How the IRS Works the Offer In Compromise
Once It Accepts It Into Inventory
There are common misconceptions about how the IRS actual works an Offer In Compromise. You will find in this presentation excerpts from the IRS manual on how the IRS looks and processes an Offer In Compromise.
Remember, this is a very thorough look at your case. You should be absolutely certain all the information is correct or your offer will be denied.
Keep in mind, the financial statement you turn in is being audited by the IRS. Make sure Fresh Start Tax helps you process this offer so you can get the very best results in the end.
General information about the method that the IRS uses to examine the Offer In Compromise, doubt as to collectability.
- This page provides instructions for analyzing the taxpayer’s financial condition to determine how the IRS uses their Financial Analysis Handbook.
- It will also provide information on the analyzing and verifying of financial information and should be used in conjunction with their case load of taxpayers who have not paid their federal taxes.
What the IRS considers the taxpayers “Ability to Pay”
- The ability to pay determination should be made on the liability(s) is based solely on the financial statement given to IRS usually on a 433A, 433B or a 433F. It also uses other source information.
First step in the process is the “Verification Stage”
- A thorough verification of the taxpayer’s financial statements of collection information statements. Form 433-A and/or Form 433-B involves reviewing information available from internal sources and requesting the taxpayer provide additional information or documents that are necessary to determine Reasonable Collection Potential (RCP). You can find links on our site for the other sources that are used by the IRS.As a general rule, requests for a real estate appraisal should not be requested from a taxpayer when the information would not be necessary, and/or is readily available from other internal sources. These types of requests should be tailored to the specific taxpayer situation. Most of the IRS information pulled on real estate comes from Zillow.com or other such sites.
- Collection issues that have been previously addressed during a balance due investigation by field personnel will not be re-examined unless there is convincing evidence that such reinvestigation is absolutely necessary. It is expected that the results of a previous collection investigation will be used and only supplemented when necessary to make a determination on an Offer In Compromise.
- Investigative actions that are less than 12 months old may be used to evaluate the OIC, unless the taxpayer indicates there has been a material change or there is evidence indicating his financial situation has changed in the intervening months. Most Revenue Officers will conduct a thorough check on all financial statements.
- The IRS will get as much of the information as possible through the taxpayers financial statement and internal sources.
- The IRS will use internal locator services that are not available to the public or indicate a discrepancy and request that the taxpayer provide reasonable information necessary to support the CIS.
- A full credit report will be requested prior to accepting an offer when the current balance due exceeds $100,000.
- Regardless of the amount of the liability, the following information sources may be considered:
The IRS will conduct record checks on the last filed tax return, State Motor Records, Real Estate Record Checks, and the Credit Bureau.
IRS will review and research all Taxpayer Submitted Documents
- Collection Information Statements submitted with an OIC should reflect information no older than the prior six months. If during the processing of the offer, the financial information becomes older than 12 months, contact should be made with the taxpayer to update the information.
- In certain situations, information may become outdated due to significant processing delays caused by the IRS and through no fault of the taxpayer. In those cases, it may be appropriate to rely on the outdated information if there is no indication the taxpayer’s overall situation has significantly changed. Judgment should be exercised to determine whether, and to what extent, updated information is necessary. If there is any reason to believe the taxpayer’s situation may have significantly changed, secure a new CIS.
- The IRS will not make a blanket request for information that would include such items as real estate appraisals, or information that is not necessary based on the financial statement or taxpayer’s facts and circumstances. Requests for financial information should be tailored to the taxpayer’s specific situation.
- Revenue Officers or Offer Investigators may receive offers where the taxpayers have not provided, either proof of payment for certain monthly expenses claimed on the Form 433-A or statements showing current real estate mortgage or motor vehicle loan balance. Often the taxpayers are not actually paying claimed expenses, or they are not allowable under offer program guidelines.Taxpayers frequently list their unsecured credit card bills under “secured debt” or other expenses. While a taxpayer may have a liability for a court ordered judgment that is senior to the NFTL, unless the taxpayer is actually making payments on that liability, it is not considered as an allowable monthly expense.
- If a taxpayer does not substantiate claimed expenses for Form 433-A categories of court ordered payments, child/dependent care, life insurance, other secured debt, or other expenses the IRS Agent will complete the form assuming that the taxpayer is not making any payments for the particular unsubstantiated expense. However, substantiation of claimed health cases expenses of less than the allowable standard is not required.
