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BACK TAXES AND TAX DEBT

How Does the IRS Calculate My Reasonable Collection Potential for an Offer in Compromise?

Jim Buttonow, CPA, CITP SVP Post-Filing Tax Services Published On July 09, 2021

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A taxpayer may qualify for an offer in compromise (OIC) if the taxpayer cannot pay their tax bill with equity in assets and monthly installment payments before the collection statute of limitations expires. In an OIC, they can potentially settle their tax bill by offering the IRS their “reasonable collection potential” or “RCP.” 

RCP is a computation that uses IRS OIC rules to determine how much to offer the IRS to settle a tax liability. RCP is equal to the net realizable equity in assets (1), plus a future multiple of monthly disposable income (2).  

Net realizable equity in assets

The first component of RCP is the net realizable equity in the taxpayer’s assets. RCP values assets at their “quick sale value” (QSV) less associated liabilities against the asset to determine net realizable equity in assets. The QSV is generally 80% of the asset’s value. For example, a home with an appraised value of $200,000 will be deemed to have a QSV of $160,000 (80% of $200,000). If the home has a $150,000 mortgage, the net realizable equity in the home is $10,000 (QSV of $160,000 less the mortgage of $150,000).  

Cash and cash equivalents do not have a QSV and are generally valued at their gross amounts. When determining net realizable equity in assets, the IRS allows some special exclusions in determining RCP. For example, the IRS allows the taxpayer to reduce cash by $1,000 and a month’s worth of allowable expenses. Also, the IRS allows $3,450 to be excluded from the value of a vehicle for up to 2 vehicles (joint household).

To determine total net realizable equity in assets, the IRS will add up the net realizable equity for all of the assets with positive equity. Negative equities are not allowed to reduce the total equity. 

Multiple of monthly disposable income

The second component is a multiple of the taxpayer’s monthly disposable income. Monthly disposable income (MDI) is a calculated amount that is reflective of the taxpayer’s average remaining income after payment of necessary expenses.

OIC rules allow taxpayers to reduce MDI by allowing additional expenses. For example, for an OIC, older or high-mileage vehicles are allowed an additional $200 of operating expenses in computing RCP.

Taxpayers have two payment options for an OIC. The first is a lump-sum payment option where the taxpayer can pay an accepted OIC amount within 5 months of acceptance. The second is a periodic payment option where the taxpayer makes 24 monthly payments on the offer amount throughout the offer investigation period. 

For the lump-sum method, the taxpayer will offer the IRS 12 months of MDI in the offer amount. For the periodic payment method, the taxpayer will offer 24 months of MDI. For taxpayers who have significant MDI, the lump-sum method can significantly reduce the offer amount.

Example:

A taxpayer owed $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 purposes of computing RCP. The RCP for each OIC payment option is as follows:

  • Lump-sum payment method: (1) $10,000 (net realizable equity in assets, plus (2) 12 months of MDI of $300, or $3,600. The total RCP or offer amount is $13,600.
  • Periodic payment method: (1) $10,000 (net realizable equity in assets, plus (2) 24 months of MDI of $300, or $7,200. The total RCP or offer amount is $17,200.

Keep researching or ask us for help

For assistance creating a strategy to address your tax issue, visit Jackson Hewitt’s Tax Resolution Hub to see the various ways we can help you.

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.

View Jim's LinkedIn Profile Jackson Hewitt Editorial Policy

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