If you owe the IRS money and you can’t pay right away, you may be worried about the consequences ahead. Fortunately, there are some steps you can take to resolve your debt and move forward with confidence.
In this article, we’re taking a closer look at a question we hear from our visitors – how much should I offer in compromise to the IRS?
How Much Should I Offer in Compromise to the IRS?
An offer in compromise (with doubt as to collectability) to the IRS should be equal to, or greater than what the IRS calculates as the taxpayer’s reasonable collection potential. The trouble is that estimating too low or attributing a reasonable collection potential that is below what the IRS estimated is almost guaranteed to get your offer rejected.
This not only costs you a significant amount of time, but it can also cost you quite a bit of money, as your debt continues to grow while the IRS deliberates your offer and the IRS requires that your offer is accompanied by the initial payment.
The key to a good offer in compromise, then, is knowing how the IRS calculates what you can afford to pay.
Explaining an Offer in Compromise
When the IRS determines that a taxpayer owes them money, they send a bill and Notice of Deficiency, with a “tax assessment date”. This tax assessment date serves as day one of your tax debt to the government, a debt that expires after ten years (plus applicable tolling periods).
During this period, if left unpaid, tax debts continue to grow through penalties and accruing interest, and as the debt grows, so does the IRS’s applicable arsenal of collection actions to coerce payment.
When a tax debt goes ignored for long enough, the IRS may be more eager to settle for less than its total value, especially if it determines that the taxpayer does not have the financial means to pay off the entire debt before it expires. The IRS can be very particular about offers in compromise (as it wants to avoid leaving money on the table), and getting an offer accepted is often easier said than done.
Estimating Your Reasonable Collection Potential
The IRS estimates whether an offer is acceptable or not through the taxpayer’s reasonable collection potential. This is calculated based on net realizable equity, and expendable income over a certain period (income after taxes and living necessities).
Net realizable equity is determined from any properties and assets the taxpayer still owns. For example, if the taxpayer owns a home, then the IRS will estimate the realizable equity of that home by taking its quick sale value (often calculated as 80 percent of the total value) and subtracting any current liabilities against the asset (like a mortgage).
If an asset has negative equity (its value has fallen below the liabilities against it, i.e., a home worth less than its mortgage costs), it will not count towards the IRS’s calculated net realizable equity.
The IRS will also calculate all cash the taxpayer has left to their name, save for one month’s worth of allowable expenses, and $1,000. When calculating the value of vehicles, the IRS also allows for an additional $3,450 per vehicle to be excluded from the calculation of one or two vehicles, depending on whether the taxpayer lives in a joint household or is single.
What this means is that net realizable equity roughly translates to all the money you can round up after liquidating all non-exempt assets and accounts, save for a month’s allowance.
This is then added to the IRS’s estimation of your monthly expendable or disposable income over a period of time, depending on how you structure the offer. If you decide to pay a larger amount over five months, then the IRS will calculate a year’s worth of disposable income. If you make a long-term payment offer (24 monthly installments), the IRS will calculate two years’ worth of disposable income.
While this might sound drastic, many taxpayers who run the numbers themselves might come to realize that they end up saving thousands, if not tens of thousands of dollars this way, while still satisfying the IRS’s requirements and getting their debt resolved. That being said, running the numbers this way is still no guarantee that the IRS will accept your offer. There are a few other things you can do to improve your chances.
Use the IRS’s Online Pre-Qualifier Tool
The IRS has its own online pre-qualifier tool to help you determine whether an offer in compromise is a good idea in your specific case. This tool asks a few basic questions on your financial status, tax filing information, assets, income, and expenses, and calculates a preliminary offer based on the information you have provided.
Note that this does not count as an official estimation but is instead meant to help you get a ballpark idea of what the IRS might come up with when chewing through your data. It can be a helpful tool to see if an offer in compromise is a better option than a regular monthly installment plan, and by how much.
Work with a Tax Professional
Nothing beats working with a professional when setting up an offer in compromise. Tax professionals with experience in tax debt resolution remain your best bet for getting an informed decision on how to calculate your reasonable collection potential and create an offer that the IRS is likely to accept the first time around, as they can estimate what your offer should be based on successful estimates they have provided in the past.
A tax professional can also walk you through all the other requirements that you must watch out for when setting up an offer in compromise. Basic but important ones include being up to date on all tax returns and estimated payments. Certain factors also rule out eligibility, such as going through individual bankruptcy.
When you are prepared to make an offer to the IRS, note that you must send the first payment in your plan with the offer. If the IRS rejects your offer, they may either keep the payment and count it against your debt, or send it back to you, depending on the reason for the rejection.
Appealing an Offer in Compromise
If an offer in compromise is rejected, you have the option of appealing that rejection. It’s a good idea to consult with a professional before you do this – certain circumstances such as being involved in an innocent spouse claim or waiting on the IRS to respond to a Doubt as to Liability offer must be waited out before a different offer in compromise can be filed to begin with.
A tax professional can advise you on how to approach the appeals process, as you may have multiple options of doing so (including the US Tax Court, as well as the IRS’s own Independent Office of Appeals).
Alternatives for Dealing with Tax Debt
An offer in compromise is a great way to resolve your tax debt when there is reasonable doubt as to your ability to completely pay off the debt before it expires. But if an OIC is not the best option for you, then a tax professional can help you explore all other alternatives.