The Offer in Compromise - simple explanation and description
An Offer in Compromise or IRS Offer in Compromise may be just the right IRS Tax Help one needs. It is an out of court agreement between the IRS and the taxpayer that resolves the taxpayer's liability. The Internal Revenue Service has the authority to settle or compromise federal tax liabilities by accepting less than full payment under certain circumstances. These circumstances are:
Doubt as to liability
- Doubt exists that the assessed tax is correct.
Doubt as to collectibility (most common)
- Doubt exists that you could ever pay the full amount of tax owed.
Effective tax administration
- (i.e., economic hardship)
The most common resolution for an Offer in Compromise is doubt as to collectibility. The inquiry in this type of OIC is substantially similar to inquires made in a bankruptcy, i.e. Income is lower than acceptable expenses, insufficient assets to satisfy the debt if liquidated, etc. Many taxpayers file an OIC after receiving a discharge in bankruptcy in order to settle non-dischargeable tax debt.
If you qualify for an Offer in Compromise and meet the IRS criteria, our veteran Tax Attorneys, Enrolled Agents, and Tax Specialists will contact the IRS for you and negotiate your Offer in Compromise settlement. The negotiations usually center on the proper valuation of your assets, accurate information about your monthly income, and living expenses.
We have the advantage of a national perspective regarding the Offer in Compromise process, because we have active cases throughout the United States, which helps eliminate the misapplication of tax law and prevent unnecessary errors while negotiating Offer in Compromise settlements. Through many years of experience and insight into unpublished IRS administrative practices and policies, Tax Tiger has developed an expert understanding of the Offer in Compromise process, and because of this, we have been able to settle cases at the lowest amounts the IRS will allow for each qualifying taxpayers situation. That insight we have into the Offer in Compromise process allows us to minimize the opportunity the IRS has to return an offer without resolution.
Tax Tiger prepares Offer in Compromise submissions with all documentation necessary to provide a very strong and substantiated case, in a very professional presentation, which is often complimented by many IRS agents working the cases. Our staff has IRS manuals at their disposal, specifically ones related to the Offer in Compromise procedures and Collection Activity, which allows us to force the IRS to follow the legal and administrative procedures as well as what Congress has mandated the IRS to follow.
Once the IRS accepts the Offer in Compromise, you have three payment plan options that the IRS may agree to:
- Cash (paid in 90 days or less)
- Short-Term Deferred payment (more than 90 days, up to 24 months)
- Deferred Payment (payment terms over the remaining statutory period for collecting the tax)
How much time do you have? The IRS will withhold collection activity for the duration that the offer is in review.
Our contracted attorneys have worked at very high levels within the IRS, and understand the most effective ways to deal with them in resolving your IRS problem. We have the insight and knowledge of the IRS, negotiating skills, and a tax staff second to none at reducing your tax liability. Our tax staff prepares returns year round, not just during the three months of tax season. Our mindset is not "black and white", because the tax law is often ambiguous and allows room for negotiation in areas most are unfamiliar with. We specialize in identifying and creatively applying factual information to defend and protect you as the taxpayer, and essentially to obtain a favorable tax settlement on your behalf, and this is a distinct advantage in choosing your representative. The IRS will often make determinations on incomplete facts and they certainly will not come to conclusions that will reduce your liability. Our inside knowledge of the IRS processes and way of thought will be beneficial in negotiating the best possible settlement. The firm you select must have a high degree of competence, knowledge, skill, and ability in preparing a complete and professional Offer in Compromise.
The Offer in Compromise - detailed information
The Offer in Compromise program is authorized by federal tax law. The program is older than the income tax, allowing revenuers in the 1800s to compromise excise tax liabilities. The Internal Revenue Service takes the offer program seriously and to be successful, the taxpayer must also. Preparing an offer goes far beyond filling in the blanks. The offer must present an overall picture of a deserving taxpayer. Today, there are three ways to compromise income tax liability under federal law.
If the taxpayer does not believe he or she owes the tax and wants to settle by compromise, the taxpayer can file an Offer in Compromise based on doubtful liability. If the taxpayer simply does not have the resources to pay the outstanding obligation, the taxpayer can file an Offer in Compromise based on doubtful collectibility. Since 1998, the taxpayer can also seek to compromise the tax obligation on the basis that it is good public policy or that it is simply equitable.
