Sam Brotman, JD, LLM, MBA July 2, 2020 30 min read

How IRS Offers in Compromise Work

What is an Offer in Compromise

An offer in compromise (OIC) is when the IRS accepts less than the full amount the taxpayer owes. You can pay a lump sum over five months OR make monthly payments over a period of 24 months. The IRS will take a reduced amount and in return, you promise to file and pay your taxes on time for the next five years. For example, say you owe the IRS $100,000. You can make an offer of $10,000. The IRS will accept the $10,000 under the condition that you file and pay your taxes in full on time for the next five years.

How was the $10,000 OIC determined? The minimum acceptable amount of an OIC is based on the taxpayer’s RCP — reasonable collection potential. The IRS, like every other government agency, has rules and standards for determining reasonable collection potential. RCP is equal to the quick sale value of the taxpayer's assets plus net monthly income times 60. The net monthly income is based over a period of five years, which is the basic formula that the IRS uses for evaluation.

The IRS takes your assets less what their value is if you quick sell them. To illustrate … Suppose you need to get rid of your car ASAP. You wouldn't be able to get 100 percent of the price you were asking for because you need to get rid of it fast. If you offered it for 80 percent of its value, someone would probably come along and buy it pretty quickly. That’s what a quick sale is.

When you submit an OIC, the government will take that offer and will translate it into two tables. The first table is an asset and equity table (AET) where you would list your assets such as banks accounts and your vehicle(s) and you would make a determination on what their fair market value is. The IRS, based on information that they have, will make adjustments to that, and then they look at what the quick sale value is.

With your car, it's quick sale value is 80 percent. With investments, it's 70 percent because you have 10 percent  penalty and you'll put 20 percent toward taxes. If your car has an open loan or your house has a mortgage, the IRS will subtract those amounts and come up with a net equity amount.

When we work with clients on an OIC, we try to lower the amount of equity in the taxpayer's assets as much as we reasonably can. We do that by looking at valuation, such as the Kelley Blue Book value for cars. We can also discount the value of the car based on any damage.

The AET is just the first part in defending your OIC. Where the offer calculation gets complicated is with the income and expense table (IET) and there can be some pretty big discrepancies between what the taxpayer is reporting and what the IRS is reporting. As a taxpayer, you need to make sure that you substantiate all expenses that you are claiming because if the IRS isn’t convinced you paid an expense, they will disallow it.

There are several ways to document expenses that we recommend to clients. They can use their most current profit loss statement, business bank statements or copies of checks. Use anything that you can do to prove your expenditures to the IRS. Keeping good records is to your advantage since it can take the IRS several months to process your request. By the time they come back to you with questions or denials, your circumstances may have changed making the original IET numbers you submitted obsolete.

Most offers in compromise for people who are self-employed are going to include housing, utilities, car ownership, health insurance, current taxes, child and dependent care, etc. Most of these categories on the OIC form are based on local and national standards. The taxpayer will claim one thing, but the IRS says, "If you're a family of two living in San Diego, we're only going to allow you a certain amount to spend on housing and utilities." Are your living expenses greater than IRS’ standard? “Tough luck. Move somewhere cheaper and pay your taxes.”

One thing to pay attention to is if there is any difference between what you are claiming and what the IRS allows. You can claim as much as the standard allows or accept the actual. Where you attract red flags is when the amount you’re trying to claim exceeds the standard.

How can you fight this? Going back to our housing example, that’s one area that is very difficult to challenge unless you can make the case that you need to live in a certain area to be close to work. You’ll have better luck trying to defend out-of-pocket medical expenses, which is an area that frequently exceeds the IRS standards. Other “gray” areas include food, clothing and miscellaneous. For example, if you follow a specific diet and you can prove that it offers significant health benefits, you can claim it. Or, if because of your religion, you have to follow a specific diet, you can try to claim those expenses if they exceed the IRS standard.

