What is an Offer-in-Compromise & Who Qualifies
One of my most commonly asked questions is: “will the IRS settle with me for pennies on the dollar?” This question originates from promises of late night infomercials and radio ads from tax resolution firms. The answer to the question is: “It depends.” The IRS does have an Offer-in-Compromise program. The Offer in Compromise (or OIC) program, is an IRS program under 26 U.S.C. § 7122 which allows qualified individuals with an unpaid tax debt to negotiate a settled amount that is less than the total owed to extinguish the debt.
A taxpayer will file Form 656, along with the required substantiation documents package to determine if the taxpayer is eligible for the offer in compromise program. The objective of the OIC program is to accept a compromise when acceptance is in the best interests of both the taxpayer and the government and promotes voluntary compliance with all future payment and filing requirements.
In general, most Offers-in-Compromise are filed due to Doubt as to collectability which effectively means that the taxpayer will not be able to fully pay the tax debt prior to the expiration of the collection statute. If the taxpayer can prove that he/she cannot satisfy the full tax liability before the statute expires, he IRS will consider a settlement based on the following formula:
Settlement Amount = (monthly disposable income x a number of months) + the net realizable equity in the taxpayer's assets. In general, a taxpayer can offer to pay the liability over 5, 12 or 24 months. Taxpayers usually must put a deposit of 20% of the offer amount prior to the offer getting reviewed.
A key point to focus on is the IRS’s definition of disposable income. Disposable Income is known by the IRS as Collection Financial Standards (CFS). CFS is effectively taxpayer’s monthly income less allowable monthly expenses. The allowable monthly expenses are established by the IRS on both a national and local basis. According to the IRS:
“Collection Financial Standards are used to help determine a taxpayer's ability to pay a delinquent tax liability. Allowable living expenses include those expenses that meet the necessary expense test. The necessary expense test is defined as expenses that are necessary to provide for a taxpayer’s (and his or her family's) health and welfare and/or production of income.
National Standards for food, clothing and other items apply nationwide. Taxpayers are allowed the total National Standards amount for their family size, without questioning the amount actually spent.
National Standards have also been established for minimum allowances for out-of-pocket health care expenses. Taxpayers and their dependents are allowed the standard amount on a per person basis, without questioning the amount actually spent.
Maximum allowances for housing and utilities and transportation, known as the Local Standards, vary by location. In most cases, the taxpayer is allowed the amount actually spent, or the local standard, whichever is less.
Generally, the total number of persons allowed for necessary living expenses should be the same as those allowed as exemptions on the taxpayer’s most recent year income tax return.
If the IRS determines that the facts and circumstances of a taxpayer’s situation indicate that using the standards is inadequate to provide for basic living expenses, we may allow for actual expenses. However, taxpayers must provide documentation that supports a determination that using national and local expense standards leaves them an inadequate means of providing for basic living expenses.”
For purposes of an OIC, it is imperative to note that the IRS will not allow all expenses the taxpayer may actually have. Common disallowed expenses are college tuition payments for a dependent, credit card and personal loan payments may be disallowed since they represent unperfected debts. It is important to recognize that the IRS may disallow all other expenses that do not meet the necessary expense test outlined above.
The number of months over which disposable income must be calculated into the offer amount is based on the smaller of the number of months remaining until the Collection Statute Expiration Date (CSED) for the tax debt or 12 or 24 months, depending on the payment option for the OIC which the taxpayer chooses.
The IRS does not only take into account a taxpayer’s income, but also looks into available assets prior to making its determination to accept an OIC. The IRS utilizes Net Realizable Equity (NRE) in assets is the quick sale value of the asset. NRE is often 80% of Fair Market Value (FMV) less any liabilities which are secured by the asset (such as a loan or mortgage). As an example, if a taxpayer has a home worth $500,000 and owes $400,000 on the home, the IRS will calculate the net realizable equity in the asset as follows: ($500,000 x .80) - $400,000 = $0. In this case, the IRS will not expect that any equity in the home be included in the Offer amount.
If you owe the IRS and think you may qualify for an Offer-in-Compromise, give us a call today at 201-529-8024, and we will be assess your situation.
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