Offers in Compromise: A Guide

By: Royston Mendonza

Overview

Very simply, an Offer in Compromise (“Offer”) is where a Taxpayer “offers” a sum of money to the Internal Revenue Service (“IRS”) to “compromise” a tax debt for less than the total amount owed.

Form 433-A

To begin an Offer calculation, you must first fill out IRS Form 433-A (OIC). The current version was released in May of 2012. This form mainly discloses information regarding the existence and valuation of the Taxpayer’s assets, income and expenses. These numbers are then used to calculate the amount which will be offered. It is important to note that the information on this form must be accurate to the best of the Taxpayer’s knowledge, since the Taxpayer signs the form under the penalty of perjury. The various sections of the form can be broken down as follows:

Section 1 of the form asks for the Taxpayer’s personal and household information. This includes name, address, date of birth, Social Security number, marital status, employment/occupational information as well as information regarding individuals living in the Taxpayer’s household.

Section 2 discloses “self-employment” information. This is relevant when the Taxpayer and/or his or her spouse run their own business. This is not limited to sole proprietorship’s and can extend to corporations, single-member LLC’s, etc.

Section 3 discloses information regarding the Taxpayer’s assets. “Hard” assets such as real estate, vehicles and other valuable items (ie, fine jewelry, artwork, firearms, etc.) are valued per “quick sale.” That is, the items are valued at 80% of their fair market value. This is done because, due to depreciation and costs of sale, the IRS knows it would not ultimately receive the full market value for the items. In addition, if the items are secured (ie, have a loan and corresponding lien on them), only the value over and above the security interests is used. This is referred to as the available “equity” in the asset. Furthermore, the IRS also allows an exemption (currently up to $3,450) for vehicles used for the welfare of the Taxpayer’s family and/or the production of income. Available equity in qualifying vehicles can be offset by the exemption amount.

“Liquid” assets such as cash and funds in bank accounts are taken at full value. This is because “money is money” and these assets do not depreciate. In certain circumstances, however, up to $1,000 can be exempted from a checking account if the funds are used for the Taxpayer’s basic living expenses. For Offer purposes, certain assets which initially appear to be liquid are also listed at quick sale value since the Taxpayer probably has limited access to them and/or would somehow be monetarily penalized for early withdrawal. These include investment accounts, 401(k) accounts, individual retirement accounts (“IRA’s”) and cash value of life insurance policies.

To prepare this section, several documents need to be produced by the Taxpayer. These include, but are not limited to: most recent three months of bank statements; most recent investment account statements; most recent 401(k) statements; most recent IRA statements; most recent life insurance cash value; deeds for real property; most recent mortgage statements; titles to vehicles; most recent vehicle loan statements and a listing/valuation of valuable items. Section 4 discloses assets relative to a Taxpayer running his or her own business. Cash and bank accounts are listed at 100%. Hard assets are valued at 80% of their fair market value and are offset by any security interests. One of the main differences with this section is that the IRS excludes up to $4,290 of equity in “tools of the trade.” Furthermore, despite any available equity, certain business equipment can be listed at $0 if such item(s) is critical to the operation of the Taxpayer’s business.

To prepare Section 4, the Taxpayer should provide documentation including, but not limited to: most recent three months of business bank account statements; deeds/titles to hard business assets (ie, office buildings, machinery, vehicles, etc.); mortgage or loan statements on hard business assets and an itemized valuation of unencumbered tools or equipment.

If applicable, Section 5 calculates the Taxpayer’s net monthly business income. Net monthly business income is gross monthly income offset by monthly business expenses. Ideally, the Taxpayer can provide an updated “profit & loss” statement. This will show a year-to date amount of all the business the Taxpayer took in minus all of the Taxpayer’s business expenses. Resulting amounts, if any, constitute profit or business income. It is likely the amounts on this statement will need to be divided over the timeframe of the statement to calculate monthly figures. For example, if a statement covers 6 months, then all amounts on the statement should be divided by 6.

There are often times when the Taxpayer is unable to provide an updated profit & loss statement. If the Taxpayer advises that his or her income was at the same level approximately one year ago, then it may be possible to use the previous year’s tax return for net business income. Schedule C of the return will show gross receipts for the year along with applicable business expenses. These figures can then be divided by 12 for monthly amounts.

The first part of Section 6 discloses monthly household income. Most often, this includes employee wages and/or net business income. However, the form includes various other sources. If the Taxpayer receives income from any of the other enumerated sources, then it must be disclosed on the form.

If the Taxpayer runs his or her own business, then the net monthly business income from Section 5 can be transcribed into the appropriate line in Section 6. If the Taxpayer receives wages, then you must obtain the Taxpayer’s most recent paystubs. Monthly wages must be shown as a gross amount. Therefore, it is important to note the frequency of the Taxpayer’s paychecks. For example, if the Taxpayer is paid bi-weekly, then he or she receives 26 paychecks a year. Taking the gross amount from a paycheck, multiplying by 26 and then dividing by 12 will give you a monthly figure.

