Since 2012 the IRS has been much more willing to compromise with taxpayers with overwhelming tax debt than in the prior decade. IRC §7122 permits the IRS to accept offers in compromise in settlement of tax obligations for less than the full outstanding tax liabilities. The willingness of the IRS to exercise this authority has ebbed and flowed through the years. In 2012 as part of its Fresh Start initiatives, the IRS greatly liberalized the standards that it uses for acceptable offers. The statistics for the most recent fiscal years are:
|Offers in compromise:||2012||2013||2014|
Number of offers received
Number of offers accepted
The 2010 Taxpayer Advocate’s report to Congress illustrates the ebbs and flow of the offer environment during the first decade of this century. The acceptance rate went up and down but never reached a 40% acceptance rate and for the decade was in the 25% to 30% range.
In general, an Offer in Compromise (“OIC”) is an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liabilities for less than the full amount owed. An OIC is generally not accepted if the IRS believes the liability can be paid in full as a lump sum or a through payment agreement. The IRS looks at the taxpayer’s income and assets to make a determination of the taxpayer’s “reasonable collection potential.” OICs are subject to acceptance on legal requirements. To determine the taxpayer’s ability to pay, the IRS determines a value of the taxpayer’s assets and adds the value of his ability to pay in the future. The combined value of those two components is known as Reasonable Collection Potential (“RCP”).
The 2012 Fresh Start changes that caused the upward movement in the number of accepted offers included:
- Revising the calculation for the taxpayer’s future income
- Allowing taxpayers to repay their student loans as part of their budget
- Allowing taxpayers to pay state and local delinquent taxes as part of their budget
- Expanding the Allowable Living Expense allowance category and amount
- Excluding a portion of the taxpayer’s bank accounts from the value of their assets
- Excluding a portion of the taxpayer’s equity in motor vehicles from the value of their assets
- Excluding from the value of their assets property used to produce income
Under the Fresh Start policies when the IRS calculates a taxpayer’s RCP, it will now look at only one year of future income for offers paid in five or fewer installments, down from four years, and two years of future income for offers paid in six to 24 months, down from five years. All offers must be fully paid within 24 months of the date the offer is accepted. The prior policy resulted in IRS demands for very large compromise payments even when the taxpayer had few assets. The revisions have resulted in a 75% reduction in the amount required to settle tax obligations in five or fewer installments. They will result in a 60% reduction in the amount required to be fully paid within 24 months.
When reviewing a taxpayer’s budget to determine ability to pay in the future, the IRS applies Allowable Living Expense standards. The standard allowances impose parsimonious budgets upon a taxpayer in collection determinations by incorporating average expenditures for basic necessities. Notwithstanding substantial criticism of the IRS over the years, it has insisted upon applying the same standards for food and clothing in all areas of the country whether high cost locales like Alaska, Hawaii and New York City or lower cost Midwestern areas. These standards are used when evaluating OIC requests.
In response to criticisms from the National Taxpayer Advocate and taxpayer representatives, the IRS expanded the National Standard miscellaneous allowance to include additional items. Taxpayers can use the miscellaneous allowance for expenses such as credit card payments and bank fees and charges. In the past the IRS refused to recognize taxpayer obligations to pay student loans and state tax delinquencies. The new guidance now allows payments for loans guaranteed by the federal government for the taxpayer’s post-high school education. In addition, payments for delinquent state and local taxes may be allowed based on percentage basis of tax owed to the state and IRS.
On the asset side of the RCP equation, the IRS now allows taxpayers to exclude $3,450 from the equity of motor vehicles used for commuting or for the health and welfare of the family. The IRS also allows the taxpayer to exclude from assets the aggregate combined value of $1,000 in their bank account plus their allowable expenses for one month. Of particular note for the small business person, the IRS will completely exclude the value of all income-producing assets.
Each state tax authority has its own rules for compromise that rarely conform to the IRS rules. States like New York and California are noted for their particularly unfriendly approach to taxpayers seeking compromises, while others are more understanding of life’s circumstances that cause a taxpayer to incur substantial tax obligations.
Practitioners are well-advised to review the current IRS offer in compromise guidelines when advising taxpayers with large tax obligations. Taxpayers should be wary of nationally advertised tax resolution firms which may not deliver on their broadcast promises. Many tax resolution firms have been forced out of business by strict enforcement of consumer protection laws by state and federal authorities. Prior to hiring any heavily advertised tax firm, check the Better Business Bureau and the state attorney general’s office for complaints. Because of the complexity of the offer process, most taxpayers should seek out the services of an experienced Enrolled Agent, CPA or attorney before submitting a proposed compromise to the IRS.
Source: Forbes.com/Robert E. McKenzie ©2015