IRS Offer in Compromise – Another Boring Explanation About How It Works

I am asked so often whether it’s true that the IRS will actually settle tax debt…I find myself thinking about it even when I don’t want to be.  It’s like a song that you can’t get out of your head.  Don’t Stop Believing.
So in another effort to answer this question yet again…and to help clear my head for the weekend, here is a quick review:

YES!  THE IRS WILL SETTLE TAX DEBT FOR LESS THAN WHAT IS OWED

The IRS settles tax debt formally and they do it all the time.  The “program” that is used to tell the IRS whether it should settle, is call the “Offer in Compromise” program (“OIC”).

AGAIN, IT’S FORMAL

The OIC program process isn’t one that is based on some phone calls and some wheeling and dealing.  It is formal.  The Taxpayer has to prove that the facts and circumstances qualify him or her for settlement.

“Hey – do you think you’d take 10%”, doesn’t work.

FIRST REQUIREMENT TO SETTLE

The first “hoop” of several that need to be jumped through, is proving to the IRS that the taxpayer can’t afford to pay all of the tax debt before the 10 year date on the IRS’ ability to collect runs out.  This date is commonly known as the Collection Statute Expiration Date or CSED.

In my opinion…this is not only the first hoop to jump through, but for most people the most difficult part of the OIC process.

WHY IS THE FIRST REQUIREMENT SO DIFFICULT TO SATISFY

Three Reasons:

Reason One – CSED Length

The CSED is 10 years long plus anytime the taxpayer did anything to stop it like file an appeal, request a payment plan, file a bankruptcy, or leave the country.

Reason Two – Most Recent Date Used

The most recent tax year is the year used to calculate the CSED.  If the taxpayer owes for five years from 2013 to 2017…the 2017 CSED is used to determine the 10 year + CSED.

Reason Three – Budget set by the IRS

The IRS looks very closely at three things when you request a settlement.  Your income, assets, and budget.  It will try to use the largest income amount it can prove.  It will give a discounted value on assets, but…it will count their remaining value.

But the most common problem is that it limits the budget to one that is based on what it thinks the average household spends – not necessarily what the taxpayer spends. (IRS Collection Standards)

An Example:

Tax debt                          $50,000.00

Asset Value                     $8,000.00

Avg. Income                   $4,500.00 per month

Avg. Budget                    $4,500.00 per month

CSED                                80 remaining months

Given the above…you’d think the IRS Settlement should be $8000.00.

But look at what happens when the IRS uses it’s budget.

Assuming that budget includes $250.00 more per month than what the IRS thinks the average car payment is, and $300.00 in minimum credit card payments above their standard amount for miscellaneous expenses…it will see an ability to pay $550.00 per month toward the debt.

Given 80 months remaining on the CSED, the amount the IRS believes the taxpayer could afford toward the debt will be:

$8,000.00 plus $44,000.00 or $52,000.00.  Rejection.

Yes, the IRS will actually reject the offer if the numbers show an ability to pay before the CSED.

WHAT IF THE FIRST “HOOP” IS SATISFIED – WILL THE IRS SETTLE?

Probably.

If the first rule is met, the IRS is supposed to multiply the excess number by 12 and add the asset value to it and allow the taxpayer to pay that amount over several payments and settle the debt.

In the example above – assuming that excess car payment amount were $150.00 and not $250.00, the excess income would be $450.00, not $550.00.

$450.00 x 80 is $36,000.00 plus $8,000.00 = $42,000.00  – LESS than the debt so:

$450.00 x 12 + $8,000.00 is $13,400.00.

$13,400.00 should be the settlement amount.

BUT HOW DOES THE SETTLEMENT AMOUNT GET PAID?

Using the 12 month multiplier example above…the taxpayer would have had to pay 20% with the OIC filing and the rest in 5 installments after acceptance.

There is another way to skin the “payment cat” that has to do with using a larger multiplier and  longer pay-back period.  You can ask me later.