- When computing equity in real estate or allowable motor vehicles, and the taxpayer has not submitted substantiation of loan balances claimed on the Form 433-A, the IRS agent should request a credit report and use the loan balance information to determine the current balances of any relevant loans from commercial lenders. If the loan is from a private source, it may be necessary to contact the taxpayer/representative for the information.
- If not present in the file when assigned for investigation, appropriate documentation from below should be requested to verify the information on the CIS.
- The pay stubs with current year to date figures
- If self-employed, proof of gross income, receivables and commission statements for the past three months.
- 3 months is defined from the date the Form 656 was signed.
- The IRS will also ask for retirement account statements, brokerage accounts, securities or any investments statements.
- The IRS will also include in their discovery, life insurance policies, motor vehicle purchases, contracts for the vehicles and lease agreements including pay off amounts.
- Real Estate warranty deeds, mortgage deeds, and pay off amounts on any other assets.
- The Service will ask for any loan applications submitted to any lender within the last year.
- Homeowners policies and insurance riders.
- Divorce decrees, proof of child support payments.
Equity in Assets
- Proper asset valuation is essential to determine realized collection potential on each and every case.
- The IRS many times may visit or make field calls to locate or personally ascertain the condition of assets.
Net Realizable Equity
- For Offer In Compromise purposes, assets are valued at net realizable equity. Net realizable equity is defined as quick sale value (QSV) less amounts owed to secured lien holders with priority over the federal tax lien.
- Quick Sale Value is defined as an estimate of the price a seller could get for the asset in a situation where financial pressures motivate the owner to sell in a short period of time, usually 90 calendar days or less. Generally, Quick Sale Value is an amount less than fair market value but greater than forced sale value. QSV is defined as no less than 75% of FMV.
Jointly Held Assets
- When taxpayers submit separate offers but have jointly owned assets, assets are allocated equally between the owners. Equity will be based on each owners contribution to the value of the asset. In most cases assets are split up on a 50/50 basis.
- When investigating the reasonable collection potential for an Offer In Compromise that includes business assets, an analysis is necessary to determine if certain assets are essential for the production of income. When it has been identified that an asset or a portion of an asset is necessary for the production of income, it may be appropriate to adjust the income or expense calculation for that taxpayer to account for the loss of income stream if the asset was either liquidated or used as collateral to secure a loan to fund the offer.
- When valuing income-producing assets the process is as follows:
- If there are equity and assets, the IRS will include these full equity in the assets and the value of the income that is being thrown off.
- If there is equity but no income available, the IRS will just consider the equity.
- If the taxpayer has to get a loan to pay off the offer the loan payment will be included in expenses.
- Each case if different in nature and we should be contacted when it comes to these types of areas.
- Review checking account statements over a reasonable period of time (generally three months).
- Determine if there are funds in the account that are not spenton a monthly basis. Generally, this would be the amount reflected on each month’s statement when the account is at its lowest point.
- Overdrafts are treated as a zero balance.
- Average the lowest daily ending balance on each of the three statements and use this amount as the value of the account for cash purposes.
- If the bank statements reflect an amount that is not spent, this amount will be added as an asset, however, it cannot be valued for less than zero.
- Financial securities are considered an asset and their value should be determined and included in the reasonable collection potential when investigating an Offer In Compromise.
- When the taxpayer will liquidate the investment to fund the offer, allow any penalty for early withdrawal and the current year tax consequence.
- To determine the value of publicly traded stock, research a daily paper or inquire with a broker for the current market price. Then, allow for the estimated costs of the sale to arrive at the Quick Sale Value.
- To determine the value of closely held stock that is either not traded publicly or for which there is no established market, consider the following methods of valuing the company and assign a portion of the company’s value to the taxpayer’s stock:
- Secure and verify a financial statement
- Review recent year’s annual report to stockholders.
- Review recent year’s corporate income tax returns.
- Request an appraisal of the business as a going concern by a qualified and impartial appraiser.
- When a taxpayer holds only a negligible or token interest, has made no investment and exercises no control over the corporate affairs, it is permissible to assign no value to the stock.
- Life insurance as an investment is not considered necessary. However, reasonable premiums for term life policies may be allowed as a necessary expense.
- When determining the value in a taxpayer’s insurance policy, the IRS will consider the ability to sell the policy, surrender the cash value, borrow against the policy, or pull out the immediate equity from the value of the policy.
Retirement or Profit Sharing Plans
- Funds held in a retirement or profit sharing plan are considered an asset and must be valued for Offer In Compromise purposes.
