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Posted on Jan 30, 2014 in Offer in Compromise, Tax, Tax Problem Toolkit, Tax Q&A | 4 comments

TPT005 – Offer in Compromise: Doubt as to Collectability

TPT005 – Offer in Compromise: Doubt as to Collectability


There are three main types of offers in compromise that you can submit to the IRS.  The most common is the offer in compromise based on doubt as to collectability.  By filing this type of offer in compromise with the IRS you are telling them that you agree that you are liable for the taxes, interest and penalties that have accrued against you, but you can’t afford to pay them.  Since you cannot afford to pay the taxes in full you are requesting that the IRS take a reduced amount for this.  No doubt you have seen the late night television commercials stating that they can help you settle your taxes for “pennies on the dollar.”  They make it sound so easy.  So automatic.  My friends, it is not always that easy or automatic.  It all depends on your individual financial situation at the time you file your offer in compromise.

When I say your “financial situation” what I am talking about is your current income, your monthly expenses, and the equity that you have in the assets that you own.  Figuring out your income is usually the easy part.  If you are employed at a job, then you probably get a normal paycheck or at least a W2 at the end of the year that tells you what you made that year and you can average that out over the months.  I know that many of you are self-employed but that you do not keep good records and it is hard to determine what you actually earn.   In this situation it takes a lot more work to determine what to put in this line on the IRS forms.  But, you have to do this work – for a couple of reasons.  First, it is just good business for you to keep good records and stay on top of your company’s finances.  How else do you know how well your company is doing?  Second, the IRS is going to require you to prove to them what you say your income is.  They do not simply just take your word for it.

You will also need to include your spouse’s income in this calculation.  This is probably common sense if your spouse also owes the taxes with you, but a alarming question is often asked when the other spouse is not liable for the taxes.  Your spouse wants to know why they have to provide their income information.  Will they become liable for the taxes by doing so?  The short answer is no, they will not become liable for the tax by submitting their income information.  The IRS just requires the total household income in order to calculate what percentage of the household expenses to allow you to claim in the offer in compromise.  So, if you have the only income for the home, then you will be able to claim 100% of the expenses.  If, you and your spouse have equal incomes then you will only be able to claim 50% of the expenses and so on.

Now, where the IRS really gets you is on the expense side of the equation.  Most people do not live extravagant lifestyles.  They are simply trying to get by from one month to the next or maybe even one week to the next.  You have a mortgage or rent payment, the usual utilities like power, water, gas, cable and telephone, a car or two, some monthly prescriptions, and so on.  Here’s the catch: for many of the expenses you will list on your financial statement the IRS has “national standards” that they will allow as your monthly expenses.  These are called collection financial standards.  The problem with these national standards is that they are lower than what the average person spends on these monthly expenses and they do not changes very frequently so they will not take into consideration things like gasoline that costs $4 per gallon.  So if, for example, you have a family of three and your mortgage payment is $1,500 per month, the IRS may only allow $1,100 per month as the national standard for your area.  So right off the bat you are $400 in the hole.  Most Americans do not know about these national standards until it is too late when dealing with the IRS and they have already lost their fight for an offer in compromise.  The IRS will require that you provide lot of information about your monthly expenses like receipts, bills, invoices, mortgage statements, bank statements, etc.  The process of gathering the material to include with your financial declaration can often take days if you are not of the organizational variety.

The IRS will multiply the difference in your monthly income and allowable monthly expenses by a factor.  If you plan on paying a lump sum offer in less than five installments the factor is 12.  If you plan on paying your offer in more than five installments, then the factor is 24.  So, if you have $2,500 in monthly income and the IRS allows $2,100.00 in monthly expenses you will have a difference in income and expenses of $400.00.  This is multiplied by 12 for a base offer amount of $4,800.00.

Next, the IRS looks at your net realizable equity in the assets that you own.  Basically, what this means is that you have to come up with the cash value of the assets that you own.  But the IRS does not use the original retail price for your assets, but rather a discounted price similar to what you would get if you HAD to sell your assets in a very short time.  That is good news.  And just like before, you will have to provide documentation supporting your valuation of your assets such as Kelly blue book statements for your cars, a recent appraisal for your house if you have one or some other way to value the real estate, appraisals for jewelry, etc.

In the event you do have equity in an asset, the IRS will normally require you to add that equity (or a portion of it) into what you have to pay to settle your tax debt.  But there are ways around that, too.  If you have no way to borrow money against your assets, then the IRS may not include the equity.  Let’s talk about an example.  Your home has $50,000 of equity so that will make your offer in compromise a difficult sell to the IRS.  But, your IRS problems are indicative of other financial problems you have and your credit is horrible.  If you can go to a few banks or finance companies seeking a loan against your property you may find you can borrow.  But, you may be turned down for the loan.  If you provide those loan denial letters to the IRS they can ignore the equity in those assets.

If you have equity in your assets of $4,000.00 then that will be added to your base offer amount determined from your income and expenses for your total offer amount.  In our example $4,800 + $4,000 for a total offer amount of $8,800.00.  This may be good for your situation or not so good.  The offer amount has nothing to do with how much you owe.  It is simply a function of your ability to pay.

After you have provided all of this information the IRS will closely scrutinize every item.  Remember, most IRS offer examiners are very nice and pleasant to deal with but they are not on your side.  They are trying to find a way for you to pay a larger amount in your offer in compromise or for your offer to be rejected altogether.


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Let’s continue this conversation in the comment section below. What questions do you have about dealing with IRS collections?


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