THE SECOND BIG HOOP – NOT ABLE TO PAY THE SETTLEMENT

The second big problem that we see is that even when a taxpayer makes the numbers work, they have no way to pay the settlement amount.  This happens because the asset value is usually tied up in a home or other difficult to sell asset and/or the excess income number was created using a fictional budget…the taxpayer doesn’t actually have the excess and hasn’t been able to save it.

HOW TO JUMP THROUGH THIS SECOND HOOP

If the taxpayer plans ahead and creates a “tight” situation with this potential problem in mind, he or she might be able to pay the settlement amount.  Even then…a third party often has to get involved to help the taxpayer come up with the money.

WHAT DO I DO

If you have a large IRS debt, start the process of determining whether an OIC might work by doing the following:

  • Become an expert on the issue of your average income and budget
  • Become an expert on the value of your assets
  • Provide your expert analysis to me
  • Allow me to review your analysis and the IRS’ history re: your IRS debt and apply the facts to the rules

If you’ll provide the numbers and other valuable information about yourself,  I do the evaluation for free.  Once we know what’s going on, we can discuss whether you can make an offer work, either now or in the future.  We’ll also discuss your other options.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IRS Debt? 7 reasons bankruptcy is often used to deal with it

idea_lightbulb_cartoon2-thumb-375x491-53213IRS Debt and Bankruptcy

No one likes bankruptcy, except bankruptcy attorneys.  For most Americans, it remains a very negative process.  In fact…many of our clients refuse to even consider bankruptcy during a first meeting.  I don’t blame them.  It is interesting however, how many of those who are initially so opposed, change their minds once they see the potential benefits.

Why is bankruptcy such a mind changer?  Some quick background:

The Bankruptcy Code, which is updated occasionally by Congress, reflects our Nation’s desire to provide a fresh start for debtors. The Code attempts to create a system that forces those that can afford to pay their debt out, and allows those that can’t…in.

This balancing process between “who should and who shouldn’t” is applied to tax as well. Certain types of tax are considered so important by society that the bankruptcy code doesn’t allow for them to be wiped away (discharged). “Trust fund” taxes like taxes that are withheld from an employee paycheck to be forwarded to the government by the employer, are a common example.

Income taxes don’t warrant the same concern, and therefore the bankruptcy code provides for their discharge in specific circumstances. Those circumstances are as follows:

  • The tax return had to be filed more than two years before the bankruptcy filing.
  • The tax return had to be due for filing more than three years before the bankruptcy filing.
  • The tax debt had to have been “assessed” or entered into the IRS record as a debt, more than 240 days before the bankruptcy filing
  • The taxpayer didn’t file a fraudulent return.
  • The taxpayer didn’t engage in tax fraud more generally or engage in tax evasion.

These dates are found in the Bankruptcy Code sections 507(a)(8)(A)(i), 523 (a)(1)(B) and 507(a)(8)(A)(ii).Of course you realized while reading this list that nothing is ever that simple, and for a number of reasons you are right.

  • The first reason is that in an effort to be fair to the debt collectors at the IRS, the Bankruptcy Code requires that the clock stop ticking in certain circumstances. Circumstances like time spent in a previous bankruptcy, collection due process appeal, or offer in compromise.  It is not always easy to calculate these time periods as a result. Also, the taxpayer has to wait for these time periods to pass. In the meantime, the IRS is aggressively looking for money.

So if the date calculations are complex, and the tax lien can negate many benefits of the discharge…why such a mind changer?The primary reasons:

1.  The Bankruptcy Code controls the Tax Code

If the taxpayer meets the various bankruptcy qualification criteria and the tax debt meets the requirements for discharge, the IRS has little say in the matter. This isn’t a subjective decision on it’s part. It has to do what is told. If it doesn’t i.e. it tries to collect the debt when it wasn’t supposed to, the taxpayer can sue. This is as opposed to trying to deal with the IRS directly in an offer/installment/other situation where the IRS is the decider of facts and the applier of the law.

2.  Bankruptcy can be a “one-stop” shop

Many people with serious tax debt have other serious debt as well. If planned well, bankruptcy can deal with all of the problems at one time and some that many don’t realize were “fixable”. Not only can income tax and consumer debt be dealt with, but cars can be “crammed down” to market value, homes saved, and assets protected. All legal options provided by the tax code, deal with the tax debt only.

