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By Michael S. Anderson of Anderson Tax Law logo for Arizona tax attorney Michael S. Anderson P.C.

    change-thumb-375x249-60735As you already know, in May 2012, the IRS published new guidelines regarding its for its IRS offer in compromise (OIC) program. It did this in relation to it’s “Fresh Start” program. The purpose of the changes was to help taxpayers who are having a difficult time as a result of the poor economy, rid themselves of more debt and get their financial lives in order.

    Whether the IRS stays true to it’s intent, is yet to be seen… but I thought it wise to provide a short review of three of the most important changes that were made to the program. All of these changes were focused on how the financial analysis is done to determine eligibility.

    1. Allowing the taxpayer to include student loan payments and partial state installment payments, and minimum credit card payments in the allowable budget calculation.

    When the IRS is negotiating a Taxpayer’s ability to pay a tax debt, it reduces the ability to pay by a set of “allowable” living expenses. These are called “Allowable” because the IRS creates the living expense guidelines in an effort to promote uniformity.

    However, these “standards” have created a mess. They usually cause an overstatement of the Taxpayer’s ability to pay the debt and make it difficult for the Taxpayer to comply with the negotiated payment amount and maintain a basic living standard at the same time.
    The IRS had finally admitted to the problem by expanding how it defines “allowable” living expenses.

    One way is to allow for the monthly payments toward local delinquent state tax. It has limited this amount though by permitting only a certain portion of the tax payment to be included in the calculation of the Taxpayer’s reasonable collection potential.

    Example: Taxpayer owes delinquent income taxes (including penalties and interest) of $50,000 to the IRS and $10,000 to the State of Arizona. Of the combined total liabilities ($60,000), 84% is owed to the IRS (50,000 ÷ 60,000), and 16% (10,000 ÷ 60,000) is owed to the state. If you make the additional assumption that after calculating the Taxpayer’s reasonable collection potential without the state tax liability, the IRS decides that the Taxpayer has has $200 per month in disposable income. The IRS would allow monthly payments of $32.00 to the state (16% of $200) with the remainder ($168.00) going toward to the Settlement Amount with the IRS.

    Student loan payments that are guaranteed by the Federal Government for after high school education and that are actually being regularly made are included fully in the allowable expense calculation.

    Further, minimum credit card payments, bank fees and charges are also included when calculating the miscellaneous allowance amount.

    2. Changing the way that dissipated assets are used to calculate future income.

    A “dissipated” asset is an asset that has been sold, transferred, used as collateral for a loan, or otherwise disposed of and isn’t available anymore to pay down the tax debt.
    The IRS gets to include the value of the dissipated asset in in calculating the reasonable collection potential of the Taxpayer if the asset became “dissipated” within six months prior to or after the tax assessment in an attempt to avoid the payment of the tax or was used for purposes other that to pay items necessary for the production of income or income or the health and welfare of the Taxpayer and his or her family.

    The IRS has been able to use a three-year look-back period from the date the OIC was submitted to calculate the value of the Dissipated Asset and to determine whether it should be included in calculating the reasonable collection potential.

    Example: The taxpayer cashes out a 401k account to pay for a vacation to Cancun. The value of that cash out would be included in the Taxpayer’s reasonable collection potential.

    Now…equity in assets that produce income won’t generally be included in calculating reasonable collection potential. In order for the equity to be excluded, the asset has to be critical to the operation of a viable and ongoing business. The income from the business will continue to be included in the reasonable collection potential calculation.

    Example: Acme Company has 2 machines that produce tennis rackets. One machine has no equity and is encumbered and one has $50,000.00 in equity and isn’t encumbered. They both produce $20,000.00 in net revenue per year. The incomes from both of the machines are going to be included in the reasonable collection potential calculation but the value of the second machine won’t be included. If the vehicles weren’t necessary however to the success of the business, the IRS may be able to include the equity.

    3. Changing the way that basic future income is calculated.

    Under the old guidelines, the IRS would assume at least four years of future income when calculating reasonable collection potential if the settlement amount was going to be paid within 5 months. It would consider five years if the settlement amount was going to paid over a longer period.

    The four-year look forward period has been reduced to 12 months and the five-year look forward period to 24 months.

    Example: Taxpayer has monthly income of $6,000, allowable expenses (also expanded) of $5,700, and no assets with any real value. If all other OIC qualifications are met and the OIC was completely paid within five months of acceptance, the Taxpayer would have had to pay $14,400 ($300 × 48) under the old system. The required payment amount using the new calculations would be only $3,600 ($300 × 12).

    Will OIC Acceptance Rates Improve as a Result of the Above?

    We think that approval rates will increase over the long term. The IRS is indicating higher acceptance rates overall already. For many taxpayers however, we have continued concerns and caution our clients to make sure that they undergo a rigorous analysis with a qualified attorney before embarking on an offer in compromise. If the offer in compromise fails, the taxpayer will have wasted potentially thousands of dollars in fees and other expenses and will have stopped the IRS statute of limitations clock from running.