As with everything else, OIC is a numbers game. You need to submit as many legitimate expenses and as little income as possible. Remember that the IRS is going to project your future income for the next five years. If it looks like you’ll be able to pay off the full amount of your tax liability in five years or sooner, your OIC will be rejected.

Also, believe it or not, the IRS makes mistakes! If you receive a notice that the IRS needs more information or flat-out disallows your OIC, don’t give up. We have helped clients overturn IRS decisions by finding errors or submitting updated income and expense numbers.

If you have overwhelming tax debt and want to submit an offer in compromise, you need an experienced tax attorney in your corner. Samuel Brotman and his associates have years of experience in getting client’s OICs accepted by the IRS. Don’t go it alone. Give us a call.

 

How to Complete IRS Form 433-A

The 433-A (OIC) is the financial statement the IRS uses to evaluate an individual offer in compromise. It's like a collection information statement.. Basically, the purpose of this form is to calculate the taxpayer's reasonable collection potential.

For purposes of doing an offer in compromise, just remember, it's always the quick sale value of any assets, plus whatever their future income is 60 months. That's generally how they're going to be evaluated. The first thing you do with offer in compromise is to start with section one. Section one's all personal and household information such as name, date of birth, SSN, etc.

Section Two deals with employment information, which will include information about your current job if you are working. You will need your employer’s name and complete address, years employed and wage and hours. You can get this information from your W-2. Self-employment is addressed in Section Four

Section three addresses cash and liquid assets. You get this information from documents like bank and credit card statements, even if it’s for a bank account that you haven’t used for a long time. You need to get bank statements within the period of the offer (usually six months) showing a zero balance..

If you have a savings account with zero balance, you need to get statements from that account and list it. The reason why you need to substantiate zero balance accounts is because when the OIC unit gets one of these offers, they'll run your name through Accurint to see what your assets are and then run your credit report. The IRS Is able to find these things and you don't want to be accused of leaving anything off the offer.

With cash and investments, there's no quick sale value for those. The cash in your bank account is worth what it is but you do get to take a credit for a month's worth of living expenses. For example, say that your monthly living expenses are $5,000 and you have $3,000 in your bank account. You will get to keep the $3,000 as credit towards your living expenses.

Also include stocks, bonds, 401(k), etc. A 401(k) will have a penalty for withdrawal. Then there's also tax head on it. A lot of times, it will be 25 percent in tax plus a 10 percent penalty. You want to make sure that you discount those assets sufficiently so that you take the lowest possible value out of that. If you sold it, what would it really be worth after all the taxes and penalties? Then included that amount and do the same stocks and bonds and other investments.

You do not have to list term life insurance. Term life insurance is life insurance that doesn't have any value. The IRS is only looking for life insurance policies that have an actual value. You don't have to list that. If you own a house, you want to get the lowest possible valuation for you house that you can. If you go on Zillow, you can get the value of the house and then quick sale it and if the mortgage balance exceeds that, then you're done. You can stop. So long as the mortgage balance equals or exceeds the value of the property, then you're good to go.

If you go on Zillow and there's still equity in the property after doing 20 percent for quick sale and then still looking at the mortgage balance, then you're going to want to take another valuation. You can try using property tax valuation, based on the county assessor’s estimate, but the IRS will sometimes challenge them. Why? Often, the information is really old and outdated.

You can also turn to your homeowner's insurance policy. A lot of times, the homeowner's insurance will put a value on that house that they will generally list as replacement value and not a fair market value. It's not what someone would be willing to pay for it, it's what would cost to replace it, which is a lower value. If you can, take that value. As long as you have backup for it, the IRS will probably not challenge it.

For your vehicles, you need year, make, model, and mileage. If they're leased, they don't have any equity in them because the taxpayer doesn't own them. If you own them, go on KBB.com (Kelley Blue Book). I always recommend that clients list vehicles in fair condition. Then if it's an older vehicle, we will take a percentage off the quick sale value.