To successfully compromise a tax liability based on collectibility, it is the taxpayer's job to convince the Internal Revenue Service that they will receive more by acceptance of the offer than they will obtain by proceeding with collection remedies. However, some assumptions applied by the IRS in reviewing an offer are actually more liberal than the results should the Internal Revenue Service attempt collection. For example, a taxpayer who collects his salary on a monthly basis may have only $800 in take home pay after garnishment of his wages. The Internal Revenue Service therefore allows the taxpayer an amount equal to his or her (hereafter "his") reasonable expenses, assuming that the taxpayer will not stay at the job if the taxpayer is not allowed enough money to live on.
If the offer is location sensitive (valuation of real estate), it will be sent back to a local IRS group. The information is initially reviewed for processability. If the taxpayer a) hasn't filed all required returns, b) is in bankruptcy, or c) is in business with employees and has not been in compliance with 940/941 filing and depositing requirements for the two preceding quarters and the current quarter, then the offer will be returned as non-processable.
If, from the information provided by the taxpayer, it is obvious that the offer is less than the IRS would otherwise collect, the offer is also returned non-processable. Unfortunately, the IRS has taken the position that incomplete offers (such as omitting the vehicle mileage) are returned. Offers may also be returned if the government determines that the sole purpose of the offer is to delay collection.
Once the offer is found to be processable, it is "processed" and freeze codes are input into the computer to stop collection action. The IRS must cease all collection activity, unless collection of the tax liability is determined to be in jeopardy (which is a rare event). If the taxpayer receives any notices during the offer process, a follow up should be made to ensure that the offer has been properly coded in the system.
The offer then awaits assignment to an offer specialist. The goal of the IRS is to process offers within a six-month time frame and it appears that most offers are being processed within that time frame. A new law that just went into place last year, states that the IRS has 24 months to process an Offer or it is automatically deemed accepted. Offers that present no novel issues may be accepted without further communication, or after a rather simple request for additional information or clarification.
If the case is referred to a local IRS office, the taxpayer will receive a letter notifying him of an assignment to a revenue officer who will be contacting the taxpayer, or their representative in the near future. Once the revenue officer begins working the case, the case will again lie dormant until the offer reaches the top of the pile. The process will then move very rapidly.
If the revenue officer feels the amount offered is inadequate, he will usually supply his calculations that will lead to a minimum offer amount. In effect, this is a counter-offer. Counter-offers are based upon the IRS's ability to collect, not upon the amount owed.
Counter-offers will arise from differences in opinion between the offer specialist and the taxpayer as to the value of assets (usually the house or car), as to the actual income of the taxpayer, and as to the necessity of the taxpayer's expenses.
Each rejection is given an independent review by an independent administrative reviewer, a position created as a result of Section 3462 of the 1998 act. The independent administrative reviewer must review all offers prior to communicating such rejection to the taxpayer. The taxpayer can appeal the rejection in most cases and may have more luck with the appeals officer. Likely areas of appeal are valuation problems and issues having to do with the necessity of expense items, such as cost of travel to work. Today, nearly 70% of all valid Offers are rejected by clerks failing to give the Offer a thorough review, leading to more and more appeals.
If the revenue officer recommends acceptance, it goes to his group manager for review. Upon acceptance, the taxpayer receives a letter outlining the terms and a copy of the offer executed by the Internal Revenue Service.
In determining the Offer amount, the offer specialist is charged with determining the amount of unpaid tax liability that can be collected by (1) liquidating taxpayer's assets (Valuation Issues) and (2) through an installment plan with respect to taxpayer's income (Income Issues).
Valuation Issues - In the case of assets, the issue is how much the Internal Revenue Service will realize if the IRS seizes the assets and auctions them rather than how much the taxpayer can get through careful marketing.
First, you are going to have to offer an amount exceeding the cash the IRS could raise if they come in and sell all your assets (current IRS valuation is 80% of FMV). Therefore, you have to have some outside source for obtaining the offer funds. This would generally be a loan or gift. However, the IRS cannot make you borrow from your credit cards, life insurance or 401k plans, so these may also be sources of funds.