- Contributions to voluntary retirement plans are not a necessary expense. Review of the retirement plan document is generally necessary to determine the taxpayer’s benefits and options under the plan.
- When the taxpayer will liquidate the retirement plan to fund the offer, allow any penalty for early withdrawal and the current year tax consequence.
- When determining the value of a taxpayer’s pension and profit sharing plans consider the following
- The equity will be the cash value less any expense for liquidating the account.
- The equity can be considered the available loan value.
- The equity is the current ,market price of the stock.
Furniture, Fixtures, and Personal Effects
- The taxpayer’s declared value of household goods is usually acceptable unless there are articles of extraordinary value, such as antiques, artwork, jewelry, or collector’s items. Exercise discretion in determining whether the assets warrant personal inspection.
- There is a statutory exemption from levy that applies to the taxpayer’s furniture and personal effects. This exemption amount is updated on an annual basis.
- Consideration must be given whether the qualification is head of household, single or married.The levy exemption is different for each
Motor Vehicles, Airplanes, and Boats
- Equity in motor vehicles, airplanes, and boats must be determined and included in the RCP. The general rule for determining NRE, as discussed in IRM 220.127.116.11.1 above, applies when determining equity in these assets. Unusual assets such as airplanes and boats may require an appraisal to determine FMV, unless the items can be located in a trade association guide. The case file should document how the values were determined.
- It is not necessary to personally inspect automobiles used for personal transportation. When it appears reasonable, accept the taxpayers stated value. For these vehicles, consult a trade association guide. In most cases, the vehicle will be discounted for the FMV to 80% to arrive at the QSV.
- When these assets are used for business purposes, they may be considered income producing assets. See IRM 18.104.22.168.3 above for a full discussion on the treatment of income producing assets.
- Equity in real estate is included when calculating the taxpayer’s reasonable collection potential in an acceptable offer amount.
- When determining equity in real estate, the fair market value of the property must be established. FMV is defined as the price at which a willing seller will sell and a willing buyer will pay for the property, given time to obtain the best and highest possible price. The following methods may be used to establish fair market value:
- Recent purchase price or an existing contract to sell
- Recent appraisals in the area
- Real estate tax assessment for the current year
- Market comparable
- Homeowners insurance replacement cost
- Once the FMV of real estate is established, a determination regarding a reduction of value for offer purposes must be made. If the value of real estate is reduced beyond 80% or if FMV is not reduced to QSV, document the basis for the value used.
- For real estate and other related property held as tenancies by the entirety when the tax is owed by only one spouse, the taxpayer’s portion is usually 50% of the property’s.
- Sometimes IRS will use Zillow.com in determining FMV.
Accounts and Notes Receivable
- Accounts and notes receivable are considered assets unless a determination is made to treat them as part of the income stream when they are required for the production of income. When it is determined that liquidation of a receivable would be detrimental to the continued operation of an otherwise profitable business, it may be treated as future income.
- To determine the value of accounts receivable treat them as follows:
- When the accounts receivables have been sold at a discount or pledged as collateral on a loan, apply the provisions of IRC to determine the lien priority of commercial transactions and financing agreements.
- Closely examine accounts of significant value that the taxpayer is not attempting to collect, or that are receivable from officers, stockholders, or relatives.
- To determine the value of a note receivable, consider the following below:
- Whether it is secured and if so by what asset(s).
- What is collectible from the borrower.
- If it could be successfully levied upon.
- Is the receivable actual a true and valid receivable.
Inventory, Machinery, and Equipment
- Inventory, machinery, and equipment may be considered income producing assets.
- To determine the value of business assets, consider the following:
- For assets commonly used in many businesses, such as automobiles and trucks, the value may be easily determined by consulting trade association guides,blue books or black books.
- For specialized machinery and equipment suitable for only certain applications, consult a trade association guide, secure an appraisal from a knowledgeable and impartial dealer, or contact the manufacturer. Ebay and other search engine are used on specialized equipment,
- When this type property is unique or difficult to value and no other resource will meet the need, follow local procedure to request the services of an IRS valuation engineer.
- Consider asking the taxpayer to secure an appraisal from a qualified business appraiser.
- There is a statutory exemption from levy that applies to an individual taxpayer’s tools used in a trade or business. This exemption for tools of the trade generally does not apply to automobiles. The levy exemption amount is updated on an annual basis.
- In some cases IRS can stop by other businesses in the area and find out current sales prices.