Generally, if a car's more than that seven years old, then take an additional discount, because it's probably not worth what the KBB is asking for. When you go on KBB, you always want the dealer trade-in value because that's going to be the most accurate determination. Dealer trade-in value, that's the quick sale, go from there.

When you go on Zillow, or when you go on KBB, or when you get the insurance statements, just make sure you have copies of that in the offer package. At the very end of the offer, you're going to see a checklist of items the IRS wants and that's really, really important.

When filling in the sections about personal property, unless you have any really expensive items, all you have to do is list personal assets. There is an exclusion in the IRM for about $8,000 worth of personal assets. We just use those personal assets like clothes and household items. The IRS isn’t going to be able to get value for that. The same with furniture. So, unless you have any artwork or expensive jewelry or anything along those lines, then you don't have to list any of that.

For business assets, we go off the list of items being depreciated which you can use from the depreciation schedule filed with your personal or business tax return. Business assets include equipment, tools, machinery, and things like that. There is another section in the IRM that gives you exclusion for tools that are being used for the production of income. So take that, if you can. The point is you just get all the assets on there, and you get reasonable value for them.

I recommend that you consult with a professional about accounts and notes receivable. We usually do not list AR because we view it as uncertain and not definite. There's no way to value it if it's not collectible..

With business income, you want to use the time period that best works to your advantage. Is it better to take a quarter? Is it better to take a six-month period or is it better to take a year? It depends on what the your business is. We usually get 12 months of bank statements the client’s or use their tax return. Take a look at your income totals, not expenses Take either three months, six months or 12 months, whatever works best.

Use the higher of either the national standard or your claimed expenses for monthly household expenses. If you’re over the standard on housing and utilities, you want to be very careful about that because the IRS will only give you credit for up to a year. You need to make sure you make up for it in other categories. The IRS won’t question is you’re over the standard of food expenses, as long as you have special dietary needs  that can be backed-up by your doctor.

Out-of-pocket medical is always one where you can usually go above the standards, especially since the IRS lowered them. Same thing for health insurance premiums, don't worry about it. We usually take about 25-35 percent for taxes for self-employed people, depending on how much income they're earning; 25 percent is usually about the standard. Look at their your year's tax return and see how much actual tax you paid.

If you’re paying more tax in the current year than you did in the old year, obviously take the higher value. The goal is to zero out the your income based on what your expenses are. You don't want to go super negative on expenses because if you’re negative on expenses, the IRS is going to ask questions. How are they living?

Unless you’re getting loans which are documented on the bank statements or unless there's some plausible explanation for how you’re living, then you need to zero that out. If you have expenses that are way over income, you want to start taking expenses off that list. You can put them back on later, but you want to make that number zero or as close to zero. For every dollar that's listed, the IRS is going to multiply it by 60 and that's going to be as minimum offer amount. That's what we want to do.

Calculate the minimum offer amount. It's the same thing if you go through the calculations on Section seven. If the offer amount doesn't shake out to what you want it to be, then just list the offer amount as whatever you feel like. I usually advise my clients to never offer more than $5,000 on an offer. In most cases, they'll only offer $1,000. Don't even matter what the liability is.

The same strategy applies to section eight. If you have filed for bankruptcy, include a copy of the petition. If you’re a beneficiary of a trust instead of a life insurance policy, it’s really in your best interest to consult with a professional. The rest of the stuff is pretty straightforward.

The most important part of the OIC is actual form itself and that it’s well-organized  Try to see if from the perspective of the offer specialist. If you
get a nice package in the mail and it's organized and the numbers are really clear, it all makes sense and you can flip through and you can see things and it's really easy, then there's more of a chance that the offer is going to be accepted on the spot versus having to go through the analysis. We want to get our offers accepted when they're submitted if possible. That's why we screen out as much bad stuff out of the offer as we can.

