Of all of the services we offer, the most often asked about is the Offer in Compromise process. Taxpayers frequently ask us about “settlements” and, more often than not, what they mean is what is formally called an Offer in Compromise.
What is an Offer in Compromise?
According to the IRS: “An offer in compromise allows you to settle your tax debt for less than the full amount you owe. It may be a legitimate option if you can’t pay your full tax liability, or doing so creates a financial hardship.”
While the Federal Offer in Compromise program has been around for decades, political pressures effect how useful this program is in any given year. Sometimes, the Offer program is wide open and accessible to a wide range of taxpayers. . . and other times, it is nearly impossible to get even the most reasonable Offer through.
Enforcement action by the IRS is a pendulum…going from tough to easy to tough to easy again; at this time it appears they may be easing. Nowhere is this better shown than the IRS has expanded its “Fresh Start” initiative by offering more flexible terms in its Offer in Compromise (OIC) program.
In May of 2012, the IRS announced its Fresh Start Initiative -providing more flexible terms to its Offer In Compromise (or OIC) program, which helps taxpayers settle tax debts. This loosening of restrictions coincided with the period where many in Orange County were hardest hit by the recession. While the economy of Orange County did rebound faster than much of the rest of the state, our current circumstances in Orange County are still much different than before the recession. It’s more important that our neighbors have options to handle what may feel like overwhelming tax problems. There are ways to resolve your tax issues and one may be an Offer In Compromise.
How Does It Work?
While the formal Offer In Compromise process does have a number of technical aspects to it (specific forms need to be filed, documentation supplied, etc.), here’s what you need to know. Put simply, when considering an Offer in Compromise, the Internal Revenue Service is going to weigh how much you owe them against how much money you have. If the debt is greater than your assets (either current or projected), then they are willing to consider a settlement.
There’s quite a bit of nuance here, so it is important that you always consult with a professional before submitting an offer. A good starting point on your end is to just make a solid assessment of your finances. If you own a house in Huntington Beach with $550,000 in equity, but owe the IRS $23,000, the odds of them accepting your settlement are low. If you own a house in Costa Mesa that is upside down by $195,000 and you owe the IRS $250,000, well, then you may be a good Offer candidate.
Ultimately, the IRS is going to look at your assets (homes, cars, bank accounts), your income, and your expenses.
What kind of expenses does the IRS allow?
When the IRS calculates a Taxpayer’s reasonable collection potential (called RCP), it will now look at only one year of future income for offers paid in five or fewer months (down from four years) and two years of future income for offers paid within 24 months of the date the offer is accepted.
The allowable living expenses have also been expanded: Taxpayers can now include credit card payments and bank fees and charges. Student loans guaranteed by the federal government will be allowed. In addition, payments for delinquent state taxes will be allowed based on a percentage basis owed to the state and the IRS.
Finally, the Government says they are concerned about the challenges businesses face in a slow economy. To enhance the employment rate, equity in income producing assets will not be included in the calculation of reasonable collection potential for on-going businesses.
Are there downsides?
It’s important that before you file an Offer, you get experienced, professional advice because there are potential downsides to a failed Offer in Compromise.
When you submit an Offer in Compromise, you have to give a down payment toward the settlement. If your Offer is rejected, the IRS keeps this amount (it gets applied to your account balance, but you are still out the cash).
The IRS explains:
“Your initial payment will vary based on your offer and the payment option you choose:
- Lump Sum Cash: Submit an initial payment of 20 percent of the total offer amount with your application. Wait for written acceptance, then pay the remaining balance of the offer in five or fewer payments.
- Periodic Payment: Submit your initial payment with your application. Continue to pay the remaining balance in monthly installments while the IRS considers your offer. If accepted, continue to pay monthly until it is paid in full.”
There are risks in submitting an Offer In Compromise: like we said, if your Offer is rejected, they’re going to keep your down payment. Submitting an Offer In Compromise also tolls (puts on hold) the bankruptcy and the collection statute. There is certainty of resolution of the tax problem with a bankruptcy; there is uncertainty of outcome with an Offer in Compromise. That said, with non-dischargeable taxes such as trust fund taxes and Substitute For Return (so, when you don’t file and they file for you) assessments, the new liberalization of the Offer in Compromise program offers a welcome and much needed window of opportunity for taxpayers to get closure on their tax problems.
What’s Excluded From the OIC Calculation?
The IRS excludes the equity in income producing assets in on-going businesses. Back payroll taxes, as well as income taxes, may be compromised if you qualify. If a business, for instance, depends upon a 100 K machine and cannot operate without it then the new Offer In Compromise (OIC) rules exclude the equity in the machine. The new Offer In Compromise program dramatically expands the universe of taxpayers eligible to compromise their outstanding tax obligations.
Cash in bank is reduced by a thousand dollars plus the taxpayer’s allowable living expenses for a month. If the taxpayer’s monthly living expenses are four thousand dollars a month, and the average balance in the bank account is five thousand dollars, the entire amount is excluded from the offer in compromise calculation.
Up to $3,450 in equity per car in a household is excluded of vehicles owned by a taxpayer. When the taxpayer owns a vehicle that is six years or older or has mileage of 75,000 miles or more, an additional $200 of additional operating expenses are allowed up to two cars per household.
California State Offer In Compromise
The California State Franchise Tax Board does advertise that they have an Offer In Compromise program to settle back state tax debts.
According to the Franchise Tax Board:
“If you are an individual or business taxpayer that does not have the income, assets, or means to pay your tax liability now or in the foreseeable future, you may be a candidate. The Offer in Compromise program allows you to offer a lesser amount for payment of a non-disputed final tax liability. Generally, we approve an Offer in Compromise when the amount offered represents the most we can expect to collect within a reasonable period of time.”
While the settlement program absolutely exists with the California tax agency, the reality is that tax professionals see very few- if any- settlements actually accepted by the state. In fact, our industry universally finds that the Internal Revenue Service Offer In Compromise procedure is far more accessible to taxpayers than the State of California’s process has ever been.
Ultimately, what causes the biggest issue is what the state determines to be “a reasonable period of time.” For the IRS, a reasonable number of years is one to two, but for the State, this number sometimes exceeds 20 years. Worse yet, the State will even require that you sign a Collateral Agreement with them, which means that an agreed upon percentage of any future earnings above a specific threshold will have to be paid to the State, even if your settlement is accepted.
How We Can Help
At Tax Crisis Institute, we have over 30 years of first hand experience with filing and fighting for Offers In Compromise for our clients here in Orange County. Our expertise can help guide you in what can often seem like a totally overwhelming, perhaps even impossible, process.