To understand the changes that the IRS announced and how they benefit Taxpayers with tax debts you need to know the basics of how the IRS Offer in Compromise program works.  In simplest terms the IRS will accept a tax settlement for an amount equal to your total collection potential.  Collection potential is your net equity in assets (Quick Sale Value minus loans against them) plus your monthly disposable income calculated out, in most cases, five years.  Here is an example to demonstrate this:

EQUITY IN HOME:   Taxpayer owns home worth $200,000 and has a mortgage on the property of $150,000.  First we reduce the homes fair market value (FMV) to its quick sale value (QSV). The IRS allows a 20% discount from FMV to reach QSV or in this example $160,000.  We then subtract the loan balance of $150,000 to come up with net equity of $10,000 that must be included in the IRS offer in compromise.  Please note you do not have to sell the home.  They just want to include any equity you may have in your tax settlement.

EQUITY IN VEHICLES:  Taxpayer owns a car outright with no loan against it and a FMV of $5,000.  The IRS will want to include the QSV of the vehicle $4,000 in the tax settlement.

EQUITY IN TOOLS OF THE TRADE:  Taxpayer owns $10,000 of automotive repair equipment that he uses to generate income.  In the past the IRS only allowed the Taxpayer to exempt $4,180 of this equipment from inclusion in the Offer in Compromise amount.  So the Taxpayer would have to include $5,820 in the tax settlement.

DISPOSABLE INCOME:  Taxpayer makes $3,500 net after taxes.  Based on his family size and the state and county he/she lives in the IRS allows $3,400 in expenses.  In this case the Taxpayer would have $100 net disposable income.  In the past the IRS would factor this net disposable income out five years or 60 months to come up with $6,000 that would need to be included in the tax settlement.  What the IRS will allow you in expenses is where it gets extremely tricky and it would be best to have a tax attorney pull these numbers for you.  There are expenses that they allow that they do not “advertise” so to speak.

ACCEPTABLE OFFER IN COMPROMISE AMOUNT:  In this example, under the old rules the IRS would expect a settlement of $25,820 made up of the following:  $10,000 net equity in the home, $4,000 net equity in the vehicle, $5,820 net equity in tools and $6,000 in future income.

THE IRS TO ACCEPT LOWER OFFER IN COMPROMISE TAX SETTLEMENTS NOW

The main changes the IRS made to the Offer in Compromise in 2012 and how they would affect the example above are:

SHORTER FUTURE INCOME CALCULATION:  The IRS now only factors your future income a maximum of two years or 24 months.  In the above example this would save the Taxpayer at least $3,600 on their offer in compromise.

INCREASED EXPENSES ALLOWED IN OFFER IN COMPROMISE:  The IRS has now increased the types of expenses they allow.  These include a portion of state/local back taxes being paid, maintenance on high mileage vehicles (75,000+ miles) and more types of student loan payments.  This can dramatically decrease the Taxpayer’s disposable income which will in turn dramatically decrease the Taxpayer’s final tax settlement amount.  For instance, if in the above example the Taxpayer was paying $100 a month towards a student loan there would be zero monthly disposable income so nothing would be added to the offer in compromise tax settlement for future income.

PERSONAL VEHICLE EXEMPTION INCREASED FOR OFFER IN COMPROMISE:  The IRS has now created a $3,450 equity exemption per personal vehicle.  In the above example this would mean the Taxpayer would only have to claim $550 equity in the vehicle as opposed to $4,000 under the old OIC rules.

MOST INCOME PRODUCING ASSETS EXEMPT UNDER NEW OFFER IN COMPROMISE RULES:  The IRS in most case will now exempt any equity in tools of the trade that are used to produce income.  In the past the IRS essentially wanted to “double dip” by first taking the equity in the income producing asset and then also using the income produced from such asset to increase the Taxpayer’s monthly disposable income.  The IRS now seems to have realized that this is unfair in that if the Taxpayer has to sell the income producing asset to pay the Offer in Compromise tax settlement the Taxpayer will then not have the income from the asset.  There is a complex formula that they apply to decide whether to include the equity in the asset or its future income.  If you have this issue you should talk it over with an experienced Offer in compromise tax attorney.

In addition to the above changes, the IRS has also relaxed its rules on dissipated assets.  In the past they would look back 3 or more years to determine if in the past you had the funds available to pay the taxes but chose to pay another debt or go on vacation or basically do anything with the funds but pay the taxes.  The IRS then would conduct a dissipated asset analysis and include those funds in any accepted Offer in Compromise tax settlement.  It now appears that they will only be looking back six months, absent blatant fraud or transfers definitively made to avoid paying the taxes in question.  You still can’t sign over your life’s savings to your buddy a day before the tax is assessed and not include the value in your OIC tax settlement.

In the past, and I’m sure even in the future, the IRS is just not going rollover and give you a tax debt settlement.  You are going to have to complete many long forms, collect all of your financial data and, in all but the simplest cases, hire an experienced Offer in Compromise tax attorney to negotiate it for you, but now more than ever, if you qualify for the OIC program and with professional legal assistance, you should get your IRS tax debt settlement.

If you have any questions regarding whether you now qualify for an Offer in Compromise tax debt settlement I encourage you to give me a call at 303-376-6267 or send me an e-mail at john@cotaxattorney.com.  If offer a free consultation which includes pre-qualifying you for the IRS Offer in Compromise program.