As we all know, it’s never simple with the IRS. Some rules relating to an OIC are beneficial, and some are very harsh. Below we review a few of the “beneficial” and “not so beneficial” rules the IRS applies when reviewing an IRS Offer in Compromise and when you should consider getting OIC help.
Overview of the Offer In Compromise Process
When the IRS reviews an Offer in Compromise, they try to determine the most that you could pay them to settle the debt. Obviously, the rub here is that you are using the same information to show the IRS how little you can afford to pay. This dance between the taxpayer and the IRS all plays out based on financial information provided by the taxpayer to the IRS. The main two areas of concern are the Value of The Assets, and the Value of the Leftover Income Stream. The assets are reduced by what is called Quick Salve Value, and any related Liabilities. Any value beyond that is called equity and the IRS wants the value of the Equity included in the Offered Amount. The Left-Over Income is valued by Adding all income and subtracting out all ALLOWED expenses. Whatever is left over has value to the IRS. They value it by multiplying the left-over income by 12 if you pay the Offer off within 5 months of acceptance. If you need more than 5 months and up to 24 months, then the Multiplier is 24. If there is a lot of left over income, you would want to full pay within 5 months and use a multiplier of 5 if at all possible. If you only have assets, you may want to consider paying over 24 months.
The goal, of course, is to get your assets valued as low as possible, and then get as many expenses allowed as possible. The IRS is on the other side of the table trying to do just the opposite. They have the ultimate power to decide, but the more you know the better your chances are to prevail. Power versus skill. David versus Goliath. Taxpayer versus the IRS.
Beneficial Rules of an IRS Offer in Compromise
Cash for Monthly Expenses
The IRS does allow you to keep a certain amount of cash for next month’s bills. For example, if monthly bills are $2,000, and you have $3,500 in the bank, the IRS will allow you to value that $3,500 at $500 in the Offer. This is because they allow you to keep $1,000, plus enough cash to pay next month’s bills of $2,000. The $500 is calculated as follows: $3,500 total, less $1,000 exemption, less $2,000 for one month’s bills. This is an oversimplification, as the IRS may challenge the amount of monthly expenses allowed to reserve, but at least it’s nice to know you can kick out a certain amount of cash from how much you must give them in an OIC. In this case, not knowing the rules would cost you an additional $3000 in your offered amount. The IRS is under no obligation to tell you to offer less.
Asset Valuation
A second “beneficial” rule is that you can reduce many assets’ values by 20% for “quick sale value”. The IRS knows that if they took the asset from you and sold it, they would not get full price. Therefore, they will allow certain assets to be valued at 20% less than fair market value. As an example, let’s look at a house that is worth $300,000 and has a mortgage of $200,000. The house has $100,000 of equity that the IRS could get at in an OIC. However, the IRS would allow a value of $40,000. This is calculated as follows: $300,000 (the value of the house) minus $60,000 (20% of $300,000 for quick sale reduction in value) minus $200,000 (the mortgage of the house), equals $40,000. On the other hand, if the equity of the home minus 20% and loans is less than zero, you might not be required to offer any amount.
Expenses Allowed
Some Expenses are not allowed, while others may be limited. But some items, such as health insurance are allowed at a 100% no matter how high. And medical expenses are fully allowed as well. The IRS even allows a small amount for medical expenses even if you have none.
Some expenses are allowed with no proof. One example is food, clothing and misc. This is called the National Standards. They allow a certain amount based on the size of the family. This can be a good or bad situation depending on the family. I’ve seen families who make a lot of money be limited by the National Standards, but I’ve seen larger low-income families who don’t spend even close to the allowed amount. This can be a boon for them as they are allowed a lot more than they spend, which gives a lot of cushion in other areas where expenses may be limited or disallowed.
Not So Beneficial Rules of an Offer in Compromise
Credit Cards
Credit cards and unsecured debt can be very troublesome. The IRS is looking to see how much cash you have available to determine if you can pay them monthly, or how much the cash flow is worth to them in an offer. For example, let’s say that you combine all your income and it added up to a total of $4,000 per month that you had available to pay all your bills. Further assume that your total expenses are $3,900; which includes your rent/mortgage, utilities, food, credit card debt, etc. What you REALLY have available to pay the IRS is $100 per month. But let’s say your minimum monthly credit card payments are $400 per month. This would be a big problem as instead of the REALITY that you only have $100 per month to offer, they would value it at $500 per month. The IRS thinks you have $400 more per month to offer than you really do.
Monthly Leftover Income
A second harsh reality of an OIC relates to your monthly left-over income. This problem relates to the IRS’s use of “caps”. Let’s use the same example as above and assume that you have $100 per month left over at the end of month. The IRS has maximums that they will allow for such things as car payments, house payments (rent or mortgage payments), and even food. For example, today the housing cap for a single Denver resident is $1,568 (be aware that this changes regularly). This amount is the total allowed for ALL housing: mortgage/rent, utilities, water, sewer, trash, phone, cable, etc. If your actual payments for all these items totaled $1,868, then you’d be over the cap by $300. This would cause a problem just like the disallowed credit card payments. The IRS would think you have extra $400 per month rather than the real amount of $100 per month.
What Does This Mean?
