Rev. Rul. 73-304

The Internal Revenue Service has reconsidered I.T. 3852, 1947-1 C.B. 15, in light of the decision in Robbins Tire and Rubber Co. 52 T.C. 420 (1969) and 53 T.C. 275 (Supplemental Opinion) (1970), acq., page 3, this Bulletin.

I.T. 3852 holds that the acceptance by the Government of a lump sum in compromise of Federal income tax deficiencies, including penalties and interest, which is less than the principal amount of the deficiencies, does not result in payment of income tax, penalties, or interest, but is in lieu of liability therefor, and that no part of the amount accepted by the Government from the taxpayer in compromise of the Federal income tax deficiencies may be deducted as interest.

Section 163 of the Internal Revenue Code of 1954 provides that there shall be allowed as a deduction all interest paid within the taxable year on indebtedness.

The court held in Robbins that the amount of deductible interest would be determined in accordance with Rev. Rul. 58-239, 1958-1 C.B. 94 [superseded by Rev. Rul. 73-305, this page], which relates to the application of payments to outstanding tax liabilities, and that each payment made by the petitioner would be applied first to tax, penalty, and interest, in that order, due for the earliest year, then to tax, penalty, and interest, in that order, for the next succeeding year until the payment is absorbed. The decision in Robbins was grounded on the premise that I.T. 3852 applies only when an offer in compromise has been executed "in a lump sum less than the principal amount of the deficiencies", and that where the offer in compromise and a collateral agreement, viewed as a single contract, permit the Commissioner to collect, even conditionally, an amount equal to the total liabilities sought to be compromised, such contract cannot be held to be a lump sum offer in compromise for an amount less than the principal amount of the deficiencies.

In view of the Robbins decision, payments made pursuant to the terms of offers in compromise and collateral agreements that have been accepted by the Government in compromise of outstanding tax liabilities, in accordance with section 7122 of the Code, will be applied as follows:

1. If an offer in compromise and collateral agreement have been accepted by the Government in compromise of an outstanding liability, allocation of payments made pursuant to those agreements will be made by the Service in accordance with the terms of the agreements;

2. If neither the offer in compromise nor the collateral agreement contains provisions regarding the allocation of payments made pursuant thereto, payments when received, whether paid in installments or in a lump sum, or whether paid pursuant to the offer or the collateral agreement, shall be applied by the Service first to tax, penalty, and interest, in that order, for the earliest taxable period, then to tax, penalty, and interest, in that order, for the next succeeding taxable period, until the payments are absorbed;

3. If the amount of the accepted offer in compromise covering original liability for tax, penalty, and interest exceeds the liability for tax and penalties (but not all the interest) and no collateral agreement has been accepted by the Government, the same allocation of payments as provided by 2 above, will be made by the Service;

4. If, however, no collateral agreement has been accepted by the Government and the amount of the accepted offer in compromise covering the original liability for tax, penalty, and interest is equal to or less than the liability for taxes and penalty, no payments will be allocated to interest. Automatic Sprinkler Co. of America, 27 B.T.A. 160 (1932).

Accordingly, amounts paid which are allocated to interest as set forth above may be deducted as interest under section 163 of the Code in accordance with the taxpayer's method of accounting.

I.T. 3852 is hereby superseded.