Volume 24 Issue 3 -- May/June 2012
Over the past year, the IRS has made a series of changes in its guidelines for Offers in Compromise. Some of these changes can be thought of more as tweaks in the prior guidelines, but in May of this year, the IRS made some bold changes in its Offer program.
In a nutshell, the most important of these latest changes are the following:
Perhaps an IRS recognition of the rigidity of the prior rules and their implementation has produced new, surprisingly liberal guidelines for the analysis of OICs.
In evaluating Offers, the IRS determines the Reasonable Collection Potential (RCP) based upon two factors: (1) equity in assets and (2) future income. To be successful, an Offer must offer this RCP.
Previously, Offers had to include income or cash flow over 48 or 60 months (or, in some cases the remainder of the ten-year collection period) if the OIC was not to be paid in a lump sum. Now the IRS has reduced the period of time over which cash flow payments are to be calculated to one or two years, depending upon whether the Offer is paid in five or fewer months.
For example, assuming that the taxpayer has no equity in assets and available cash flow of $5,000, the total income for one year would be $60,000. If that $60,000 could be paid in five or fewer months then only $60,000 would need to be offered. If it cannot be paid in five or fewer months, then the Offer would have to include $120,000 payable over up to 24 months.
By comparison, the prior guidelines usually required an Offer to include either 48 or 60 months’ worth of income. In this instance, that would effectively require payment of 4 or 6 times the amount expected under the new guidelines.
Perhaps the trade off for the reduced income amounts is the shortened period for paying Offers. All Offers now must be paid in 24 months or less.
In determining the value of equity in assets, previously the IRS insisted on including 80% of the value of all assets. Now, for some assets, the approach is markedly different. The new guidelines state that if an asset is producing income and is essential for a business, the income from the asset, but not the equity, should be included in the reasonable collection potential for the OIC.
A quick example: If a machine worth $100,000 with no debt produces $5,000 of income per month, then only the income of $5,000 per month but not the equity in the machine itself should be included in the OIC. In some cases, equity in essential business assets might also be excluded.
In the past all cash had to be included in an OIC without any reductions. The new guidance surprisingly permits $1,000 of cash to be subtracted from a bank and/or savings account. In addition, certain living expenses can also be excluded from cash. The example contained in the new guidelines is $10,000 of cash should be reduced by the $1,000 and living expenses of $3,000 also, leaving cash of only $6,000 to be included in the OIC. This is a welcome change for those trying to get an OIC accepted.
Under the new guidelines, $3,450 per car can be excluded in projecting the equity in a car used for work or essential transportation. If a family has two cars, they might be able to exclude up to $6,900. The new rules apply to “cars,” not airplanes, boats, and possibly trucks. The issue of what to do with a pickup truck, which may be the only vehicle in some families, is not addressed.
The new guidelines expand the expense allowance for student loan obligations. Also, in the past, state and local taxes were never deductible when computing cash flow for an OIC, but now an allocation formula can sometimes be used to claim a portion of those tax payments as allowable expenses in computing cash flow.
There are also potentially significant changes in the way the IRS will treat dissipated assets (assets transferred for less than fair market value). No longer will the IRS look back 5 years; now it will not usually go back more than 3 years.
If these new changes are implemented in a reasonable way (not a given with the IRS offer specialists), it could make Offers available and affordable to wider groups of taxpayers.
If you have questions about these new Offer guidelines, please contact Tax & Business Professionals.
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.