3.  The lowest debt settlement program is the no asset chapter 7 bankruptcy

Where the bankruptcy trustee in a chapter 7 bankruptcy is unable to collect any assets for liquidation and distribution to creditors, which is a common occurrence, the IRS will get nothing as well. This amount is always less than the settlement amount in an offer in compromise.

4.  Offers in Compromise don’t work for many

The vast majority of offers in compromise filed in the U.S. fail. There are a number of reasons. Some of them are:

a.  Legal standards do exist that govern how the IRS should view the offer to compromise the debt, but they are…a bit loose. Loose enough that the IRS is able to inject a great amount of subjectivity into the process. Bankruptcy on the other hand, creates quantifiable results based on objective criteria. Offer in compromise results are all over the place.

b.  These legal standards have a lot to do with what the IRS thinks you can afford to pay toward the debt over time. The starting point for household budgets is very low and is usually much lower than the taxpayer’s actual budget. The IRS doesn’t have to consider certain budget items at all, like consumer debt payments and savings plans. This usually results in a large discrepancy between what the IRS thinks the taxpayer can afford and what the taxpayer thinks he can afford.

c.  Failure is costly. Most need legal representation and that costs money. Most/all of which doesn’t get refunded when the offer fails. Most have to pay some large amount to file the offer (20% of cash offer amount, or monthly payments based on the offer amount) which isn’t refundable when the offer fails. The debt continues to grow in the background thanks to interest, and when the offer fails all the new debt is waiting with hat in hand and even a smile.

5.  High income taxpayers don’t always have to “qualify” for a chapter 7 bankruptcy

There is an exception in the bankruptcy code to the requirement that all who file chapter 7 bankruptcy must pass a test of ability to pay debt. Where the majority of the debt is tax debt, this rule doesn’t always apply. As a result, many who wouldn’t be able to even hope for an offer in compromise, are able to use bankruptcy to discharge the debt.

6.  Many with serious tax debt don’t have large assets

Most taxpayers with serious tax debt, will see the IRS record a Notice of Federal Tax Lien. As mentioned above, that lien attaches to all assets. When the bankruptcy is filed and the underlying debt is discharged, the tax lien remains and is in essence a secured debt. It’s value is based on the value of the assets on the date of the bankruptcy filing. If the taxpayer owned a home that was “underwater”, a car with $5000.00 in equity and some furniture, the lien is almost worthless and the IRS will often remove it.

7.  Chapter 13 bankruptcy is often a “cheaper” solution then an installment agreement.

The taxpayer may not be a good offer in compromise candidate, and may not be a good chapter 7 candidate because the tax debt is not the greatest part of the overall debt or for another reason. The taxpayer is left with two options: An installment agreement to pay the tax over time and wait out the statute of limitations period, or a chapter 13 bankruptcy.

The installment agreement amount is often much higher than the taxpayer would like. The chapter 13 bankruptcy payment on the other hand, can be based on friendlier budget criteria. In many cases the taxpayer can deal with all of his debt with a smaller monthly payment than the IRS was requiring to deal with the tax debt alone.

5 Commonly Used Ways To Deal With IRS Debt

Faced with large tax debt and feeling hopeless? Take heart…if you are willing to create a “strategy” and combine it with some hard work and patience, there may be a real solution. The following are the most 5 common methods people use to deal with tax debt.

1. Use the IRS Statute of Limitations to Your Advantage

Congress limited the time the IRS has to figure out how to get paid.  26 U.S.C Section 6502 provides this limit and as a result, the IRS has ten years to get the debt collected. Many people with IRS debt buy the time necessary to get to the 10-year period by negotiating an installment agreement or non-collectible status placement.

An example:

Imagine a tax debt of $120,000.00 and that the IRS has let 7 years pass without fully attempting to collect the debt, but they are now at the doorstep. The debt has grown to $200,000.00 with penalty and interest over time, but the taxpayer can only afford to pay $100.00 per month toward the balance. If the taxpayer were able to negotiate such a payment, only $3600.00 of the $200,000.00 would be paid before the debt disappeared.

