The most challenging step in the offer in compromise application process is in determining the amount you should offer in compromise to the IRS.
The main principle is simple; you just have to calculate your Reasonable Collection Potential (RCP) based on your monthly income and the value of your assets.
However, a broad spectrum of factors can affect RCP calculation, which makes each case differ. Your current place of residence, credit score, monthly income, and household size are some factors you must consider when applying for an offer in compromise.
The IRS offers clear guidelines on calculating the sum you’re offering in compromise, but these rules can be hard to grasp. We’ll show you how to interpret the offer in compromise rules and use them to calculate how much you should offer in a compromise to the IRS.
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Table of Contents
Reasonable Collection Potential Calculation
Please note: We’ll focus on how to calculate how much you should offer in compromise when applying for Doubt as to Collectability OIC. Please read the Ultimate Guide to the IRS Offer in Compromise to find out how to estimate the amount you should offer in compromise when applying for other OIC types.
The amount of money the IRS thinks a taxpayer can use to settle a tax debt is called the Reasonable Collection Potential.
You’ll need Form 433A (OIC) to calculate the RCP based on the value of the assets you own and your monthly income. Hence, assets and income are the two main components you’ll use to calculate RCP and establish how much you should offer in compromise.
The IRS will reject your application if the sum you offer doesn’t match their RCP calculation. Part 5.8.5 of the Internal Revenue Manual contains instructions on how to calculate the RCP accurately.
Dissipation of Assets
Complete transparency is the best approach to the offer in the compromise application process. Transferring the ownership of assets to friends or family members to exclude them from the RCP calculation isn’t advisable.
The IRS refers to this practice as the dissipation of assets and goes the extra mile to detect any attempt to hide the assets that should be included in the RCP calculation. The agent will review your records for at least the last three years.
Your application will be automatically rejected if the dissipation of assets is detected during the review.
Understanding the Concept of Quick-Sale Value
Most applicants make the mistake of thinking they can sell their assets at 100% of their market value.
However, this isn’t the case, as often the IRS imposes a 90-day deadline for the sales of assets that can be used to settle the tax debt. The term quick-sale value refers to an estimated value a taxpayer can get for an asset within three months.
Its approximate value is usually 80% of the asset’s fair market value, although taxpayers can prove that individual assets’ quick-sale value is under 80% of the market value.
Conversely, in certain situations, the IRS can assume that the asset’s quick-sale value is the same as its fair market value.
Special Circumstances
Applying for the doubt as to the collectibility offer in compromise is usually recommended when a taxpayer cannot pay the tax debt in full. Hence, a certain percentage of taxpayers is eligible to apply for doubt as to collectability with special circumstances offered in compromise.
Section 3 of Form 656 outlines these circumstances:
- Public Policy or Equity – Special circumstances under which the collection of the entire tax debt undermines the belief that federal tax laws are applied fairly.
- Economic Hardship – Taxpayers suffering from a life-threatening illness or cannot pay their living expenses can apply for special circumstances offer in compromise.
RCP Components
Income and equity are the two elements of the reasonable collection potential equation. Depending on your current financial situation, you can use just one or both elements to pay the federal taxes you owe to the government.
Equity
The amount of equity you have in different assets can be used to establish how much you should offer in compromise to the IRS. The agency assumes that taxpayers can sell their assets to cover any debts they owe on these assets and use the rest as RCP.
Although this general principle applies to all equity, the rules differ slightly from one asset to the other.
Cash Accounts
The money you keep in different accounts must be included in the offer in compromise at its fair market value. This includes cash on the following accounts:
- Money market accounts.
- Stored value cards.
- Savings accounts.
- Certificates of deposit.
- Cash on hand.
- Checking accounts.
The general rule for calculating the amount you should offer in compromise is based on the cash you have that you must deduct from your monthly living expenses plus up to $1,000 from the total amount you have.
Hence, your maximum offer will depend on your state’s average living costs.
Real Estate
The first step you’ll have to take to use real estate equity in an offer in compromise is to determine the property’s fair market value. You can then use this amount to calculate the property’s quick-sale value.
You’ll have to deduct mortgage, property tax, and other fees you must cover after you sell a property to calculate the maximum amount you can offer in compromise using the property’s equity. These rules aren’t the same if the property you must sell is your primary residence.
Life Insurance
A life insurance policy can be treated as equity and used in an offer in compromise if it has a cash value. However, keep in mind that the amount you can offer depends on more than one factor.
Investments
All investments you make must be a part of your equity element in the offer in compromise. The funds in your traditional IRA account are treated as an investment with equity, so you can use it in your offer.
Besides retirement accounts, you can also use:
- Cryptocurrency
- Investment accounts
- Safe deposit boxes
- Closely-held stock
It’s important to remember that the funds you have in an investment account will be evaluated at the quick-sale value.
Furthermore, you’ll have to deduct federal and state tax, all applicable federal and state penalties, and broker commission to calculate the asset’s equity and the amount you can include in the offer.
Vehicles and Other Possessions
Artworks, antiques, vehicles, or personal effects can be used as assets in an offer in compromise. The Internal Revenue Bulletin for the current year includes information about the minimum value these assets can have to be included in an offer.
It’s worth noting that the value of cars is always calculated at quick-sale value. Moreover, this process is slightly different for taxpayers with a single status on a tax return and those who file tax returns jointly.