Hopefully, this walk-through of the A433 form was helpful. If you are thinking about submitting an offer in compromise to the IRS, it’s possible to complete the form on your own. However, if your situation is complicated, you’re self-employed or have some of the special circumstances described in this post, you should seek professional advice. The tax attorneys at Brotman Law can help you prepare your OIC so it has the greatest chance of being accepted the first time around.

 

FAQs: Offers in Compromise and Form 433A

Does it cost anything to file an OIC?

Yes. The filing fee is $205. In addition, the IRS will require a 20 percent down payment if you are making a cash offer.

How long is the repayment period?

Five months if you offer to settle for lump sum. Twenty-four months if you are on an installment payment plan.

If I declare the available amount on my credit card(s) as an asset, won’t I have to pay it back? Isn’t that just creating more debt?

It is creating debt, but the IRS views itself as a priority creditor. They want you to deplete all available credit cards, all available lines of credit, anything that you have that has value in it, in order to pay your taxes.

When we have a client with a lot of open credit cards, we tell them to either; A, max the credit cards, or B, get rid of them. When they have a home equity line of credit, we get rid of the line of credit. You want to deplete any open sources of equity.

How much leeway does the IRS give you regarding personal living expenses like food?

Not much. The IRS has standards for expenses like food, clothes, car expenses, etc. As an example, the standard for a single person is $612 a month. If you spend that much or less, you’re good. If you spend more, then the IRS will only allow the $612. There are religious exceptions. One way to get around this for food expenses, is to have your doctor submit a letter stating that you need to follow a specific diet for health purposes. There are also religious exceptions.

I use my car for business.  How much am I allowed to claim?

The IRS standard for vehicle expenses if roughly $400 a month. This is one area where it’s very difficult to get an exception. The IRS also doesn’t care how far your daily commute is. If your car is paid off and is an older model, you can try to argue that you have ongoing maintenance expenses. If you care is paid off, but has a decent resale value, that doesn’t necessarily work in your favor. It might be time to go out and buy car, which will add a claimable expense to your OIC.

Should buy a life insurance policy? Does the IRS count that as income?

No. Life insurance is an allowable expense. But, remember, they are looking at your reasonable collection potential over five years. During those five years, that whole life insurance policy is going to increase in value, therefore, it’s not a good idea to purchase life insurance for the purposes of adding expenses to your OIC.

Does the same advice apply to health insurance?

The IRS will allow health insurance, so if you are uninsured or underinsured, this presents the ideal situation to go out and purchase new or upgraded coverage.

What about retirement accounts?

All retirement accounts need to be reported on the forms and schedules you submit to the IRS along with Form 433. No listing them would be considered filing a false document. In most cases, the IRS will expect you to withdraw funds from your retirements accounts to put towards your tax debt. However, in certain circumstances, such as if your retirement accounts are with a foreign financial institution, the IRS will consider an exception. In those cases, it’s best to work with a qualified tax attorney. The IRS also takes a hard look if substantial amount were withdrawn from your retirement accounts prior to filing your OIC.

I recently declared bankruptcy. Can I still file an OIC?

No. The IRS will not accept an OIC if the taxpayer has declared bankruptcy. After the bankruptcy is discharged, you can file an OIC.

What is the difference between a rejection and return?

If your OIC is rejected, you have 30 days to file an appeal. If you offer is returned, you can try to submit a new offer, along with the application fee and down payment.

An Offer in Compromise is a good solution for individuals or businesses who are quagmire in back taxes with no relief in sight. However, it’s mandatory that you stick to the rules by making your payments on time AND filing and paying your taxes in full for the next five years. But, it’s not the best solution for everybody. If you have a backlog of taxes and are unsure about your next move, consult with the attorneys at Samuel Brotman Law. We can put together a strategy tailored to your specific needs that will get you back in the good graces of the IRS as quickly and painlessly as possible

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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