Offer In Compromise (OIC)  Examples

Example 1, on page 2 Illustrates how an Offer In Compromise amount can end up much higher than

Example 2 

Tom and Jeri owe the Internal Revenue Service $25,000. They do not own any real estate but instead rent the apartment they live in. Tom is self-employed and has net income of $20,000 per year. Jeri works part time and earns $15,000 per year. 

They both have used cars with a combined value of $6,000 with no loans on them. They do not have any children. Their gross monthly income is $2,917 and their allowable monthly living expenses are $3,000. Tom has tools used in his business with a fair market value of $1,000. 

Their average bank account balances are $200. In this case, there is no future income component as the taxpayer’s allowable expenses exceed their income. The net asset value component of the taxpayer’s offer is $5,000, 80% of the cars value of $6,000 plus the $200 average bank account balance. Tom’s tools fall under the exempt amount of $3,125 as they are used in his business. Tom and Jeri would have to offer at least $5,001 for an Offer In Compromise to be accepted.

Please note in Tom and Jeri’s example that they have a negative monthly cash flow of $83. This is realistic because it is not so large that they are not able to cover expenses by juggling bills. I believe that if you show a negative cash flow that does not look realistic, the Internal Revenue Service will believe you have an income source you are not disclosing. If your monthly cash flow is negative, check your numbers again so you can reasonably explain how you are paying your bills. 

Example 3 

  Fred and Jennifer owe $250,000 in back payroll taxes from Fred’s business. They own their home, which has $30,000 in equity after computing an 80%, quick sale value, 3 vehicles with equity of $15,000 based on a quick sale valuation and average bank account balances of $2,500. Fred also has a self employed IRA of $35,000. Fred and Jennifer have determined that if on an IRS payment plan would have to pay $200 per month. They are going to make a lump sum cash offer which will be paid within 5 months of acceptance so they will use a 48-month factor for the future income component. $200 x 48 = $9,600. Their accountant has advised them that if Fred withdraws his IRA to help fund the offer, the state and federal taxes and penalties will be $10,000. For offer purposes the IRA will be valued at $25,000. Their minimum Offer in Compromise amount would be $30,000 + $15,000 + $2,500 + $25,000 + $9,600 = $82,100 or $82,101.

If they were going to make a short term periodic payment offer over 24 months, the offer amount would be 60 x $200 = $12,000 + $30,000 + $15,000 +$2,500 +$25,000 = $84,500 or $84,501. The monthly payment amount would be $3,520.87. The first payment would have to be submitted with the offer along the $150 processing fee. The initial payment and the monthly payments are submitted with Form 656-PPV. 

Example 4 

Assume the same facts for Fred and Jennifer in case 3 except they are making monthly payments of $325 on one of their vehicles and the loan will be paid off in 24 months. Because of the retired debt concept, their offer in Compromise will increase by the $325 per month payment multiplied by the remaining months of the 48, 60 month or remaining period on the collection statute. With a lump sum offer it would increase the offer by 48-24 = 24 x $325 = $7,800. With a deferred payment offer it would increase by 60-24 = 36 x $325 = $10,700. The recomputed offer amounts would be $82,101 + $7,800 = $89,901 for a lump sum offer and $84,501 + $10,700 = $95,200 for a short-term periodic payment offer. As previously stated, do not do this computation in computing your offer amount for Form 656. When your case is assigned to an Offer Specialist, they will compute it. Just be aware the issue may arise. 

Example 5　 

  When Fred and Jennifer computed the future income component of their offer, one of the monthly expenses that they listed was life insurance of $200 per month. During the OIC investigation the Offer Specialist requested verification of the life insurance expense. Due to lack of cash flow Jennifer had allowed the policy to lapse six months earlier. Jennifer had planned on reinstating the policy in the future and tried to explain this to the Offer Specialist. Since the IRS only allows expenses you are actually paying, the $200 per month expense was not allowed. This had the effect of increasing the offer by $200 x 48 = $9,600 for a lump sum Offer in Compromise and $200 x 60 = $12,000 for a short- term periodic payment offer. Make sure you are actually paying the expenses you list. This issue also comes up often with alimony and child support. Taxpayers sometimes will submit a court order as verification of an obligation, but are not actually paying it. The IRS will often times always ask for verification of payment.