When calculating the value of the cash flow on the Offer form (433OIC, and Form 656) the IRS multiplies the left-over income by a multiplier. The multiplier is 12 if you offer to pay within 5 months or less, and a multiplier of 24 if you offer to pay within 24 months (but more than 5). So, let’s say you are planning to pay the OIC within 5 months of acceptance. If you used the true number of $100 left over income per month, then the Offered Amount would be $1,200 (plus asset value as described previously). However, if the IRS disallowed the credit card payments of $400 per month, and the amount over the caps for housing of $300 per month, then the IRS would show that you have total left over income of $800 per month. With that in mind, the IRS would use a multiplier of 12 times $800, so the OIC would have to be increased to $9600 (plus assets value). That is a huge increase over the $1,200 amount based on the true left-over income of $100 per month! It is TWICE as bad if you pay for more than 5 months, as the multiplier would then b3 24. Thus, the offer would increase to $19,200 (plus asset value). This is calculated by multiplying the $800 left over income times 24.
Statute of Limitations Effect on your Offer
The Statue of Limitations (SOL) can have a terrible effect on an OIC. Make sure you understand this critical concept. I’ve seen many Offers, even Offers prepared by supposed professionals, fail due to the SOL. The offer should have never been submitted as it had no hope of being successful on the day it was mailed. I don’t know if it’s intentional as these unethical firms get paid win or lose, or if they just don’t understand the rules, but either way, you are out a lot of money, and they won’t give it back.
How does the SOL work?
So, how does the SOL work and how does it affect an Offer? Generally, the IRS has ten years from the time the tax is assessed (when the debt shows on the IRS records). This is called the Statute of Limitations. (For more info on the SOL, please see below the tab labelled “IRS Problem Resources” at the top of the page).
How does the SOL Affect your Offer?
How it affects an Offer in Compromise (OIC) is that if your financial information indicates that they COULD get paid over the remaining statute of limitations, they won’t accept an Offer even though you qualify for a much lower amount.
For Example
In the illustration above, the left-over income is $800 per month per the IRS rules. In an offer that would be paid within 5 months that has $800 leftover income the offer would be $9,600 (as described above, remember that a five-month Offer has a multiplier of 12). To this you would add the asset value as calculated in the offer. Let’s say that the assets were $500, so the total assets plus your leftover income value of $9,600 would be $10,100. That is what your offer would be accepted at IF YOU QUALIFY. If you owed $50,000 dollars to the IRS, then they would settle for $10,100 if accepted. However, let’s say there were 100 months (8 years and 4 months) left on the SOL (Statue of Limitations), then the IRS would claim that you could pay $80,000 plus $500 in assets for a total of $80,500. That would be calculated by multiplying the $800 per month times 100 months left on the SOL, and then adding the assets of $500. Because the amount that could be collected is more than the amount owed ($50,000), you don’t qualify at all, even if your offer calculates to $10,100. I think this is a very unfair rule, because the person with identical finances, but owes a lot more would be rewarded by the IRS by accepting the OIC, but the person who owes less doesn’t get one. In the example above if a person owed $100,000 or even $1,000,000, they would have their offer accepted at $10,100, while the person who owes $50,000 doesn’t get an Offer at all, because the IRS COULD collect $80,500 at any given time. Unfair indeed, but the IRS makes the rules, and this is one of the most unfair and bad rules in the Offer arena.
5 Years of Current Compliance
Another bad rule to be aware of is that once your Offer is Accepted you are not completely done. You must walk the straight and narrow for five years following the acceptance of your OIC. In other words, if you fail to file or fail to pay your taxes for any one of the five years following the accepted offer, the whole thing is undone. You will owe the original amount prior to the Offer, PLUS all the interest and penalties that would have accrued as if the OIC was never accepted. I’ve seen it happen and it’s devastating!
IRS keeps refunds during OIC (NOTE THIS RULE HAS BEEN SUSPENDED DURING COVID)
The IRS will keep your refunds on your federal tax returns during the pendency of the Offer as well as the year that the OIC is accepted. This often surprises people, so keep it in mind as you file… don’t get your hopes up for a big fat refund, as they will keep during the offer as well as the year its completed
Attorney Review
This is a rare, but awful thing that can happen with an OIC. After your OIC is accepted, it can be reviewed by an IRS attorney and sometimes these attorneys come up with lame excuses to deny an Offer. I’ve seen cases where they say things such as the Taxpayer didn’t try hard enough to pay the taxes before submitting the Offer. You don’t even get to explain your circumstances and it’s hard to overturn in appeals. This is a situation where I’d love to see some change in the rules. When an IRS attorney arbitrarily denies an offer that the professional IRS worker who specialized in OICs has accepted, I believe the taxpayer should have access to Tax Court review. But that is not the case unless the Offer was submitted under the oversight of a CDP (Collection Due Process) appeal. That is a whole different issue, but you should consider doing so if you have received a Form 1058, LT 11, CP90 or CP91 or any other form that is a “Final Notice of Intent to Levy”. If you have any of these letters, learn quickly what they are about, as after 30 days of receiving one, you lose the opportunity to get Tax Court Oversight.
Get OIC Help!
The IRS offer in compromise is full of loopholes, nooks and crannies. If you are considering an OIC in any way – contact Advanced Tax Solutions today and talk to a tax professional for OIC help.
