Offer in Compromise, IRS hype or hope?

UPDATED APRIL 30, 2005

Federal tax law has allowed the IRS to settle tax liabilities for less than the total due for nearly 40 years. However, it wasn’t until 1992, that the Internal Revenue Service started accepting Offers (Offer in Compromise) on a routine basis. There is not now, nor has there ever been any form of Tax Amnesty on the federal level.

In 1995, it became more difficult to get Offers through because the IRS brought Collection Financial Standards into play. That took away much of the discretion of IRS Revenue Officers in favor of charts which allow set amounts for certain expenses and maximum allowances for others. In particular, the Housing and Utility allowance has made it very difficult for homeowners in expensive areas to get their Offers through.

The basic guideline for getting an Offer accepted is that your Offer must exceed the value of your assets PLUS what the IRS can reasonably expect to collect from you over the next four years.

First, you need to list the total of your assets. The biggest asset for most taxpayers would be their personal residence. You must also count your vehicles, retirement funds and the average balance in bank accounts. Fortunately, the IRS discounts assets such as homes and vehicles by 20% and then reduces the value further by anything owed against it such as a mortgage or an auto loan. If the fair market value of your home is $200,000 and the mortgage is $150,000, the equity for IRS purposes is only $10,000 ($200,000 minus 20% minus $150,000). SPECIAL NOTE. IF YOU LIVE IN AN AREA WITH A HOT REAL ESTATE MARKET, THE IRS MAY TAKE A SMALLER DISCOUNT. FOR INSTANCE, HERE IN THE SAN FRANCISCO METRO AREA OR IN PARTS OF SOUTHERN CALIFORNIA, THE IRS IS ONLY TAKING A 10% DISCOUNT BECAUSE THE MARKET IS MOVING UP RAPIDLY. MAKE SURE TO CHECK WITH US TO SEE HOW THE IRS IS LOOKING AT REAL ESTATE IN YOUR AREA.

The same calculation is done on vehicles. For retirement funds, the discount is whatever it would cost in taxes to take the funds out now. If you under 59 1/2 yrs. old and are in a combined state and Federal tax of 40% (not unusual in states like California), the IRS will discount the value of the retirement funds by 50%. That’s due to the fact that you would pay 40% in income tax and another 10% for the withdrawal prior to age 59 1/2. All the assets are then totaled. If the value of the assets exceeds the tax owed, an Offer is not possible.

Second, how much can you afford to pay the IRS each month? The objective is NOT to get a payment agreement, but in order to reach an acceptable Offer, we have to determine how much the IRS expects they could collect from you monthly. To do that, we need to determine your income minus your allowable monthly expenses. Unfortunately, what you think is a necessary expense may be different from what the IRS considers to be necessary. And, there are caps on what the IRS allows for housing & utilities, transportation and food, clothing, etc. Once we determine how much the IRS believes you can pay each month, we multiply that amount by 48. If that total is greater than the amount you owe the IRS, you cannot get an Offer accepted.

Finally, we total the value of your assets PLUS the amount you can pay each month X 48. The grand total is the minimum amount you can Offer. If that total is more than what you owe, you cannot submit an Offer. If it sounds like you’ll never get an Offer accepted, think again. About 90 of our clients Offers have been accepted. Why? Because we won’t submit a bad Offer, but also it’s because if your calculations are off by $100 a month, it equates to a $4,800 difference in the amount of your Offer!! When an Offer is being considered, a $100 is not a $100 because it is multiplied by 48.

The Offer process isn’t easy and it is not fast. Because the IRS has gotten much tougher on Offers, the wait on Offers has gotten shorter. It can take anywhere from 6 to 9 months depending upon the IRS District in which you live and the levels of approval needed. If you think a tax professional has a better chance of getting an Offer accepted, you’re right. So, how you do decide who to hire? My page on Who Should I Hire? should help to answer that question.

IRS Allowed Expenses for Food & Clothing
IRS Transportation Expenses
IRS Housing & Utility Expenses