Income
You must understand the IRS’ Collection Financial Standards to calculate the income component of your offer in compromise. To put this in a simple way, the income component is the sum that stays in your bank account after your monthly pay expenses.
Collection Financial Standards guideline states that taxpayers can only deduct national standard, national out-of-pocket, local standard utilities and housing, and local standard travel expenses when calculating the excess monthly income.
Depending on the offer type, the monthly excess income value is multiplied by the future income multiplier of 12 or 24 to determine the income component.
Gross Monthly Income
The gross monthly income is the sum of the taxable and non-taxable income you receive from your paycheck, social security, unemployment check, rent, or any other source of income. It serves as the basis for the monthly excess income calculation.
National Standard Expenses
Food, apparel and services, personal care products and services, housekeeping supplies, and miscellaneous constitute the national standard expenses. The sum you can deduct from the gross monthly income depends on the size of your family, and it ranges from $785 for one person to $1,900 for a four-member family.
Remember, the IRS limits the maximum amount for each of the five national standard expenses. You must provide sufficient evidence to exceed these limits in case one or more members of your household have special dietary or other needs that increase your living costs.
Local Standard Housing and Utilities Expenses
In addition to the family size, the local standard housing and utility expenses also depend on the state and city where the taxpayer lives. These expenses include mortgage payments, electric bills, house maintenance, and internet bills.
The local standard housing and utilities expenses amount you must include in an offer in compromise must be the lesser of your actual monthly housing and utility costs (how much you’re currently spending) or the amount specified in the chart for the region where you live.
You can find this chart in the Collection Financial Standards document. Moreover, you can supply evidence that your expenses exceed local standards.
Local Standard Transportation Expenses
Public transportation, ownership costs, and operating costs are the three categories of local standard transportation costs. Public transportation and ownership costs for one or two cars are the same nationwide.
The maximum amount you can deduct from the gross monthly income on the account of public transportation is $242. The maximum ownership cost is $588 for one car or $1,176 for two cars. Operating costs depend on the region, so you must check the regulations for the state you live in.
Taxpayers with a single filing status can claim expenses for more than one vehicle, but the maximum amount they can claim is lower than the local standard transportation expenses for two cars.
National Out-of-Pocket Health Care Expenses
The maximum amount of national out-of-pocket health care expenses depends on the age. For example, taxpayers under the age of 65 can claim $75. This amount increases to $153 for taxpayers over this age limit.
It’s also worth adding that these expenses are available to each household member, whether they have actual medical expenses or not. Moreover, taxpayers can exceed these limits if they provide sufficient documentation.
Other Expenses and Considerations
Section 7 of Form 433-A OIC features the Other Monthly Expenses section that lists expenses you can claim that don’t fall in any of the major expense categories. These expenses include:
- Child support and other court-ordered payments
- Taxes (both state and federal)
- Life insurance premiums
- Health insurance premiums
- Child care payments
- Other (Professional fees, employer-mandated payroll deductions, union dues, etc.)
It’s important to note that your current income isn’t always used to calculate the RCP. Under certain conditions, retired debt, future income collateral agreement, or unemployment can be used to establish how much you should offer in compromise.
Don’t forget that the IRS only allows taxpayers to use a different income amount other than the current income amount if they can provide sufficient proof of special circumstances.
Using the Future Income Multiplier to Formulate an Offer
Once you determine the excess monthly income and the equity in your assets, you must multiply this value by the future income multiplier. The future income multiplier can either be 12 or 24, depending on how long you intend to pay the sum of the offer to the IRS.
The lump sum cash offer option involves paying 20% of the offer you’re making upfront and dividing the rest into up to five payments you can make in a one-year period.
Periodic Payment Offer enables you to pay your tax debt in up to six payments over two years. However, you’ll have to start making payments before the IRS accepts your offer in compromise application.
Putting an Offer Together
You must first determine your reasonable collection potential before deciding how much you should offer in compromise. The sum you offer must be the same as your RCP and sufficient to cover the IRS’ debt estimation.
Calculating the income and equity components can be difficult as you must be familiar with the IRS collection regulations.
Furthermore, you must check if you qualify for special circumstances exceptions that enable you to claim higher expenses and reduce the includable amount for a specific asset or source of income.
The IRS may still reject your offer in compromise application even if the amount in your offer is accurately calculated based on the value of the assets you own and your current income.
Frequently Asked Questions
Although paying the entire sum in full is an option, you don’t have to settle your debt with a single payment. Lump sum cash offers and periodic payment offers to allow you to split the sum you’re offering into five or six payments.
The minimum offer in compromise the IRS will consider is the sum of your excess monthly income multiplied by the future income multiplier of 12.
You must report all assets and their equity to the IRS. Failing to include your assets in an offer in compromise usually results in the rejection of the offer by the IRS.
The IRS doesn’t require the taxpayer to make offers in compromise for a fixed percentage of their tax debt. However, your application will be rejected if the estimation of your reasonable collection potential isn’t the same as the IRS’.
Talk to a CPA
Your chances of settling your tax debt with an offer in compromise will decrease significantly if you miscalculate your excess monthly income or the asset’s equity.
That’s why submitting the offer in compromise application without professional assistance can be a considerable disadvantage that affects the outcome of the process.
Visit choicetaxrelief.com or call 866-800-TAX if you need a CPA who can help you determine how much you should offer in compromise to the IRS.
Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
