On May 21st, the IRS announced major revisions to the Offer in Compromise program (http://www.irs.gov/newsroom/article/0,,id=257542,00.html). A major impact of such revisions is to enable high-income/low-net-asset individuals a much greater opportunity to resolve their tax debts through the Offer in Compromise (“OIC”) program. Here is why. Offers in compromises are analyzed based upon one’s equity in assets and future net income. Prior to the May 21st announcement, taxpayers had to include as part of their offer an amount equal to 48-60 months of future net income. The May 21st announcement reduces the multiple to 12-24 months, an extraordinary reduction!
In his memorandum to subordinates, Scott Reisher, IRS Director of Collection Policy, provided nine pages of interim guidance to the Internal Revenue Manual. The highlights with respect to the future income component of OIC computations, provide:
· There will be no retirement of the first $400 of auto loan debt. Thus, even if the final payment of the automobile will take place within the horizon of the current analysis, the first $400 will be retained in the budget for evaluating the offer (5.8.5.17).
· Payments of student loans guaranteed by the federal government for post - high school education will now be allowed (5.8.5.20.4).
· The IRS will continue to allow $200 per month for older (over 6 years old) or high-mileage (over 75,000 miles) motor vehicles as an additional operating expense above and beyond the vehicle operating costs standards set forth on the IRS website. Up until the May 21st announcement, this additional $200 would NOT be allowed if the taxpayer had a monthly automobile loan payment. Under the new standard, the additional $200 in operating costs will no longer be tied to the absence of a car payment.[1]
· Clarification that expenses for state and local income tax installment agreements will be treated as allowable expenditures in proportion to the balance due to the state and/or locality as compared to the amount due to the IRS (5.8.5.20.4(7)). Form 433-A(OIC) has been revised to include a line item specifically for delinquent state and local taxes. The new rules are detailed and intricate. Accordingly, if you are dealing with a state tax debt, you should review the new guidance carefully.
· Future income is clearly defined in 5.8.5.23 as:
a. If the offer will be paid within 5 months, then only 12 months of future income will be required; and
b. If the offer will be paid in more than 5 months but within 24 months, then only 24 months of future income will be required.
Compare this to the previous standards of 48 and 60 months, respectively.
· Payments of more than 24 months (previously over the life of the statute) are no longer available! In practice, I had never used this alternative. But, it had always been an option I would have used in certain circumstances (i.e. large amount of assets, but little excess monthly income).
In addition to addressing the future income component of Reasonable Collection Potential (“RCP”)[2], the interim guidance addresses the net fair market value of assets as follows:
· The equity in income producing assets will no longer be added to the RCP of viable ongoing businesses unless such assets are not critical to the business operations (IRM 5.8.5.5.1). In some situations, this is a material change which eliminates what many believed to be a double-counting of assets. Two of the examples provided are particularly instructive:
“Example (5) A real estate salesman has a vehicle with $30,000 in equity. The vehicle is used to transport clients and assists in the production of income. The taxpayer's net monthly disposable income is $3,000. The equity in the vehicle generally will not be included in the RCP.
“Example (6) The same salesman in the previous example only has net monthly disposable income of $500 per month. Consider including the equity in the vehicle, yet allow for the impact the loss of the vehicle may have on the taxpayer's income.”
· There is a substantial write-up on revisions to IRM 5.8.5.16 regarding dissipation of assets. The dissipation rules appear to be narrowed and better defined. Generally the time-frame is limited to three years. Specifically, the new guidance states: “if the offer is submitted in 2012, any asset dissipated prior to 2010 should not be included.” The new rules appear to focus on intentional attempts to avoid the payment of tax. Yet, the rules, along with the examples, make it clear that transfers taking place more than three years prior to the submission of an offer in stating that it “may (emphasis added) be appropriate to include” a dissipated asset in the offer computation if the transfer and/or sale occurred within six months before or after the assessment of the tax liability. The new rules are worth reading as they provide significant guidance and several examples. It is my opinion that the net impact is that dissipated assets will still be an issue in the OIC arena and that the extent of such is still somewhat unknown.
· The first $3,450 per car will, generally, be excluded from net equity computations of vehicles owned by taxpayers. This exclusion is limited to two cars per household.
See http://www.irs.gov/pub/newsroom/interim_guidance_memo_for_offer_in_compromise.pdf for Mr. Reisher’s memorandum.
