Sam Brotman, JD, LLM, MBA December 16, 2013 5 min read

IRS Financial Analysis

IRS financial analysis is conducted by the IRS in order to both analyze and verifies financial information. When conducting an IRS financial analysis, the IRS evaluates the income and expenses of the taxpayer to calculate for disposable income. Disposable income is defined as gross income less all allowable expenses. During their IRS financial analysis, the IRS also analyzes assets to resolve balance due accounts. To do this, the IRS will request that the taxpayer makes full, immediate payment if their cash on hand is equal to the total liability. In addition, the IRS will identify key sources of funds, “liquid assets which can be pledged as security or readily converted to cash” (IRS.gov, “Part 5. Collecting Process, Chapter 15. Financial Analysis, Section 1. Financial Analysis Handbook,” 8/24/2013). Identification of key sources of funds is also extended to considering unencumbered assets, interests in estates and trusts, and lines of credit (“Section 1. Financial Analysis Handbook”). When analyzing assets to resolve balance due accounts, the IRS will also determine the priority of the Notice of Federal Tax Lien.

Under this category, the taxpayer may qualify for the six-year rule. This rule is most applicable to taxpayers unable to pay in full their federal tax liability; this rule also applies to those taxpayers who do not qualify for a streamlined installment agreement. Within this context, taxpayers must provide financial information but do not have to substantiate reasonable expenses. “All expenses may be allowed if the taxpayer establishes that he or she can stay current with all paying and filing requirements, the tax liability . . . can be fully paid within six years and within the CSED, and expense amounts are reasonable” (“Section1. Financial Analysis Handbook”). The six-year rule is not applicable to corporations, partnerships, LLCs, and business expenses.

Part of the IRS financial analysis process, the IRS will also verify financial information by conducting interviews, asking pertinent questions, and documenting the results. The IRS will ask questions with regard to the generation of income, the nature of the business process, the main products and services, major suppliers, assets held in the name of the taxpayer, and type of internet presence. The IRS will also “observe and document the physical layout of the business, the number of employees, the type and location of equipment, machinery, vehicles and inventory” (“Section 1. Financial Analysis Handbook”). The IRS will also verify previous collection issues addressed by field personnel to determine if reinvestigation is absolutely necessary.

IRS Financial Analysis - Net Realizable Equity in Assets

The net realizable equity in assets is defined as a calculation of the fair market value of the property multiplied by the quick sale discount factor, or 80%, subtracted by the balance of any loans secured by the property. The net realizable value of your assets is specific to cars, real estate, and personal property.

IRS Financial Analysis - The Asset/Equity Table

The asset/equity table (AET) is defined as a table that lists all of the taxpayer’s assets, encumbrances, and exemptions. The table calculates “the equity which is included in the reasonable collection potential (RCP) calculation” (IRS.gov, “Part 5. Collecting Process, Chapter 8. Offer in Compromise, Section 4. Investigation,” 8/24/2013). The major headings of the asset/equity table include the following: assets, fair market value, quick sale reduction percentage, quick sale value, encumbrances or exemptions, and net realizable equity.

Under each major category, the taxpayer lists information concerning different types of assets. References to assets include cash/bank accounts, offer deposit, loan value life insurance, pensions/IRA/401k, real estate, furniture/personal effects, vehicles, accounts receivables, and tools/equipment. On the table, the taxpayer calculates the amounts and lists the future income value. The IRS allows exemptions based upon the total dollar amount of the assets. With regard to cash/bank accounts, net equity should not be less than zero.

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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