You’ve likely heard tax resolution outfits on television and radio promise to “settle your tax debt for pennies on the dollar.” What they’re referring to is the IRS Offer in Compromise program, which, while not an option for everyone, does provide certain taxpayers with the opportunity to settle their IRS tax debts for less than the full amount owed. While I can appreciate the inherent limitations of short television and radio ads, this oft-repeated “pennies on the dollar” mantra does a real disservice to the average taxpayer’s understanding of what’s involved in settling a tax debt with the IRS. It is important to keep in mind that it’s the IRS’s mission to collect as much tax, penalties, and interest that they can for the US Treasury, and in order to convince an Offer Examiner to accept an Offer in Compromise, one must generally demonstrate that doing so would be in the government’s best interest. There are number of ways this can be done, but because submitting an Offer in Compromise that is rejected by the IRS will typically only worsen a taxpayer’s predicament, it is important to have a thorough understanding of the IRS policies and procedures surrounding the evaluation of the acceptability of an Offer in Compromise prior to submitting one to the IRS.
Different Types of Offers in Compromise:
Doubt as to Collectibility Offer:
The most common type of an Offer in Compromise is what’s known as a Doubt as to Collectibility Offer in Compromise (DATC). A DATC Offer is based on the notion that the IRS will not be able to collect the full amount owed from a taxpayer in the time they have to collect. The acceptability of a DATC Offer will rest on the Collection Information Statement required to be submitted along with the Offer.
Doubt as to Liability Offer:
A Doubt as to Liability Offer in Compromise (DATL) will be accepted by the IRS if it can be shown that there’s a genuine dispute as to the existence or amount of the correct tax debt under the law. This generally means that both the taxpayer and the IRS must have some doubt that an assessed liability is incorrect. DATL Offers are typically only considered in instances where the IRS has made an assessment against a taxpayer, typically through a Substitute For Return or examination in which the taxpayer failed to participate, and there are grounds to believe that the resulting assessment was overstated but the records do not exist to ascertain what the proper assessment should have been. This situation is exceedingly rare, and as a result, DATL Offers are quite rare as well. Typically in the instances cited above, it would be more practical to request an Audit Reconsideration from the IRS in an attempt to lower the prior assessments.
Effective Tax Administration Offer:
An Effective Tax Administration Offer in Compromise (ETA) is appropriate in circumstances where there is no doubt as to the legality of the assessment sought to be compromised, nor is there doubt to its collectibility. The acceptability of an ETA Offer rests on a taxpayer’s ability to show that payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances. In other words, it must be shown that the IRS’s collection of the full liability would undermine public confidence that the IRS is administering the tax laws fairly and would thus be detrimental to voluntary compliance. In light of this, regardless of the inequity of collecting the full liability, the IRS will not accept an ETA Offer if there is a belief that doing so could undermine voluntary compliance. In determining whether the acceptance of an ETA Offer might be detrimental to voluntary compliance, the IRS looks at the taxpayer’s prior history or compliance, whether the taxpayer has taken any deliberate actions to avoid the payment of taxes, and whether the taxpayer has ever encouraged others not to comply with the tax laws.
Doubt as to Collectibility with Special Circumstances:
The final, and perhaps the least well-known of the different grounds under which an Offer can be submitted is what’s known as a Doubt as to Collectibility with Special Circumstances Offer (DATCSC). A DATCSC Offer is a hybrid Offer of sorts, combining elements of both a DATC Offer and an ETA Offer. At its core, a DATCSC Offer is similar to a DATC Offer in that it requires a showing that the IRS is unlikely to be able to collect the full amount of the liability from the taxpayers in the time left to collect. However, while the acceptability of a DATC Offer rests on a fairly rigid determination of the taxpayers ability to pay (see Reasonable Collection Potential, below), a DATCSC allows the taxpayer to put forth arguments, similar to those submitted under an ETA Offer, that, if compelling, would allow the IRS to accept an Offer in Compromise for even less than the DATC guidelines would typically provide.
Determining your Reasonable Collection Potential:
The bedrock of any Doubt as to Collectibility Offer in Compromise consideration is what the IRS calls your “Reasonable Collection Potential,” or “RCP.” In short, a taxpayer’s RCP is the amount that the IRS figures to be able to collect from a taxpayer in the time they have left to collect. One’s RCP is comprised of both net realizable equity in assets, such as real property, vehicles, bank accounts, etc., as well as the one’s ability to pay out of their future income after allowing for necessary living expenses.
In determining a taxpayer’s equity in assets, the IRS will typically look at an assets fair market value, but will typically reduce the fair market value by 20% for illiquid assets in the recognition that an asset that may have to be liquidated quickly by a taxpayer to fund an Offer in Compromise may not sell for its full fair market value on account of the hastiness of sale. In addition, they will typically provide an allowance for the taxpayer to cover any income tax liability or withdrawal penalty associated with liquidating an asset. The rules for determining equity in assets can often get complicated in instances where assets are owned jointly with a non-liable person, typically a non-liable spouse, and especially in community property states. The IRS may also attempt to include in a taxpayers RCP the value of “dissipated assets,” which are assets that the Service believes the taxpayer transferred in an attempt to avoid the payment of the tax liability or used the assets or proceeds for other than the payment of items necessary for the production of income or for the health and welfare of the taxpayer or their family.