Keep in mind that, if the Taxpayer’s business is a corporation, then he or she will receive wages along with net business income or distributions. Also, this section asks for household income. Therefore, spousal or other family member income contributing to the household must be disclosed.

The second part of Section 6 asks for monthly household expenses. The various lines address several of the most common household expenses including, but not limited to: food, clothing, personal care products, housing, utilities and vehicle costs. Several of the lines in this part will be covered by “IRS National Standards.” Based on location and household size, the National Standards dictate maximum monthly household expenditures. In order to take an expense, the Taxpayer must actually be paying it. Expenses such as housing, utilities, vehicle ownership costs, public transportation, health insurance and life insurance must be proven. Therefore, copies of monthly bills or other statements should be provided. However, the IRS realizes that other expenses are more difficult to prove. These include food, clothing, personal care products, vehicle operating costs and out-of-pocket medical expenses. For these items, the IRS will usually take the National Standard amounts without further explanation.

It is also important to note the National Standards are maximum amounts. For the aforementioned expenses requiring proof, even if the Taxpayer spends more than the National Standard, the maximum National Standard is all the IRS will consider. Conversely, if the Taxpayer spends less than the National Standard, the IRS will only consider what they are paying. Taking the total gross monthly household income from the first part of Section 6, and offsetting that amount with total monthly expenses from the second part of Section 6, you get the Taxpayer’s monthly “disposable” income. This is the monthly income that the Taxpayer can put forth towards the Offer. Sometimes, the Taxpayer’s monthly expenses will be greater than his or her monthly income. In these cases, he or she has $0 disposable income.

Section 7 is where the total Offer amount is calculated. First, you take the Taxpayer’s total asset value from Sections 3 and 4. Then, you must calculate the Taxpayer’s “future remaining income.” Basically, this is the Taxpayer’s monthly disposable income figure multiplied over a number of months. Currently, the multiplying factor is 12. Therefore, if a Taxpayer has $100 in monthly disposable income, then his or her future remaining income is $1,200 ($100 x 12 = $1,200). The total asset value is then added to future remaining income to produce the minimum Offer amount. Based on the above example, if the Taxpayer has $1,000 in assets, then the total minimum Offer amount must be $2,200 ($1,200 + $1,000 = $2,200).

An Offer is based on a Taxpayer’s current financial circumstances. The minimum Offer amount reflects the IRS’ “reasonable collection potential.” This means that, in an effort to settle a tax debt, an Offer is supposed to be equivalent to what the IRS can reasonably expect to get from someone if they enforced collection against them.

Form 656

Next, you must complete Form 656. Form 656 simply lays out the basic Offer details and can be outlined as follows:

Section 1 asks for the Taxpayer’s basic identifying information.

Section 2 asks for the tax periods that the Taxpayer owes for.

Section 3 asks for the reason for the Offer. Most often, this will be “doubt as to collectability.” This is where the Taxpayer concedes the tax liability, but is proclaiming he or she has insufficient assets or income to pay in full. There are also Offers based on “doubt as to liability.” This is where the Taxpayer is offering less than the full amount owed based on his or her questioning of the underlying assessment itself. Lastly, there are Offers based on “effective tax administration.” In limited instances, the Taxpayer can offer less than the amount owed if he or she can prove “exceptional circumstances.” Such circumstances typically include hardship caused by mental and/or physical illness. This type of Offer is very difficult to get accepted.

Section 4 asks whether the Taxpayer’s falls under low income guidelines.

Section 5 outlines the Offer payment terms. A “lump sum cash” Offer utilizes the multiplying factor of 12 as discussed above. When the Offer is submitted, the Taxpayer must provide a check or money order for $150 for the application fee, along with another check or money order for a 20% down payment on the total Offer amount. The Form itself, along with its accompanying instructions, indicates that a lump-sum cash Offer must be fully paid in 5 or fewer installments for up to 24 months. However, Section 5.8.2.8 of the current Internal Revenue Manual (publication which outlines, among other things, how Offers should be processed by the IRS) states that a lump-sum cash Offer must be fully paid in 5 months or less. As such, it remains unclear as to exactly how long a Taxpayer has to pay off a lump-sum cash Offer.

The Taxpayer also has the option to submit a “periodic” Offer. These Offers allow the Taxpayer to pay the Offer in equal installments each month for 24 months. However, a periodic Offer utilizes a multiplying factor of 24 rather than 12. When the Offer is submitted, the Taxpayer must submit the same $150 application fee along with the first month’s installment. Then, even before the Offer is accepted or rejected, the Taxpayer must keep submitting the monthly payments.

Section 6 allows the Taxpayer to designate the Offer deposit to a specific liability. This is optional, but can be very beneficial in some cases. Namely, after the evaluation of an Offer, a Taxpayer may want to file bankruptcy. By the time the Offer is evaluated, the oldest liabilities may be dischargeable. In that case, the payment can be designated to minimize the most recent liability.

