When facing substantial tax debt, an Offer in Compromise (OIC) can be a potential lifeline for resolving outstanding liabilities. The OIC allows taxpayers to settle their debt with the IRS for less than the full amount owed. However, determining the right amount to offer requires a careful evaluation of your financial situation. In this article, we’ll break down how to assess your offer, the factors the IRS considers, and strategies for submitting a realistic proposal.
Understanding How an Offer in Compromise Works
An Offer in Compromise is part of the IRS’s Fresh Start initiative designed for taxpayers who cannot pay their full tax debt without facing significant financial hardship. It’s a formal agreement between you and the IRS, where the agency agrees to accept less than the owed amount if you meet strict eligibility criteria. The IRS will generally only accept an OIC if it believes that you meet one of two eligibility criteria:
- Doubt as to Liability (DATL): Doubt as to Liability means that there is genuine uncertainty about whether the assessed tax debt is accurate or legally owed. In this scenario, you’re arguing that you do not actually owe the full tax amount because the liability itself is questionable. It’s crucial to provide strong supporting documentation to back your claim.
- Doubt as to Collectibility (DATC): Doubt as to Collectibility means that you agree you owe the tax debt but argue that you cannot pay the full amount. In this scenario, you demonstrate that your financial situation makes it highly unlikely that you will be able to p
Key Criteria for Eligibility
Before making an offer, you must meet specific eligibility requirements, such as:
- Filing all required tax returns.
- Making necessary estimated tax payments for the current year if you are self-employed.
- For businesses with employees, ensuring all required federal tax deposits are current.
Factors the IRS Considers
The IRS considers several factors when evaluating your offer. They look at your overall financial situation, including current and future income, to determine your ability to pay. They look at your necessary living expenses based on national and local standards. These include housing, transportation, food, and medical costs. They also look at your asset equity, or the value of your assets minus debts and liabilities. The IRS will reject offers that it deems insufficient, so it’s essential to carefully document your financial situation and provide accurate and complete information.
Calculating Your Offer Amount
The IRS evaluates your offer based on your Reasonable Collection Potential (RCP), which is the amount the agency believes it can collect from you through future income and assets. To calculate your RCP, the IRS takes into account the following items.
Value of Assets
The IRS expects you to include the realizable value of your assets in your offer. This includes:
- Cash and bank accounts: Any readily available funds in checking, savings, or investment accounts.
- Vehicles: The quick sale value, typically 80% of the fair market value, minus any loan balances.
- Real estate: Equity in properties, calculated by subtracting any mortgage balances from the property’s fair market value.
- Other personal assets: Valuables such as jewelry, stocks, retirement accounts, or collectibles.
Future Income
The IRS also factors in your future income, usually calculated as a multiple of your monthly disposable income. The calculation differs based on the offer’s payment terms.
- Lump-sum cash offer: The IRS considers 12 months of disposable income if you agree to pay your offer amount within five months. This option requires you to pay 20% of the offer amount upfront, with the remainder due within five months.
- Periodic payment offer: If you plan to pay over six to 24 months, the IRS considers 24 months of disposable income. Note that you must make payments while your offer is being considered.
Example Calculation
Imagine you have $5,000 in cash, a vehicle worth $10,000 (with a $3,000 loan balance), and disposable income of $400 per month. Here’s how the IRS would calculate your RCP:
- Cash: $5,000
- Vehicle: $10,000 x 80% = $8,000 – $3,000 (loan balance) = $5,000
- Disposable income for a lump-sum offer: $400 x 12 = $4,800
- Total RCP: $5,000 (cash) + $5,000 (vehicle) + $4,800 (income) = $14,800
Your offer must generally be at least $14,800 to be considered.
How to Determine a Reasonable Offer
First, you’ll need to conduct a financial analysis. Use IRS Form 433-A (OIC) or Form 433-B (OIC) to get a thorough understanding of your financial situation. Be honest and transparent about your income, expenses, and assets. The IRS uses national and local expense standards to determine allowable living expenses. If your expenses exceed these standards, you may need to justify them or accept that the IRS will only consider the standard amount. While it might be tempting to make a very low offer, remember that the IRS will scrutinize your proposal. Offering too little can lead to a rejection and prolong the resolution process. Aim to submit an offer that reflects your true ability to pay, as calculated by your RCP.
Common Reasons for OIC Rejection
The IRS may reject your OIC for several reasons.
- Insufficient offer amount: One of the most frequent mistakes is proposing an amount that is unrealistically low. If your RCP is higher than your offer, the IRS will likely reject it.
- Incomplete documentation: Failing to provide requested financial information can derail your application. Double-check that all the required documents, such as bank statements, pay stubs, and asset valuations, are provided and are current.
- Overlooking required tax filings: To qualify for an OIC, you must have filed all required tax returns and made any estimated tax payments for the current year. Ensure your tax obligations are current before applying. Do not accumulate any more tax obligations and file any new returns on time.
- Unrealistic expenses: If the IRS does not agree with your claimed living expenses, it may adjust them based on standard amounts. Many taxpayers mistakenly claim excessive or non-allowable expenses, which the IRS will adjust or reject. Familiarize yourself with the allowable expense standards and make your budget align with them.
- Not seeking professional help when needed: Navigating the OIC process can be complicated and can take time. If you’re unsure how to proceed or feel overwhelmed, consider seeking help from a tax professional, such as a tax attorney, enrolled agent, or CPA. They can guide you through the process, help calculate an accurate RCP, and ensure your application is as strong as possible.
If your offer is rejected, you have the option to appeal within 30 days or explore other tax relief options, such as installment agreements.
Tax Help with Offers in Compromise
Calculating the right amount for an Offer in Compromise is a delicate balance between what you can afford and what the IRS will accept. Start by thoroughly evaluating your assets and disposable income, then use the IRS’s guidelines to propose a reasonable amount. While it may take time and effort, a well-prepared OIC can provide substantial relief and help you move forward from your tax debt. If you’re unsure about navigating this process, consider consulting a tax professional to ensure your best chance of success. Optima Tax Relief has over a decade of experience helping taxpayers get back on track with their tax debt.
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