In determining the taxpayer’s future income, the IRS will look at the monthly income and expenses associated with the taxpayer’s home. The IRS will first add up all of a liable taxpayer’s gross monthly income from sources such as wages, social security, annuities, etc. and subtract from that income expenses that the IRS deems to be necessary. The IRS defines necessary expenses as those that can be shown to provide for the health and welfare of the taxpayer and their family and/or provide for the production of income and are in amounts that are reasonable. In the context of an Offer in Compromise, the IRS will generally allow the amount that a taxpayer can substantiate as actually having spent or the or the published IRS Collection Financial Standard for a particular expense category, whichever is less. If it can be shown that an expense in excess of the standard allowance is necessary, the IRS will allow an expense that exceeds the standard. Collection Financial Standards can vary greatly based on household size and location.
After subtracting allowable expenses from gross monthly income, a monthly ability to pay is determined. This monthly income is added to a taxpayer’s equity to determine a taxpayer’s minimum acceptable Offer amount. The number of months of a taxpayer’s ability to pay that is factored into this calculation depends on the type of Offer that is submitted, as explained below.
Lump-Sum Offer in Compromise vs. Periodic-Payment Offer in Compromise:
The requirements for the evaluation and satisfaction of the terms of a proposed Doubt as to Collectibility Offer in Compromise vary based on whether the taxpayer elects to make a Lump-Sum Offer (LSO) or a Periodic-Payment Offer (PPO).
The guidelines for an LSO dictate that the minimum acceptable Offer amount is calculated by adding a taxpayer’s non-excludable equity to 12-month’s worth of the taxpayer’s monthly ability to pay. This 12-month multiple only applies, however, if the taxpayer can show that their equity, when combined with their monthly ability to pay, is not sufficient to full-pay all outstanding liabilities over the time the IRS has to collect (i.e. before any Collection Statute Expiration Date expires for a liability prior to that liability being paid in full). A successful Offer therefore often hinges on being able to show the IRS that a taxpayer cannot full pay the liability over the remaining time to collect. A Lump-Sum Offer generally requires that a taxpayer submit 20% of the offered amount with submission of the Offer, something known as a TIPRA payment. If an Offer is rejected, the IRS will keep this TIPRA down payment and apply it against a taxpayer’s outstanding liabilities, however a taxpayer is allowed to designate which balance a TIPRA payment is applied against, so long as the designation is made in writing at the time the payment is made. If the IRS requires a taxpayer to raise the amount of their Offer prior to acceptance, the taxpayer will need to make an additional TIPRA payment to bring the total TIPRA payment up to the required 20% of the total Offer amount prior to the Offer being forwarded for acceptance. Once an LSO is accepted, a taxpayer generally has 5-months from the date of acceptance to satisfy the balance remaining on the Offer.
A Periodic-Payment Offer (PPO) differs from an LSO in a couple critical ways. First, rather than looking at 12-months of a taxpayer’s monthly ability to pay in calculating the minimum acceptable Offer amount, the IRS will use a multiple of 24 months. This means that most Offers submitted as PPOs will result in a more expensive Offer than would have been acceptable under the LSO guidelines. However, there are a couple features of PPOs that may make a PPO a more attractive option depending on your situation. For example, a PPO does not require a large TIPRA downpayment in order to processable by the IRS. Instead, a PPO requires that you propose a 24-month payment plan that will provide for the payment of the offered amount in 24 monthly installments. The first monthly payment is due with the submission of the OIC. Form 656 allows you to individually designate the amount of the first monthly payment and the last monthly payment, allowing taxpayers the ability to either front load, or more commonly, backload the payment of their OIC. Payments made under a PPO prior to the IRS issuing a determination letter with respect to the Offer are considered TIPRA payments and can therefore be designated towards specific liabilities. If a PPO is accepted, a taxpayer simply needs to continue making the periodic payments in accordance with agreed upon plan in order to satisfy the terms of the agreement. If a PPO is rejected, a taxpayer is generally not required to make further payments while an appeal is pending, but would need to resume payments should the Offer be accepted in Appeals.
Conclusion:
While I’ve endeavored to lay out the basics of what goes into successfully navigating the IRS Offer in Compromise process above, there are a whole host of other factors that may come into play in negotiating for the acceptance of an OIC, things such as Appealing a Rejected Offer in Compromise (future article coming), Collateral Agreements (future article coming), and post-acceptance compliance requirements. Things get more complicated when business tax liabilities are involved, especially employment taxes, which can give rise to Trust Fund Recovery Penalty Assessments. While the IRS expects taxpayers to be able to navigate the OIC process alone, many of the Offers in Compromise that I’ve had accepted by the IRS were for taxpayers that had previously submitted an Offer only to have it be rejected. Submitting an Offer in Compromise can be a lengthy and expensive endeavor, so it pays to get it right the first time. If you’re interested in submitting an Offer in Compromise to the IRS, please contact us to request a consultation to discuss your specific situation.