Can the IRS disregard compromise settlement because of bankruptcy?

THE situation we envision in this discussion is where you have an offer in compromise which has been accepted by the IRS then you file for bankruptcy relief. Do you owe the original amount prior to the OIC or do you owe the compromised amount accepted by the IRS? For example, you owe the IRS $20,000 for back income taxes for the tax year 2012 because you got lucky at PAI GOW at Pechanga and won $100,000. Last month, you were able to sell the IRS your sob story that you lost everything you won, lost your job, have no assets , have moved from your house which you lost to foreclosure into your 2012 E350-Benz, and lost all your teeth due to malnutrition because you have no money for food.  Based on this rendition of your down and out life story, the IRS accepted your OIC of $1,000 as a compromise settlement of the $20,000 of back taxes. After a month, you have a change of fortune for the better. You get promoted to a high ranking position at Kaiser, chief scientist, so you now make $200,000 a year. You decide to file for Chapter 13 relief and list the IRS as being owed $1,000, the compromised amount. But the IRS files a proof of claim that you owe $20,000 claiming that they have disregarded your OIC because of your good fortune. Who is correct?
In Re Mead, the debtors submitted an OIC for their 1998 through 2009 federal income tax liabilities. They offered to pay $4,000 in four installments of $1,000 each over a period of 13 months. The IRS accepted the OIC and the debtors made one payment prior to filing for Chapter 13 bankruptcy. In the bankruptcy, the IRS filed a proof of claim for more than $104,000 owed in taxes and penalties for the years 1998 through 2009. The debtors objected that the claim should be limited to the $3,000 still owed on the compromise. They asserted that they were not in default on the compromise, and argued that allowing the IRS to disregard the compromise solely on the grounds that they had filed for bankruptcy would violate anti-discrimination language of Section 525(a). This section of the bankruptcy code is called “Protection against discriminatory treatment” due to bankruptcy filing. It prohibits the government as well as private employers from “discriminating” against a person who filed for bankruptcy. For instance, the government cannot terminate you from employment or deny you renewal of a license, or refuse to issue you a license just because you filed for bankruptcy. Private employers cannot terminate you just because you filed for bankruptcy.
While debtors complained of discrimination, the IRS believed that its actions were allowed by the very terms of the OIC submitted by debtors. The official OIC form says the original amount of the debtors’ tax liability would remain the IRS records until all terms and conditions of the OIC were met. The form states that if the debtors filed for bankruptcy before they fully met all the terms of the OIC, “any claim the IRS files in the bankruptcy proceedings will be a tax claim.” The IRS argued that this provision allowed it to file a proof of claim for the original amount of its claim for the debtors’ unpaid taxes, including penalties and interest. The IRS believed that the term “tax claim” means the full amount prior to any compromise being reached. Sure.
The Judge, who also owed the IRS a significant amount, found that it could just as easily mean the amount of the compromised claim. “Here, if the court was to credit the Internal Revenue Service’s interpretation of the condition, the contract would run afoul of federal law. If tax claim meant pre-compromise amount then the condition that allowed the Internal Revenue Service to disregard the compromise and attempt to collect the entire amount simply because a taxpayer was now a debtor in bankruptcy is a violation of Section 525…”

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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S Fremont Ave Bldg A-1 Suite 1125 Unit 58 Alhambra, CA 91803.

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