The IRS requires the last three months of personal bank statements. The offer specialist will determine the average personal checking balance and subtract one month's necessary living expenses from it. Any excess will be considered a cash asset. Total balances in all savings accounts will be added to that to determine total cash assets available. It is imperative that the bank statements tell the same story as the financial statements submitted with your Offer. If the deposits on the bank statements exceed the income figure, this needs to be explained (loans, inheritances or the like).
If the taxpayer is self-employed, the business will be considered an asset. However, if the hard assets of the business (accounts receivable, equipment, operating capital) are liquidated, the resulting income will disappear. Therefore, where the primary source of income is the business, do not count the accounts receivable as an asset and also count the money coming in from those receivables as income.
If the taxpayer is self-employed, the business will be considered an asset. However, if the hard assets of the business (accounts receivable, equipment, operating capital) are liquidated, the resulting income will disappear. Therefore, where the primary source of income is the business, do not count the accounts receivable as an asset and also count the money coming in from those receivables as income. If the business is profitable, it should continue. If not, it should be liquidated. The value of the business then becomes the net value of the assets in the forced sale scenario. Accounts receivable can either be, allocated to the business, or to future income, but not both.
When collecting, the Internal Revenue Service steps into the shoes of the taxpayer. If the taxpayer cannot liquidate his retirement plan without terminating employment, the asset has no value to the IRS. However, it must be listed and should include an explanation as to why it cannot be liquidated.
The IRS can levy retirement vehicles such as IRAs. Since voluntary liquidation will generate a tax and penalty, the IRS will allow a discount to reflect the payment of tax and penalty upon liquidation, but only if you are going to liquidate the IRA to pay the offer amount. You must include the entire amount.
At this point, the potential for bankruptcy should be mentioned. Income taxes that are due at least three years before filing the bankruptcy, if the returns were actually filed at least two years before the petition and the taxes were assessed at least 240 days before the petition, may be dischargeable. In the case of IRAs, bankruptcy courts will weigh the needs of the creditors against the needs of the bankrupt in determining whether the IRA is protected. The IRS should, and often will weigh the bankruptcy option in valuing the offer. If the taxpayer is a candidate for bankruptcy, he should probably begin with a bankruptcy analysis. The offer program is often referred to as the IRS bankruptcy equivalent.
Automobiles seem to be the hardest asset to reach agreement over. The IRS rarely realizes the value of an automobile at auction and it is extremely unlikely that the IRS will realize low blue book value. However, the offer specialist is likely to argue that the correct value should be somewhere between low blue book and retail. It is essential that all automobiles be listed because the offer specialist will check with the DMV for all vehicles registered in the taxpayer's name. This includes vehicles recently transferred out of the taxpayer's name (there is a box that requires disclosure of any recent transfers for less than full value).
The Internal Revenue Service has historically allowed a 20% discount from the fair market value of real property, i.e. your home. This is called "quick sale value." It means that a home for which a taxpayer recently paid 20% down will be reflected as having zero equity.
If the taxpayer owns a home he should obtain an appraisal or a good market analysis. The IRS will sometimes ask for backup documentation if the taxpayer resides in an area with increasing home values. The form asks for the amount that the taxpayer could sell the property for "today," which suggests quick sale vale. We believe that this allows the 20% discount from true market value that is based upon presenting the home in its most favorable circumstances to be taken.
Under the community property law of some states, all community property is responsible for the debts of either spouse. However, a house held in joint tenancy, if in fact it is a true joint tenancy, is deemed held one-half by each spouse and presumably would support the same type of discount that fractional interest holders claim. A prenuptial or even post nuptial agreement separating property, if executed at a time in which no fraudulent conveyances are occurring, can equally separate the property. Therefore, review of title to property and of marital agreements may be productive.
The statute provides exemptions from levy and these exemptions apply when valuing the assets. A taxpayer may exclude a certain amount in tools and equipment used in a trade or business, and a certain amount in furniture and household belongings. The IRS will apply these exemptions. However, the taxpayer may want to address the exemptions. For example, in some cases it may be possible to argue that an automobile should be eligible for the exclusion as a tool required in a trade or business.
