An Offer in Compromise (OIC) can be one of the best ways to avoid an IRS tax levy, and to reduce your tax debt if you have fallen far behind. Earlier this month I was speaking with a senior IRS collection official about Offers in Compromise, and he brought up an interesting point. First, a little background. The IRS will allow taxpayers to reduce the amount of their tax debts if the IRS concludes that it is unlikely that the tax debt will be paid during the remaining time the IRS has to collect. This time period is referred to as the Collection Statute Expiration Date or CSED. If the tax can’t be paid during the CSED then the IRS may accept a settlement amount.
The IRS calculates this settlement amount, by adding the taxpayer’s net realizable equity in assets to the amount collectible from future expected income after payment of “necessary” living expenses. This is known as the reasonable collection potential or RCP. The amount collectible from future expected income is determined based upon the period over which the taxpayer proposes to make payments. If the payment period is from 1 to 5 months then the future income is determined over a 12 month period. On the other hand, if the taxpayer wishes to make payments over more than 5 months (up to a maximum of 24 months) then the future income is calculated over the entire 24 month period.
To take a simple example. Assume a taxpayer owes the IRS $300,000, and has assets of $25,000. In addition, she has monthly income, after necessary living expenses, of $2,000. If the taxpayer can pay the offer amount in 5 months or less than the RCP, the amount offered, would be $49,000 ($25,000 + 12 months x $2,000). On the other hand, if the taxpayer needs more than 5 months, then the RCP would be $73,000 (25,000 + 24 months x $2,000).
Now for the tip from the IRS collection official with whom I spoke. The payments made over the 24 months do not need to be equal in amount! So in the above example it would not be necessary to pay $3,041.67 per month ($73,000/24 months). Instead the IRS could accept monthly payments of $1,500 per month for 23 months with a balloon payment of $38,500 in the 24th month. Any other variation is possible, so long as $73,000 is paid by the 24th month. However, there can be no renegotiation once the OIC is accepted. So if the taxpayer defaults in month 24 because she can’t afford the balloon don’t expect much sympathy. Do expect that the IRS will want a credible explanation, and documentation of the taxpayer’s ability to come up with the balloon payment. It may be friends or family, liquidation of assets (e.g. retirement accounts, real or personal property, etc.), forthcoming settlement, inheritance, wages, or the like. If the IRS financial analysis determines that the OIC cannot be funded, the offer will be rejected. The mere hope that things are going to get better won’t cut it.
If you have tax problems, and you are considering an offer in compromise or another alternative to your tax problems call the tax lawyers at Brager Tax Law Group, A P.C.
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