Business as a Going Concern
- Evaluation of a business as a going concern, is sometimes necessary when determining a reasonable collection potential of an operating business owned individually or by a corporation, partnership, or LLC. This analysis recognizes that a business may be worth more than the sum of its parts, when sold as a going concern.
- To determine the value of a business as a going concern consider the value of assets, future income, and intangible assets such as:
- Ability or reputation of a professional
- Established customer base
- Prominent location
- Well known trade name, trademark, or telephone number
- Possession of government licenses, copyrights, or patents
- A check of their WEB site could hold keys to these values
- If it is a franchised business check with the home office
Dissipation of Assets
- During an Offer In Compromise investigation it may be discovered that assets have been sold, gifted, transferred, or spent on non-priority items or debts and are no longer available to pay the tax liability. This section discusses treatment of the value of these assets when considering an Offer In Compromise.
- Once it is determined that a specific asset has been dissipated or transferred, the investigation should address whether the value of the asset, or a portion of the value, should be included in an acceptable offer amount.
- Inclusion of the value of dissipated assets must clearly be justified in the case file and documented as appropriate. A determination that assets were dissipated should include an analysis of the following facts:
- When the asset(s) were dissipated in relation to the offer submission.
- When the asset(s) were dissipated in relation to the liability.
- How the asset was transferred.
- If the taxpayer realized any funds from the transfer of assets.
- How any funds realized from the disposition of assets were used.
- The value of the assets and the taxpayer’s interest in those assets.
- When the taxpayer can show that funds have been spent to provide for necessary living expenses, these amounts should notbe included in the reasonable collection potential (RCP) calculation.Situations to consider
- Dissolving an IRA account to pay for necessary living expenses during unemployment;
- Using bank accounts to pay for medical expenses;
- Disposing of an asset and using the funds to purchase another asset that is included in the offer evaluation.
- If the investigation clearly reveals that assets have been dissipated with a disregard of the outstanding tax liability, consider including the value in the RCP calculation.Dissipated Assets that may result in an increase to the RCP calculation:
- Dissolving an IRA account to pay unsecured credit card debt
- Sale of real estate and “gifting” the funds from the sale to family members.
- A recent refinancing of equity in property and using the funds to pay unsecured debt.
- The value of dissipated assets should not automatically be included in the calculation of the RCP. Each particular case must be evaluated on its own merit, and meeting the facts stated in paragraph (3) above.
- If the tax liability did not exist prior to the transfer or the transfer occurred prior to the taxable event giving rise to the tax liability, generally, a taxpayer cannot be said to have dissipated the assets in disregard of the outstanding tax liability.
- Allowable expenses consist of necessary and conditional expenses, Financial Analysis Handbook, and further discussed below. Once allowable expenses are determined, they are used to calculate the amount that can be collected from the taxpayer’s future income.
- When determining a taxpayer’s housing and utility expense, use an amount sufficient to provide for basic living expenses. Use the amount shown in the expense standard schedules as a guideline except to the extent such use would result in the taxpayer not having adequate means to provide for basic living expenses.The National Standards are posted elsewhere on the Fresh Start Tax web site.
- Allowable expenses are different region to region and by the amount of individual in the household. The Fresh Start Tax has an exclusive piece on other parts on our site.
Necessary Living Expenses
- A necessary expense is one that is necessary for the production of income or for the health and welfare of the taxpayer’s family. The IRS Financial Analysis Handbook, discusses the national and local expense standards, which serve as guidelines to provide accuracy and consistency in determining a taxpayer’s basic living expenses. The standards are available on the IRS web site and are periodically updated.
- Taxpayers are allowed the National Standard Expense amount for their family size,and region of there homestead without questioning the amount actually spent. If the total amount claimed is more than the total allowed by the National Standards, the taxpayer must provide documentation to substantiate and justify the expenses that exceed the National Standard amounts. Fully document the reason for the exception or allowance of additional expenses.
- Generally, the total number of persons allowed for national standard expenses should be the same as those allowed as dependents on the taxpayer’s current year income tax return. There may be reasonable exceptions. Fully document the reasons for any exceptions.
- These statistics of put together from various sources including the Dept. of Labor. A comment here, the Statistics are unreasonable. Foster children or children for whom adoption is pending; Custodial parent has released dependency exemption to ex-spouse.
