This year may have been difficult financially, and when tax time rolls around you might discover that you owe more to the California Franchise Tax Board (FTB) than you can afford to pay.
The one kernel of good news is that you can make an offer in compromise to the State of California, just as you would with the IRS. It is a problem that many individuals or business owners in California have faced.
If this is your situation, there is light at the end of the tunnel. The FTB is willing to work with cooperative delinquent taxpayers to come up with a solution that works for both parties. One of these solutions is the offer in compromise (OIC). Could it be the right choice for you? Before you make a decision, you need to understand:
- What is involved
- How it can help your situation
- Whether you are eligible
- How to apply
At Brotman Law, we have found OICs to be a viable option for many of our clients. It can lessen the tax burden and give the taxpayer some breathing room. Most importantly of all, it gets the collectors off your back.
What is an Offer in Compromise?
The quick definition of an offer in compromise is “a settlement for less than the full amount you owe.” In practice, it’s slightly more complicated. Generally, an offer in compromise is something of a last resort. The FTB will generally consider an offer in compromise if you can prove that you have no way to pay your outstanding taxes, and when the amount offered is “the most the Franchise Tax Board can expect to collect within a reasonable period of time.” In this case “reasonable amount of time” is five-to-seven years.
Should You Consider Making an Offer in Compromise?
The FTB will expect you to exhaust most other avenues for paying off your tax debt. The most common way to pay off outstanding taxes is an installment agreement, but you will also need to consider taking out a loan or selling off assets. If you absolutely cannot find a way to pay and have no prospect of being able to pay the full amount within five years, you will have to look at making an offer in compromise.
The main benefit to the OIC, aside from having to ultimately pay less money to the FTB, is that in most cases it will halt the collections process. The FTB will usually release any state tax liens on your property and stop the actions of any third-party collection agencies.
Making an offer in compromise is not without its drawbacks, however. It is a financially invasive process, and the standards for acceptance are stringent. You may need to sell assets and forfeit tax credits and refunds. There is no guarantee that your offer will be accepted, and even if it is, you will need to be perfect in your tax dealings for the foreseeable future. One missed payment or late filing could jeopardize the agreement.
You will likely be waiving some tax benefits such as the statutes of limitations on investigation and collections. An OIC will likely stop the clock and leave you open to future scrutiny. You may also be asked to enter into a collateral agreement with the FTB. In a collateral agreement, you must promise to pay the FTB a percentage of any future income over a certain threshold for a period of five years.
To apply for an offer in compromise, you must have filed all your tax returns to date. To be eligible, your financial situation must be fairly dire, and it is up to you to prove your inability to pay the total debt. Each case is decided individually, and the FTB gives specific consideration to the following factors:
- Your ability to pay
- Your equity and assets
- Your present and future income
- Your present and future expenses
- The potential for changed circumstances
- Whether the offer is in the best interest of the state
The taxpayer can apply for a California State Tax Offer in Compromise only if they filed tax returns or are not required to file tax returns. The taxpayer also must fully complete the Offer in Compromise application, and provide all supporting documentation.
Then, the consumer must come to an agreement with the FTB regarding the amount of tax they owe, and must authorize the Franchise Tax Board to conduct an investigation and verify information on the taxpayer’s application.
If the Franchise Tax Board thinks the taxpayer has a potential for a future increase in earnings, it may, after approval of the application, require that the taxpayer enter into a so-called collateral agreement with the FTB. The agreement is for a duration of five years and will require the taxpayer to pay the FTB a percentage of future earnings if earnings become higher than certain threshold established by the FTB and agreed to by the taxpayer.
The FTB usually does not require collateral agreement if the taxpayer is on fixed income or has limited potential for increase in income.
Unfortunately, collection activity by the FTB does not stop even if it enters into an agreement with the taxpayer. The FTB may continue to collect tax if stopping collection efforts can potentially result in loss of the FTB’s ability to collect what is owed. Interest also continues to accrue.
The taxpayer submits an agreed-upon payment amount only when the Franchise Tax Board requests payment according to the Offer in Compromise Agreement. The Franchise Tax Board requires lump sum payment under this program.
The FTB can also work with an installment agreement if the taxpayer has the ability to make monthly payments that in total will exceed the amount initially offered by the taxpayer and accepted by the Franchise Tax Board.
To fill out a California State Tax Offer in Compromise application, the taxpayer will need to provide a significant volume of information. That includes verification of income, documents, such as pay stubs for the previous three months, or financial statements for the previous two years, if self-employed.
Any investment or ownership in the business or trust will have to be disclosed. For expenses, the taxpayer can provide billing statements for the previous three months. The Franchise Tax Board will require complete bank information, including statements for all accounts for the last six months for those who are employed, and for the previous two years for self-employed taxpayers. Information submitted must also include closed bank accounts.The FTB also requires information about securities owned, interest in real estate, information from the IRS, legal documents such as divorce decrees or marital settlement agreements, medical information such as any medical condition that should be considered by the Franchise Tax Board and any powers of attorney.
On the application, the taxpayer will be required to provide information about any court proceedings, bankruptcies, repossessions, recent transfers of assets, assets owned (like vehicles), life insurance, other assets, including anticipated assets and anticipated increase in income. The application will ask detailed information about the taxpayer’s expenses, too.
OICs for Businesses
Effective January 1, 2009, through January 1, 2023, the OIC program will extend to qualified active businesses where the taxpayer has not received reimbursement for the taxes, fees, or surcharges owed to the state, to successors of businesses that may have inherited tax liabilities of their predecessors, and to consumers who incurred a use tax liability.
Business taxpayers will have to provide additional information, including complete information about ownership and management of business, all bank accounts and credit cards, all assets and liabilities of a business, life insurance, receivables, pending litigation or pending judgments. Also, information about machinery, equipment, vehicles, trucks, aircraft and securities must be provided.
