How Exactly Does an Offer in Compromise Work with the IRS?
An Offer in Compromise is the one and only way that the IRS will voluntarily write off back taxes owed by you or your business. It is true that bankruptcy can discharge income taxes; however bankruptcy cannot discharge payroll taxes for a business or the owner of that business. It also cannot discharge any self-employment taxes.
A good Offer essentially stands on two legs. The first leg is the total value of the equity in your stuff. The second leg consists of the household income/expense analysis. This post will discuss each of these in turn, followed by a discussion of the expectation of time the process will take, along with a few additional requirements of the Offer process.
Equity. First of all let’s be clear: the IRS is not interested in the silverware in the kitchen drawer, the CD player in the bedroom, or the goldfish in the front room. We are talking about equity in large assets, usually consisting of (1) Real Estate (homes, land, timeshares); (2) Vehicles (cars, motorcycles, 4-wheelers, jet skis, etc., that are titled in your name); (3) Retirement plans (401k, IRAs, and the like); and (4) Life Insurance with a cash value (if you can surrender your life insurance right now and get some money, that is cash value. If you were to stop paying, and the insurance goes away, that is term insurance, and has no value to the IRS.)
For this first leg of the Offer, we take the equity value in each. We do NOT have to sell your stuff – only offer the cash equivalent in an Offer to the IRS. For example, if you have a car that is worth $10,000 with a loan remaining on it of $6,000, then we would take an 80% value of the car of $8,000, (this compensates for the “fire sale” value of your car,) subtract against it the $6,000 still owed, and we come up with an equity of $2,000 in the vehicle. Interestingly enough, with recent rule changes, the IRS now allows a $3,450 exemption in each vehicle, up to two vehicles per family. In this case, that exemption would wipe out the equity in this car, and so we would have no equity for purposes of the Offer in Compromise! Nice, right?
We would go through a similar analysis of your assets in the above categories. Also, if you have other uniquely valuable stuff like an antique coin collection, for example, or a pre-revolutionary flintlock musket, the value of these would have to be added into the Offer.
Household Income Expense Analysis. In second leg of the Offer analysis, we take all the income coming into the household and total it up. Income includes salaries, 1099 income, social security, retirement income, disability, and even child support and alimony. Everything that comes into the home as money, each month, is income for an Offer in Compromise.
Next, we go through a number of expense categories that the IRS has deemed as essential and necessary. Some examples would be for food, housing, utilities, health insurance, car payments, withholding taxes, etc. For each of these categories there is a maximum amount the IRS will allow; above that cannot be counted in your Offer. The numbers go up based on the size of the household as well. For example, for food, clothing, and miscellaneous, the allowable amount for one person is $583 per month. For a household of four people, that increases to $1,482 per month.
Once we have tallied up these expenses, we then compare that monthly total against the income for the month. Whatever the net number is, we then multiply that number by twelve and add to the number that comes from the equity in your stuff, as discussed above. This final combined number is the minimum number the IRS will accept in settlement of any back taxes.
Timeline. An Offer in Compromise, from start to finish, can take anywhere from 6 months to 24 months. An Offer typically will take about 9 months on average from our experience.
Additional Considerations. There are a few other commitments you make as a part of an accepted Offer in Compromise. First of all, you promise to file your taxes on time and pay your taxes in full for the next five years. No extensions. If you are a day late, and a dollar short, your Offer will blow up, and you are back to owing the original taxes, plus penalties and interest! I have had two clients do that in the past 10 years; it truly is a tragedy.
Also, if you are entitled to a refund for the taxes for the year in which you had an Offer accepted, the IRS gets to keep that refund. For example, if you have an Offer accepted in October 2014, and then you are entitled to a refund when you do your 2014 taxes come next April 2015, the IRS will keep that refund, in addition to the settlement you agreed on. Essentially, it is one last chance for the IRS to get something from you on those back taxes. This can be planned for, but it does require some effort ahead of time.
Does the IRS really give Offers to People? Absolutely! This is an option every person should look into when deciding how to deal with IRS back taxes. We have had many accepted Offers for clients over the last 9 years; if you fit, you could be one of those as well. An Offer in Compromise will settle income taxes, penalties, interest, payroll taxes, and business taxes. If your situation qualifies, it is a comprehensive solution to your IRS tax problems.