The above scenario happens more often than you would think. However, there are things people do that stop the ten-year clock from running. Filing an offer in compromise, a bankruptcy, a collection due process appeal, or anything else that stops the IRS’ ability to collect also stops the statute of limitations clock from ticking. It isn’t always advisable to do anything other than to negotiate the payment plan or non-collectible status as a result.

2. Challenge the Tax Debt

What about a situation where the IRS assessed a debt against you that you know isn’t correct.

Usually, this is the result of an audit “gone bad” or the creation of a tax return by the IRS, because you didn’t file it yourself.

Audit Appeal

IRS Audits that go badly can be appealed. If done right, they can be appealed to the US tax court. If your audit result is wrong, you have a limited amount of time to bring the appeal, so call someone now.

Substitute Tax Return Appeal

Tax returns filed by the IRS come with appeal rights as well. Most people don’t respond in time and lose them, however. Thankfully, the assessment of the tax from the incorrect return can be challenged using the IRS audit reconsideration process.

Challenge Trust Fund Recovery Assessment

There are other things the IRS does to assess tax debt that can result in an incorrect debt amount, like the assessment of the trust fund recovery penalty against a responsible party.

Where the business has withheld the employee portion of the payroll tax but didn’t send it in, the IRS stick the amount on you personally as a penalty if you are the “responsible” party.

There are defenses to this, however, and the assessment of the debt can be challenged as a result.

Innocent Spouse Relief

Sometimes the tax is correct but it just isn’t fair that the spouse should be stuck with it. The law provides the ability to challenge the debt based on some theories about innocent spouses.

3. File an IRS Offer in Compromise

26 U.S.C Section 7122 provides the basis for the settlement or one-time reduction of the tax debt. In essence, you would be making an offer to compromise and settle the back tax liability. But this isn’t horse-trading.  The amount that the law requires the IRS to settle for is based on objective criteria. The criteria is called the IRS reasonable collection potential or the RCP.

In theory, the RCP is the amount that the IRS could collect from you before the statute of limitations period on collection runs out.

The vast majority of offers filed in the last several years fail primarily because the RCP calculation is rigged a bit in the IRS’ favor. The IRS is allowed to use as a starting point for calculation purposes, a budget that is based on averages they have created.

For instance, they may have pre-determined that a family of four only needs $1650.00 per month to pay for all housing and utilities expenses. That family may be actually spending $2100.00 per month. If in the end, the IRS were able to use the $1650.00 figure to determine the RCP, then the amount of extra income per their calculation would be at least $450.00 per month.

If the statute of limitations period remaining on collections is 8 years than the RCP, just based on this number could be as high as $43,200.00

Typically, the IRS must use a smaller multiplier than the statute period, but even then, you can see how quickly the RCP can grow.

Successful Offers in Compromise, require much thought and planning as a result. They shouldn’t be entered into lightly.

4. Bankruptcy

Bankruptcy and its relation to tax debt are misunderstood. Many people including many attorneys believe that bankruptcy can’t resolve income tax debt. Nothing could be further from the truth.

In fact, the treatment of the tax debt is not up to the IRS. The Bankruptcy Code governs the treatment of the debt. The Bankruptcy Code says that income tax and certain other tax debts can be wiped away in bankruptcy, if it meets certain date requirements and the taxpayer didn’t cheat.

Sometimes the date requirements haven’t been met yet and we guide our clients in negotiating a payment plan or non-collectible status to help them avoid collection activity while they wait for those dates to arrive.

5. Penalty Abatement

As a taxpayer, you have the right to request the cancellation of any IRS penalty. There are more than 140 penalty provisions and they all have a good faith exception.

If you have been penalized for something like a failure to pay the tax on time, but you acted in good faith and there exists some reasonable basis for the failure, then the penalty can be removed along with interest on it. This removal often makes it easier for you to deal with the underlying debt.

 

Written By:

Michael S. Anderson, Attorney
2158 N. Gilbert Rd. Ste 101
Mesa, Arizona 85203

Phone: (480) 507-5985
Fax: (480) 507-5988
Email: [email protected]
Website: www.taxlawyeraz.com