The Franchise Tax Board will ask for business references, for detailed income information, about salaries and disposals of assets worth more than $500 in recent period.
In some instances, OIC proposals may involve partnership accounts. If only one partner has requested an OIC, the responsible office should suspend collection actions only for the partner requesting the OIC.
Since the majority of major tax fraud cases involved corporations, it is important to note that an OIC will not be considered in situations where the taxpayer has been convicted of criminal (felony) fraud. However, taxpayers who have been assessed a civil fraud penalty may participate in the OIC program. In these cases, the CDTFA requires a minimum offer of the tax plus the fraud penalty. The minimum offer requirement may be waived if it can be shown that the taxpayer making the offer was not the person responsible for perpetrating the fraud. Usually, this situation occurs in partnership accounts where the intent to commit fraud can be clearly attributed to another partner.
Because every case is unique, it is impossible to say what the chances are that the FTB will accept your offer. It is worth noting that even if the IRS has accepted your offer in compromise, the FTB will not automatically also accept your offer on the state level. They will review your case themselves. The FTB is stricter and more aggressive than the IRS in determining which offers in compromise will be accepted.
California Interagency Offer In Compromise
California’s streamlined Offer in Compromise process, where now a single application can be used for three different agencies: California Department of Tax and Fee Administration (CDTFA), Employment Development Department (EDD) and Franchise Tax Board (FTB). The application is located at http://www.edd.ca.gov/pdf_pub_ctr/de999ca.pdf.
Just like before, taxpayers can apply for an offer in compromise program when they are unable to pay their full tax liabilities to the state. The program allows taxpayers to negotiate a reduced amount of their non-disputed tax liabilities.
The state will consider an Offer In Compromise when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects collection potential. However, previously California taxpayers had to submit a separate form to each of the three agencies. Now, they can submit a single interagency application with the state, and all three agencies will coordinate the offer in compromise process among themselves.
The form is available online at the California Tax Service Center (www.taxes.ca.gov), as well as at each of the three tax departments’ websites (CDTFA (www.cdtfa.gov), EDD www.edd.ca.gov, FTB www.ftb.ca.gov).
The individual agencies must still negotiate each Offer in Compromise separately for their respective taxes. For example, the FTB will negotiate a state income tax liability with the taxpayer and the CDTFA will negotiate a sales or use tax liability.
Main requirements for application have not changed. The taxpayer will have to agree with the amount due and the amount due is final, and the CTFA determines you do not have, and will not have in the foreseeable future, the income, means or assets to pay the amount due in full.
Generally, respective agency rules regarding offer in compromise programs did not change significantly. The CDTFA will also consider an offer in compromise for open and active businesses that have not received reimbursement for the taxes, fees, or surcharges owed; successors of businesses that may have inherited tax liabilities form their predecessors; and consumers, who are not required to hold a seller’s permit, but incurred a use tax liability.
Certain conditions apply, however, like signing a collateral agreement prior to approval of an offer and agreeing to remain current on all tax returns filed during the succeeding five-year period.
Like before, these three agencies will not initiate tax collection activity while the offer is pending. Agencies will look at taxpayer’s ability to pay, amount of equity in taxpayer’s assets, present and future income and expenses, likely future change in circumstances, and whether tax evasion or fraud is involved. Agencies can use both public and private sources of information to verify the taxpayer’s financial condition. If the offer is approved, then all tax liens will be released.
Therefore, a single application for all three agencies is a positive development, but the fact that three agencies still negotiate separately is probably a drawback.
The Process: How to Make Your Offer
Complete the forms – OIC FTB Application – FTB 4905PIT or the OIC Multi-Agency Application – DE 999CA. If you are making an OIC for Business Income Tax you will need to fill out the OIC FTB Application – FTB 4905BE.
You will be required to submit substantial documentation with your application form, such as pay stubs and statements from all of your bank accounts for the last six months to two years, including any bank accounts which you have closed. The forms ask for highly detailed information about assets, investments debts, insurance, court proceedings and pending litigation and even medical information if you have a condition which the FTB should take into account.
Legal documents to include are:
- Vehicle registrations
- Marital settlement agreements
- Divorce decrees
- Marital property settlements
- Trust documents
- Bankruptcy documents
If you are making an OIC for a business, you will probably have to include all of the above along with business references and comprehensive information about ownership, management, salaries and more.
The most challenging part of any OIC application is usually determining the amount to offer. The IRS has a set formula as a starting point for this calculation, but the FTB does not. At this point, it may be worth speaking with an experienced tax attorney. While representation is not required, it can help.
If your offer is accepted, you will have to pay the OIC in full. The FTB does not accept installments for offers in compromise. They will ask for a cashier’s check or money order for the full amount of your offer. If they do not accept your offer, they will contact you to discuss your case.
They may counter with a higher sum, or it may be that they have determined that you can afford to pay off the debt within five years. In that case they will help you set up an installment agreement. This is another area where a tax attorney can help. The appeals process for an FTB OIC is fairly casual, but negotiations are best handled with a professional by your side.
A huge tax bill can be devastating, especially when you do not have the means to pay it. For many people, the natural first reaction is avoidance and denial, which can quickly make a tough situation much worse.
Consequences for delinquent unpaid taxes are severe, and the longer you take to respond, the more trouble you can cause for yourself or your business. Remember that there are always options. If you are willing to work with the FTB, they will be willing to work with you.
At Brotman Law, we have seen and negotiated many deals with the FTB and can help you review your specific situation to arrive at a reasonable dollar amount with the highest likelihood of acceptance. Give us a call to find out how we can help you negotiate an offer in compromise with California or any other tax issues you may have.