Offer In Compromise And Reasonable Collection Potential

Command Central is working two Collections cases with the same revenue officer.

For the most part, I am staying out of it. There is a young(er) tax guy here, and we are exposing him to the ins-and-outs of IRS procedure. This is a subject not taught in school, and training today is much like it was when I went through: a mentor and mouth-to-ear. Friday morning we spent quite a bit of time trying to determine whether someone’s tax year was still “open,” as it would make a substantial difference in how we approach the situation.

COMMENT: This is the statute of limitations. The IRS has three years to assess your return and then ten years to collect. Hypothetically one could get to thirteen years, but that would require the IRS to run the three-year gamut before assessing and then the ten-year stretch to collect. I do not believe I have ever seen the IRS do that. No, of greater likelihood is that the taxpayer has done things to suspend the statute (called “tolling”), things such as requesting payment plans or submitting offers in compromise. Do this repetitively and you might be surprised at how long ten years can stretch. 

Personally, I suspect one of these two clients is dead in the water.

Why?

Let’s like at some inside baseball for an offer in compromise.

Collections looks at something called reasonable collection potential (RCP). As a rule of thumb, figure that the IRS is looking at a bigger number than you are. RCP has two components:

(1)  Net realizable equity in your assets

The classic example is a paid-off house.

To be fair, the IRS does spot you some room. It will use 80% (rather than 100%) of the house’s market value, for example, and then allow you to reduce that by any mortgage. Yes, the IRS is pushing you to refinance the house and take out the equity. It is not unavoidable, however. The push could be mitigated (if not stopped altogether) in special circumstances.

(2)  Future remaining income

This is a multiple of your monthly disposable income.

Monthly disposable income (MDI) is the net of

·      Monthly income less

·      Allowable living expenses (ALE)

Trust me, what you consider your ALE is almost certain to be significantly higher than what the IRS considers your ALE. There are tables, for example, of selected expense categories such as allowable vehicle ownership and operating costs. The IRS is not going to spot you $1,000/month to drive a luxury SUV when calculating your ALE. You may owe it, but they are not going to allow it. Yep, the math has to give, and when it gives, it is going to fall on you.

MDI is then multiplied by either 12 or 24, depending on which flavor offer in compromise you are requesting.

The vanilla flavor, for example, requires you to submit a 20% deposit with the offer request.

That is a problem if you are broke.

Then you have to pay the remaining 80% payments over five months.

 But – you say – that 80% includes twelve months of income. How am I to generate twelve months of income in five months?

I get it, but I did not write the rules.

Let’s look at a recent case. We will then have a quiz question.

Mr. D owed taxes for 2009 through 2011, 2013 through 2017, and payroll tax trust fund penalties for quarter 2, 2014 and quarters 3 and 4, 2015. These totaled a bit under $410 grand.

Shheeessshhh.

Mrs. D owed taxes for 2011 and 2013 through 2017.

OK. Those were joint income tax liabilities and would already have been included in Mr. D’s $410 grand.

They filed and owed with their 2018 return.

In March 2020 they requested a Collection Due Process Hearing.

They filed and owed with their 2019 return.

In July 2020 they offered $45,966 to settle their personal taxes for 2009 through 2011 and 2013 through 2019. Total personal tax was about $437 grand.

Now began the Collections dance.

Their offer was submitted to the specialized unit that works with offers. The unit wanted more information. The D’s had disclosed, for example, that they had retirement accounts.

The IRS asked: could you send us paperwork on the retirement accounts? 

The D’s send information for her IRA but not for his 401(k).

COMMENT: It almost never works to play this game.

The IRS calculated RCP based on their best available information.

Let’s look at just one facet: the house.

The D’s said the house was worth $376,600 on their original application. It had a mortgage of $310,877.

The IRS said that the house was worth $680,816.

COMMENT: Really? Did they think the IRS had never heard of Zillow or Movoto?

Following is the taxpayers’ comment:

On September 24, 2021, petitioners acknowledged that this value did not reflect the actual fair market value of the personal residence, stating that ‘we always start low as the initial starting point of the negotiation.’”         

COMMENT: Again, it almost never works to play this game.

Here is the math for NRE:

FMV	680,816
	80%
Adjusted	544,653
Mortgage	(310,877)
RCE	233,776

                                          

 

 

The D’s argued that the $680,816 value for the house was ridiculous.

They had it appraised at $560,000.

The IRS said: OK. Even so, here is the NRE:              

FMV	560,000
	80%
Adjusted	448,000
Mortgage	(310,877)
RCE	137,123

The IRS of course determined the D’s could pay significantly more than their proposed offer. I want to stop our discussion here and go to our quiz question:

I have given you enough information to know the IRS would turn down their offer of $45,966. How do you know?

Go back and review how RCP is calculated.

It is the sum of realized assets and some multiple of income.

The offer was less than RCP.

In fact, it was less than the asset component of RCP.

Could it happen? Of course, but it would take exceptional circumstances: think elderly taxpayers, maybe severe if not terminal illness, the residence being the only meaningful asset, etc.

That is not what we have here.

So the D’s tried a gambit:

Petitioners propose that this Court find as fact their allegations that the SO was ‘hostile, irate [and] yelling’ and ‘not qualified to be impartial and honest in this case.’”

That might work. Must prove it though.

Jawboning the SO when gathering information does not seem like such a brilliant idea now.

Here is the Court:

Since the record before us (which we are bound by) is silent as to any of the SO’s alleged acts of impropriety or bias, we find this argument by petitioners to be unsubstantiated.”

Offer denied.

Our case this time was Dietz v Commissioner, T.C. Memo 203-69.