The vast majority of individuals know that they can settle a tax debt with the IRS through an offer in compromise. As a tax attorney, almost every individual and business that has owed taxes to the IRS has asked me questions related to an offer in compromise. The article and video below should provide comprehensive information regarding an offer in compromise.
An offer in compromise is an agreement with the IRS where an individual or business taxpayer offers to pay an amount to the IRS that is less than the total amount of taxes owed to satisfy their liability. Many people would call this a tax settlement or an accord and satisfaction with the IRS, and it pretty much is.
I am always asked, “how much do you think it will take to settle my taxes with the IRS?” Many people have the misconception that there is a percentage that can be offered to the IRS to settle their liability or that the IRS will automatically accept. The truth is, the amount the IRS will accept to settle the tax debt is based upon each taxpayer’s ability to pay and what the IRS considers to be a taxpayer’s reasonable collection potential (RCP). A taxpayer’s RCP is determined by their equity in assets and their disposable income, and then general equation for an offer in compromise would look like: Equity in Assets + Disposable Income X 12 (or 24). Please note that prior to May of 2012, the IRS would multiply disposable income by 48 or 60, which often created situations whereby the IRS would accept an offer, but the taxpayer without assistance had no way to satisfy the debt within the time period the IRS wanted payment.
Equity in Assets:
Equity in assets would be calculated by taking the fair market value of the taxpayer’s assets from their home, car, bank accounts, retirement accounts, stock, gun collections, jewelry, art and all other assets (including business interests) less any liability associated with the asset such as mortgage or car loan. It is important to know that the taxpayer is allowed an exemption for certain assets and a reduction in the fair market value of certain assets. For example, a taxpayer is allowed approximately a $3,450 exemption for each personal vehicle, up to two vehicles. Thus, if a taxpayer had a 2010 Ford F150 with a fair market value of $20,000 and a car loan of $10,000 the equity in such vehicle that would be included within the taxpayer’s offer would be $6,550. This would be calculated: $20,000 (Fair Market Value) less $10,000 (car loan) less the $3,450 exemption. If the car loan exceeded the fair market value of the vehicle, then no equity would be included from such vehicle in the offer amount. An example of a reduction of the fair market value would be that generally, the IRS will allow a 20% reduction in the fair market value of a taxpayer’s primary residence when calculating the equity in such property. Thus, if a taxpayer owned a house with a fair market value of $300,000 and a mortgage of $200,000, the amount of equity from such property included in the offer amount would be $40,000. This would be calculated: $300,000 (fair market value) multiplied by .8 less $200,000 mortgage= $40,000. You could also multiply $300,000 by 20%= $60,000 and then subtract such amount from the fair market value of the property.
Disposable Income is calculated by taking the taxpayer’s total household income less the taxpayer’s allowable expenses. I state “allowable” expenses because the IRS may not allow all of the taxpayer’s expenses and the IRS has established national standards for allowable expenses that will provide an amount that the IRS will allow the taxpayer to use or claim as an expense. Items such as food, clothing, housing, utilities and transportation have an allowable standard that is all the taxpayer will be allowed to claim as an expense. For example, a single taxpayer living in Denver, Colorado may be allowed $1,250 for housing and utilities. If the taxpayer was actually paying $1,750 for housing and utilities, the taxpayer would only be able to claim $1,250 as an expense when calculating disposable and essentially the excess $500 would be considered disposable income by the IRS.
Now that we know the offer equation and have a better understanding of how the IRS will view equity in assets and disposable income, lets provide an example. Assume Jeffrey owes the IRS $123,000. Jeffrey has total equity in assets after exemptions and reductions in fair market value of $12,000. Jeffrey has monthly disposable income of $1,500 after all allowable expenses are deducted from his monthly income. Jeffrey’s offer amount would be $30,000 ($12,000 + $1,500 x 12) or $48,000 ($12,000 + $1,500 x 24).
When preparing your offer in compromise you must select one of two options for payments to the IRS. Option one is considered a cash offer whereby you pay 20% of the offer amount when submitting the offer, and the remaining offer amount is paid over five or fewer payments within a certain time period of the IRS accepting the offer. Generally, the IRS will want the remaining 80% of the offer within 3-6 months of acceptance. When offering to pay under such terms, the taxpayer’s disposable income is only multiplied by 12 as opposed to 24, which could be a very big advantage to the taxpayer. If you were offing $20,000 to settle the liability, you would make a payment of $4,000 when submitting the offer and the remaining $16,000 would be payable upon acceptance within a reasonable time frame. Option two allows the taxpayer to pay their offer amount over 24 months. The taxpayer’s disposable income is multiplied by 24. If a taxpayers was proposing an offer amount of $24,000 the taxpayer would make a payment of $1,000 when submitting the offer and would continue to make $1,000 per month payments to the IRS until a determination or final agreement had been reached. If a taxpayer’s offer in compromise is not accepted, the payments are applied to the total liability.
