Many of you have seen or heard the ads on television or radio promising to settle your IRS back taxes for pennies on the dollar with the use of an Offer in Compromise (OIC).

While an OIC can be extremely helpful in settling back taxes, a thorough analysis must be performed to determine whether you are a good candidate for the program and the extent of your possible tax savings. At East Coast Tax Consulting Group we always conduct such an analysis before recommending you submit an OIC to resolve your IRS tax problems.

The amount of your offer is dependent upon (1) the equity in your assets, (2) the excess of your monthly income over allowable expenses, and (3) the time period over which you will pay your offer.

Generally, the IRS values your equity in property at “quick sale value” minus any debt which encumbers the property. Quick sale value is typically 80% of a property’s value.

The IRS provides allowable national and local expense standards for the following expense categories:

  • Food, Clothing, Miscellaneous (FCM)
  • Housing and Utilities
  • Car Expense-ownership
  • Car Expense-operating
  • Out-of-pocket medical (OPM)

You are allowed the full IRS standard for FCM and OPM even though you have spent less. All other allowable expenses must be substantiated and are limited to the IRS standard except under special circumstances. Some expenses such as medical insurance, court-ordered payments, and federal, state and local income taxes and FICA taxes are generally allowable without limitation.

You can pay your offer in five or fewer installments within five months of acceptance (Lump Sum Cash Offer) or within twenty four months of submission of your offer (Periodic Offer). A lump sum cash offer requires you to make a 20% nonrefundable payment with your offer.

In determining the amount of excess income to be included in your offer a multiple of twelve is used in a lump sum cash offer, while a multiple of twenty four is used in the periodic offer.

The following examples are provided to give you a better understanding of how an offer amount is calculated and whether you may be a candidate for the OIC program.

Example 1

Taxpayer A and his wife owe three years of back taxes totaling $90,000. The remaining statute of limitations on collections is between 3-5 years.

The couple owns a home in Wantagh, NY where they live with their two young children. The home is worth $400,000 and has a mortgage of $325,000. Taxpayer A is employed and earns $120,000 a year. His wife does not work as she takes care of their children.

For offer purposes the taxpayers do not have any equity in their home as the quick sale value of $320,000 ($400,000 X 80%) is less than the mortgage of $325,000.

The taxpayer’s actual monthly expenses are as follows:

  • Housing and Utilities-$3,400
  • Food, Clothing, Miscellaneous-$1,900
  • Taxpayer A’s car lease$ 525
  • Wife’s car lease $300
  • Taxpayer A-operating costs of car-$400
  • Wife-operating costs of car-$300
  • Health Insurance-$550
  • Term Life Insurance-$50
  • Charitable Contributions-$50
  • Income taxes/FICA taxes-$2,000
  • Other-$525

 

The offer amount is calculated below:

 

Monthly Income

Monthly Expenses

Actual

IRS Standards

Allowable

Wages

$10,000

 

Food, Clothing, Misc.

$1,900

$1,465

$1,465

 

 

 

Housing and Utilities

3,400

3,891

3,400

 

 

 

Vehicle #1 Ownership/Lease Costs

525

517

517

 

 

 

Vehicle #2 Ownership/Lease Costs

300

517

300

 

 

 

Vehicle #1 Operating Costs

400

342

342

 

 

 

Vehicle #2 Operating Costs

300

342

300

 

 

 

Health Insurance

550

 

550

 

 

 

Out of Pocket Health Care Costs

240

240

 

 

 

Life Insurance

50

 

50

 

 

 

Taxes (Federal, State, Local, FICA)

2,000

 

2,000

Total Income:

$10,000

 

Total Living Expenses:

 

 

9,164

 

 

 

Total Available Monthly Income:

 

 

$   836

 

 

 

 

OFFER AMOUNT

 

Lump Sum Cash

 

Periodic Payment

Remaining Monthly Income

$   836

 

$   836

 

     x12

 

     x24

 

10,032

 

20,064

Plus Total Equity in Assets

 

Offer Amount

$10,032

 

$20,064

 

The lump sum offer of $10,032 and periodic payment offer of $20,064 represent potential tax savings of approximately $80,000 and $70,000, respectively. You can see that charitable contributions and other personal expenses incurred by the taxpayers are not allowed in computing the offer amount, thereby increasing the required payment.

The taxpayers in this example are able to borrow the money needed to fund their offer and thus are good candidates to resolve their IRS back taxes with an Offer in Compromise.

Example 2

Taxpayer B is single and lives in Ft. Lauderdale, FL, where he rents a condo on the Intracoastal. He owes the IRS $30,000 in back taxes and the remaining statute of limitations on collections is six years. Taxpayer B earns $70,000 a year and has no assets other than his personal belongings.

His monthly living expenses are as follows:

  • Housing and Utilities-$2,000
  • Food, Clothing, Miscellaneous-$1,000
  • Car Lease-$500
  • Operating costs of car-$400
  • Income Taxes/FICA Taxes-$1,600
  • Other-$400
  • Health insurance-$100

The offer amount is calculated below:

Monthly Income

Monthly Expenses

Actual

IRS Standards

Allowable

Wages

$ 5,833

 

Food, Clothing, Misc.

$ 1,000

$   583

$   583

 

 

 

Housing and Utilities

2,000

1,833

1,833

 

 

 

Vehicle #1 Ownership/Lease Costs

500

517

500

 

 

 

Vehicle #1 Operating Costs

400

346

346

 

 

 

Health Insurance

100

 

100

 

 

 

Out of Pocket Health Care Costs

60

60

 

 

 

Taxes (Federal, State, Local, FICA)

1,600

 

1,600

Total Income:

$ 5,833

 

Total Living Expenses:

 

 

5,022

 

 

 

Total Available Monthly Income:

 

 

$   811

 

 

OFFER AMOUNT

 

Lump Sum Cash

 

Periodic Payment

Remaining Monthly Income

$   811

 

$   811

 

     x12

 

     x24

 

9,732

 

19,464

Plus Total Equity in Assets

 

Offer Amount

$ 9,732

 

$19,464

The lump sum offer of $9,732 and periodic payment offer of $19,464 represent potential tax savings of approximately $20,000 and $10,500, respectively. The taxpayer in this example is able to borrow the money needed to fund his offer. Looks like another good offer candidate. Not so fast! The taxpayer’s excess monthly income is sufficient to fully pay his outstanding taxes over the remaining statute of limitations including any additional interest and penalties. Therefore, the IRS will not accept his offer, but would require the taxpayer to enter into an installment agreement.

Although an Offer in Compromise can help struggling taxpayers resolve their IRS tax problems, an extensive analysis of each taxpayer’s situation must be performed to determine if it is the proper resolution for the taxpayer.