The IRS Offer in Compromise: Doubt as to Collectability
One of the most powerful tools available to taxpayers facing federal tax debt is the IRS offer in compromise – doubt as to collectability. This is typically what those “1-800” tax service company commercials are referring to as “pennies on the dollar” tax settlements. Taxpayers often do not realize how this process works and the complexities that can arise through the course of submitting an offer in compromise.
An offer in compromise, doubt as to collectability is authorized through I.R.C. § 7122, which sets forth the statutory framework for submitting an offer. There are two types of offers recognized by the IRS: doubt as to collectability and doubt as to liability. The former seeks to settle tax debt that is undisputed while the latter seeks to settle tax debt that is in dispute. To successfully settle tax debt through a doubt as to collectability offer in compromise, a taxpayer must first determine a minimum offer amount based upon their net equity in assets and net monthly income. They must also satisfy a full-pay test, which is based on their net monthly income multiplied by the months remaining on the collections statute of limitations. The minimum offer amount calculation is summarized as follows:
Minimum offer = (net realizable equity in assets) + (net monthly income X 12)
For example, a household of 2 has a home worth $200,000, secured by a mortgage with a balance of $150,000. They also have two paid-off vehicles worth $12,500 and gross monthly income of $5,000. Their net equity in assets would be calculated by reducing the $200,000 home value by 20%, subtracting the mortgage balance of $150,000, and adding the value of the vehicles (reduced by 20%) less $6,900. This leaves net equity of $13,100.
The taxpayers’ net monthly income would then be calculated by subtracting their household expenses from their gross income of $5,000. These expenses are capped by IRS standards based on household size. In this example, assume the taxpayers have $4,800 of allowable household expenses, leaving net monthly income of $200. This results in a minimum offer of $15,500 ($13,100 in net equity + $2,400 in net monthly income of $200 multiplied by 12). To support the above calculations, the IRS requires taxpayers to submit a detailed financial statement with at least 3 months of supporting documentation for the income, expenses, assets, and liabilities claimed in the offer.
To successfully compromise the liabilities above, the taxpayers must also satisfy a full-pay test, based on their net monthly income, the total tax liability owed, and the number of months remaining on the IRS collections statute. The IRS generally has 10 years to collect taxes owed, measured from the date of filing or assessment, whichever is later. The offer in compromise full-pay test is summarized below:
Tax liability > net monthly income X # of months remaining in the collections statute
If the taxpayers in the above example owed $10,000 in current year federal income taxes, they would not pass the full-pay test and their offer would therefore not be accepted because $10,000 is less than $24,000 ($200 net monthly income X 120 months left in the statute of limitations). However, if the taxpayers owed $100,000 in federal income taxes, they would pass the full-pay test and their offer would be accepted since $100,000 is greater than $24,000.
Once the offer amount has been calculated and the taxpayers have satisfied all required tests, the offer may be submitted to the IRS for consideration. 20% of the offer amount is paid with the submission of the offer along with a $186 filing fee. Taxpayers have two options to pay the amount offered: (1) a 5-month option; or (2) a 24-month option. Under the 5-month option, the taxpayer has 5 months from the date the offer is accepted to pay the remaining 80% of the offer amount. Under the 24-month option, the taxpayer has 24 months from the date the offer is submitted to pay the offer amount. The 24-month offer also requires the taxpayer to multiply their net monthly income by 24 instead of 12, which may lead to a higher offer amount.
A few more rules. An accepted offer in compromise is subject to a number of contingencies. Most significantly, the IRS requires 5 years of tax compliance under the terms of the accepted offer. If the taxpayer fails to remain compliant, either by failing to file a return or failing to timely pay a liability, the compromised tax debt will be resurrected, along with penalties and interest. This result is severe and requires strict compliance in order to prevent it.
In sum, a doubt as to collectability offer in compromise is a powerful tool available to qualifying taxpayers to settle outstanding tax liabilities. The offer process is extremely mechanical and requires significant technical knowledge of the tax code and IRS regulations. There are several exceptions to the general rules explained in this article and it is critical to seek advice from experienced tax counsel when considering an offer in compromise.