We often meet with taxpayers that would like to have their tax problems solved with an offer in compromise. While an offer in compromise is an excellent way for qualified taxpayers to settle back tax debt for much less than what they owe, there are various reasons why an offer will not be accepted by the IRS.
In most cases, the IRS will not accept your offer unless it equals or exceeds your reasonable collection potential (RCP). The IRS considers your future remaining income (FRI) and equity in your assets to determine your RCP and thus your ability to pay.
FRI is your monthly income less your allowable living expenses per IRS expense standards. Income taxes and FICA taxes are included as allowable expenses. The resulting FRI is multiplied by either a factor of 12 for a lump sum cash offer or 24 for a periodic payment offer. A lump sum offer requires a 20% down payment of your offer amount and the balance to be paid in five or fewer installments within five months of acceptance of your offer. A periodic payment offer requires monthly payments (they do not need to be equal) over a 24-month period beginning at the time you submit your offer.
In order to calculate the equity in your assets, including any bank accounts, retirement accounts, automobiles, and real estate, you first need to determine its fair market value (FMV). Then you reduce FMV by any dollar amount or percentage permitted by the IRS, and any debt encumbering the asset. For example, if you own a home, the IRS will value it at 80% of its FMV less any loan balance.
We recently met with Alex and Samantha who owed the IRS $ 80,000 with 5 years remaining on the collection statute. After performing a financial analysis, we determined that they had FRI of $200 a month and equity in their home of $20,000 (after applying the 20% reduction prescribed by the IRS and their outstanding mortgage.) They had no other assets with equity.
Based on the above facts, Alex and Samantha would need to offer $22,400 or $24,800 depending on whether they selected a lump sum cash offer or a periodic payment offer. Seems like a good settlement with a minimum savings of $55,200. But wait, they don’t have the ability to borrow $20,000 ( the amount of home equity to be included in their offer) due to their income, and don’t have family or friends that can help.
Unfortunately, the IRS requires you to include the equity in assets in your offer, even if you can’t reach the equity. On rare occasions, the IRS will make an exception due to special circumstances such as advanced age or illness. However, these factors don’t exist with Alex and Samantha.
Partial Pay Installment Agreement
Is there another way they can have their tax problems solved that produces a similar result to an offer in compromise? Yes, a Partial Pay Installment Agreement (PPIA) can be a good alternative.
A PPIA is payment plan that allows you to pay what you can afford over the remaining statute of limitations (SOL). The IRS will review your financial condition every two years to determine any changes that would allow you to pay more. Interest and applicable penalties continue to accrue during the term of the PPIA. However, once the SOL expires, the balance owed is uncollectible and written off. You’ll need to give the IRS a collection information statement that provides detailed information about your finances. When determining your ability to pay, you’ll have to adhere to the IRS expense standards rule.
Even when you have equity in assets, the IRS may grant a PPIA if you can’t sell the asset or borrow against it. For example, if the taxpayer’s loan payment would exceed their disposable income and they won’t qualify for a loan the IRS may grant a PPIA. Of course, the IRS wants you to prove your inability to borrow, by providing documentation that your loan was denied.
So, let’s get back to Alex and Samantha and see how we had their tax problems solved with a PPIA. We proved to the IRS that they could not borrow the equity in their home and were able to set-up a PPIA at $200 a month, the amount of their disposable income. Remember, they have 60 month’s remaining on the SOL, so if their financial condition does not improve over this time frame, they will pay the IRS $12,000 to resolve an $80,000 tax debt. This actually produces a better result than the OIC they originally contemplated.
If you need your tax problems solved, please call East Coast Tax Consulting Group’s tax resolution professionals at 561-826-9303 for your FREE consultation.