An Overview of the IRS Tax Collections Process for Non-Tax Lawyers
25. Issues in the Offer in Compromise Process
The next thing I want to talk about, I want to talk about some issues associated with Offers in Compromises.
The first issue I wanted to discuss is what we call dissipated assets. A dissipated asset is an asset that the taxpayer has disposed of, that the IRS is going to count towards their reasonable collection potential or their minimum Offer in Compromise.
For example, this happens all the time. People will liquidate their IRAs and they will go out and spend money on all sorts of things. They’re going on vacations or trips or food or whatever.
The IRS will come back and they’ll say, “Wait, the $100,000 in this IRA, what happened to the money?” The taxpayer will throw their hands and then go, “I don’t know. We just spent it.”
The IRS goes, “That $100,000 of money should have been used to pay your tax liability. So, we’re going to consider this a dissipated asset.”
Dissipated asset comes up all the time with property. They come up with IRA’s securities. Basically, you need to be able to substantiate to the IRS the money that was used with the dissipated assets was recently spent on ordinary and necessary living expenses, what other things that the IRS are going to accept.
It’s really important that the outset to identify any dissipated assets that you might have, otherwise you might make an Offer in Compromise only to be disappointed at the end.
The next issue I want to talk about is valuation. Valuation is a really hot topic within the IRS and it’s something that practitioners use all the time to present the client’s financials in the best light possible.
One of the examples I’ll give is for the house. You have a house and you go ahead and Zillow and the house is worth $500,000. Then you go on the property tax, coming to assessor’s website and the tax assessor says it’s worth $350,000. You go to the taxpayer’s insurance. The insurance says it’s worth $450,000.
Well, now you’re creating a genuine dispute as to what the property is really worth. There are different ways of we’re looking at valuation issues. The IRS will consider valuation issues based on a number of things. When valuing assets, it’s always important to take the valuation in its most beneficial towards the client or the taxpayer because valuation is something that is– it can be challenged by the IRS– but if you provide a value to the IRS and you provide backup of the value of the value of the IRS, it is up to the IRS to refute that value. They will do it in extreme circumstances. Don’t get me wrong. If you list an asset for far lower than what the IRS feels the fair market value is, they will come back and challenge your valuation.
But in most cases, if you have a credible and reasonable explanation about how you arrived with your valuation, for example, if you KBB a car and that car is worth $10,000, but your car is a big dent in the side of it. Then that car is ultimately worth less than what the KBB value is. If you can explain that to the IRS or provide some explanation to them, that’s when we’ll avoid that issue.
The final issue I want to talk about is what we call future income potential. This has been a catch up permission with the IRS to screen out Offers in Compromise in the past. It’s they are less aggressive about it than they were a few years ago but they still use it.
Let’s say I have a client who is a Physician. They’ve been earning $300,000 to $400,000. All of a sudden that physician is unemployed. If the physician is unemployed even for an extended period of time, they’re not making any income, they have no positive cash flow, the IRS is still going to make the argument that they have the ability to go out and earn more money.
Because that potential for future income exists, this happens all the time with businesses by the way. Because the potential for future income exists, the IRS will not accept the offer because they believe that they eventually go up and collect that money for that taxpayer. They’ll be able to collect more money than the taxpayer is offering and they offer.
With respect to future income potential, you want to paint circumstances for the IRS that would defeat future income potential. The best time to do this is when initially submitting your offer.
The taxpayer or the representative has a chance to question the offer statement. That statement can be used to mitigate any belief from the offer specialist that the taxpayer has the ability to go out and earn money. It happens all the time with people who are lawyers or who hold advanced degrees. Those offers can be particularly difficult to get accepted if the IRS thinks your job prospects were great.
So by painting the picture that you haven’t been able to find the job that will increase the chance of mitigating your future income potential.