If you have tax debt, there are a few ways you can get back in good standing with the tax man, one of these being an offer in compromise. You may be asking yourself “how much should I offer in compromise to the IRS”? Here’s what to know.
Tax debt is frightening. A debt to the government isn’t easily forgotten, and the IRS can leverage a steep interest rate and multiple penalties to grow your debt over time. Thankfully, in many cases, taxpayer debt is relatively minor. One mistake on your return or one deduction you might have erroneously applied to your tax liability can lead to a surprise bill of a few hundred dollars.
But some mistakes and issues come with a much heftier price. Forgetting to pay your quarterly dues, or to miss a return for months on end can lead to a big bill. As can bad financial or tax advice, creating a bogus return that makes no sense, and forcing the IRS to completely scrap what you’ve sent in.
When coupled with unfortunate financial circumstances, a large tax debt can be financially and socially crippling. The IRS may resort to collection actions to coerce a payment plan, including placing all your property on a lien, or even enforcing a levy on your wages.
So, what happens if you just aren’t in a position to pay your debt? Can the IRS levy you indefinitely? Not if you talk them into a payment plan that might benefit both of you. That is where an offer in compromise comes into play.
Understanding an Offer in Compromise
An offer in compromise is a proposal the taxpayer themselves have to draft and send to the IRS (with the help of a tax professional, if you choose to avail of one’s services). The “compromise” in this case is that you agree into a monthly payment plan, but for a reduced total debt.
An offer in compromise is not a given, even for taxpayers who have fallen on hard times. But a well-crafted offer does raise your chances of the IRS taking the deal, which can mean dealing with a fraction of the debt originally pinned on you.
How an Offer in Compromise Works
The first prerequisite is eligibility. The IRS has a pre-qualifier tool that you can use to get a rough idea of whether an offer in compromise is a possibility for you. This tool can be helpful, but don’t rely on it. It isn’t a guarantee from the IRS itself that they would accept your offer, and there’s still a bit of paperwork to go through before the offer gets sent their way.
The basic eligibility requirement for an offer in compromise is financial proof that you cannot reasonably pay off your debt within the next few years. In theory, the offer in compromise exists so taxpayers who have been saddled with tax debt for years can at least pay off some of it before their debt expires. A win-win for both parties – the taxpayer gets back into good standing with the IRS, and the IRS sees some of the taxpayer’s tax liability covered.
Over the years, the requirement for an offer in compromise has dropped from “paid until tax debt expiration” to “paid within two to three years”. This means that if you cannot reasonably pay your debt in monthly installations over 24 to 36 months, you may be able to negotiate a reduced tax debt with the IRS.
Calculating what that reduced tax debt should look like is the next step towards an offer in compromise. The trick here is that the government is asking you to make a proposal. Don’t be fooled into thinking they’re generous in this case. The IRS can take months to deliberate your proposal, during which time your debt will continue to accrue penalties and interest. And if they reject it, it will take some more time before your next attempt is considered.
The IRS will comb through your finances, tax returns, and information reports from different agencies and financial institutions to determine your reasonable collection potential (RCP) before engaging with your offer in compromise. In other words, your RCP is the amount of money the IRS expects to see from you on a monthly basis. If your offer is under that RCP, it has a poor chance of being accepted.
When is an Offer in Compromise Valid?
Should you consider an offer in compromise? The answer depends on whether you think you can afford to pay your tax debt within the next few years, without making unreasonable cuts to the rest of your expenditures. The IRS obviously won’t consider an offer in compromise if you have multiple valuable assets to liquidate, a stable monthly income well above your basic cost of living, and very few dependents.
But if you are struggling to make ends meet, have no potential source of liquidity, and are living on the only asset you own, you may want to talk to a tax professional about considering a reasonable offer in compromise to cut down on the impact your tax debt will continue to have on your finances.
You don’t need to be broke to make an offer in compromise work. You just need to prove that you can’t be expected to pay your debt off in a short period of time.
Calculating Your Reasonable Collection Potential
The IRS will generally calculate your reasonable collection potential based on your net realizable equity and your expendable income.
Net realizable equity is what you have to your name if everything is sold at its quick sale value, i.e., the price you could get if you wanted to liquidate it fast, often calculated at 80 percent of current market value, minus any current liabilities against your assets, such as a mortgage or ongoing credit.
Expendable income is any money you earn after taxes – this means it does not take into consideration rent and food. The number of dependents you have may also impact your RCP.
In addition to assets and income, the IRS will also take into consideration any money held in your bank accounts as cash, minus one month’s worth of allowable expenses and $1,000 extra.
When calculating the value of any vehicles you own, the IRS allows for an additional deduction of your net equity per vehicle (one vehicle if you live alone, two if it’s a joint household).
You can put these numbers together yourself by taking your current earnings minus taxes and basic living costs, your current cash, the value of every asset you can sell and still live with a roof over your head, and then getting an estimate of how much you can set aside per month this way. If you can cover your entire debt within a year or two of monthly payments, it will be difficult to make the IRS accept a reduced tax debt.
But if it becomes clear that you’re in over your head, then taking note of whatever you can pay will give you a good idea of what your offer in compromise might look like.
Always Talk to a Professional
At any rate, it’s important to discuss the idea with a tax professional. Not only will they have a better idea of how to negotiate an offer in compromise with the IRS, but they may be able to help you realize a better deal depending on other circumstances in your life, and other ongoing costs and liabilities.
We at Rush Tax Resolution are at your disposal. Give us a call for a free consultation, and more information on potential offers in compromise.
