Offer in Compromise with IRS: How To Best Settle a Tax Debt

Offer in Compromise with IRS: How To Best Settle a Tax Debt

One of the best options to resolve a tax debt with the IRS is what is called IRS Offer in Compromise.  As tax attorneys, we have years of experience submitting  offers in compromise to the IRS and this article will provide insight as to common or frequent questions we receive.

 

What is the IRS Offer in Compromise Formula or What is the IRS Offer in Compromise Equation?

When reviewing an offer in compromise, the IRS applies a very black and white formula or equation to determine what they consider is a taxpayer’s ability to pay and thus what they will accept as an offer to settle the tax debt (if an offer would be accepted).  

The offer in compromise formula is relatively simple, it is:  

Equity in assets plus disposable income x 12 (or 24).  

The key issues with the formula are 

• equity in assets, and 
• disposable income.  

 

Equity in Assets as it Applies to the Offer in Compromise Formula

So what is equity in assets as it relates to an offer in compromise formula?  In short, the equity portion would be all equity in all assets, whether a bank account, retirement account, home, investment real estate, stocks, cars etc.  You can ask yourself, if I sold or liquidated all of my assets, what would my equity be?  

• Debt against Equities – The calculation of your equity for purposes of the offer does take into account any secured debt encumbering an asset.  For example, if your home had a fair market value of $600,000, but your total mortgage or loan amount encumbering the real estate was $500,000, on face value you would only have $100,000 for purposes of the offer in compromise with IRS.  

 

• Reduction in Fair Market Value – It is also important to note that for certain assets, the IRS allows a reduction in the fair market value of the asset when calculating the equity portion.  Using the example above, the IRS allows a 20% reduction in the fair market value of real estate when calculating the equity.  Thus, the fair market value would be $480,000 ($6000,000 x .80) and given the total debt encumbering the property ($500,000) is greater than the fair market value, no equity from the home in the above example would factor into the offer amount.  

 

• Other Reductions – In addition to allowing a reduction in the fair market value of certain assets, there are also exemption amounts for certain assets such as bank accounts and vehicles that you get a dollar for dollar exception on when calculating the equity for that specific asset.  For example, you can exempt the first $1,000 from a bank account or you get a $3,450 exemption for equity in a vehicle for up to 2 vehicles. 

Offer In Compromise Formula for Disposable Income

In terms of income and monthly disposable income, the IRS looks at your total monthly income less all monthly “allowable expenses” to calculate your disposable income.  It is important to note that only “allowable expenses” are allowed because for expense items such as your house payment, rent, utilities, food, clothing, car payments and car operating costs, the IRS sets a standard or “allowable amount” that you can claim as an expense based upon where you live and the number of dependents in your household when calculating your disposable income.  For example, the IRS may only allow you a monthly expense amount of $2,440 for housing and utilities when your actual out of pocket expenses may be $3,100 per month.  Therefore, there can be a variance in what you feel your monthly disposable income is and what the IRS determines your monthly disposable income to be.

Running the Numbers: Example of an Acceptable Offers In Compromise

Let’s run some numbers for an example.  Let’s assume Brad has a home with a fair market value of $450,000, a mortgage of $350,000, a retirement account worth $20,000 and bank account with $1,500.  Brad’s monthly gross income is $7,000 and Brad’s allowable expenses are: $730 for food and clothing, $2,000 for housing and utilities, $620 for a car payment, $260 for car operating expenses, $500 for health insurance and $1,500 for current year taxes.

 

Brad’s Equity in assets would look like the following:

• Home: Fair Market Value $360,000 ($450,000 x.8) – $350,000 = $10,000
• Retirement Account: $20,000 x .8 = $16,000
• Bank Account: $1,500 – $1,000 exemption = $500
• Total Equity in Assets: $26,500

 

Brad’s monthly disposable income would look like the following:

$7,000 – $730 – $2,000 – $620 – $260 – $500 – $1,500= $1,390

 

Based on equity in assets of $26,500 and monthly disposable income of $1,390, Brad’s offer would be $43,180, which is $26,500 + ($1,390 x 12).

There are many factors and issues that come into IRS offer in compromise formula and the above is a simple example to illustrate the general equation.  Further, many other factors come into play when the IRS is making a determination as to whether or not to accept an offer in compromise.

 

How Do I Settle My Taxes With The IRS? The Offer in Compromise Process

Now that we have explained the IRS offer in compromise formula, another common question is, how do I settle my taxes with the IRS?  To settle your taxes with the IRS, you need to submit the proper offer in compromise forms, statements and payment to the IRS.  The financial statements required will be dictated by the type of taxes owed and whether or not you own any businesses.  If you owe individual income tax debts, you will submit Form 433A OIC, which is an individual financial statement.  If you own any businesses, you will also need to submit Form 433B for each business that you own (unless the business is a single member LLC).  In addition to the proper financial statements, you need to provide the correct attachments for the financial statements depending upon the assets and items reported on the financial statements.  The offer in compromise form that is submitted with the financial statements is Form 656.  Form 656 states the taxpayer’s information, the tax years and type being offered for settlement, the offer amount and payment terms for the offer.  The applicable financial statements and Form 656 are submitted with payment to the proper IRS Offer in Compromise Unit (generally in Memphis, TN or Holtsville, NY).

Determination of the Offer

Once the financial statements, attachments, Form 656 and initial payment are submitted to the IRS, an IRS offer examiner will be assigned for review and determination of the offer.  It generally takes 5-6 months for the offer examiner to make contact with you.  The offer examiner may ask for additional information and may have questions.  Eventually the offer examiner will make a determination.  The determination could be to accept the offer as initially proposed, accept an offer but at an increased amount or reject the offer altogether because the IRS feels you can satisfy the tax debt and therefore they would not settle on the tax debt.  If the offer examiner rejects the offer but proposes an increased amount, you can amend Form 656 to the increased amount and the offer may be processed with a recommendation for acceptance by the offer examiner.  If the offer examiner has rejected your offer, you have 30 days to appeal the rejection.  The appeal of the offer rejection will go to an IRS Appeals Officer and you will likely be contacted by the appeals officer within 2-4 months from filing the appeal.  The appeals officer calls an appeals hearing or conference date whereby you can present additional information as to why you disagree with the offer examiner’s rejection and support your position.  After the case has been heard by the appeals officer, the appeals officer can either sustain the IRS offer examiner’s rejection or agree to accept or modify the offer you originally submitted.  

 

How Do I Negotiate With the IRS?

In addition to the above, many taxpayers will ask, how do I negotiate with the IRS?  While there can be some negotiation with the IRS regarding an offer you really need to have the right set of facts to negotiate.  For example, an individual who has $500,000 equity in assets and $2,000 per month of disposable income is highly unlikely to be able to negotiate an offer on a $100,000 tax debt.  If you have the equity in assets and/or income to satisfy the tax debt, the best negotiator in the world may struggle to negotiate with the IRS regarding an offer in compromise.  Thus, the platform and ability to negotiate with the IRS is or may be truly limited by the facts and circumstances of each case.

While an offer in compromise is a viable option to resolve a tax debt with the IRS, you may want to consider hiring a tax attorney to prepare the proper statements and forms, as well as represent you through the process with the IRS. Experience negotiating with the IRS and profound knowledge of the offer in compromise process will both expedite the resolution and provide the best possible outcome to you. Get in touch with us if you’d like to discuss settling your tax debt with the IRS.