An IRS offer in compromise is a legal agreement between the government and a taxpayer wherein the IRS agrees to take a lesser amount in settlement for delinquent taxes.
Many taxpayers often wonder why the IRS would offer such a program. There are several reasons; however before we cover the rationale behind this second chance opportunity offered by the government let us discuss some the programs aspects.
To prepare and negotiate a successful offer in compromise is an arduous task. The duration of this process is anywhere from 6 months to 1 year. Most offers in compromises are rejected by the IRS. In fact in 2009 of the 52,000 offers that were submitted only 21% were accepted. However, the chances for an IRS settlement are increased if a given taxpayer is organized the responds timely to the IRS’s request.
Types of Offer In Compromises
There are (2) types of Offer in Compromises generally used to settle tax debt. The first and more common type is “Doubt as to Collectability”. The second type is” Effective Tax Administration”.
Under the caption “doubt as to collectability the taxpayer is seeking tax relief stating they do not have the income nor the assets to full pay their back taxes. Under the “Effective Tax Administration” the taxpayer agrees they have sufficient income and or assets to completely pay the delinquent taxes but doing so would create an economic hardship.
For purposes of this article our discussion will focus on the “Doubt as to Collectability” Offer In Compromise. Remember under this caption the taxpayer is provided with tax relief because they lack the financial ability to full pay their outstanding tax debt. Here’s how it works.
Let’s assume the following:
- Mr. T owes the IRS $50,000 in back taxes.
- Mr. T owns his home with a market value of $300,000.
- His mortgage balance is $250,000.
- Mr. T’s monthly income is $6,000.
- His monthly household expenses are $5,900.
- No retirement savings or other assets.
The amount to offer in a federal offer in compromise is based on two components, future income and current assets.
Step one is to determine Mr. T’s future income. In this example after Mr. T pays his allowable living expenses he has a surplus of $100. Computed as follows:
Gross Monthly Income $6,000
Allowable Living Expenses $5,900
Net Surplus $ 100
Step two is to determine how long Mr. T has to pay the offered amount. There are generally three options: a) 90 days b) 2 years c) life of collection statute.
If Mr. T decides to choose the 2 year payment plan his monthly surplus of $100 would be applied to a multiple of 60. The result of which is $6,000. Thus $6,000 represents the future income portion of the amount to offer.
In part two of this series we will discuss how to calculate the asset portion of the offer.
Since the calculated offer amount of $6,000 is less than his outstanding tax debt of $50,000 the IRS will consider the offer. Mr. T will be able to make monthly payments of $250 for 24 months to satisfy his back taxes. He could also make a deposit of 20% of the offered amount in this case $1,200 and pay the reminder once the offer is accepted (within a 24 month period of submission). Please take note that the IRS will not add additional interest or penalty to offer amount of $6,000.
Why would the IRS settle a $50,000 tax debt for $6,000 and offer payments terms that does not include interest or penalties? Here are a few reasons:
- Congress wants the IRS to reduce the tax gap. (collect unpaid taxes).
- Taxpayers who are lucky to have an offer in compromise accepted must file and pay on time for 5 years after the offer is accepted. This stipulation keeps former delinquent taxpayers in the system as current taxpayers, thereby closing the future tax gap.
- The collection statute may expire before the IRS collects the tax. The IRS position is something is better than nothing.
For immediate advice regarding an offer in compromise or other tax issues contact our office at (212) 684-3637.
We are Nationwide Tax Solutions, a CPA firm with over 20 years of experience solving IRS problems. Contact us at www.nwtaxsolutions.com.