We regularly receive calls from people who tried to resolve their tax obligations through an Offer in Compromise, but the Offer was rejected. Some have submitted the Offer on their own and some have been represented by an accountant, CPA, or an attorney. The one thing all of these Offers had in common was that the amount offered had no basis. The number was just a guess at what the IRS might accept to resolve the obligation. That is unfortunate as the IRS has provided guidelines for how to calculate the amount can be accepted for a compromise. They key is to understand and follow these guidelines.
There are different kinds of Offers with different guidelines: the Offer based on Doubt as to Collectability (DATC), the Offer based on Doubt as to Liability (DATL), and the Effective Tax Administration (ETA) Offer. While not technically an Offer, the taxpayer may also qualify for, want to submit, or be forced to consider a partial payment installment agreement under which they make a payment each month remaining in the statute of limitations on collections.
Within each of these Offers are many issues and considerations. The starting point is to know and understand these issues and considerations before you submit an Offer. A taxpayer may not be eligible for an Offer and submitting one, or submitting the wrong kind, could be a waste of time and money.
This article will focus on what we have found to be the most common type of Offer, the Offer based on DATC. The point of a DATC Offer is to offer to pay the IRS more than it believes it can collect from the taxpayer through enforcement actions like levies and seizures, after allowing for the taxpayer's reasonable and necessary living expenses.
The first step is to determine if the IRS will believe the taxpayer can pay the obligation within the time left on the statute of limitations on collections. Does the taxpayer have equity in assets or sufficient excess monthly income to pay the obligation in full? If yes, the taxpayer will not be eligible to use a DATC Offer. A common example is the taxpayer who has no excess monthly income but owns a house with no debt and plenty of equity to pay the tax obligation in full. The taxpayer may think it is unfair to use the equity in his or her house, but the IRS may believe it is unfair to other taxpayers to allow this taxpayer to pay less than the full obligation when they have used the tax money to payoff their mortgage. If the taxpayer can pay the obligation in full, with assets or cash flow, they will not qualify for an Offer.
The IRS may determine that the taxpayer cannot pay the obligation in full, but conclude the taxpayer can pay a significant amount which is more than the amount they would have to pay in an Offer. If this is the case, the IRS may decline an Offer and ask the taxpayer to enter a partial payment installment agreement and make monthly payments for the time left on the statute of limitations on collections. A good example is the taxpayer who owes $100,000, with only five years left on the statute of limitations on collections, has no assets, but can afford to pay $1,000 per month. They cannot pay the obligation in full. An Offer may be $12,000, but the IRS could collect $60,000 through a partial payment installment agreement.
If the IRS determines the taxpayer cannot pay the obligation in full and cannot make payments over the life of the statute of limitations on collections that are significantly more than an acceptable Offer amount, they will consider an Offer.
An acceptable Offer amount, assuming it will be paid within 5 months of when the Offer is accepted is an amount that is equal to or exceeds the sum of 12 times the taxpayer's excess monthly income plus the taxpayer's equity in assets, valued at the assets' quick sale values. Unless qualifying for a waiver of a down payment, the taxpayer will have already paid a 20% down payment with his or her Offer.
If the taxpayer wants to pay the Offer amount over twenty-four months, usually because they cannot afford a 20% down payment, an acceptable Offer amount will be the equity in assets valued at quick sale value plus 24 monthly payments. Unfortunately, the payments must begin when the Offer is submitted, and like the 20% down payment, may not be refunded if the Offer is rejected.
There are many more considerations when evaluating an Offer, but the starting point is understanding how the IRS evaluates and calculates an acceptable Offer. Knowing this can save a taxpayer significant time and money.
We will evaluate additional issues with the Offer in Compromise process in later articles. Please let us know if you have a specific question about Offers or any other tax matter.