Income Issues - Most taxpayers that fail to qualify for an offer, fail because they are able to pay from income that they have offered. The offer specialist determines the monthly amount that the Internal Revenue Service will receive under an installment agreement from the taxpayer's financial information submitted. To arrive at the offer amount, the offer specialist merely multiplies the monthly income times 48 months. If the taxpayer can make payments of $100 per month, the offer amount must be at least $4,800 (plus that value of the taxpayer's assets).
Historically, the 48 multiplier is approximately the present value of five years of collection. The time frame arises from the old six-year statute of limitations, less one year to reflect the average time it took a taxpayer to file the offer. Since the present value of a five-year stream of income was approximately equal to 48 times the monthly amount available under an installment agreement, the current practice is to calculate the amount available to the IRS for offer purposes by multiplying the monthly income available by 48 if the taxpayer can pay the offer amount within 90 days of acceptance. A new law currently in place, will allow the taxpayer to pay over 5 months. For longer payout periods, the multiplier goes up.
For the wage earner, the income side of the equation is fairly easy. For self-employed individuals, net income is supposed to be a realistic projection. Last year's net income is acceptable. If the projection differs from the taxpayer's previous year's schedule C (or E in the case of a partnership or S Corporation), the taxpayer needs to attach an explanation.
In most cases, this explanation of projected income is the single most important attachment to the offer. In it the taxpayer can explain the trends in the industry, problems internal to the company, contingent liabilities and a host of other limiting factors.
The taxpayer is allowed by the Internal Revenue Service to apply certain National Standards as expenses related to transportation, household goods, and housing allowances. These are derived from IRS charts and vary by income level and the number of persons in the household. The amounts are updated periodically and can be found on the IRS website.
The taxpayer is always able to offer information that will allow a variation from the standard, but variation is rare. This expense category is based on national averages and is a substitute for actual monthly expenditures. An individual with no dependants earning $3,000 per month is entitled to $556 per month, while a family of four earning $6,000 per month is entitled to $1,546 per month.
Unlike the national standard expenses, housing and utility expenses are not automatically granted. The expense allowed will be the lesser of (1) the taxpayer's actual expenses and (2) the median expense of living in the county of residence. In other words, for a family of four in Contra Costa County, the housing expense will be the lesser of the median expense in the county, which is $2,434, or the actual expense incurred by the taxpayer. However, there is again room for argument here.
Household and utilities include rent or mortgage payments on the taxpayer's principal residence, property taxes, property insurance, necessary maintenance and repair, parking, homeowner's dues, gas and electricity, telephone, garbage, water and any other expense associated with home ownership or renting. In the case of shared living (taxpayer lives with fiancé), the revenue officer will usually allocate the expenses between a taxpayer and the person sharing the residence on the basis of actual contribution to the household, if by agreement. If there is no agreement, allocation will probably be proportional to income (if taxpayer earns $10,000 and fiancé earns $20,000, taxpayer gets one-third of the household and utilities expense).
There is room for argument where the housing cost can be tied to income or health and welfare issues. If employment is dependant upon living close to the job, higher costs can be justified. In the case of the elderly, cost of relocation can justify higher living expense.
The IRS asks that proof of car payment, lease, fuel, oil, insurance, parking and registration fees to be submitted with the Offer. These are requested for the non-business use of the car, assuming that business use will be netted out in the net income statement. As in the case of household and utilities, there is a cap on the amount of transportation expense. The cap has two components, namely the monthly ownership cost (lease or monthly loan payment) and operating costs. Operating costs are based on average transportation cost determined by metropolitan statistical area while ownership costs are determined nationwide. The cap on car payments for the first car for the San Francisco Bay Area is $471, while the cap on the second car is $332 per month. The balance of the monthly operating expenses (gas, oil, necessary maintenance, insurance, parking and tolls and registration) cap out at $401 for one car, and $484 for two cars. If the taxpayer has no car, the cap for public transportation is $325 per month.
