Clients ask me all the time, "Can't you
simply tell the IRS my offer"? The answer is, "no." The only
way to make an offer to reduce your tax is through the Offer in
Compromise program which is authorized
by federal tax law. There is a statue in the law that governs
the process. The Internal Revenue Service has set up detailed
procedures designed to follow the law. The offer process is more
investigative in nature than an examination or audit. The IRS is
serious about the offer process and if you want your offer to be successful,
you need to get serious too.
The offer process is deceptively simple. A
winning offer is much more that filling out the forms. To get
final approval of your offer you must meet the requirements and
you must be able to verify your information with documents.
There are a lot of documents that you must provide. The
requirements are many and they are interrelated so there are a
lot of moving parts. After you get involved you begin to
realize just how complicated it can be.
There are three ways to compromise income tax
liability:
Doubt as to Liability: The first way
is called Doubt as to Liability. It is called this because you
are saying that you doubt you owe the tax. Doubt as to Liability
is rarely used. There are a number of reasons it is not used.
The main reason is because once your tax has been assessed there
is a legal presumption that they are correct and this
presumption is hard to overcome. Another reason is that if your
taxes are in fact incorrect there are usually other remedies
available that are easier to do.
Doubt as to Collectibility: If from your perspective you
doubt you could ever pay the tax liability then you might say
there is "Doubt as to Payabilty". From the IRS's point
of view, the tax is not "collectible", so they label
the process "Doubt as to Collectibility." If you are making you
offer based upon your not being able to pay, you must be able to
convince the IRS that it is unlikely you will ever be able to
pay. Here is a simple example: An offer that would surely be
approved for an elderly person of low income may not be approved
for a person of the same income if they were just starting out in a professional career. There is a lot about the decision
process that is relative.
Effective Tax Administration: You can also request to compromise
your tax debt on the reasoning that it is good public policy or that
paying the tax is simply not equitable... it isn't fair.
Effective Tax Administration or ETA might be used if you were
disabled or had a serious medical condition or there were
unusual or extenuating circumstances that would make paying the
tax unconscionable.
Most likely your offer would be based on
Doubt as to Collectibility. To successfully compromise your tax liability
based on collectibility, you must convince
the IRS that they will get more from you if they accept
your offer than they will get otherwise.
Processability and Processing Procedures
Your offer is initially reviewed to qualify
it for processing. Here are the reasons that your offer would be
returned to you as not processable: a) You have not filed all
your required tax returns. b) You are in bankruptcy. or c) Your business is not in compliance with 940/941 filing and depositing requirements.
Your offer will be returned as not
processable if it is obvious that the offer amount is less than the IRS
would collect using collection activities.
Offers may be returned if the IRS believes that
the sole purpose of the offer is to delay collection.
It usually takes about seven to ten days for
the IRS to make a determination as to processability. As soon as
your offer is entered into the IRS system as processable, freeze codes are
put into the system to stop collection activity. Almost always,
the IRS stops all collection action. In unusual situations if
collection of the tax is found to be in jeopardy they may
attempt collection.
Your offer will be held pending assignment to an
Offer Specialist. The IRS is trying to process offers within six
months and that is about the way it is working out. Sometimes it
takes longer but never less than five or six months. The IRS has 24 months to process
your Offer or it will be automatically accepted. Offers that
present no unusual issues may be accepted without further
inquiry. Normally, additional
information or updated information is required.
If your offer is sent to a local IRS
office, you will receive a letter notifying you of the assignment
and alerting you to pending contact from your Offer Specialist or their representative. Once the
Specialist receives your offer, they will place it in the queue
where it will await its turn to be worked. As soon as your offer
finally reaches the point where it is actually being worked, the process
moves quickly.
Should your Specialist believe that the amount
you offered is insufficient, you will normally be provided the calculations
that were used to determine the minimum acceptable offer.
Consider this a counter-offer, which is determined by how much
they think they can eventually collect. Their counteroffer is
not determined by the amount owed.
Usually, counter-offers are made based upon
valuation differences between the Offer Specialist and the taxpayer
for example, the value of your home or car. Additionally, the
Specialist may have a different opinion as to your actual
income, or the necessity of your living expenses.
