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The IRS Makes Substantial Changes to the Offer In Compromise Process

Posted by attorney Irina Goldberg

On May 21, 2012, the IRS announced a new expansion of its "Fresh Start" program. As part of this expansion, IRS has made a number of substantial changes to the Offer In Compromise (OIC) program. These changes are more defined than the original "Fresh Start" Streamlined OICwhich promised flexibility for certain offers but did not provide specifics. These new changes revise the financial analysis used to qualify a taxpayer for the program. As a result, more taxpayers will have a chance to participate in the program and those who have submitted an OIC in the past and were rejected should consider refiling. Key points of the changes include:

  • Revisions made to the calculation of a taxpayer's future income
  • An expansion of the allowable living expenses which offset monthly income

In order for the IRS to accept a taxpayer's OIC, the IRS must believe that the amount owed by the taxpayer cannot be paid in either a lump sum or through a payment arrangement. In order to make this determination, the IRS looks at the taxpayer's Reasonable Collection Potential (RCP). This RCP is the minimum that the taxpayer should offer to settle a liability and it is calculated through a two part formula (1) Future Remaining Income and (2) Total Available Assets.

  • Future Remaining Income

In order to determine Future Remaining Income, the IRS reviews the household income and allowable living expenses of the taxpayers. If the taxpayer has income left at the end of the month after all allowable living expenses are accounted for, the IRS will require that this Future Remaining Income be paid as part of the offer. Prior to these changes, the IRS would multiply this income by 48 or 60 months (depending on whether the offer could be paid in less or more than five months respectively). Now the IRS will only look at one year of future income for offers paid in five or fewer months and two years of future income for offers paid in six to 24 months. What this change means is that before, a taxpayer with $500 left over at the end of the month would have to offer at least $24,000 to settle a liability. Now this taxpayer will have to offer at least $6,000. In addition, the IRS has expanded the allowable living expenses to include credit card payments, bank fee charges and minimum student loan payments. Furthermore, the IRS will also allow the repayment of state and local delinquent taxes, based on the percentage basis of tax owed to the state and IRS. What this means is that if a taxpayer owes the state $25,000 and the IRS $100,000, the taxpayer owes the state 20% of the total liability and the IRS 80% of the total liability. If the taxpayer has $500 of disposable income per month, the IRS will allow $100 towards the repayment of state delinquent taxes.

  • Total Available Assets

The IRS requires that the taxpayer include all equity (less a quick sale discount for some assets) in assets owned by the taxpayer as part of the offer. While this second step appears straightforward, the IRS also includes the value of dissipated assets into the calculation of the RCP. A dissipated asset exists "where it can be shown that the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the asset 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 within six months prior to the tax assessment." For example, if a taxpayer has a 2007 tax liability with the IRS and sold his or her business in 2009, the taxpayer will have to provide an extensive and detailed accounting to the agent showing that the proceeds from that sale were used for the production of income (i.e. invested in a new business) or for necessary living expenses. As part of the new changes, the IRS states, that it can generally go back only three years to include dissipated assets, including the year of submission. If the offer is submitted in 2012, assets dissipated prior to 2010 will not be included. Nevertheless, this change is subject to exceptions where it may be appropriate to include the value of the asset dissipated more than three years ago. The IRS provides several examples of these situations which, it notes, are not exclusive. These include:

  • The dissolution of an IRA to pay for a child's wedding
  • The refinance of a house where the funds were used to pay credit card debt incurred during an extravagant vacation
  • The sale of real estate where the funds were gifted to family members

Overall, it appears that the determination of whether dissipated assets should be included in the offer amount should be evaluated on a case by case basis and is up to the discretion of the individual agent assigned to the offer. As a result, these changes would still require the taxpayer who sold his business in 2009 to provide an accounting that shows that the proceeds were used for the production of income or for allowable living expenses. This is evident from the examples provided by the IRS of situations in which the value of an asset should not be included: - The dissolution of an IRA during unemployment or underemployment where a review of available sources verifies that the taxpayer's income was insufficient to meet necessary living expenses - The disposition of an asset and use of the funds to purchase another asset which is included in the offer amount.

Although the changes relating to dissipated assets appear to have little effect on the OIC process, hopefully, these changes will at least make it easier for taxpayers to avoid inclusion of these assets where the income actually was used to pay for necessary living expenses or the production of income. Regardless, the changes made to the calculation of Future Remaining Income should make a substantial difference in the amounts and types of offers that will be accepted.

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