To have an Offer in Compromise (“OIC”) accepted by the IRS, there are several things you will need to complete before submitting the OIC. Perhaps the biggest is to determine if your financial situation qualifies. In our blog post, IRS Offer In Compromise Qualifications and Requirements For Acceptance, we discuss what financials the IRS will use to determine your eligibility, which consist of your assets, household income, and household expenses.
In this blog, we will be taking a closer look at these items because these are what the IRS will use to determine your ability to repay the tax debt. It also needs to be mentioned that qualifying for an OIC is not some cookie-cutter process. Each financial situation is unique and what works for one person may not work for another. But, by better understanding what the IRS is looking for you should be able to create a more accurate and objective financial analysis for yourself.
DETERMINING THE VALUE OF YOUR ASSETS
It’s important to note that when calculating your financials that you include your personal assets, household income, and expenses. The above mentioned blog goes over what is considered your household.
Real Property (Buildings and Land)
As for your assets, there are several items the IRS will look at. The first being any real property that you own. Most of the time this will simply be your home. To calculate the equity by IRS standards, you’ll need to figure out what 80% of the fair market value of your home is. The easiest way to find the fair market value will be to look your home up on Zillow, Redfin, Trulia, or a similar site.
You will then need to compare this to how much you still currently owe on your home. The difference will be the equity, which will need to be included in your reasonable collection potential (the minimum amount of your offer).
- If you disagree with the fair market value found on one of the websites listed above, you will need to have the home appraised in order to prove this. Otherwise, the IRS will use the information they gather during their own investigation for their calculations.
Now, what happens if you have equity in your home but are unable to access it due to poor credit or other liens? Unfortunately, a denial letter showing you cannot access the equity in your home is not something the IRS will accept, at least at the moment (in prior years this was accepted).
It is also important not forget about any other properties like a vacation home, rental property, or land your household may have. Any of these items will also need to be taken into consideration.
Your Vehicles (Including Recreational Vehicles)
Any vehicles you have can be considered when determining the value of your assets. The only real exception to this would be if any vehicles are leased. Determining the equity in each vehicle can be done by finding 80% of the fair market value and comparing it to the amount that is still owed on each. Once you have done this, you are then able to reduce the amount of equity by $3,450 for your primary vehicle or $3,450 for both yours and your spouse’s primary vehicle, if you are married. This additional deduction is only allowed for primary vehicles of the taxpayer and their spouse, if any. In some cases, your vehicle(s) may have no equity, which actually helps your chances of qualifying for an OIC.
As for any recreational vehicles such as a motorcycle, RV, boat, trailer, etc. the IRS will also look at the equity these vehicles have. Generally, these vehicles will almost never be excluded from your financials. The only cases where this may occur would be if you could prove the vehicle was your primary mode of transportation or the vehicle is used to produce income necessary to maintain your household. There is also the possibility that the recreational vehicle(s) do not have any equity in them.
Life insurance with cash value can also be used in determining your ability to repay a tax debt. Types of life insurance that have cash value would be whole life, universal life, and variable life insurance. Finding the cash value of a policy can be done by referencing a recent statement from your provider or contacting your provider directly.
Retirement accounts are also a big factor in determining your ability to repay a tax debt. Your 401k, IRA, 403b, and similar accounts are definitely something the IRS will request information on. With a substantial amount in any of these accounts, even if you’re unable to currently borrow against them due to loans or distributions you may have already taken out, the IRS will see this as a possibility for you to repay the tax debt.
Other assets that the IRS will take a look at include stocks, bonds, mutual funds, and of course any bank accounts you have.
HOUSEHOLD MONTHLY INCOME
When calculating how much monthly income your household has, remember to consider each member of the household. Calculating the household monthly income should not be too difficult if you work as an employee where you receive a W-2. For self-employed individuals this could be more challenging. Before we dive into calculating your monthly income as a self-employed individual, here is a list of income sources for you to consider.
- Hourly wages, salaries, overtime, and bonuses
- Self-employment income (net business income)
- K-1 distributions from an S-Corp
- Distributions from a C-Corp
- Rental Income
- Income from the sale of stocks or bonds
- Social Security
- Alimony and Child support
Now, for those who are self-employed with income that is not consistent month to month, you will have to go a few extra steps to determine your monthly income. The best thing you can do is prepare a profit and loss statement that captures your income and expenses related to your self-employment. The profit and loss statement should begin at Jan. 1 of the current year and go through the month you are currently in. This will give you the net business income for your self-employment. Then you will be able to divide this number by however many months the profit and loss was for to get your monthly gross income.
If it is the beginning of the year, this may be more difficult to do, especially if your work is seasonal. In this case, you may have to simply use your profit and loss from the previous year to estimate your monthly income. If your income has been fluctuating from year to year you may also be able to use a three year average. To do this you look at what your net business income for self-employment has been for the past three years and take the average.
However, this process will only work if your income shows it has been declining for all three years or it has gone up and down each year. If your income has been increasing each year, this method will typically not be accepted. The IRS will argue that the income is trending upward and that if the trend continues you should be able to make enough to repay the tax debt.
HOUSEHOLD MONTHLY EXPENSES
Your household monthly expenses consist of several different things, some of which are very straight forward and others that have some caveats. It is important to remember that the IRS does have standards they use for these expenses as well. These can hurt or help you depending upon how large or small of an expense you have. You can view the IRS collection financial standards here. Here are some of the most common expenses that the IRS will be taking a look at.
- Mortgage payment (including insurance, taxes, etc.) and Utilities
- Rent payment
- Car payments
- Gas and Auto Insurance
- Household Goods (food, clothing, housekeeping supplies, etc.)