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New Form 433 – A Changes:
Below is a listing of changes to form 433-A (OIC) (new revision date is 05/12) which I have compiled through a visual comparison of the old and new forms:
1. Line item for “Delinquent State and Local Taxes” in personal budget (53). 2. Addition of field for Fax Number. 3. A box for “Cash” has been added within Cash and Investments sections for both personal (Section 3) and business (Section 4) assets. Previously, there was no process to report cash holdings. 4. A section for Accounts Receivable has been added to Section 4 on business assets. 5. The line for “Additional Household Income” was removed from Section 6. However, a new yes/no question has been added (“Are there additional sources of income used to support the household, e.g. non-liable spouse or roommate, for example.”). 6. The term “minimum payment on credit card” has been added to the food, clothing and miscellaneous section of the Monthly Household Expenses. Note that the Collection Financial Standards were revised on April 2, 2012 in anticipation of the May 21st announcement and include minimum credit card payments and the Internet costs discussed below. 7. The term “Internet” has been added to the housing and utilities section of Monthly Household Expenses. 8. Revision of Section 7 to take into account the lower multiples on future monthly income (12/24 vs. 48/60). 9. In Section 8, other information, the term “County Filed” referring to bankruptcies has been changed to “Location Filed”. 10. The question “Have you been party to a lawsuit?” has been changed to “Are you or have you been party to a lawsuit?”. 11. The checklist has been expanded to include “Verification of State/Local Tax Liability, if applicable”, while deleting the term “Accountant's depreciation schedules, if applicable”. |
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Reduced Offers Examples: One of the most significant changes is the multiple to be used by the IRS in computing the Future Net Income component of Reasonable Collection Potential (“RCP”). The following examples illustrate that policy change with respect to offers paid within five months of acceptance, wherein the multiple is reduced from 48 to 12.
Example #1: - Taxpayer owes $125,000 to the IRS - Taxpayer earns $80,000 per year. - We agree with IRS that the Taxpayer can afford to pay $750 per monthto the IRS. - We agree with the IRS that the Taxpayer has $40,000 in realizable value of his/her assets.
Under the old rules the acceptable offer (RCP) would have been $76,000, computed by multiplying the $750 by 48 ($36,000) and adding the $40,000.
Under the new rules the acceptable offer (RCP) will now be $49,000, computed by multiplying the $750 by 12 ($9,000) and adding the $40,000.
Example #2: - Taxpayer owes $400,000 to the IRS - Taxpayer earns $250,000 per year. - We agree with IRS that the Taxpayer can afford to pay $4,000 per month to the IRS. - We agree with the IRS that the Taxpayer has $5,000 in realizable value of his/her assets.
Under the old rules the acceptable offer (RCP) would have been $197,000, computed by multiplying the $4,000 by 48 ($192,000) and adding the $5,000.
Under the new rules the acceptable offer (RCP) will now be $53,000, computed by multiplying the $4,000 by 12 ($48,000) and adding the $5,000.
The result in this example #2 appears too good to be true. And, although on the face of the matter, the computations work, the IRS is likely to use its general rule that the acceptance of the offer would “not be in the best interests of the government” as a reason for rejecting such an offer.
In addition, if the full payment of the tax can be made within the statute of limitations to collect the tax (usually ten years from the filing of the return), then the offer will be rejected. So, in example #2, if the remaining time on the statute to collect the tax is 100 months or more, the offer will be rejected as the Taxpayer could pay the entire tax over the 100 months ($4,000 times 100 months equals $400,000, which is the tax due).
Each case will be considered based upon its own individual facts and circumstances. |
[1] Note that the $200 of additional automobile operating expenses is only allowed in an offer environment. It is not allowed in determining the amount of an acceptable installment agreement or in determining whether a taxpayer qualifies for CNC (currently not collectible) status.
[2] RCP is the minimum amount acceptable as an offer. RCP is defined by the IRS as the total of taxpayer’s realizable value in real and personal assets, and his/her future net income. Realizable value is, essentially, gross value less secured debt. For example, unsecured credit card debt is usually not considered. In addition, the IRS will discount valuations based upon “Quick Sale Value”. Future net income is based upon a forecast of the excess of gross income over allowable expenses – food, clothing, housing, transportation, medical and taxes – over a minimum of 12/24 months (formerly 48/60 months).
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