After you have gone through the process of getting into tax compliance and analyzing your financials to determine that you qualify for an Offer in Compromise (“OIC”), it’s time to determine what you should offer as a settlement to the IRS. In this blog, we will discuss how to calculate a proper settlement amount, the importance of submitting a proper settlement amount, and whether or not paying the settlement in payments is possible.
Calculating A Proper Settlement Amount
Before you are able to determine how much should be offered when submitting your OIC, you will need to take an in-depth look at your financials. This is to determine how much equity you have in your assets, as well as how much disposable income you have at the end of each month. For assistance in doing this you can see our blog Financial Qualifications You Need To Know For An Offer In Compromise.
To actually calculate your offer amount there are two different calculations you could use. The first calculation is used if you plan on paying your offer amount in a lump sum payment or at least within 5 monthly payments. The second calculation is used if you are planning on paying your offer amount in 6-24 monthly payments. The IRS does not accept offers in compromise with periodic payments that extend beyond 24 months.
Note: Whatever offer amount you decide to submit, the IRS will require 20% of that amount be paid with the submission of the OIC along with the the application fee, unless you qualify as a low income taxpayer.
So, let’s look at a few scenarios where the financial analysis has been completed and the offer amount needs to be determined.
Taxpayer is single with no dependents. Tax debt is a total of $60,000. Financial analysis shows equity in assets of $5,000 and no disposable income (monthly allowable expenses exceed monthly gross income).
In this example, the offer amount is fairly simple. Because there is $5,000 worth of net equity in assets, that is the minimum offer amount. No additional amount needs to be added to the $5,000 offer because there is no disposable income. So, the offer amount would be $5,000.
Taxpayer is single with no dependents. Tax debt is a total of $60,000. The statute of limitations the IRS has to collect the tax debt is the full 10 years. Financial analysis shows no equity in assets and disposable income of $300 each month.
In this example, the taxpayer no longer can use the equity in assets as a basic starting point for the offer amount. What they will need to do is calculate what a monthly payment to the IRS would look like first. Because the IRS has 10 years or 120 months to collect the $60,000, the taxpayer will need to divide the $60,000 by 120 month ($60,000/120) = $500. This shows that in order to pay the tax debt back within the time frame the IRS has to collect the taxpayer would need to pay $500 a month. This is not be possible due to the fact that they only have $300 at the end of each month in disposable income. So, to calculate the amount that will be offered the taxpayer will need to decide whether they are going to pay the settlement offer in a lump sum payment (in 5 months or less) or through periodic payments (between 6-24 months).
For lump sum payments or payment plans of 5 months or less, multiply the disposable income amount of $300 by 12 months ($300 x 12) = $3,600. This will be the offer amount because the taxpayer here does not have net equity in assets.
For payments being made in 6-24 months, multiply the disposable income amount of $300 by 24 months ($300 x 24) = $7,200. Again, this will be the offer amount given their is no equity in assets.
Taxpayer is single with no dependents. Tax debt is a total of $60,000. The statute of limitations the IRS has to collect the tax debt is the full 10 years. Financial analysis shows net equity in assets of $5,000 and disposable income of $300 each month.
In this example, the taxpayer has both equity in assets as well as disposable income. We know from example 1 that the $5,000 in equity is a baseline for what the offer amount would need to be and from example 2 we know that the amount required to pay the tax debt off before the statute of limitations expires is more than the $300 of disposable income.
If the taxpayer decides a lump sum payment or 5 or fewer payments is best, they will use the 12 month calculation. We know from example 2 that the calculation for this is $3,600. So, the $3,600 will need to be combined with the $5,000 worth of net equity in assets for a minimum offer amount of $8,600.
If the taxpayer decides that the 6-24 month payment option is better, they will use the 24 month calculation. We know from example 2 that the calculation for this is $7,200. So, the $7,200 will need to be combined with the $5,000 of net equity in assets for an offer amount of $12,200.
Why The Collection Statute Of Limitations Matters
Knowing how much longer the IRS actually has to collect the tax debt from you may not necessarily change how much you should offer as a settlement but, it will make the IRS more amicable when reviewing whether to accept an OIC or not. The collection statute of limitations the IRS has for collecting a tax debt is 10 years from the date the liability is assessed. This means that if you haven’t filed a return but, you know that you do owe, the statute of limitations won’t begin until that return is filed and the balanced is assessed.
Tax return for the year 2010 was due to be filed by April 15th of 2011 and there was going to be a balance due. However, the return was not actually filed until Jan. 1st of 2014. This means the IRS would have ten years from the Jan 1, 2014 date to collect the balance, not ten years from the original due date of April 15th, 2011.
It is also important to note that if a return remains unfiled, the IRS is able to go back at any point and make an assessment or adjustment to any substitute return they may have filed for you.
The collection statute of limitations can also be extended by what are called tolling events. These events pause the timer on the collection statute of limitations. Once the tolling event is completed the timer will begin again.
Common tolling events are:
- Filing for a Collection Due Process Hearing (CDP)
- Filing for an Offer In Compromise
- Pending Installment Agreements
So, let’s take a look at why you need to know how much longer the IRS has to collect the tax debt. The biggest reason would be so you can see exactly what number the IRS will be looking at to compare to your financials.
The tax amount owed is $50,000 but, the IRS only has 5 years (60 months) left to collect. This means the IRS will argue that if your disposable income is $833 or more ($50,000/60=$833) at the end of each month, you have the ability to pay the tax debt in full.
Barring any assets with equity in them, this scenario shows that someone who may still have a few hundred dollars in disposable income each month could still be able to settle the tax debt. This is due to the fact that the IRS knows they only have so much time to collect and as that time approaches it is less and less likely that they collect the entire amount. So, they are willing to accept an offer to at least be able to collect something and then allocate the time and effort it would have taken to try and collect that money towards something else.
Why It’s Important To Submit An Acceptable Settlement Amount
When referring to a settlement amount being acceptable, you don’t just want to consider what the IRS is willing to accept but also what you are able to pay. For instance, if your financial analysis shows that the IRS would most likely be looking for a settlement of $25,000 but, it is all based on equity in an asset that you cannot actually access, this may not be a good option simply because you have no actual way to pay the settlement amount. Now, perhaps borrowing the settlement amount from family or friends is a possibility but, if it isn’t, you don’t want to be stuck defaulting on the settlement payments because then the entire OIC process will be for nothing.
Submitting an offer to the IRS for a lesser amount than what your financials show you can pay is also not something that is recommended. First, the IRS is going to review your financials themselves because when you submit your OIC you must include actual up-to-date documentation of your expenses. So, when they review your financials and determine your reasonable collection potential is more than what you offered, they will counter your offer with the amount they determine. However, if you submitted an OIC and you do not qualify for the OIC in the first place, you will simply have extended the collection statute of limitations. If the IRS determines that this was done intentionally to delay collection action, you could face civil or criminal penalties.
Determining the proper amount to offer with your OIC really comes down to making sure you do a proper financial analysis, figuring out the time frame you would like to pay the settlement amount in, and determining whether the settlement amount you can offer realistically fits within your financial situation. By evaluating these factors you can make an educated decision on whether an OIC is the best possible way for you to take care of your tax debt. Discussing your options with a tax attorney is always advisable because each case does differ. Having someone who is knowledgeable in tax laws and procedures can be a huge advantage in making sure the process is done properly and timely.