How does an Offer In Compromise (OIC) work?
A lot of people ask me if the IRS REALLY does compromise IRS debts. The answer is a resounding YES! We do lots of them with great success. But you need to understand how they work. Here’s a BRIEF (and incomplete) overview of how it works.
The IRS wants you to include the value of two things in an Offer In Compromise. They want to know the value of your assets (adjusted value) plus the future value of your income. They add them together to determine your “reasonable collection potential”. The RCP is the amount they think they could collect over time. Following is a quick example of how these two items are calculated for the purposes on an Offer In Compromise.
Value of your assets (adjusted value).
Things to consider when determining the adjusted value of your assets is that you get to reduce the assets to “quick sale value”. Items like houses and cars are reduced by 20% right off the bat, and then you reduce it further by any debts outstanding against the asset. An example would be a house, Fair Market Value of $250,000 with a mortgage of $190,000. Without knowing the rules, you may assume your net equity in the house is $60,000. But really, it’s $10,000 in the IRS’s eyes. This is calculated by taking $250,000 times 80% (20% reductions) which equals $200,000. Then subtract the mortgage of $190,000 and the IRS values your house at $10,000 for the Offer.
Any cash you have can be adjusted too. The cash you have is allowed to be reduced by a $1000 exemption as well as one-months’ worth of living expenses. For example, if you have $3,500 in the bank and your normal living expenses are $2,000 per month you could value the Cash at $500.00. This is calculated by subtracting one month’s household expenses ($2000) and the $1000 exemption from the $3500.00 which least $500 that has to be included in the Offer.
If there were no other assets (but things like IRAs, cars, and such would all have to be similarly valued), then the ASSET part of the Offer would be a total of $10,500. ($10,000 for the house but $500 cash).
Value of your Income
The IRS also wants to see what they can collect over time. Let’s say you make $3000 per month. If your monthly living expenses (subjects to caps, or maximums allowed) were $2500 per month (for housing, food, cars entertainment etc.) then there would be $500 left over each month that could be paid to the IRS. The IRS would place a value on that $500 per month by using a “factor”. Right now, the IRS uses a factor of 12 for a cash settlement (paid 5 months after the Offer is accepted), or a factor of 24 if you pay over two years. Most people do cash offers as they are a much better deal. Therefore, for the purposes of this example, the IRS would value the $500 per month in a cash offer at $6000. This is calculated by taking the left-over income of $500 multiplied by the Factor of 12 which is $6000.
Value of your offer
As mentioned prior, the IRS wants the value of your assets, plus the future value of your income stream. In this example the assets, as adjusted, totaled $10,500. The future value of the income stream was $6,000. Add those together and the total is $16,500. This is what you’d offer the IRS. So, if you owed $100,000 in back taxes the $16,500 would be a great deal! However, if you only owed $12,000, you would not want to make an offer. Perhaps a payment plan would be a better solution!
Caveat!
This is a very big simplification to just help you understand how an Offer In Compromise works. It’s not intended to be everything you need to know about submitting an Offer. The IRS has caps (maximums that they will allow) that need to be factored in. There are other ways to value assets. Valuing retirements plans would include subtracting the taxes and penalties for withdrawing the funds. If the IRS could collect the entire balance over the remaining statute of limitations for collections, then you would not qualify for an Offer at all. Because of theses things, and more, you can’t assume because of the example above you know everything you need to know to submit an Offer In Compromise. However, this might be helpful to settle your mind that they do indeed work, and maybe even help clarify whether you potentially qualify for an Offer (or not). I hope it helps!
If you need additional IRS offer in compromise help, contact Advanced Tax Solutions.
Go Back The IRS wants you to include the value of two things in an Offer In Compromise. They want to know the value of your assets (adjusted value) plus the future value of your income. They add them together to determine your “reasonable collection potential”. The RCP is the amount they think they could collect over time. Following is a quick example of how these two items are calculated for the purposes on an Offer In Compromise.
Value of your assets (adjusted value).
Things to consider when determining the adjusted value of your assets is that you get to reduce the assets to “quick sale value”. Items like houses and cars are reduced by 20% right off the bat, and then you reduce it further by any debts outstanding against the asset. An example would be a house, Fair Market Value of $250,000 with a mortgage of $190,000. Without knowing the rules, you may assume your net equity in the house is $60,000. But really, it’s $10,000 in the IRS’s eyes. This is calculated by taking $250,000 times 80% (20% reductions) which equals $200,000. Then subtract the mortgage of $190,000 and the IRS values your house at $10,000 for the Offer.
Any cash you have can be adjusted too. The cash you have is allowed to be reduced by a $1000 exemption as well as one-months’ worth of living expenses. For example, if you have $3,500 in the bank and your normal living expenses are $2,000 per month you could value the Cash at $500.00. This is calculated by subtracting one month’s household expenses ($2000) and the $1000 exemption from the $3500.00 which least $500 that has to be included in the Offer.
If there were no other assets (but things like IRAs, cars, and such would all have to be similarly valued), then the ASSET part of the Offer would be a total of $10,500. ($10,000 for the house but $500 cash).
Value of your Income
The IRS also wants to see what they can collect over time. Let’s say you make $3000 per month. If your monthly living expenses (subjects to caps, or maximums allowed) were $2500 per month (for housing, food, cars entertainment etc.) then there would be $500 left over each month that could be paid to the IRS. The IRS would place a value on that $500 per month by using a “factor”. Right now, the IRS uses a factor of 12 for a cash settlement (paid 5 months after the Offer is accepted), or a factor of 24 if you pay over two years. Most people do cash offers as they are a much better deal. Therefore, for the purposes of this example, the IRS would value the $500 per month in a cash offer at $6000. This is calculated by taking the left-over income of $500 multiplied by the Factor of 12 which is $6000.
Value of your offer
As mentioned prior, the IRS wants the value of your assets, plus the future value of your income stream. In this example the assets, as adjusted, totaled $10,500. The future value of the income stream was $6,000. Add those together and the total is $16,500. This is what you’d offer the IRS. So, if you owed $100,000 in back taxes the $16,500 would be a great deal! However, if you only owed $12,000, you would not want to make an offer. Perhaps a payment plan would be a better solution!
Caveat!
This is a very big simplification to just help you understand how an Offer In Compromise works. It’s not intended to be everything you need to know about submitting an Offer. The IRS has caps (maximums that they will allow) that need to be factored in. There are other ways to value assets. Valuing retirements plans would include subtracting the taxes and penalties for withdrawing the funds. If the IRS could collect the entire balance over the remaining statute of limitations for collections, then you would not qualify for an Offer at all. Because of theses things, and more, you can’t assume because of the example above you know everything you need to know to submit an Offer In Compromise. However, this might be helpful to settle your mind that they do indeed work, and maybe even help clarify whether you potentially qualify for an Offer (or not). I hope it helps!
If you need additional IRS offer in compromise help, contact Advanced Tax Solutions.
