Many clients who owe back taxes want to eliminate or negotiate a reduction in the amount owed. Such a negotiation is called an Offer In Compromise.
This post will explain an offer in compromise and what you need to know to make sure it doesn’t end up costing you more than it’s worth.
What is An Offer in Compromise
An offer in compromise or OIC is a negotiated agreement to pay the IRS an amount less than that which is actually owed. It can be a legitimate option if you can’t pay your full taxes, or if doing so creates a significant financial hardship.
In theory, an offer in compromise sounds great. Unfortunately, many people end up paying large sums of money to companies who negotiate these offers on their behalf, only to have them fail.
The key to success lies in determining whether you are a good candidate for the offer in compromise program. The IRS considers your income, expenses, and asset equity. A key metric they use in making this determination is an amount known as your “reasonable collection potential” or RCP.
Reasonable Collection Potential
Your RCP is the amount the IRS expects it would be able to collection by attaching your wages and income and seizing assets in order to settle the tax assessment. Your RCP helps the IRS decide whether to accept or reject your Offer In Compromise. They expect your offer equal or exceed your RCP.
How To Calculate Your RCP
You can calculate your RCP by filling out IRS Form 433A.
Reasonable collection potential is calculated by taking:
- 100% of cash, investments & receivables (pus)
- Fair market value of real estate, auto and assets (times) 80% less loans (plus)
- Your monthly disposable income (times) 48 months or 60 months.
The fair market value of assets is multiplied by 80% less loans or mortgages held against the property. For example, if your homes’ value is $150,000 and your mortgage is $100,000 you would calculate it as follows:
- $150,000 * .80 = 120,000 – 100,000 = 20,000.
$20,000 would be the reasonable collection value of your home.
Disposable income is calculated from Form 433A by taking total income less the lower of actual living expenses or IRS collection financial standards. Multiply the result by 48 if you plan to pay the offer within 90 days or multiply by 60 if you plan to pay the offer in greater than 90 days.
Your offer then should be as much or greater than the reasonable collection potential number. The offer is made on IRS Form 656.
Bottom Line
An offer in compromise can be a life saver for individuals who owe the IRS a lot of money. It can work against you unless you know how to calculate a reasonable compromise. We can help you with the calculation and IRS negotiations. Call us (215-342-4200) or fill out the contact us form on our Directions page.