Rejected offers are given an independent administrative
review. The independent
administrative reviewer must review all offers prior to sending
out the rejection notice. You can
appeal the rejection in most cases and may get a better
deal with
the appeals officer. Common reasons for appeal usually relate to
valuation of property and matters having to do with the necessity of
living expenses, and work related expenses such as
transportation. Many offers are denied by Specialists who do not
see eye-to-eye with the taxpayer so those offers must be appealed
to receive a full and fair hearing.
When the Offer Specialist recommends acceptance,
your offer is sent to the group manager for final review. Once
accepted, you are sent a letter explaining the terms of
acceptance and a copy of the
offer signed by the IRS's authorized Officer.
Calculating Your Minimum Acceptable Offer
(MAO) also know as Reasonable Collection
Potential (RCP)
The offer Specialist must calculate your Minimum Acceptable Offer (MAO) by determining the amount of unpaid tax
liability that can be collected (1) from liquidating your assets and (2)
from your income using an installment payment plan. With
regard to your assets, there may be valuation issues and with
regard to your income, there may be issues related to amount and
duration of income as well as expense issues.
The Collection Information Statement Form
433A is basically in two parts:
1. Assets, Liabilities and Equity and
2. Income and
Expenses
1. Assets, Liabilities and Equity
You may be surprised to find out that when it
comes to determining how much your house is worth, the Internal Revenue Service
will place a lower value on it based upon how much can be realized if the IRS seizes
it and auctions it (called "Quick Sale Value" or QSV
- generally = 80%) rather
than how much you could get marketing and selling in an open
market.
Your minimum offer will have to be
more than the cash the IRS would receive if they sold all your assets.
You must have an outside source of funds. A good source might be a loan or
gift, usually from a relative or friend. The IRS cannot make you borrow
on your credit cards but if you have available credit, they will
want to increase your offer amount. So credit cards are double
edged, they give you something to offer and they increase your
offer. An outside source will not increase your offer. Having cash value in
life insurance can be a problem unless you can mount a
serious threat of bankruptcy. It isn't easy to scare the IRS
with bankruptcy threats.
If you cannot take money out of your retirement plan at work,
either by withdrawal or loan, then it is valued at zero in
calculating your MAO. You may need to do some cash planning with
your IRA. Most employer sponsored retirement plans will let an
employee roll an IRA into their qualified plan at work.
The offer Specialist will calculate your average personal checking
account balance using the most recent three months bank
statements that you must send in with your offer. The Specialist
will subtract one month's allowable living expenses from the
average balance. The result will be added to your MAO. Cash in savings accounts will be
added to your MAO. Your bank statements must verify the financial
information submitted with your Offer. Deposits
on your bank statements must agree with your income or they must
be explained by loans, legitimate gifts, etc.
If you are self-employed, the value of
your business will be considered an asset (business valuation
may be arguable). If your main source of income is your business, do not
double count your accounts receivable in your MAO by including
money coming in from those receivables as income. This is an
area where you may need some accounting help.
If you cannot
liquidate your retirement plan without terminating your employment
then the asset has no value and is not added to your MAO.
Nevertheless, you must include details to explain how the asset
is being treated in your offer calculation.
Because the IRS can levy IRAs they must be
included. Because voluntary liquidation gives rise to a tax and
a penalty, you are allowed a discount for the payment of
tax and penalty upon liquidation.
If you are a potential candidate for
bankruptcy you need to weigh the pros and cons of a bankruptcy
compared to the IRS Offer
in Compromise. The IRS sometimes will consider the consequences
to the government if you filed bankruptcy. Any threat of
bankruptcy must be credible and you may need supporting
documentation such as a letter from a bankruptcy attorney.
Regarding IRAs, bankruptcy courts will consider the needs of the creditors
and the needs of the individual to decide whether the IRA is
protected or not. This can vary and you would need to see an
attorney in your state. The IRS may consider the potential for bankruptcy
in valuing the offer.
