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By Michael S. Anderson of Anderson Tax Law logo for Arizona tax attorney Michael S. Anderson P.C.
  • IRS Offer In Compromise – 4 Reasons Most Offers Fail

    Background

    An “offer in compromise” is simply an offer to settle tax debt made by the taxpayer to the IRS that may result in a settlement agreement between the two.

    The real driving force behind the process is that…like most creditors, the IRS is smart enough to know when a “bird in the hand” is worth more than “two in the bush”, i.e. if it really believes that it will get less in the end, it will agree to take what it can now, and call it a day.

    The initial standard used to determine the “bird in the hand” value is whether the amount being offered by the taxpayer to settle the debt once and for all, is greater than or equal to the “reasonable collection potential” of that taxpayer. (RCP)

    So…first question:

    How Does The IRS Determine One’s “RCP”?  The most common way stated generally is as follows:

    The equity value of taxpayer assets PLUS The difference between the taxpayer’s income and budget when multiplied by 12.

    An example: Fanny Fictitious

    Fanny has the following:
    $30,000.00 Equity in home (“Market value” of home – loan amount)
    $5000.00 Equity in car (“Market value” of car – loan amount)
    $10,000.00 “Value” of Retirement Fund
    $45,000.00 Total Equity
    $5,500.00 (gross monthly income)
    $5,300.00 (gross monthly living expenses including proper tax withholding)
    $200.00 (Remainder) X 12
    $2400.00 Ability to pay from income
    $45,000.00 PLUS $2400.00 = $42600.00
    $42,600.00 = Reasonable Collection Potential

    Fanny’s RCP would be $42,600.00.

    If she owes more than $42,600.00, than in theory, it’s a good settlement, i.e. the IRS is getting…the bird… and Fanny is paying less than she owes.

    Great right? Now the catch.

    The payment would have to be made by sending 20% of it as a lump sum with the filing of the offer proposal and the remainder within a very short period of time following the agreement. (by the way if the offer doesn’t pan out, the IRS keeps the 20%)

    What…?

    Yes, this type of offer in compromise requires the amount to be paid in full, very quickly following acceptance.

    So what if Fanny doesn’t have access to such a large sum of money?

    She could convince the IRS to try and calculate the RCP another way. She would multiply the remainder number by 24 instead of 12 thereby increasing the RCP but also thereby creating a payment plan of sorts. A payment plan that requires the RCP be paid over what is typically a two year period.

    There are exceptions, but you are getting the idea.

    This RCP thing seems simple enough…

    So, Why Do So Many Offers In Compromise Fail?
    How many? Nationwide you can count on about a 65% to 80% failure rate each year.

    A few reasons:

    1. The Relationship Between 12 and Fannie’s Lifestyle

    It’s a bad one. The IRS is able to “impose” a budget on Fanny, at least to start. That budget is usually not the same as Fannie’s actual budget. It is lower. Every dollar that the IRS can remove from the budget is 12 dollars added to the cash offer and at least 24 to a “payment plan” offer.

    Many people that file offers in compromise don’t fully understand this relationship and the IRS’ ability to use budget numbers different than their own.

    Of course, this basic budget can be challenged in different ways, and an experienced practitioner will understand some of the ins and outs related to convincing the IRS to agree to a more reasonable number.

    2. Inability to Pay Offer Amount

    Assume that Fanny owes the IRS 1 million dollars. The above RCP is only $42,600.00. A savings of…alot.

    Holy smokes. That is really a fantastic settlement. Amazing.

    Fanny doesn’t have $42,600.00 though. She can’t borrow it because no one she knows has that kind of dough.

    She switches to the payment plan but the monthly amount needed to pay the settlement over a limited period of time leaves her too little income to pay her actual bills.

    3. Unclear Standards

    The law surrounding what constitutes an acceptable offer in compromise is a bit..fickle. You know, uncertain, flighty, gray etc.

    An example of this is found in a 2008 Tax Court Case,Leslie B. Bennett v. Commissioner.

    Ms. Bennett owed some money to the IRS. She calculated her RCP and submitted the offer.

    Although the IRS admitted that the offer amount she submitted was more than “ten times” the RCP based on it’s own calculations,they rejected the offer.

    Some of the reasoning:

    1. Internal Revenue Manual (IRM) Part 5.8.7.6(5)(Sept. 1, 2005), says that a rejection can be based on a determination that an acceptance of the offer is simply not in the government’s best interests.
    2. In other parts of the IRM the IRS is allowed to reject the offer if the taxpayer had a bad history for filing returns on time and there was some belief that she would continue in that manner.
    3. The doubt as to collectability i.e. the RCP amount above only determines whether the offer should be “considered for acceptance”.

    Quoting from the case. “This language…doesn’t require that the Commissioner accept an offer in compromise whenever the amount exceeds the collection potential. Rather, it only establishes grounds for winning consideration”.

    What this case really stands for is that RCP is really just the beginning. You don’t have the right to appeal the denial of the offer and win just because the numbers make sense. The IRS can deny the offer for a whole host of reasons including quite possibly…just because.

    4. I Just Can’t Hack It

    It takes an organized and dedicated person to put together the information necessary to submit with a compromise offer.

    In the more complicated case, the amount of paperwork kills a few trees. Sometimes, multiple submissions must be made and more trees meet their doom.

    Not only that, but in order to make the RCP work to the taxpayer’s best advantage, some planning i.e. changes must often be made.

    Many bail out during this process. It is just too much work, and the inability to keep up, dooms the case from the start.