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The IRS Offer in Compromise

A Brief Explanation of the IRS Offer in Compromise

An IRS Offer in Compromise is an agreement between the IRS and the taxpayer to settle tax debt. Under specific conditions the IRS can settle out of court or "compromise" federal tax liabilities by accepting less than the full amount owed. The specific conditions are:

• There is doubt that the tax assessed is correct. This condition is called Doubt as to Liability.

• There is doubt that you could ever fully pay your tax liability. This is called Doubt as to Collectibility and is the basis for most Offers in Compromise.

• The tax liability is creating an undue or unfair hardship. For example, there is a medical disability and the taxpayer would be harmed by collection activity. This condition is called Effective Tax Administration.

Doubt as to Collectibility is the most frequently used basis for an Offer in Compromise. The process is a lot like the process used in a bankruptcy proceeding. For example, if your income is lower than "allowable" expenses and your assets are inadequate to pay the taxes then possibly doubt exists that you could ever pay the tax in full. You can file an Offer in Compromise after you are discharged in bankruptcy to resolve tax debt.

If your circumstances meet the IRS criteria to qualify for an Offer in Compromise then I will be happy to work with you and negotiate with the IRS to resolve your tax debt. The key to successful resolution is accurate information that is verified by documentation. Information is required for your assets, income, and allowable living expenses on a monthly basis.

Having many years of experience working with taxpayers all across the United States, I developed a thorough understanding of the process and have the ability to get the IRS down to the rock bottom, lowest amount possible. I have done it many times and I can do the same for you.

Your Offer in Compromise will be organized systematically into a spiral bound package containing all the required documentation to make your case in the strongest possible way. I often receive compliments from Offer Specialists, Revenue Officers and Appeals Officers telling me that I have presented a most compelling case for the taxpayer.

There are three options for repaying an Offer in Compromise tax settlement.

1. Cash Offer in Compromise - Tax debt settlement amount must be paid within 90 days of acceptance.

2. Short Term Deferred Offer in Compromise - Tax debt settlement must be paid over 24 months.

3. Long Term Deferred Offer in Compromise - Tax debt settlement must be paid off over 60 months.

Taxpayers are often surprised to learn that the offer process takes about five to six months to complete (longer if we appeal). During this time the IRS will withhold most collection activity. In other words they won't garnish your wages, levy your bank account or levy self-employment income while they are working on your case, but they may file liens. This can give you some valuable breathing room.

A More Complete Explanation of the IRS Offer in Compromise

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 IRS 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 be serious too.

The offer process seems deceptively simple. However, after you get involved you begin to realize just how complicated it can be.  A winning offer is much more than filling out the forms. To get final approval of your offer you must meet the requirements and you must be able to support your information with lots of documentation. The requirements are many and they are interrelated so there are a lot of moving parts. 

There are Three Ways to Compromise Income Tax Liability:

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 Payability". 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 your offer based upon 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:

• There are unfiled tax returns;

• You are in bankruptcy;

• Payroll deposit requirements are not being met;

• It is obvious that the Offer amount is less than the IRS would collect using collection activities; or

• 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 in place 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. Once your offer finally reaches the point where it is actually being worked on, the process moves quickly.

Should your Specialist believe the amount you offered is insufficient, you will normally be provided with the calculations that were used to determine the minimum acceptable offer. Consider this a counteroffer, which is determined by how much they think they can eventually collect. Their counteroffer is not determined by the amount owed.

Usually, counteroffers 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 need to 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 known 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.  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 they seize it and auction 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 were to file 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 W-2. 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 Lets Consider your Allowable Living Expenses for Three Main Categories:

Household, Housing and Transportation: The main categories for your expenses and their associated limitations are: Household Goods, Housing Allowances, and Transportation. 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 good 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 consists 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 the 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 will 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 had been misled by the IRS (and had 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 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.

Offer in Compromise for the Various States

Your state may have an Offer in Compromise program.

Your state tax liability should be taken into consideration along with your federal tax liability. Complications can arise if you submit an offer for both federal and state. 

If you want to settle with your state and the IRS and you include 100% all of your assets on both the state and federal offers - watch out - because your combined settlement amount will include twice the value of your assets. Your state may be willing to accept an offer at less than full asset value when a federal liability must also be settled if the state will receive a pro-rata portion. For example, if the state tax is one fourth of the combined taxes then the state may expect one fourth of the combined settlement.

Working two offers may be necessary. But unfortunately it is tricky because the state may be processing offers more rapidly than the federal, leaving you to decide to either accept the state offer without knowing whether your federal offer will be approved. Your state may allow time to await the IRS decision.

Filing requirements and information for your state may be similar to the Internal Revenue Service requirements.

Your state may require a copy of the Internal Revenue Service Offer in Compromise.

It is usually best to prepare the federal and state Offers in Compromise at the same time. You have more opportunity for a comprehensive settlement, avoiding duplication of asset valuation and net available income. Additionally, the processes and procedures are similar so that there are advantages in working them simultaneously.

You may still have a lot of questions about your situation so please call. I will be happy to help you and answer your questions.  
 

Ralph Sayers, CPA

(877) 316-4331

ralphs@tampabay.rr.com