The Healthcare expense category consists of (1) the monthly average of out-of-pocket expenditures (not reimbursed by insurance) for medical expenses, and (2) the cost of maintaining medical insurance, averaged over some period (such as six months). The form requires supporting data for the last three months and this is another area where there seems to be extreme scrutiny. A statement as to the reason for the expenses may be advantageous.
Revenue officers will generally look to the rate at which taxes are actually being paid currently (withholding for wage earners and estimated taxes for non-wage earners). Taxes should include federal and state withholding, SDI, FICA, and Medicare.
Court ordered payments and child support require the attachment of the court order and proof of payment (checks).
The IRS will accept Life Insurance payments, but only if it is for term insurance equal to 3 times the taxpayer's average salary. Additional cost will have to be justified by statements.
Other expenses allowable generally fall into two categories. Any expenses incurred in the production of income, these would include excess gasoline expenditures for taxpayers living far from their job, bridge tolls, parking expense, union dues, home office expense where warranted and any other expense which, if not incurred, would adversely impact the taxpayer's earning ability. In the case of self-employed individuals, these expenses will probably be netted out in the net income statement.
Other expenses can also include any item for which there is a compelling argument. Tithing has been accepted (and rejected) depending on the circumstances. The IRS does not consider sending a child to college more important then paying taxes.
Common sense will tell you that a family unit cannot spend more than it takes in. Therefore, the taxpayer will need to explain why expenses exceed income. If this is the result of subsidy by parents or the borrowing against credit cards, a statement to that effect will go a long way.
If the taxpayer finds that he is unable to pay the amount offered in full within ninety days of acceptance (recently changed to 5 months), taxpayer can opt to pay over a period of 24 months. However, the offer price will be higher because a 60 multiplier will be applied to the income realization instead of the 48 multiplier. This calculates out to an interest rate of up to 15%. Alternatively, the taxpayer can have the IRS determine how much the taxpayer can pay on a monthly basis and the taxpayer can agree to pay that amount monthly through the period that the statute of limitations runs. The statute of limitations for collection is ten years from the date of assessment and can be determined from an Internal Revenue Service transcript on which it is coded as CSED. These transcripts are available at any IRS office and the officer on duty will usually be glad to determine the collection statute for the taxpayer.
If there are special circumstances, the Internal Revenue Service can use an alternate set of rules that look to the fairness of accepting the offer. The IRS refers to the offer as based upon the need for effective tax administration. The IRS can accept an offer based upon the fact that collection of the tax would create an economic hardship on the taxpayer or that collection of the full tax would be detrimental to voluntary compliance.
Regulations released in July, 1999, give four examples of situations in which compromise is appropriate. These include the mother with a child having a long-term illness if liquidation of her assets would leave her without the ability to provide for her child, a retired person that would not have sufficient assets to provide for basic living expenses if his retirement plan were liquidated, and a disabled taxpayer with a home that has been specially equipped to accommodate his disability and where liquidation of the home would render him unable to get these facilities elsewhere. In each case, the fact pattern includes the fact that the taxpayer's overall compliance history does not weigh against compromise.
The fourth example represents a complete reversal of IRS policy and results from some of the testimony given at the Congressional hearings in 1997. In the case of corporate Trust Fund taxes (withholdings of payroll 940/941 taxes), if there has been an embezzlement of funds of which a corporation was unaware and should not have known of, and if the company is profitable, but not profitable enough to pay the liability, the IRS will consider settlement.
Secondly, the IRS will compromise a liability where exceptional circumstances exist such that collection of the full liability will be detrimental to voluntary compliance by taxpayers. This is a standard hard to comprehend. It appears that the intention is that if the overall story is compelling enough, taxpayers in general would lose faith in the system if the liability were not compromised.
The two examples start with a taxpayer incapacitated for several years and, when he becomes able to care for himself, finds he owes more than three times the original tax. The second example is that of a taxpayer that has been misled by IRS advice (in response to his E-mail, etc.), as often as this happens, most taxpayers do not obtain this advice in writing, therefore no action can be taken.
One thing is clear. The equitable offer is the far more uncertain road to travel, and may well take far longer than the well-defined offer in compromise based upon doubtful collectibility.
The State Offer in Compromise
Many states now have an Offer in Compromise program. Since we are located in California and most of our State Offer in Compromises are for California, we will address the differences and requirements for CA.
