When taxpayers cannot pay their back taxes, IRS allows them to submit an "offer-in-compromise" ("offer") for the amount owed, plus the promise to timely file all tax returns and pay all taxes for the next 5 years. The latest Taxpayer Bill of Rights ("TP III"), which was part of the IRS Restructuring Act of 1998, greatly improved the offer process.
In the Northern California district last year, approximately 6,000 offers were submitted, of which 55% were accepted at 11 cents on the dollar, on average, compromising about $145,000,000 in back taxes.
Liberalized Processing Policy
IRS is now required to process all submitted offers, with two exceptions: (1) When the taxpayer is currently in bankruptcy; or (2) If the taxpayer has not filed all required tax returns. Because all other offers are processable, taxpayers enjoy their appeal rights and other protections under TP III.
IRS is permitted to accept an offer when there is either: (1) doubt as to liability (the taxpayer may not owe any tax) or (2) doubt as to collectibility (the taxpayer does not have resources to pay the amount owed) -- about 99% of all offers. Most noteworthy, IRS must now consider each offer based on ability to pay, rather than relying on an artificial minimum floor (such as $500).
When an offer is based on doubt as to liability, the amount of the outstanding tax is not considered. Thus, in an extreme circumstance, a $100 offer could extinguish a $1 million tax liability.
Doubt as to a taxpayer's collectibility requires financial forms (listing current assets and liabilities as well as income and current expenses) and entails an analysis of a taxpayer's assets and earning capacity. These are two distinct financial considerations. Note: Taxpayers may also be required to provide three to six months of bank statements, cancelled checks, and relevant contracts or leases. IRS calculates the value of a taxpayer's assets and "excess earnings" (the amount remaining after "necessary" living expenses), then combines the two as the minimum acceptable offer.
Assets are valued at their "quick sale" value, usually 80% of their fair market value. Thus, a car worth $5,000 would have a quick sale value of $4,000.
This calculates how much of a taxpayer's income can be paid towards back taxes. The formula: Gross income, less necessary living expenses = excess monthly income. Excess monthly income X 60 months = total excess earnings. Total excess earnings reduced by the current discount rate (assume 6%) = excess earnings.
To illustrate: Suppose a taxpayer had $3,000 of income from all sources and $2,500 of necessary living expenses, leaving $500 in excess monthly income: Step One: $500 x 60 = $30,000; Step Two: 30,000 x 94% = $28,200 = excess earnings.
Under TP III, IRS must also consider equity, fairness and hardship when considering an offer. IRS must cooperate with taxpayers who are trying in good faith to meet their tax obligations, possibly by eliminating penalties and interest during the time a taxpayer's liability is under consideration.
Unfortunately, taxpayers cannot offer an amount IRS can otherwise collect. Instead, an offer is usually made by borrowing funds from a third party (almost always a friend, relative or significant other) and making a lump-sum cash offer from the borrowed funds.
Protect Yourself: If you find yourself in an offer situation, it is better to lease than own. IRS usually cannot levy or sell leased property, so lease your automobiles and furniture. Rent an apartment. Avoid acquiring assets in your name; however, do not transfer assets to another to make yourself appear poor. You could run afoul of the fraudulent transfer prohibitions.
If you are contemplating marriage, consider a pre-nuptial (pre-marital) agreement specifying that your future spouse's wages are his or her separate property.
If you own assets, value them at the lowest supportable price. Remember, used furniture, equipment, and clothing are usually worth about 10-20 cents on the dollar. Use low blue book for your automobile and then reduce its value further for needed repairs, excess mileage or other reasonable damage.
If you own a home, reduce its value by accrued taxes and repair costs. Hire a contractor to provide you with an independent valuation of its condition and estimated repair costs.
After 12/31/99, IRS can no longer levy (seize) a taxpayer's property while an offer is pending and during a 30-day period after an offer is rejected. If the rejected offer is appealed, the prohibition against a levy continues. The taxpayer has the right to appeal any offer rejected to IRS Office of Appeals.
Offers are filed within your IRS district. If you reside in the Northern California District, send your offers to IRS at 1301 Clay St. #1040 - S, Oakland, CA 94612.
You may obtain the necessary forms by calling 1-800-Tax Form, or from the IRS Website http://www.irs.ustreas.gov/prod/forms_pubs/index.html.
Caution: Don't blindly follow the IRS offer forms (they fail to use quick-sale value when valuing your assets).
Offers can be effectively used to greatly reduce one's outstanding tax liabilities, provided the taxpayer's total assets and excess earnings are less than the taxes owed. Having a third-party source for the offer payment, making shrewd and supportable calculations as to your necessary living expenses or creatively using the new "hardship, fairness and equity" premise are keys to a successful offer.
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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**