You might think that the value of your
automobile is a simple matter but the offer Specialist may argue that the
value should be closer to retail. This may seem absurd since the
IRS would be unlikely to get anything close to retail in
liquidation. You must be sure to include all automobiles you own
because the offer Specialist researches all registered
vehicles in your name, including vehicles recently sold or transferred.
The Offer Specialist will usually discount
the value of your home and other real estate 80% of the fair market value.
The IRS calls this discounted valuation the 'quick sale value'. If
you own a home or other real property you should get an appraisal or
credible evaluation.
In community property states, all community property is
available to satisfy the debts of
either spouse. Property held in a true joint tenancy, is only
available to satisfy one-half the debt of each
spouse. Prenuptial and post nuptial agreements can separate property, if executed
in a manner and a
time in such that the conveyance would not be deemed an attempt
to avoid or evade paying tax. It is important to thoroughly
evaluate your particular circumstances in terms of the timing
and the governing laws and to review your documents such as
marital agreements, court orders, etc.
You can
exclude amounts specified by law for tools and equipment used in
your trade
or business. Additionally, you can exclude specified amounts for
furniture and household items. You may be able to claim an
exclusion for your truck or perhaps an automobile if required in
your work.
2. Income and Expenses
First, let's consider your income and how your
net income affects your offer amount:
Most offers fall flat for the simple reason
that the taxpayer can pay
from income the amount of the offer. In other words, the Offer Specialist
will counter your offer with an installment agreement using the
information you submitted with your offer. The Offer Specialist
simply multiplies your monthly income times
48 months. For example, if you can make monthly payments of $100, then your offer amount must be $4,800 plus the value of
your assets.
The 48 multiplier seems a bit arbitrary but
there is actually a lot of history behind using 48 as the
monthly income multiplier. Current law allows you to pay a
"cash offer" over a five month period. For longer payout periods, the
multiplier goes up.
If you are a wage earner your income is
easily determined by reference to your pay stubs or W2. If you
are self-employed your income will be measured based upon
documentation appropriate under the circumstances. The idea is
to keep it real. Last year's net
income is usually a good reference point. If your projection differs from
your prior year's tax return you will need to provide rational
and reasonable information to reconcile the difference.
Your income reconciliation may be critical to
the success of your offer. Your reconciling items may include
anything that you expect will impact your business net income.
Now let's consider your allowable Living Expenses for three
main categories Household, Housing and Transportation:
The main categories for your expenses and
their associated limitations are: transportation, household goods, and housing
allowances. These are derived from IRS tables that take into
consideration the cost of living in your region, state and
county and vary by income
level and the number of persons in your household. You can find
the tables on the IRS website but it is easiest to simply Google
the term "IRS National Standards."
Household Expenses for Food, Clothing,
Housekeeping Supplies, Personal Care Products & Services and
Miscellaneous: The Household Expense Category (not to be
confused with Housing Expenses) consists of Food, Clothing and Personal Care items which are usually granted automatically and
you are generally limited to the standard amounts from the
table. This expense category is used as a substitute for actual monthly
expenditures which most people do not ordinarily have
documentation for, such as food items and other household items.
You may argue a higher amount than the standard but it is an
uphill battle. For example, if you are spending more on food than
is allowed by the standard you may successfully argue you have
an expensive diet for health reasons... if you can back up your
argument with a doctor's prescription. Don't count of winning
here unless you have a very good argument and documentation. The
point is - you need both a good reason and documentation.
Housing & Utilities Expenses on your
principal residence for Rent or Mortgage, Utilities, Taxes and any other expense associated with
home ownership or renting.You are not automatically
allowed housing and utility expenses. The
expense generally allowed will be the lesser of (1) your actual
expenses and (2) the median expense of living in the county of
residence. It is possible to argue higher amounts depending upon
your circumstances.
If you share living expenses with another
person you will be limited to your share of the expenses based
upon your actual contribution to the
household, if you have an agreement (preferably in writing). If
you don't have an agreement then the expenses will most likely
be allocated based upon your proportional share of total
household income. For example, if you earn $20,000 and your
housemate earns $20,000 then you are allowed half of the
household expenses.