The State of CA Franchise Tax Board has developed a rather distinctive Offer in Compromise program. In recent years, the Franchise Tax Board's acceptance of offers has increased dramatically and appears now to roughly parallel the federal acceptance rate.
Turn-around time at the Franchise Tax Board is more rapid. This can create complications if the taxpayer submitting an offer to both the federal and state agencies. The state agency, with its one offer group, works on a more intuitive basis. In cases where there is a possibility of changed circumstances and full payment, the state counteroffer is likely to be the amount of tax due (compromising the penalties and interest). This policy has been codified. If the taxpayer makes the case that he cannot pay the full amount, the Franchise Tax Board will review the offer emphasizing fairness in a less rigid context than the IRS.
It is the Franchise Tax Board's policy generally not to pursue collection while an Offer in Compromise is in progress. However, collection efforts are not stayed by law while the offer is being processed as is the case federally.
If the taxpayer wants to settle with both California and the IRS and lists all assets at full value on both offers, he will end up paying twice their value when settling with both agencies. The state is much more amenable to taking an offer at less than full asset value when a federal liability is involved, as long as the state is receiving an amount equal to the proportionate obligation (if the state obligation is one-third of the federal, the offer should be one-third of the federal).
One possibility is to raise enough cash to make a deposit with the state of its proportionate share of the offer funds available. This deposit will then be excluded from the assets available for the federal offer. Unfortunately, with the state processing offers more rapidly than the federal, the taxpayer is left with the dilemma of whether to accept the state offer before knowing whether a federal offer will be successful. However, the state has been extremely patient while waiting for the IRS determination.
The financial statements sought by the Franchise Tax Board in many respects parallel that sought by the Internal Revenue Service. It is the monthly income and expense analysis where the Franchise Tax Board tends to depart from the federal offer format. While the focus of the federal offer is on gross income, the state offer looks to net income.
The Franchise Tax Board asks for both the gross and net income from businesses and rentals. Strangely, the Franchise Tax Board does not ask for backup data for the business and rental income other than bank statements.
The Franchise Tax Board also asks for a three-year income summary, which allows the Franchise Tax Board to compare gross income reported by the taxpayer to that on filed returns. These issues arise in fairly few offers and the Franchise Tax Board may find it easier to deal with businesses and rentals on a case-by-case basis.
It is the expense side that differs significantly from the federal offer and frequently results in a somewhat different analysis. Their policy is to allow all reasonable expenses that are actually being paid. This may include tithing, college for the kids, and payments on credit card debt. The Franchise Tax Board does not use the national standard expense, and does not cap housing and auto expense.
The Franchise Tax Board requires a separate breakout of grocery, auto insurance, gasoline, estimated tax payments, and payments on delinquent taxes. This itemization makes the state form a much harder form to complete. However, as in the case of the federal offer, the larger the gap between income and expense, the larger the amount that will have to be offered. Because of the multiplier, it is important that the gap between income and expense be narrowed as much as possible.
In the best of circumstances, the taxpayer will keep the monthly budget electronically and will be able to account for all expenses by merely printing out a profit and loss statement on Quicken or a similar software program. If not, the taxpayer should compile a list of all expenses from the taxpayer's checkbook records. Unless the taxpayer has savings from which to draw or receives help from friends or family, all expenses, whether necessary or not, should be listed.
As with every aspect of preparing the offer, the expense statement should be as complete as possible. If there is any question on an item, the taxpayer should include the item and let the professional determine which items are appropriate and how much supporting material should be included. Most preparers have software programs that allow him to enter the information the taxpayer supplies to create a finished product.
The taxpayer is asked to describe why the offer is fair and where the offer funds are coming from. The IRS does not seek an explanation why the offer is fair, but preparing a response is a good exercise, since the strongest argument the taxpayer has is that the offer is fair (not something that the taxpayer is entitled to). The state will also seek a copy of the Internal Revenue Service Offer in Compromise (but not the attachments) and a state Power of Attorney.
The federal and state offers, if both are appropriate, should be prepared simultaneously. Many of the materials and much of the thought process is similar.
Check your state website to see if a state OIC is offered here.