You must complete the appropriate financial statement(s) and Form 656. If you are attempting to resolve an individual liability, such as a 1040 debt, you would complete Form 433A OIC. If the individual attempting to resolve their 1040 debt owns a business, they will likely request that you complete Form 433B, which is a business financial collection statement. A business attempting to resolve its debt with the IRS would prepare and submit Form 433B OIC. After completing the necessary financial statements, it is imperative that you include all of the required attachments, which will be dictated by your circumstances, but might include, bank statements, pay stubs, most current statements for retirement accounts and verification of other items as stated on the statement. Form 656 states the taxpayer’s information, the periods of tax that are included within the offer, the reason for the offer, offer amount and terms. Once all statements and forms have been compiled, your offer will be submitted to an IRS Offer in Compromise Unit. There are two main offer units, one in Holtsville, NY and the other in Memphis, TN. The 656 Instructions will state which unit you should forward your offer too, which is determined by where you live. Further, these instructions will provide for the current application fee, which must be enclosed when the offer is submitted.
What is the Procedure with the IRS Offer Unit?
Within two to four weeks of submitting your offer, you should receive a notice from the offer unit that the offer has been received and generally this notice will state that you will be contacted within 90 days. Don’t hold your breath though! Often the only contact I receive in 90 days is another notice stating that we will be contacted within another 90 days. Upon receipt, the offer unit will check to make sure the offer can be processed. Generally, this means they will check for the correct payments and forms, and may check to ensure the taxpayer is current and compliant with all tax obligations. If the taxpayer is not current & compliant, the offer will likely be returned, and the taxpayer will not have appeal rights. Thereafter, the offer will be forwarded to an offer examiner who at some point in time will contact the taxpayer or the taxpayer’s Power of Attorney. The examiner may or may not request additional information and could issue an immediate determination of which must go through their manager for review and final acceptance. It is fairly typical for the examiner to request additional information, updated information and/or have some questions.
The examiner will eventually issue a determination in writing. This determination has four potential outcomes. One, the offer could be returned, which generally only occurs when the taxpayer is not in compliance or has not made one of the appropriate payments. Two, the offer could be accepted as proposed. Three, the offer examiner may state that the offer cannot be accepted at the amount proposed (is actually rejected), but if the taxpayer increases their offer amount to a specific figure, they will recommend acceptance. Four, the offer is rejected because the examiner feels the taxpayer has the ability to satisfy the tax liability in full.
Outcome one is bad as you have no appeal rights with the IRS Appeals Office and your only real option is to resubmit another offer. Outcome two is wonderful- your offer has been accepted and you can settle your tax debt! Outcome three may be great or maybe not great as it will depend upon how much the examiner has requested you increase your offer amount too. Outcome four, may be disappointing but is not the end of the road. If your offer is rejected under outcomes three or four above, you can still provide additional information to the examiner for reconsideration and often I have seen a successful outcome with the examiner after an initial rejection. Even if the examiner and offer unit will not change their initial position and rejection determination, you have the right to request an appeal of their decision with the IRS Appeals Office. Again, I have submitted and negotiated offers that were initially rejected, but later accepted through an appeal. Thus, if you offer is initially rejected, do not lose hope!
Other Important Issues & Considerations Regarding an Offer
When considering whether or not to submit an offer to the IRS, you should know that although, there is a stay of enforcement while the offer is being reviewed, penalty and interest will continue to accrue, and the collection statute is tolled (is not running). Thus, I would only recommend submitting an offer of which has at least a realistic possibility of being accepted, if not better.
If your offer is accepted, recently the IRS has been releasing the federal tax liens within 30 days of the offer amount being paid. However, in addition to paying the offer amount that you have agreed to pay, you must also remain current and compliant for generally a five year period following acceptance of the offer. Thus, the failure to timely pay taxes or file a return could cause the offer to default. If the offer defaulted, you would be responsible for the unpaid debt, along with penalty and interest.
If you are questioning your ability to settle your tax liability with an offer in compromise, please consider speaking with a tax attorney at The McGuire Law Firm. A free consultation is offered to all potential clients, and a reasonable fee may be worth having an experienced tax attorney prepare the documents and negotiate with the IRS.