Sam Brotman, JD, LLM, MBA October 7, 2020 8 min read

What Are the Rules for an IRS Offer in Compromise

Salability of Assets

Salability, or marketability, is defined in terms of liquidity, “the ability to quickly convert property to cash or pay a liability” (IRS.gov, “Discount for Lack of Marketability: Job Aid for IRS Valuation Professionals, September 25, 2009, page 5” 8/25/2013). Under the IRS offer in compromise rules, liquidity is essentially the ability to convert an asset into cash without losing the principal. Conversion is not only specific to the term asset; it may include business, business ownership interest, and/or security.

However, liquidity differs from marketability. Used interchangeably with marketability, salability is “the capability and ease of transfer or salability of an asset, business, business ownership interest or security” (“Discount for Lack of Marketability.”) 

Marketability is defined as the fact of salability. If it is liquid, then it is marketable. However, if it is non-marketable, then it is illiquid. “Being illiquid does not necessarily mean non-marketable. It may still be sellable but not quickly or without loss of value” (“Discount for Lack of Marketability.”)

When evaluating a taxpayer’s assets, the IRS will determine the ability of the asset to be converted to cash in order to satisfy the federal tax liability. The IRS will take into consideration economic factors affecting marketability.

Current Assets: Cash and Cash Equivalents

Credit Cards

According to the IRS, the payment of credit cards does not fall under the category of necessary living expenses. It is important to consider this fact when understanding the goal of the IRS in determining your ability to pay the federal tax owed. 

Form 433-A will undoubtedly require the taxpayer to list all lines of credit and bank- issued credit cards. On the form, the taxpayer must include the account number, the credit limit, the amount owed, and the available credit as of a particular date. In essence, the IRS encourages taxpayers to pay their federal tax liabilities using a credit card because the interest rate on the card is much lower than the interest rate plus penalties charged by the IRS. 

The penalties and assessments of the IRS make it more difficult for taxpayers to repay the tax balance over time, whereas paying off the owed balance on a credit card would not incur the extra added penalties typically assessed by the IRS.

Long Term Assets

Long-term assets are defined as those that fall under the categories of stocks, bonds, real estate and cash. Taxpayers must list all long-term investments on Form 433-A. On the form, investments are defined as stocks, bonds, mutual funds, stock options, certificates of deposit, retirement assets, and corporations, partnerships, or limited liability companies in which you have a business and/or financial interest.[1] You must calculate the total value of your interest, any loan balances and the equity value minus loan balance.

Monthly Cash Flow

Monthly cash flow is determined as the ability of cash and/or earnings to come in and be expended out on a monthly basis. Form 433-A requires taxpayers to outline and calculate all categories of monthly income, whether generated as wages or through investment distributions; and calculate all categories of expenses — those specific to necessary living. To obtain the net difference, you must subtract total living expenses from total income. This gives you an idea of the monthly cash flow specific to your income and living expenses.

[1] Your interest may be defined in terms of your investment or your role (i.e., officer, director, owner, or member).

Income and Expense Table and Future Income

The IRS Income Expense Table

Similar to the asset/equity table, the IRS income and expense table (IET) outlines necessary living expenses, where the taxpayer lists both total income and expenses. The IRS income and expense table is divided into two major categories where the taxpayer eventually calculates the net difference multiplied by one or more amounts to get to “amount that could be paid from future income” (IRS.gov, “Income and Expense Table,” 8/25/2013).

Under the total income column, taxpayers must provide information with regard to the following:

  • Wages
  • Wages (spouse)
  • Interest – dividend
  • Net business income
  • Net rental income
  • Pension/Social Security (taxpayer)
  • Social Security (spouse)
  • Child support
  • Alimony
  • Other income if applicable

Taxpayers calculate amounts and list the total income in the first column of the IRS income and expense table. In the second column, taxpayers provide information concerning necessary living expenses — those claimed and those allowed.

Necessary living expenses are defined as those that are required for living and carrying on daily life. Food, clothing, housing, utilities, vehicle operating costs, health insurance, out-of-pocket healthcare costs, child/dependent care, current year income taxes, state and local taxes and secure debts are considered necessary living expenses. 

“Other expenses, such as charitable contributions, education, credit cards, and voluntary retirement allotments are generally not considered as necessary living expenses” (“Income/Expense Table”). The income/expense table is useful in helping taxpayers calculate both the amount that could be paid in the future and the amount that could be paid in general. 

Future Income Potential

Future income potential within the context of tax law and the IRS income and expense table is defined as the ability of the taxpayer to generate earnings through physical exertion. In addition, future income potential also refers to the ability of the taxpayer’s assets to generate a return on investment. 

Within the context of investing, future income potential refers to “earning potential,” the upside of a particular product generating earnings. The earning potential of an investment represents the largest possible profit made by a corporation and is usually passed on as dividends to the investors.[1] 

[1] For more information about earning potential, review the Investopedia definition. The link is available here: http://www.investopedia.com/terms/e/earning-potential.asp

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
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