An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles a taxpayer’s tax liabilities for less than the full amount owed. Taxpayers who can fully pay the liabilities through an installment agreement or other means, generally won’t qualify for an OIC in most cases. For information concerning tax payment options including installment agreements, refer to Topic No. 202. To qualify for an OIC, the taxpayer must:
- have filed all tax returns
- made all required estimated tax payments for the current year, and
- Have made all required federal tax deposits for the current quarter if the taxpayer is a business owner with employees.
In most cases, the IRS won’t accept an OIC unless the amount offered by a taxpayer is equal to or greater than the reasonable collection potential (RCP). The RCP is how the IRS measures the taxpayer’s ability to pay. The RCP includes the value that can be realized from the taxpayer’s assets, such as real property, automobiles, bank accounts, and other property. In addition to property, the RCP also includes anticipated future income less certain amounts allowed for basic living expenses.
What is Reasonable Collection Potential?
The IRS usually decides whether to accept or reject usually based on whether the amount offered reflects the RCP. If the initial calculation indicates the taxpayer cannot full pay through an installment agreement, the IRS will continue the OIC investigation to determine the reasonable collection potential (RCP). Refer to IRM 220.127.116.11, Doubt as to Collectibility, involving situations when the calculated amount potentially received through a PPIA, which does not fully pay the liability, approximates the outstanding balance.
Whether the IRS will include dissipated assets in the calculation of your RCP is a major issue. The IRS might not include dissipated assets in the calculation of the reasonable collection potential (RCP) generally. However, the IRS will include it in situations where the IRS can show the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability; Moreover, the IRS will do so if the taxpayer used the assets or proceeds (other than wages, salary, or other income) for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or during a period of up to six months prior to or after the tax assessment. This is a very important item to consider.
Generally, a three year time frame will be used to determine if it is appropriate to include a dissipated asset in RCP. Include the year of submission as a complete year in the calculation.
If the offer is submitted in 2017, any asset dissipated in 2014 or prior should not be included. Assume the taxpayer has a tax liability of $250,000, and there are 60 months left on the statute of limitations for collection. Assume the taxpayer has no unfiled tax returns. Also assume that an IRS installment agreement would not full pay the liability within the statute of limitations. The taxpayer’s ability to pay is $2,500 per month. The monthly payments over the statute total $150,000. The taxpayer offered the IRS $30,000 to settle the tax liability of $250,000. Because the IRS could receive $150,000 over the life of the installment agreement, the IRS might decide to reject the offer as lower than the RCP. A taxpayer should consider this issue. Read below for more information.
Reasonable Collection Potential Compared to Partial Pay Installment Agreement
Additionally, if the taxpayer has the ability to make installment payments, the IRS will determine the amount which may be collectible from a partial payment installment agreement (PPIA). In some instances, although the taxpayer is not able to fully pay via an installment agreement, due to a high monthly payment ability, the amount collectible through the CSED is substantially more than the RCP amount calculated as defined in IRM 5.8.5, Financial Analysis. Moreover, in these situations, when the disparity between the amount offered and the amount collectable via a PPIA is substantial, the IRS may decide that acceptance of an offer is not in its best interest. Based on this calculation, if the taxpayer is unwilling or unable to increase their offer to an amount which is closer to the PPIA collectable amount, the IRS might choose to reject the OIC and require the taxpayer to enter into an installment agreement.
If you have an IRS Tax Liability from an IRS audit or otherwise, contact us today to discuss how we can review your financial situation to determine whether you would be a good candidate for an IRS Offer in Compromise. We can help you determine whether you would qualify for an IRS offer in compromise.