The Internal Revenue Service in May announced more changes to its tax collection policies as part of its Fresh Start Initiative to help financially distressed taxpayers deal with their tax debts. The changes are to the IRS’ Offer in Compromise, or OIC, program. As a tax practitioner that has worked with the OIC program for the past 15 years, these changes are significant.
The OIC is the process whereby taxpayers can make a deal with the IRS to accept less than what the taxpayer owes. If a taxpayer owes $100,000 in back taxes, for example, they may be able to file an OIC and offer to pay $10,000 in satisfaction of their outstanding $100,000.
The determination of a proper offer amount in an OIC is based on two calculations, the first of which is the value of the taxpayer’s assets. An OIC is generally not possible if the taxpayer’s assets exceed what they owe in back taxes as the IRS will determine that it can collect the full amount owed through normal collection practices.
However, there are limited circumstances where the IRS will accept an offer amount from a taxpayer that is less than the value of their assets.
The second calculation is the taxpayer’s current – and sometimes past – income stream. The IRS will analyze a taxpayer’s current income stream against their allowable expenses to determine how much of their future income should be considered as part of the offer amount. For example, if a taxpayer’s gross income is $5,000 per month and their allowable expenses were $4,000 per month, the IRS would determine that the taxpayer must include an amount equal to $1,000 per month times 48 or 60 months – depending on how quickly the offer would be paid – plus the value of their assets for an acceptable offer amount. This is known as the “reasonable collection potential.”
The Fresh Start Initiative changes to the OIC program are extremely favorable to taxpayers. Here are some of the changes:
Where the reasonable collection potential amount used to be calculated out 48 to 60 months, that amount will now be calculated out 12 months for offers that will be paid off within five months and 24 months for offers that will be paid off within six to 24 months. Referencing the above of a reasonable collection potential of $1,000 per month that used to require an inclusion of $48,000 to $60,000, that amount now will be $12,000 to $24,000.
Another change is that the value of an item of equipment that is critical to its ongoing operations of a business will not be included in the value of the business’ assets. For example, if a business had a machine that it depended on to manufacture parts that was critical to its business and the machine was worth $100,000, the value of that machine would not be included in the offer amount. In the past it would have.
In the past the total amount of cash in the bank account was included as an asset. Now the IRS excludes the first $1,000 of cash from bank accounts. The IRS also excludes the taxpayer’s monthly living expenses. If the taxpayer has $3,000 in its bank account and their monthly living expenses are $2,700, then the entire amount in the bank account would be excluded as an asset because after deducting the $2,700 the taxpayer would have $300 left, which is less than $1,000.
Net equity of $3,450 per vehicle is excluded from the offer amount. This is after the deduction of 20 percent from the fair market value of the vehicle, which represents the amount the IRS expects to obtain on levy of the vehicle.
A dissipated asset will not be included in a taxpayer’s assets unless it can be shown that the taxpayer sold, transferred, encumbered or disposed of the asset to avoid the payment of taxes or that the money was used for something other than the production of income or the health and welfare of a taxpayer. Additionally, the IRS is limited to a three year look back for dissipated assets and the year the offer is submitted is considered a year.
So, the IRS would only look back to 2010, absent extraordinary circumstances, for an offer submitted in 2012.
Minimum payments now will be allowed on student loans that are guaranteed by the federal government in the determination of allowable monthly expenses.
Payments for state or local back taxes will be allowable in certain circumstances in the determination of monthly allowable expenses.
Some of the changes can be quite significant and have a major impact on an offer amount. Taxpayers should consult a qualified tax professional if they are considering an OIC, but only after conducting research on the firm. Various “tax resolution firms” have been put out of business lately based on deceptive ad practices, i.e., they could not deliver on what they were promising.
The author is a partner at Calone and Harrel Law Group LLP who concentrates his practice in taxation, real estate transactions, corporate, partnership and limited liability company law matters. He is a certified specialist in taxation. He may be reached at 209-952-4545