Calculating an Offer in Compromise
A guide to making an offer to the IRS to pay off your tax debt
In the past two columns, I've been discussing offers in compromise, the IRS program that gives taxpayers a fresh start. This program is designed to show mercy to taxpayers who are up against economic odds that would make collection of a tax debt impossible or present undue hardship on the taxpayer.
In part 2 of this series I explained how to roughly determine the amount the IRS will accept on an outstanding tax liability. You must itemize your holdings and your income and living expenses on Form 433-A. If you are self-employed with a legal form other than sole proprietor, you must also fill out Form 433-B. Both forms are available at http://www.irs.gov/ .
After completing these forms, you need to apply the IRS formula to determine if you qualify. From form 433-A, subtract your total living expenses on line 45 from your total income on line 32. Multiply the result by 48 (60 if you intend to repay the compromised amount with an installment plan). This is the first variable in the formula.
Next, go to the bottom of page 6 on Form 433-A to find a description of the other two elements of the formula--total cash and total equity. You'll see a shaded area for IRS use only entitled "Financial Analysis of Collection Potential for Individual Wage Earners and Self-employed Individuals." Add up the line items indicated to arrive at totals for total cash and total equity. Then plug your numbers into the following formula:
Total Cash + Total Equity + (Monthly Available Cash x 48 or 60)
For example, let's say your total cash in bank and investment accounts amounts to $1,000. You have a car that's worth $20,000 but the loan balance is $20,000 (zero equity there). Your house is upside down with a value of $250,000 and a mortgage balance of $325,000 (zero equity there). Your total monthly income less your total living expenses equals $100 per month (monthly available cash). You plan to pay off the compromised balance immediately, so you multiply your monthly available cash times 48 = $4,800. Adding in your total cash of $1,000 and your total equity of zero, you would technically be able to settle your tax debt for $5,800.
Total Cash $1,000 + Total Equity $0 + Monthly Available Cash x 48 $4,800 = $5,800
You heard me--I said "technically." There is more to it than spinning a formula. The IRS will verify every piece of income and every expense you have outlined. It will examine bank statements, perform property searches and dig through vehicle registration records to determine if you are hiding income or assets.
The IRS will want to know why you believe you will not be able to pay off the entire balance before the statute of limitations runs on your tax debt. And you'd better have a good reason.
Enduring business reversals or losing a big client is not considered a good reason. We're in a recession; everyone is suffering. There's a possibility that your business will soon begin showing enough of a profit that repayment of your tax bill could occur before the statute runs.
So what are they looking for? What will make them realize that you will possibly never be in a position to repay? Here are some examples: disability requiring a career change, terminal illness, continuing depression, alcoholism, drug addiction, a balance so large you would not be able to pay it off in this lifetime, having to provide for dependents with special needs, limited income potential due to advanced age. You get the idea.
If, after crunching the numbers, you believe you have a good chance of running an offer, you should consult with an experienced tax pro to help you prepare the offer and negotiate with the IRS. I'll tell you right now, it can get pretty damn tricky. Those guys are tough! Especially in this economic climate. The government needs every penny it can find. The dictum is enforcement and collection. Consequently, the number of accepted offers has declined from 33 percent in 2008 to a current level of only 24 percent.
If you are lucky enough to have your offer accepted, remember you must now stay in compliance by timely filing and timely paying all taxes for five years. Otherwise the IRS may rescind the offer and demand payment in full. During the offer process and for the next five years you must make all required current estimated tax payments in a timely manner. Missing an estimated payment while your offer is under consideration will blow the whole thing out of the water.
Bonnie Lee is the founder of Taxpertise located in Sonoma, Calif., a firm providing bookkeeping, payroll services, QuickBooks Training, income tax preparation and tax problem resolution including audits, offers in compromise and other representation issues. She is also the author of Taxpertise: The Complete Book of Dirty Little Secrets and Tax Deductions for Small Business the IRS Doesn’t Want You to Know (Entrepreneur Press, 2009).