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How does the IRS calculate my offer amount for an offer in compromise?
You may qualify for an offer in compromise (OIC), if you have no hope of paying your tax bill before the time the IRS has to collect your tax debt expires (called the collection statute of limitations).
In an OIC, the IRS will determine how much you need to pay them to settle your tax bill. That computation is called your reasonable collection potential (RCP).
There are 2 parts to RCP.
Part 1: Net realizable equity in assets (the money the IRS can get if you sell your assets now)
To figure out your net realizable equity in assets, the IRS will value your assets at their “quick-sale value” (generally 80% of the asset’s value), minus any debts against the asset.
- For example, your home has an appraised value of $200,000.
- The quick sale value would be $160,000 (80% of $200,000).
- If your home has a $150,000 mortgage, subtract that amount from the quick sale value ($160,000 - $150,000 = $10,000)
- Your net realizable equity in the home is $10,000.
Cash and cash equivalents do not have a quick-sale value, and the IRS generally values them at face value.
To figure out your total net realizable equity in assets, the IRS will add up the net realizable equity for all your assets with positive equity. Negative equities are not allowed to reduce your total equity.
Part 2: Your monthly disposable income for 12 or 24 months
The second part of RCP is a multiple of your monthly disposable income (MDI). MDI is basically the average amount of money you have left after paying necessary expenses.
OIC rules allow you to reduce your MDI with additional expenses. For example, for an OIC, if you have an older or high-mileage vehicle, you’re allowed $200 more in operating expenses for computing RCP.
You have two payment options for an OIC:
- The first is a lump-sum payment option where you can pay your OIC amount within 5 months after the IRS accepts it. For this method, you would offer the IRS 12 months of MDI in your offer amount. For people who have significant MDI, the lump-sum method can significantly reduce the offer amount.
- The second is a periodic payment option where you make 24 monthly payments on the offer amount while the IRS is considering your OIC. For this method, you would offer 24 months of MDI.
A taxpayer owes $100,000 and has 60 months remaining on the collection statute of limitations. They have net realizable equity in assets of $10,000 and MDI of $300 for computing RCP.
The taxpayer qualifies for an OIC because they cannot pay the IRS with their assets or equity before the collection statute of limitations expires in 60 months. They can pay $10,000 in equity in assets plus 60 months of MDI of $300 ($18,000), or a total of $28,000 in asset equity and payments before the statute expires. The $28,000 is less than the $100,000 the taxpayer owes, so the taxpayer can never pay their tax bill. This means they qualify for an OIC. The second step is figuring out how much the taxpayer will offer to settle with the IRS. This is the RCP computation.
The RCP for each OIC payment option is as follows:
- Lump-sum payment method: Net realizable equity in assets ($10,000) plus 12 months of $300 MDI ($3,600). The total RCP, or offer amount, is $13,600.
- Periodic payment method: Net realizable equity in assets ($10,000) plus 24 months of $300 MDI ($7,200). The total RCP, or offer amount, is $17,200.
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About the Author
Jim Buttonow, CPA, CITP, is the Senior Vice President for Post-Filing Tax Services at Jackson Hewitt. He’s been a leader in helping taxpayers and tax professionals resolve tax problems with the IRS, where he had worked for 19 years in various compliance-enforcement positions. Prior to his current role, Jim’s consulting practice focused on the areas of tax controversy and tax administration, which included leading product development on tax problem software for tax professionals, testifying before Congress, advocating for IRS transparency and efficiency, and proposing innovative large-scale solutions for taxpayers and tax professionals. Jim is also the author of Tax Problems and Solutions Handbook, a publication aimed at helping tax pros work more effectively in post-filing matters and resolving their clients’ most common tax problems.
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