- Life and Health Insurance
- Student Loan Payments
- Court Ordered Payments (child support, alimony, etc.)
- Child Care Expenses
- Federal and state income taxes
Mortgage and Rent Payments (Including Utilities)
Mortgage and rent payments are expenses that are subject to the IRS collection financial standards. If you are paying more than what the household standard is for your county or parish, you will be restricted to using the standard amount unless you are able to prove the additional expense is necessary. If you’re paying less than the standard, there is a possibility you actually can use the standard, which will help you in qualifying for an OIC.
Perhaps you are living with someone who is a relative or friend and don’t actually have a rental agreement but, you are still paying them each month to stay in their place. This can certainly count as a rent payment for you but, you will need to get something in writing from whoever you are staying with that outlines how much you are paying them each month and the nature of your agreement. Also, the bank statements you will provide to the IRS need to show that this money is in fact being paid otherwise, that written statement will do you no good.
Car payments are another expense that the IRS has a collection financial standard for. The expense itself is fairly straightforward. All you’ll need to do is look at either a recent bank statement to find out how much the car payment is or get a recent statement from whoever you make your car payment to. The big catch here is, unlike the standards for mortgage and rent payment, car payment standards are only used when the payment a taxpayer is making is more than the standard. For instance, the financial standard for a single individual’s car payment is $497 as of 2018. If a taxpayer’s payment is $550, they would only be able to use the standard amount. However, if the taxpayer’s payment is $300, they are only able to use their actual expense rather than taking the standard.
Car payments may also be disallowed if the vehicle payment will be paid in full within 2 years or less. The IRS reasoning behind this is that once the vehicle is paid that money can then be put towards the tax debt.
Vehicle Operating Costs (Gas and Insurance)
The operating costs for your vehicle also have an IRS collection financial standard that include the cost of your monthly gas, insurance, and potential maintenance expenses. The standards the IRS uses are based on which region you are located in and in some cases the city you live in or are close to. These standards are able to be used if your actual expenses for this category fall below the standard but, if your actual expenses are more, you will be restricted to using the standard.
You may also be able to add an additional $200 (up to two vehicles if married) for the operating costs. In order to qualify, a vehicle must be over 8 years old or have 100,000 miles or more. Additional operating costs may also be allowed if you commute long distances for work but, this would have to be substantiated.
Household Goods (Food, Clothing, Housekeeping Supplies, etc.)
The household goods expense is one that does not have many wrinkles to it. The IRS does have a standard for this expense and this is typically what would be used. However, if your household goods expense exceeds the standard amount you would need to provide evidence as to why the excess amount needs to be taken into consideration. Also, make sure when calculating this expense that you are being reasonable with your calculations (buying food at your grocery store is reasonable, including the expense of dining out for every meal may not be reasonable).
Life and Health Insurance
This expense is based solely on what amount you are paying each month. There is no standard that the IRS has. So, depending on what type of policy you have, you may have either a very high or low expense. Don’t forget to include amounts that may be withheld from your income if you are a W-2 employee.
Additional Medical Costs
The IRS does have a standard for out-of-pocket medical expenses that the average taxpayer incurs. This can be allotted to each person in the household. If there are additional medical costs that exceed the standard amount, you would need to provide evidence of this. The additional expenses also need to be ongoing or something that is paid annually. For instance, someone who pays out of pocket for prescriptions not covered by their health insurance.
Paying on a student loan is something many people have to do and the IRS allows this as a necessary living expense. There is no standard, so whatever you pay monthly is what can be taken as an expense. You do have to be making this payment in order to include it. If you have deferred your payments but they are going to be starting in a few months, you may be able to have this expense accepted as long as you can prove the start date of the payments. Also, if you have 2 years or less for repaying your student loans, the IRS won’t consider this expense due to the fact that the amount being paid toward the student loan may eventually be paid towards the tax debt.
Court Ordered Payments (Child Support, Alimony, etc.)
Payments that are court ordered are another allowable expense but, it does have to be court ordered. In the case where a person is divorced and paying their ex-spouse money each month to help out but is not legally obligated to do so means that payment cannot be included in the financial analysis.
Specifically for child support, the IRS will take into consideration the age of the child the support is for. If the child is close to turning 18 and the child support will no longer be paid, that expense will be disallowed. However, if there are arrears that still need to be paid you may be able to then include the arrears payment even if the child or children have turned 18. This does depend upon how much longer the arrears payments still need to be paid.
In the case of child care, you are able to include necessary expenses you incur to care for your child so you are able to work. This could be an expense for a daycare, day-camp, or a nanny. The most important things to remember when including these expenses in your calculation is the expenses must be necessary to allow you to work and earn income. You also need to make sure that the expense is going to a licensed facility or nanny. Paying a family friend or relative to watch your child can be a very tough argument to win if the expense is questioned by the IRS.
Your federal and state income taxes that you pay are also included in your monthly allowable expenses. This is due to the fact that these are necessary for you to pay so you do not owe in future years. Remember, if you are not having taxes withheld from your income, you will need to start having this done and also makeup for the missed payments during the year to stay in compliance.
This blog is not something that is going to give you every answer to creating your financial analysis but, hopefully it will help in making a more accurate and objective assessment. Now that you can calculate how much equity you have in your assets and how much disposable income you have at the end of each month (monthly income – monthly expenses), you can begin to determine whether you have the ability to repay the tax debt. If it shows you have more equity in your assets than the amount of your tax debt, you know that submitting an OIC probably won’t be worth it. The same goes if there is a substantial amount of disposable income. However, there are circumstances where having equity in your assets or having disposable income won’t disqualify you but, your settlement might be a larger amount. There are also the other types of OICs besides the doubt as to collectibility OIC to consider (doubt as to liability and effective tax administration).