Brotman Law Presents
The Ultimate Guide to Offer in Compromise
Are you facing a staggering IRS debt? Even worse, you have no way to pay it. What are you going to do?
Before you go into a full-blown panic and start fearing the worst, like the IRS is going to seize your house or other property, take a step back. The IRS says they are not in the banking business and most likely, they do not want to be in the real estate business.
But, the IRS wants its money and wants as much as they can get as soon as possible. Realizing the expense and futility of trying to chase down collections or bankrupt taxpayers, the IRS has repayment options, including the Offer in Compromise. These options allow the IRS to get its money without financially depleting taxpayers.
An Offer in Compromise is a type of agreement between both the taxpayer and the IRS outlining and settling the taxpayer’s tax liabilities for less than the current balance due.
If the taxpayer’s liabilities can be fully paid through the utilization of an installment agreement or any other related means, then the taxpayer would not ordinarily be eligible for an OIC.
To be eligible for the OIC program, the taxpayer must have already filed all tax returns, made the required estimated tax payments for the current year and made all required federal tax deposits for the current quarter (See IRS.gov, “Topic 204 – Offers in Compromise). Federal tax deposits are specific to business owners with employees.
I will be straight with you. Applying for an OIC is not an easy process and frankly, there is a very low percentage of OIC requests that the IRS actually accepts. Read this chapter to learn more about the process, how to qualify and how to apply.
I will also lay out the pros and cons, so you can make the best informed decision about applying.
If you have any questions, reach out to me. I have represented clients in presenting offer in compromises to the IRS and have a high success rate. We can talk and assess your situation then decide on the best route for you to take.
The Offer in Compromise Process
Taxpayers currently in an open bankruptcy proceeding are usually not eligible for an offer in compromise. The bankruptcy process will resolve any tax liabilities and other financial debts. If you do not fall under this category, then the IRS will accept an OIC on three grounds.
First, if you have genuine “doubt” regarding your tax liability, then you will need to complete Form 656-L, Offer in Compromise. Second, acceptance of an offer in compromise will be permitted if it is determined that the amount you owe is fully collectible.
Lastly, an offer “may be accepted based on effective tax administration when there is no doubt that the tax is legally owed and that the full amount owed can be collected but requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances” (See Topic 204 above).
In addition to submitting Form 656-L, taxpayers must also complete and submit Form 433-B (OIC), Collection Information Statement for Businesses.
It is important to note that penalties and interest will continue to accrue during the evaluation process. You must only submit an offer for tax years that have been assessed by the IRS.
The taxpayer must submit all required forms and fees as part of the application process. The IRS offers guidance that provides insight into the process as well as application materials.
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Pros and Cons of an Offer in Compromise
You must weigh the pros and cons of offer in compromise considering the other options available to you. When deliberating whether to choose this option, you must also consider the advantages and disadvantages. The OIC allows you the opportunity to reduce your tax liability relative to your current financial situation.
However, settling with the IRS by way of offer in compromise might be the second-best option. For example, the requirements for accepting an OIC are stringent.
Taxpayers are required to have low monthly income and practically no assets. You may end up wasting time and money on trying to settle when that effort could have been applied toward a better resolution.
In addition, keep in mind that the IRS cannot collect on your federal tax liability forever. The Collection Statute Expiration Date (CSED) prevents the IRS from collecting taxes after 10 years.
When the IRS considers an offer in compromise, it tolls it, basically freezing it while your submission is under review. Therefore, if you have an older liability, pursuing an OIC instead of letting it expire may not be your best course of action.
A possible advantage of choosing an OIC is that it may be worthwhile in terms of reducing your tax liability. You may find a saving by getting a deal to pay to a level that is consistent with your current ability to repay.
The OIC will put the activities of collectors on hold, therefore, ongoing collection activities such as wage garnishments begin before you file the offer in compromise. They may also continue after the filing.
Choosing OIC is essentially requesting non-collectible status and allowing you to be taken out of collections without the fear of levy or garnishment. This decision may sound good and may be an optimal choice in terms of reducing your tax liability, but you still must remember that the IRS can file a federal tax lien against you at any time.
If the IRS determines that you have an ability to pay, then the status of non-collectible may be removed, and you will undoubtedly be required to begin paying at your current or assumed income level.
IRS Financial Analysis
IRS financial analysis is conducted by the IRS to both analyze and verify 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 financial analysis, the IRS will analyze 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” (Part 5. Collecting Process, Chapter 15 - Financial Analysis, Section 1, Financial Analysis Handbook).
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.
It 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” (See Section1, Financial Analysis Handbook.
The six-year rule is not applicable to corporations, partnerships, LLCs, and business expenses.
As 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 about 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 necessary.
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 percent, 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.
The Asset/Equity Table
The asset/equity table (AET) is defined as a table that lists all the taxpayer’s assets, encumbrances, and exemptions. The table calculates “the equity which is included in the reasonable collection potential (RCP) calculation” (See Part 5. Collecting Process, Chapter 8. Offer in Compromise, Section 4. Investigation).
The major headings of the asset/equity table include the following:
- 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. Regarding cash/bank accounts, net equity should not be less than zero.
An Offer in Compromise is an alternative if a taxpayer is unable to pay their full tax debt to the IRS when it is due.
You can propose paying a lesser amount and it is up to the IRS to accept, return or reject your request. It is a good option for you to pay your tax debt but still be able to maintain a reasonable standard of living.
Applying for an OIC is not necessarily a cut-and-dried process. The IRS wants for you to substantiate your eligibility. This means they will scrutinize your income and expenses, which they compare to national and regional standards of average costs for housing, food, transportation, etc.
The expectation is that you will make adjustments in order to live within your means as you pay the tax debt.
While that approach may be difficult to swallow, it will get IRS collections off your back and you can make a fresh start.
If you want to explore whether an OIC is the best option for relieving yourself of tax burden, call me. I have successfully negotiated OIC for other clients and can review your situation to see if the OIC is the most sound option.