The IRS has completely revamped its offer in compromise guidelines to greatly increase the number of taxpayers who will be able to qualify. Our tax attorneys will be revisiting many of the offers in compromise that are pending, and we recommend that all tax lawyers, enrolled agents, and CPAs who have clients who have submitted unsuccessful offers in compromise in the past review their clients' current financial condition to see if they will qualify under the new offer in compromise guidelines.
The new guidelines are announced in a news release by the IRS (IR-2012-53, May 21, 2012). More details are available in Attachment 1 to Internal Revenue Manual (IRM) 5.8.5 Financial Analysis. The changes are dramatic! And like all tax law changes they are complicated and loaded with ambiguities.
The most revolutionary change that our tax attorneys have noted is the methodology of calculating the offer amount. The amount of the offer in compromise has always been determined by the amount of the reasonable collection potential (RCP). RCP is determined by adding the realizable value of the taxpayer's assets to his Future Income (FI). Thus
Offer amount = RCP +FI
Future income is defined as an estimate of the taxpayer's ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. In the past a taxpayer who could pay the offer amount in 5 monthly payments would multiply his monthly available income by 48 months to arrive at Future Income. A taxpayer who wanted to pay the offer amount over a 24 month period was required to multiply his monthly available income by 60 months to arrive at his Future Income. In both cases Future Income was added to the realizable value of the taxpayer's assets to arrive at RCP, or the offer amount.
Under the new offer in compromise guidelines Future Income will be arrived at by multiplying the monthly available income by 12 if the offer can be paid in 5 monthly payments or less. If the taxpayer needs 24 months to pay the offer amount in full then the Future Income will be determined by multiplying the monthly available income by 24. The deferred payment option which allows payment over the life of the statute is no longer available. Our tax attorneys have formulated a simple example.
A taxpayer who has $50,000 in realizable equity in assets, and monthly future income of $2,000 will pay $74,000 if the offer amount can be paid in 5 months or less, and $98,000 if the offer will be paid over a 24 month period. This compares to offer amounts under the old guidelines of $146,000, or $170,000, respectively. The higher the monthly future income, the greater the discrepancy.
The new guidelines also include changes to the necessary living expenses:
- Payments on delinquent State taxes may be allowed in full or in part.
- Minimum payments on student loans guaranteed by the federal government will be allowed for the taxpayer's post-high school education (note it says nothing about loans incurred by parents to pay for their children's' tuition).
- When the taxpayer owns a vehicle that is six years or older or has mileage of 75,000 miles or more, the IRS will allow additional operating expenses of $200 or more per vehicle. (A variation of this has actually existed in the past, but it has been buried in the IRM so deeply that most IRS offer in compromise specialists are unaware of the existence of this provision).
- The first $400 per vehicle of retired debt will not be added back to monthly available income.
Another welcome modification; the calculation of so-called "dissipated assets" has been radically altered. While the exact details are subject to numerous exceptions, and clarifications, in general assets which have been dissipated three years or more prior to the submission of the offer in compromise will not be included in the RCP. For example, if the offer is submitted in 2012, any asset dissipated prior to 2010 should not be included.
One thing that hasn't changed is that zealous advocacy on the part of tax attorneys, CPAs and enrolled agents will still be essential to negotiate the best possible deal with the IRS. Careful planning on the timing of offers is also essential.
One of the few negatives is that even before these changes were announced the IRS was overwhelmed with the number of offers in compromise it was receiving. Things are likely to get worse. Our tax lawyers are guessing that very few offers in compromise will take less than a year for the IRS to process.
Another negative is that this is bound to bring unscrupulous "offer mills" out of the woodwork. Even with the new guidelines an offer in compromise is not for everyone, and the danger is that desperate taxpayers will wind up giving up their hard-earned dollars in the hopes of realizing a benefit which is not available to them.