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.

Memphian Appeals An Offer In Compromise

I am looking at a case dealing with an offer in compromise.

You know these from the late-night television and radio advertisements to “settle your IRS debts for pennies on the dollar.”

Yeah, right.

If it were so easy, I would use it myself.

Don’t get me wrong, there are fact patterns where you probably could settle for pennies on the dollar. Unfortunately, these fact patterns tend to involve permanent injury, loss of earning power, a debilitating illness or something similar.

I will just pay my dollar on the dollar, thank you.

What caught my attention is that the case involves a Memphian and was tried in Memphis, Tennessee. I have an interest in Memphis these days.

Let’s set it up.

Taxpayer filed tax returns for 2012 through 2014 but did not pay the full amount of tax due, which was about $40 grand. A big chunk of tax was for 2014, when he withdrew almost $90,000 from his retirement account.

Why did he do this?

He was sending his kids to a private high school.

I get it. I cannot tell you how many times I have heard from Memphians that one simply cannot send their kids to a public school, unless one lives in the suburbs.

In December, 2016 he received a letter from the IRS that they were going to lien.

He put the brakes on that by requesting a Collection Due Process (CDP) hearing.

Well done.

In January he sent an installment agreement to the IRS requesting payments of $300 per month until both sides could arrive at a settlement.

The following month (February) he submitted an Offer in Compromise (OIC) for $1,500.

That went to a hearing in April. The IRS transferred the OIC request to the appropriate unit.

In late August the IRS denied the OIC.

Let’s talk about an OIC for a moment. I am thinking about a full post (or two) about OICs in the future, but let’s hit a couple of high spots right now.

The IRS takes a look at a couple of things when reviewing an OIC:

(1)  Your net worth, defined as the value of assets less any liabilities thereon.

There are certain arcane rules. For example, the IRS will probably allow you to use 80% of an asset’s otherwise fair market value. The reason is that it is considered a forced sale, meaning that you might accept a lower price than otherwise.

(2) Your earning power

This is where those late-night IRS settlement mills dwell. Have no earning power and near-zero net worth and you get pennies on the dollar.

There are twists here. For example, the IRS is probably not going to spot you a monthly Lexus payment. That is not how it works. The IRS provides tables for certain categories of living expenses, and that is the number you use when calculating how much you have “left over” to pay the IRS.

Let’s elaborate what the above means. If the IRS spots you a lower amount than you are actually spending, then the IRS sees an ability to pay that you do not have in real life.

You can ask for more than the table amount, but you have to document and advocate your cause. It is far from automatic, and, in fact, I would say that the IRS is more inclined to turn you down than to approve any increase from the table amount. I had a client several years ago who was denied veterinary bills and prescriptions for his dog, for example.

The IRS workup showed that the taxpayer had monthly income of approximately $12,700 and allowable monthly expenses of approximately $11,000. That left approximately $1,700 monthly, and the IRS wanted to get paid.

But there was one expense that made up the largest share of the IRS difference. Can you guess what it was?

It was the private school.

The IRS will not spot you private school tuition, unless there is something about your child’s needs that requires that private school. A special school for the deaf, for example, would likely qualify.

That is not what we have here.

The IRS saw an ability to pay that the taxpayer did not have in real life.

Taxpayer proposed a one-time OIC of $5,000.

The IRS said No.

They went back and forth and agreed to $200 per month, eventually increasing to $700 per month.

COMMENT: This is not uncommon for OICs. The IRS will often give you a year to rework your finances, with the expectation that you will then be able to pay more.

The taxpayer then requested abatement of interest and penalties, which was denied. Generally, those requests require the taxpayer to have a clean filing history, and that was not the case here.

The mess ended up in Tax Court.

Being a court, there are rules. The rule at play here is that the Court was limited to reviewing whether the IRS exercised abuse of discretion.

Folks, that is a nearly impossible standard to meet.

Let me give you one fact: he had net assets worth approximately $43 thousand.

His tax was approximately $40 thousand.

Let’s set aside the 80% thing. It would not take a lot of earning power for the IRS to expect him to be able to repay the full $40 grand.

He lost. There really was no surprise, as least to me.

I do have a question, though.

His monthly income was closer to $13 grand than to $12 grand.

It fair to say that is well above the average American monthly household income.

Private school is expensive, granted.

But where was the money going?

Our case this time was Love v Commissioner, T.C. Memo 2019-92.

IRS Relaxes Debt Repayment Program

Yesterday the IRS announced that it was relaxing its rules under the offer in compromise (OIC) program. This is part of the IRS’ “Fresh Start” program, and is in response to the ongoing unemployment and financial crisis.

For example:

(1) The IRS will look at one year’s future income for offers paid in five or fewer months. This is down from four years.

(2) The IRS will look at two years of future income for offers paid in six to 24 months. This is down from five years.

Fewer months means a reduced collection potential. You can negotiate a smaller payment now. These offers must be paid within 24 months, however. This may exclude some taxpayers, but it will open the door to many others.

Many practitioners, including me, have been frustrated by the IRS’ unwillingness to acknowledge certain expenses and payments when evaluating installment agreements and OICs. The classic is credit card payments. We are presently negotiating child care payments with a revenue officer, as another example. The IRS has now expanded the National Standard miscellaneous allowance to allow for bank fees and credit card payments.

The IRS is also relaxing how it handles student loan payments when evaluating offers. It intends to do the same with state income tax obligations.

There is good stuff here.