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.