- When determining a taxpayer’s housing and utility expense, use an amount sufficient to provide for basic living expenses. Use the amount shown in the expense standard schedules as a guideline unless such use results in the taxpayer not having adequate means to provide for basic living expenses. If it is determined that a standard amount is inadequate to provide for a specific taxpayers basic living expenses, allow a deviation. Require the taxpayer to provide reasonable substantiation and document the case file. Deviations from the National Standard Expenses must be verified, reasonable, and documented in the case history.A taxpayer with a physical disability or an unusually large family requires a housing cost that is not covered by the local standard. Require the taxpayer to provide copies of mortgage or rent payments, utility bills and maintenance costs to verify the necessary amount.
- A deviation from the local standard should not be considered merely because it is inconvenient for the taxpayer to dispose of high value assets. In some situations, taxpayer’s may be expected to make life-style choices that will facilitate collection of the delinquent tax.
- Absent special circumstances, when determining a taxpayer’s housing and utility expense, use the amount that is claimed or the standard, whichever is less.
- Each situation has its own characteristics about it, skill is required to get the best result.
Treatment of Non-Business Transportation Expenses
- Transportation expenses are considered necessary when they are used by taxpayer’s and their families to provide for their health and welfare and/or the production of income. Employees investigating OIC’s are expected to exercise appropriate judgment in determining whether claimed transportation expenses meet these standards. Expenses that appear excessive should be questioned and, in appropriate situations, disallowed.
- Operating Expenses — Allow the full operating costs portion of the local transportation standard, or the amount actually claimed by the taxpayer, whichever is less.
- Substantiation for this allowance is not required.
- Ownership Expenses— Expenses are allowed for purchase or lease of a vehicle.Taxpayers will be allowed the local standard or the amount actually paid, whichever is less. Generally, auto loan or lease payments will not continue as allowed expenses after the terms of the loan/lease have been satisfied. However, depending on the age or condition of the vehicle, the complete disallowance of the ownership expense may result in a transportation expense allowance that does not adequately meet the necessary expenses of the taxpayer.Therefore, in situations where the taxpayer owns a vehicle that is currently over six years old or has reported mileage of 75,000 miles or more, an additional monthly operating expense of $200 will be allowed per vehicle, for the collection period that remains after the loan/lease has been retired, plusthe operating expense.
Shared Expenses of the Taxpayer
- In most cases a taxpayer will be allowed only the expenses the taxpayer is required to pay. Consideration must be given to situations where the taxpayer shares expenses with another. Shared expenses may exist in one of two situations:
- An offer is submitted by a taxpayer who shares living expenses with another individual who is not liable for the tax.
- Related Offers In Compromise including both joint and separate liabilities. The amount of both offers should equal the total amount collectable from the shared household.Exception to the rule:Community property states. Follow community property laws in these states to determine what assets and income of the non-liable person are subject to the collection of tax.
- The offer investigator should secure sufficient information concerning the non-liable person’s assets and income to determine the taxpayer’s proportionate share of the total household income and expenses. Review the entire household’s information and:
- Determine the total actual household income and expense.
- Determine what percentage of the total household income the taxpayer contribution.
- Determine which expenses are shared and which expenses are the sole responsibility of the taxpayer.
- Apply the taxpayer’s percentage of income to the shared expenses.
- Verify that the taxpayer actually contributes at least this amount to the total household expense.
- Do not allow the taxpayer any amount paid toward the other person’s discretionary expenses.
- When the taxpayer can provide documentation that income is not mingled (as in the case of roommates who share housing) and responsibility for household expenses are divided equally between cohabitants , the total allowable expenses should not exceed the total allowable housing standard for the taxpayer.
- Remember, certain situation has unique qualities about them and only a professional can help you discern the right course of action.In this situation, it would not be necessary to obtain the income information of the other person(s). However, sufficient financial information must be secured to verify the total household expenses and prove that the taxpayer is paying his/her proportionate share. The investigating employees should exercise sound judgment in these situations to determine which approach is most appropriate, based on the facts of each case.
Read this example
In the situation where the taxpayer is renting an apartment or room and the owner of the property is not the taxpayer, the rental agreement or signed statement from the owner of the property should support the decision not to require the owner to divulge any personal information regarding income or household expenses. In this case, the investigating employee should accept the information provided by the taxpayer and make a determination based on that information.
Each Offer In Compromise is unique and very different. Believe me when I tell you, no two are the same. Have Fresh Start Tax either prepare or review each situation to give you the very best chance of getting your Offer In Compromise accepted. Remember, the IRS only accepts 25% of all Offers In Compromise. Call A Professional Today or Your Best Chance.