Sam Brotman, JD, LLM, MBA July 2, 2020 12 min read

IRS Offers in Compromise

Offers in Compromise

The government evaluates offers in compromises (OIC) based on what a taxpayer's reasonable collection potential (RCP) is. Remember, an offer in compromise is an agreement between the taxpayer and the government to forgive a past tax liability in exchange for future compliance. 

The government is not just going to forget about the liability. The government wants to make sure that the offer it is getting from the taxpayer is fair to the government and it uses a formula called reasonable collection potential to determine the acceptable amount of the offer. 

The way reasonable collection potential works is the government looks at the taxpayer's current situation, for example, "John is a taxpayer who is submitting an offer in compromise. How much could we reasonably collect from John over the next five years and is that amount equal or lower than what John's offer in compromise is?" 

The IRS is taking a five-year period and estimating how much they can get out of the guy. If that amount is equal to or less than the amount of the offer, then the government is inclined to take the offer.

RCP is equal to the quick sale value of any assets that the taxpayer has plus income minus expenses over that period of time. Starting with the asset part of it, the IRS will take all the taxpayer's assets, and estimate their value if the taxpayer were to liquidate them. That is a quick sale value.

It is the liquidation value of all the taxpayer's assets as of today. Then the government will take that number and then add that to the variance between the income and expenses for reasonable living expenses for the taxpayer over the next five years (60 months). 

Looking at Income and Expenses

If the difference between the taxpayer's income and expenses is $100 over 60 months, then it is $6,000. If it is $500 over 60 months, that is $30,000. As you can see, the reason a lot of OICs get rejected is because number one, the taxpayer has sufficient assets which are way above what the taxpayer is offering.

Number two, it is the difference between the income and expenses on the IRS's side of things. That is the calculation that the government is running. If you go through the offer in compromise process, the government comes back to you and either accepts your offer, presents a counteroffer or rejects it. 

They have these tables that they use. They break down all your assets based on that table. They break down the income that you have on a table and the expenses you have on a table. 

When we do an OIC, we are looking at those tables to see how the government is calculating what the RCP is. That, in a nutshell, is how offers in compromise are evaluated. Depending on the variables that you put into that formula you will get different results.

“Ordinary and Necessary” Living Expenses

The real kicker with offers in compromise is the term ordinary and necessary. The IRS has standards and they are based on both national standards and local living standards of how much things should cost. For example, with your housing, the IRS has an average based on where you live based on housing costs in your area.

If you go to the IRS website and look up the IRS housing standard, it will tell you what your housing expense should be. The number is probably not very much to your liking, but the IRS comes up with these standards and then that is what they consider to be your ordinary and necessary living expenses.

They take your income and your ordinary and necessary living expenses, and that is how they negotiate a payment plan. The way they calculate this is through an IRS financial standard.

They will ask you to fill out a 433-F or 433-A, or if you are a business, they are going to ask you to fill out a 433-B. That financial statement is a list of all of your assets, all your sources of income, all your available lines of credit and all your expenses. They take that information and come up with a determination based on that form.

The reason that there is an art to this is because we are moving ourselves to the science side; this is a fluid negotiating process. The numbers that are listed on the 433-A can change. By understanding the variances in the numbers and what the IRS is looking for and how the procedure works, there is an art to negotiating payment plans. 

With smaller liabilities, there is not much art to it; it is mostly science. But if you owe liabilities of $50,000 or $100,000 or a million dollars, those are liabilities that require a little bit more art than science.

Different Types of Offers in Compromise 

There are three main types of offers in OICs at the federal level. There is doubt as to collectibility, there is doubt as to liability and there is effective tax administration.

We can start with doubt as to collectibility. Doubt as to collectibility is the traditional offer in compromise that you may have heard of, "Let us settle your tax liability for pennies on the dollar."

Much like the name suggests, the reason that you are submitting an offer in compromise is the doubt that the government will ever be able to collect that liability over the next X-number of years. 

From the government's perspective, the government has a lot of people who owe it money. It is not interested in going after a lost cause, so the government would rather cut its losses, settle the account, get you in compliance and move forward. That is essentially what a doubt as to collectibility offer in compromise is.

In a doubt as to liability offer in compromise, you are debating whether or not you actually owe the liability and you are making a settlement offer to the government based on A) the fact that you do not owe this liability and B) the risk to the government, if they do not take your doubt as to liability, that they will not collect anything, or will collect less than the offer that is being made. That is a doubt as to liability offers in compromise.

An effective tax administration offer in compromise is asking the government to forgive a tax liability for a reason that does not fall within doubt as to collectibility or doubt as to liability 

Effective tax administration offers in compromises are generally reserved for old people, sick people, or those with any sort of disability. From a public policy perspective, yes, an elderly person might have sufficient assets to pay the liability, but taking away grandma's retirement fund and leaving her with nothing for the rest of her days is not the best course of action from a public policy standpoint.

When you get into those situations, they are obviously much more difficult. They are very fact-specific and very fluid. Many times, OICs do not always work.The reason for that is a lot of people do not know what they are doing when they go through the process. 

The OIC process is very formulaic and very rigid. Because of the higher amount of rejection, If you are going to do any type of OIC and you are going to make a good faith effort, I encourage you to consult with an attorney or a knowledgeable professional to help you navigate through the process.

Other Payment Options

If you owe money to the IRS, someone will show up eventually, either physically at your door or through correspondence, and say, "Hi, you owe us money. How would you like to pay us?" 

They will certainly take payments towards the liability. Now keep in mind that if you are on a payment plan with the IRS, interest in penalties will continue to accrue. 

Generally speaking, there are three types of payment plans. There is an automatic payment plan. If you owe a liability less than $10,000 to the IRS, they will automatically put you on a payment plan. 

There is a streamlined plan, which is if you owe $50,000 or less, the IRS will put you in a predefined installment agreement plan generally without the production of financials, which is great. 

Number three is the regular installment agreement. The regular installment agreement requires you to produce financials to the government. They look at and they analyze what your ability to pay is, and then you go from there.

A fourth option for adding a caveat to the regular installment agreement is something called a partial pay installment agreement. This is for older liabilities and when there is less time that the government has to collect on it, Oftentimes, they will take something rather than nothing. 

Those are really what your options are if you owe more money to the government that you can pay. The IRS will take payments and they will put you on a payment plan, and encourage you to get back into compliance.

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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