Section 7 asks where the Taxpayer is obtaining funds to pay for the Offer. Section 8 outlines the terms and conditions of the Offer. An important provision relates to refunds which may be due to the Taxpayer. Outside the realm of an Offer, if a Taxpayer owes for prior years, the IRS will generally keep future refunds and apply them to the oldest liabilities. Even if an Offer is accepted, the IRS will still keep any refund due for calendar year of the acceptance. For example, if a Taxpayer’s Offer was accepted in 2013, then he or she should not expect a refund in 2014.

Section 9 is where the Taxpayer signs to effectively submit the Offer. Again, the information presented on the form must be accurate to the best of the Taxpayer’s knowledge as he or she signs under the penalties of perjury.

Section 10 is where the Taxpayer’s authorized representative (ie, attorney, etc.) signs. For Offer purposes, an authorized representative signs Form 656, but never Form 433-A.

Submission & Evaluation

The Offer will typically consist of the forms (with original signatures), application fee and down payment. However, tabbed exhibits should also be submitted. The IRS Examiner will want documented proof of asset values, income and expenses. Tabbed exhibits make it easier for the IRS Examiner to locate the appropriate documentation. Also, submitting these items at the outset will allow the Examiner to evaluate the Offer faster and provide preliminary feedback. A “supporting statement” should also be submitted. In most cases, further explanation is necessary regarding values listed on the forms. Drafting a supporting statement is an opportunity for further explanation.

The Offer package should be sent to the IRS via certified mail with return receipt requested. Then, you have proof of mailing as well as proof of receipt. Depending on where the Taxpayer lives, the Offer can be mailed to one of two IRS Offer Units. Submission of an Offer in Compromise suspends collection against the Taxpayer while said Offer is being evaluated. In many cases, an IRS Revenue Officer has already been assigned to the Taxpayer for collection. The Offer can be sent directly to that Revenue Officer so he or she knows it has been submitted. The Revenue Officer will then forward the Offer to an Offer Unit.

About a month after the Offer is mailed, the Taxpayer will receive a letter stating his or her Offer has been received by the IRS. At this point, collection efforts against the Taxpayer should stop. The letter will also state the IRS will make contact with the Taxpayer or authorized representative in about 4 months.

If the Examiner has all the information he or she needs to evaluate the Offer, and simply does not agree with how the Offer was calculated, then the Offer will be “rejected.” The Taxpayer and/or authorized representative will receive a rejection letter, and has 30 days to submit an appeal. If the Examiner does not receive requested information within a reasonable period of time, or the Taxpayer fails to keep up on his or her ongoing tax liabilities, then the Offer will be “returned.” A returned Offer cannot be appealed. In either case, the Taxpayer’s down payment(s) is non-refundable. A rejected or returned Offer ultimately reinstates collection against the Taxpayer.

Typically, before deciding on whether to accept, reject or return; the Examiner will ask for additional information and documentation as part of an ongoing evaluation. Based on the information provided, the Examiner may adjust certain values accordingly. If the Taxpayer agrees to the changes, then the Offer will proceed to acceptance. If the Taxpayer cannot accommodate for the changes, then the Offer will be rejected.

Upon acceptance, the Taxpayer should be aware that he or she is in “probationary” status with the IRS for 5 years afterwards. Therefore, if the Taxpayer misses a tax return filing deadline or doesn’t pay his or her taxes in those 5 years, the Offer will be revoked with all liabilities coming back.

Conclusion

There is ultimately no guarantee that any Offer in Compromise will be accepted. However, an Offer can be a very effective proposal to resolve a tax debt. In many cases, notwithstanding what a person owes, the IRS looks at reasonable collection potential. Therefore, someone with relatively modest assets and income can compromise significant tax liabilities. Conversely, under the same calculations, someone with significant assets and income could end up paying close to or more than what they owe. Therefore, a person’s individual circumstances should be examined to determine whether an Offer makes sense.

Disclaimer

This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute legal advice or a recommended course of action in any given situation. This communication is not intended to be, and should not be, relied upon by the recipient in making decision of a legal nature with respect to the issues discussed herein. The recipient is encouraged to consult an independent licensed attorney before making any decision or taking any action concerning the matters in this communication. This communication does not create an attorney-client relationship between Andreozzi Bluestein LLP and the recipient.

Any links to other web sites are not intended to be referrals or endorsements of these sites. The links provided are maintained by the respective organizations, and they are solely responsible for the content of their own sites.

Attorney Advertising

Subscribe

Subscribe to the Tax Matters Blog.
First Name
Last Name
Industry
Email address
Secure and Spam free...

Subscribe

Subscribe to the Tax Matters Blog.
First Name
Last Name
Industry
Email address
Secure and Spam free...

Subscribe

Subscribe to the Tax Matters Blog.
Email address
First Name
Last Name
Industry