees to “in general” not reject, under public policy provisions, offers falling within the parameters of those guidelines.
The RCP of Cannabis / marijuana businesses should be determined as follows:
Equity in the taxpayer’s assets should be determined in accordance with 5.8.5, Offers in Compromise – Financial Analysis as fair market value of property minus any encumbrances determined to have priority over the federal tax lien.
Value of future income should be calculated based on the following:
- Determine the taxpayer’s gross income over a specific time period (normally annually);
- Limit allowable expenses consistent with Code Sec. 280E. That is, only expenses which are allowable on the taxpayer’s income tax return based on current federal law will be included in determining future income value;
- Contact the IRS Examination Division, if appropriate, for assistance in determining if the cost of the product or any related expenses, may be allowable under current examination guidelines.
Other components of collectibility referenced in IRM 184.108.40.206.1, Components of Collectibility, should also be included in the acceptable offer amount, if appropriate.
IRS concluded that, if a determination is made that the taxpayer’s offer should be accepted based on the calculation of RCP as discussed above, the offer should be considered as meeting IRS effective tax administration and public policy guidelines and should be approved.
THE ABOVE IS NOT FOR COMMERCIAL USE – EDUCATIONAL PURPOSE ONLY
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