The inquiry I receive from taxpayers more often than any other is “can’t I settle this with an Offer In Compromise?” Undoubtedly this is because aggressive radio and internet ads tell them that hiring a “tax resolution” firm to file an Offer In Compromise (OIC) will make all their problems disappear. The reality is that only a trusted advisor who knows the details of your case and your complete financial information can determine whether you are a good candidate for an OIC.
The IRS has accepted every OIC I’ve submitted, either directly or through Appeals. I am proud of this because of all OIC’s submitted, only a small minority are accepted. While I have fought very hard, strategically, and skillfully to get some of those OIC’s accepted, I don’t have a perfect record because of my advocacy. I have a perfect record because of my judgment and ethics. Unlike those firms making aggressive sales pitches, I only submit an OIC when it is truly the best option based on my experience and professional responsibility to my client.
Not all cases can be settled with an OIC. Despite the “pennies on the dollar” rhetoric, the financial analysis of an acceptable OIC amount has nothing to do with the amount owed. There is no magic percentage or flat amount of money that will make the IRS accept an OIC. I’ve settled six-figure liabilities for $1 and also with absolute confidence told taxpayers not to bother trying to settle others for even 80% of what’s owed. This is because the financial analysis of the OIC depends only on the government’s estimate of what it could collect from the taxpayer, the Reasonable Collection Potential (RCP). If a taxpayer offers more than RCP, the financial analysis will support acceptance of the OIC because it is more than the government might otherwise get. Offers of less than the RCP will generally be rejected because the government has estimated that it could collect more through other means.
The RCP is an estimation of the taxpayer’s disposable future income and the taxpayer’s assets. The income calculation is the total of employment, investment, pension, and other income sources. The government allows the taxpayer to subtract reasonable living expenses including certain guaranteed amounts for food, clothing, and healthcare, plus any additional amounts the taxpayer can show are necessary. The IRS considers any income that is not successfully allocated to allowable expenses to be disposable income. Depending on the number of payments proposed in the offer, either 12 or 24 months of disposable income must be included in the calculation of the offer amount.
Next, the value of the taxpayer’s assets are added to complete the total amount of the offer. This includes the full range of assets including real estate, personal property, retirement accounts, and life insurance policies. Proper valuation of these assets is critical to the RCP. Taxpayers and the IRS both frequently overstate the value of assets, undermining the OIC process. Although the IRS form makes crude reductions for quick sale values, more accurate reductions are possible. IRS guidelines also exclude some assets from the calculation, and recent modifications to the IRS form now explicitly exclude $1000 of cash and $3450 of equity in a vehicle. As with the disposable income calculation, allowances are possible for some types of additional assets, such as those necessary to generate income. Ultimately the value of all assets not excluded is added to the taxpayer’s disposable income to calculate the RCP.
Any OIC higher than the RCP can be recommended for acceptance. In rare special circumstances, the IRS will accept an OIC lower than the RCP. In these cases, the IRS must find that although there are additional assets or income available, a higher payment would be inappropriate on basis of hardship, public policy, or equity considerations. For example, if the taxpayer’s only asset is his retirement account, which was included in RCP, but its liquidation would leave him unable to provide basic living expenses, the offer amount could be reduced to less than the RCP. Demonstrating “special circumstances” to the IRS typically requires extra documentation, complex computations, and advocacy. It is rare that the government will allow a taxpayer to settle his debt while retaining assets he could use to pay it.
Just as the law allows acceptance of some offers that don’t meet the RCP, there are bases for rejection of offers that do exceed the RCP, namely offers against “public policy” or “not in the best interest of the government.” Although there is internal guidance for IRS Offer Examiners on how to apply these rejections and cautioning that they are exceptional tools, training, individual perspectives, and application are inconsistent. The guidance provides that these rejections should be made in limited circumstances, such as when there are indicators of ongoing criminal activity. However, I have seen examiners and managers resort to these rejections when they personally feel uncomfortable with settling large liabilities for small amounts. These cases unfortunately require elevation or appeal.
Good advocates know how to make a client’s financial conditions fit into the IRS guidelines most favorably, thereby making the OIC as low as possible. We persuade the government to accept favorable interpretations of the law and the facts of the case. But most importantly, we help clients understand their options and choose the best course of action. If an analysis of the case indicates that an OIC will not be successful, save the client money, reduce risk, or be sustainable and practical for the client, it is best to consider other options such as an Installment Agreement or Currently Not Collectible status.
In the future I will post more detailed discussion of specific elements of the OIC program, such as the obligations made under this contract between the taxpayer and the government and special considerations for offers made by low-income taxpayers. Until then, feel free to contact me with any questions about the OIC process or other collection alternatives.