An offer in compromise is a contractual agreement between the IRS and a taxpayer under which the taxpayer agrees to pay a specified amount to conclusively settle assessed tax liabilities, plus penalties and interest, for less than the amount owed. The IRS will generally accept an Offer in Compromise in circumstances where it is unlikely that the tax liability owed by the taxpayer can be collected in full and the amount offered reflects the taxpayer’s reasonable collection potential. An OIC is legitimately used by the IRS as an alternative to declaring a case currently not collectible or to allowing a protracted long-term installment agreement. Once an offer in compromise is accepted, neither party can reopen the case in the absence of falsification of assets by the taxpayer, mutual mistake or other grounds sufficient to set aside a contract.
A taxpayer’s Reasonable Collection Potential has to be accurately calculated to ensure the success of their OIC. Taxpayers must offer the IRS an amount of money at least equal to, or greater than, their reasonable collection potential if they want the IRS to approve their Offer in Compromise. If the taxpayer’s reasonable collection potential is equal or greater than the amount of tax debt, penalties and interest that they owe, then it does not make sense to incur the cost of submitting an Offer in Compromise.
REASONABLE COLLECTION POTENTIAL
Simply stated, a Taxpayer’s Reasonable Collection Potential is the amount of money the IRS believes it can collect from the taxpayer, in relation to the Taxpayer’s assessed tax debt, penalties and interest. Conceptually, it is basically the liquidation value of the particular Taxpayer’s assets plus a determination of the Taxpayer’s monthly disposable income extended over 12 or 24 months (depending on the payment terms of the offer). In determining the amount collectible from the taxpayer’s future monthly disposable income, the IRS takes into consideration the taxpayer’s education, profession or trade, age and experience and health.
The liquidation value of a taxpayer’s assets is determined on assets that would be obtainable through administrative and judicial collection procedures available to the IRS. Included in the calculation are assets beyond the reach of the government and assets collectible from third parties. The liquidated value is the amount that the IRS estimates would be realized from the sale of a particular taxpayer’s assets under hypothetical financial pressures placed on the taxpayer by requiring that they sell their asset quickly, typically in 90 days or less. A Taxpayer’s assets are generally valued at 80 percent of their current market value and any amount owed to a secured creditor is then subtracted in arriving at the assets liquidation value. Courts have consistently held that it is not an abuse of discretion for the IRS to reject an offer in compromise where the liquidation value of taxpayer’s assets exceed their tax liability.
LIQUIDATION VALUE OF YOUR ASSETS DEMONSTRATED:
The liquidation value of your assets (cars, boats, real property – etc.) is calculated as follows:
- Fair market value of the asset, times
- 80% (which represents the quick sale liquidation discount factor), minus
- the balance of any loans secured by the property. (unsecured loans are ignored)
For retirement accounts (401k, IRA, etc.)
- Fair market value of the asset, times
- 70% (which represents the quick sale liquidation discount factor), minus
- the balance of any loans against the retirement funds.
MONTHLY DISPOSABLE INCOME
A taxpayer’s future monthly disposable income is estimated by examining the taxpayer’s past and present income. For lump-sum cash offers, the taxpayer’s future income is the amount that would be collected from the taxpayer’s income over a period of 12 months. For short term periodic payment offers, it is the amount that would be collected over a period of 24 months and for deferred payment offers, it is the amount that would be collected during the remainder of the taxpayer’s 10 year statutory collection period.
What often makes or breaks an Offer in Compromise is the calculation of a Taxpayer’s Monthly Disposable Income. Even small adjustments to these monthly figures can have big effect on a taxpayer’s Reasonable Collection Potential and thus the likelihood of the success of a Taxpayer’s Offer and the associated financial benefit of making the Offer. The IRS will only allow the lower of a taxpayer’s actual monthly expenses or the IRS’s Collection Financial Standards amount for a particular expense in determining a Taxpayer’s Monthly Disposable Income. The key to successfully presenting a Taxpayer’s Monthly Disposable income as part of an OIC is to comprehensively and systematically document all of their monthly expenses taking into consideration the IRS’s imposed limitation on those expenses. It also helps to possess strong negotiation skills to ensure that the IRS allows the greatest amount of a taxpayer’s necessary living expenses where necessary.
