Tax Lawyer's Blog

Taxpayers who are indebteded to the IRS may qualify for an offer in compromise.  There are three types of offers.

• Offers based on doubt as to collectibility,
• Offers based on doubt as to liability; and
• Offers based on effective tax administration.

This article covers the most common offer filed: Offers based on doubt as to collectibility.

The IRS will accept for processing offers in compromise in which the amound offered represents the IRS’s reasonable collection potential.  Reasonable collection potential is calculated using the following algebraic formula:

A + ((B-C)x48) = D

Where:

• A = The equity in the taxpayer’s assets
• B = The taxpayer’s monthly income
• C = The taxpayer’s monthly necessary living expenses
• D = The offer amount

Example:

Eileen Levy is single and owes the IRS $80,000.00 in back taxes, penalties and interest.  She owns the following assets and owes the following debts:

• Primary Residence -  Fair Market Value $250,000.00**; Mortgage $210,000
• Automobile – Fair Market Value $22,000; debt $24,000
• Jewelry – Fair Market Value $5,000.00; debt zero

Eileen makes $4,000.00 per month working as a nurse and her monthly living expenses are $3,750.00 per month.

Now lets insert these numbers into our Reasonable Collection Potential formula:

A + ((B-C)x48) = D

Calculate A – The equity in the taxpayer’s assets

•   Equity in Residence     $40,000
•   Equity in Vehicle                N/A
•   Equity in Jewelry           $ 5,000
•   Total Equity                   $45,000

Calculate B – The taxpayer’s monthly income

Eileen makes $4,000.00 per month.

Calculate C – Taxpayer’s monthly living expenses

Taxpayer’s monthly living expenses are $3,750

Now all of the variables have been assigned values as follows:

A + ((B-C)x48) = D

45,000 + ((4,000 – 3850) x 48) = 45,000 + ((250) x 48) = 45,000 + 12,000 = 57,000.

Eileen Levy’s reasonable collection potential (assuming she is able to provide documentary proof of the value of her assets, the amount of her debts and her income and expenses) is $57,000.00

She should be able to get the IRS to accept an Offer in Compromise on the $80,000.00 she owes for the amount of $57,000.00 thereby saving $23,000.00.

Eileen would have to pay 20% of the offer amount, or $11,400.00, as a downpayment with the offer. If the offer is not accepted, the IRS would keep the downpayment and apply it to the debt Eileen owes.

The balance of the settlement offer, $45,600.00, must be paid in a lump sum within 90 days after the IRS accepts the offer. If Eileen could not pay the balance in a lump sum she could recalculate the offer amount substituting the number “60″ for the number “48″ in the above formula as follows:

A + ((B-C)x60) = D

The new offer amount using this formula would be $60,000.00. Eileen would then have to pay $12,000 (20% of $60,000) with the filing of the offer and the balance of $48,000.00 could then be paid over a 24 month period.

Word to the Wise:  Do not trust anyone who tells you that you qualify for an offer in compromise unless they have asked you about your assets, liabilities, income and expenses and performed the above calculation.

** Generally, the IRS uses 80% of the Fair Market Value for purposes of determining collection potential.  This is to account for a taxpayer’s closing costs as if they had sold the property.  Assume the $250,000.00 is 80% of the true FMV.

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