As we all know, it’s never that simple with the IRS. Some rules relating to an OIC are beneficial, and some are very harsh. Here we review a few of the “beneficial” and “not so beneficial” rules the IRS applies when reviewing an Offer in Compromise.
Beneficial Rules of an Offer in Compromise
Cash for Monthly Expenses
The IRS does allow you to keep a certain amount of cash for the next month’s bills. For example, if monthly bills are $2000, and you have $3500 in the bank, the IRS will allow you to value that $3500 at $500 in the Offer. This is because they allow you to keep $1000, plus enough cash to pay the next month’s bills of $2000. The $500 is calculated as follows: $3500 total, less $1000 exemption, less $2000 for one month’s bills. This in an oversimplification, as the IRS may challenge the amount of allowed monthly expenses to reserve, but at least it’s nice to know you can kick out a certain amount of cash from how much you have to give them in an OIC.
A second “beneficial” rule is that you can reduce many assets’ values by 20% for “quick sale value”. The IRS knows that if they took the asset from you and sold it, they would not get full price. Therefore they will allow certain assets to be valued at 20% less than fair market value. As an example, let’s look at a house that is worth $300,000 and has a mortgage of $200,000. It would appear that the house has $100,000 of equity that the IRS could get at in an OIC. However, the IRS would allow a value of $40,000. This is calculated as follows: $300,000 (the value of the house) minus $60,000 (20% of $300,000 for quick sale reduction in value) minus $200,000 (the mortgage of the house), equals $40,000. On the other hand, if the equity of the home minus 20% and loans is less than zero, you might not be required to offer any amount.
Not So Beneficial Rules of an Offer in Compromise
Credit cards and unsecured debt can be very troublesome. The IRS is looking to see how much cash you have available to determine if you can pay them monthly, or how much the cash flow is worth to them in an offer. For example, let’s say that you combine all of your income and it added up to a total of $4,000.00 per month that you had available to pay all of your bills. Further assume that your total expenses are $3,900; which includes your rent/mortgage, utilities, food, credit card debt, etc. What you REALLY have available to pay the IRS is $100.00 per month. But, let’s say your minimum monthly credit card payments are $400.00 per month. This would be a big problem as instead of the REALITY that you only have $100 per month to offer, they would value it at $500 per month. The IRS thinks you have $400 more a month to offer than you really do.
Monthly Leftover Income
A second harsh reality of an OIC relates to your monthly left over income. This problem relates to the IRS’s use of “caps”. Let’s use the same example as above and assume that you have $100 per month left over at the end of month. The IRS has maximums that they will allow for such things as car payments, house payments (rent or mortgage payments), and even food. For example today, the housing cap for a single Denver resident is $1,568. This amount is the total allowed for ALL housing: mortgage/rent, utilities, water, sewer, trash, phone, cable, etc. If your actual payments for all these items totaled $1,868, then you’d be over the cap by $300.00. This would cause a problem just like the disallowed credit card payments. The IRS would think you have extra $400 per month rather than the real amount of $100 per month.
What Does This Mean?
When calculating the value of the cash flow on the Offer form (433OIC, and Form 656) the IRS multiplies the left over income by a multiplier. The multiplier is 12 if you offer to pay within 5 months or less, and a multiplier of 24 if you offer to pay within 24 months (but more than 5). So let’s say you are planning to pay the OIC within 5 months of acceptance. If you used the true number of $100 left over income per month, then the Offered Amount would be $1,200 (plus asset value as described previously). However, if the IRS disallowed the credit card payments of $400 per month, and the amount over the caps for housing of $300 per month, then the IRS would show that you have total left over income of $800 per month. With that in mind, the IRS would use a multiplier of 12 times $800, so the OIC would have to be increased to $9600 (plus assets value). That is a huge increase over the $1,200 amount based on the true left over income of $100 per month!
The offer in compromise is full of loopholes, nooks and crannies. If you are considering an OIC in any way, shape, or form – contact Advanced Tax Solutions today and talk to a tax professional.