You must provide proof of car payment,
lease, fuel, oil, insurance, parking and registration fees.
Documentation is required for the
non-business use of your car. Your business use of a car should
be deducted from business income on your Income Statement or
Schedule C, Form 1040. There is an upper limit on the allowable
transportation expense. There are two parts to the limitation.
Your monthly ownership cost consisting of your lease or monthly loan
payment and
operating costs. The National Standards for operating costs are based
upon the average
transportation cost for your geographical area and ownership costs are
the same nationwide.
The expense category for Healthcare is made
up of your monthly average of un-reimbursed expenditures for medical expenses, and
the cost
of medical insurance. Documentation is required for the most
recent three months and for any expenses you want to be added in
to be averaged. You can expect the IRS to closely examine
documentation for this category of expenses.
Your payments for withholding and estimated taxes
must be current.
You must provide a copy of court order and
proof of payment for child support and other court ordered
payments.
You are allowed to deduct life insurance
payments for term insurance (not whole life, universal life or
variable life) equal to three times your average salary.
Higher premiums require explanation and may or may not be
allowed.
You are allowed to deduct expenses incurred in the production of
income (not deducted elsewhere) such as gasoline, tolls, parking, union dues, office in home expenses and other expenses necessary to earn a living.
You may be allowed to deduct other expenses
if you justify them with a strong argument and have required
documentation. Donations to your church or religious
organization may or may not be allowed. It can depend on your
particular needs and perhaps on the Offer Specialist's judgment.
You will not be allowed a deduction for your kid's college
tuition. In some cases expenses for home schooling and private
schooling may be allowed.
Your expenses cannot be more than your
earnings unless you are receiving money from some other source.
So be prepared to provide an explanation as to the source of
additional funds beyond your earned income.
If you are not able to pay the amount offered
within five months of acceptance of your offer, you can elect to pay over
24 months. Unfortunately, your offer price must be higher
because a multiplier of 60 will be applied to your net available
income instead of 48. A better idea might be to calculate how much
you can pay on a
monthly basis and agree to pay that amount
monthly until the Statute of Limitations runs out.
The Statute of Limitations for collection is ten years from the
date of assessment.
Effective Tax Administration or ETA:
Your offer may be acceptable if collection of the tax would create an economic hardship
for you or would be
detrimental to voluntary compliance.
Here are some specific examples of
circumstances where compromise is appropriate as explained in
IRS Regulations: A mother with a child who has a long-term illness
and
liquidation of the mother's assets would leave her without the ability to
provide for her child; a retired person that would not have
enough assets to provide for basic living expenses if his
retirement plan were liquidated; and a disabled taxpayer with a
home that has been specially equipped to accommodate his
disability and where liquidation of the home would render him
unable to get these facilities elsewhere. The overall pattern of
facts in each case needs to show a good compliance
history that does not weigh heavily against compromise.
As a result of testimony in Congressional
hearings in 1997 the IRS completely reversed its position in the case of
corporate Payroll Taxes and related Trust Fund Recovery
Penalties. If there has been an embezzlement of funds of which a
corporation was unaware and should not have known of, and if the
company is profitable, but not profitable enough to pay the
liability, the IRS will consider settlement.
This standard is difficult to understand.
Generally, the IRS may compromise a liability
where exceptional circumstances exist such that collection of
the full liability would be detrimental to voluntary compliance.
You might interpret this to mean that the IRS doesn't want to be
seen in the media as villains attacking helpless people.
The regulations provide an example where a taxpayer
incapacitated for several years discovers that he owes more than three times the
original tax. Another example is about a taxpayer who has
been misled by the IRS (and has documentation, letters etc.).
Unfortunately, in most cases the taxpayer does not have IRS advice
in writing. The moral to this story might be: Get IRS advice in
writing, but that's not always such an easy thing to do.
An offer made based upon Effective Tax
Administration is difficult to to get approved. The rules are
unclear and much is left to the judgment of the Offer Specialist
adding to the uncertainty. An offer based upon doubt as to
collectibility has a much greater chance for approval... the
concepts are much easier to comprehend and the requirements are
easier to fulfill.