Example 6 

Since Fred is self-employed operating as a sole proprietor, he is required to make quarterly estimated tax payments. Since he has employees he is also required to make federal payroll tax deposits. Due to a lack of cash flow Fred is behind on his payroll tax deposits for the current quarter. He has also not paid any estimated tax payments for the current year. The Offer Specialist gave him a short period of time to bring all tax deposits current. Fred was able to come up with the funds to bring his payroll tax deposits current but was not able get caught up on his quarterly estimated tax payments. 

Since you must be current on all tax payments and filings the Offer Specialist returned Fred and Jennifer’s offer as not processable. The IRS kept their $150 processing fee and the 20% down payment on their offer in Compromise was applied to the total tax balance owing. 

Example 7 

Two years ago Fred withdrew part of his IRA to remodel his house. The amount withdrawn was reported on Form 1099R to the IRS. Although Fred also received a copy, he forgot to give it to his accountant when he had his tax return prepared for that year. He recently received a CP 2000 Notice from the IRS informing him that he did not report the IRA withdrawal income and now he owes $15,000 in tax, interest and penalties for that year. Fred and Jennifer do not have the funds to pay the additional liability. The problem is that the year for which the additional tax is owing, is not included in their Offer In Compromise. Since all tax periods owing have to be included in an OIC there is a chance that the Offer Specialist will return the offer.

It may be possible to talk the Offer Specialist into amending the offer to include the new liability and he or she may do so if they feel it is a one-time occurrence and not something that happens on a regular basis. A similar situation occurs when a person has an OIC under investigation and they file the prior years return with a balance owing and are unable to pay it. If that tax liability and year are not on Form 656, then the offer will probably be returned.　 

Example 8 

Fred and Jennifer had their lump offer approved last year. They recently filed their tax return with a balance owing and are unable to pay it. Since you are required to stay in compliance for 5 years meaning all taxes paid and returns filed on time, their offer will default. Any payments made on the offer will be applied to the original balance owing plus interest and they will be back where they started. If they were audited in that 5-year period resulting in a balance owing that they cannot pay, their offer would also be defaulted. 

The moral of Cases 5, 6 and 7 is stay current on all filings and tax payments. In other wordsdo not owe any additional taxes or forget to file your return on time. I cannot emphasize this enough.

Example 9 

Fred is liable for a Trust Fund Recovery Penalty with a current balance of $200,000. Jennifer is not liable for any tax liabilities. They live in a non community property state. Fred’s net monthly income from his business is $4,000. Jennifer’s gross monthly salary is $3000. Their combined monthly expenses are $6,500. If they were to only use Fred’s income of $4,000 and his prorated share of expenses of $3,714 = $4,000/$7,000 x $6,500, a monthly income amount of $286 s arrived at. If they were to use both incomes of $7.000 and expenses of $6,500 then they would have a monthly future income amount of $500. If the income amounts were reversed and Fred had the lesser monthly income of $3,000, the future income amount would be $215. 

Example 10 

  Fred and Jennifer had their Offer In Compromise approved a few months ago. They were going to fund part of their offer with a loan on their personal residence. Unfortunately, there was a nation wide tightening up of credit due to increasing home foreclosures. They were not able to get the loan. They IRS gave them several more months to secure the OIC payment but they still could not come up with the funds. Their Offer defaulted and the balance owing went back to the original amount. This really happened to a client recently. Make sure you really can come up with the funds for your offer. In this case there is probably no way they could have for seen the sub-prime crises coming.

　Example 11 

　Fred and Jennifer submitted an Offer In compromise for $20,000. To arrive at the Future income amount, they listed all of their personal living expenses which included paying their daughter's college tuition which averaged about $1,000 per month, their home mortgage payment of $3,500 per month and utilities and property tax of $500 per month. The housing and utility standard in Los Angeles county where they live is $2,053 per month for a household of 2 persons. College tuition is not an allowable expense for computing future income for an OIC.

Fred and Jennifer's future income amount is understated by $2,947 = $4,000 housing less the allowable amount of $2,053 + the college tuition of $1,000. If the future income they originally computed was based on $200 per month, it is now $3,147 per month. Using a 48 month factor it comes to $151,056. With a 60 month factor it is $188,820. The amount of tax they owe is $100,000. With these correctly recomputed numbers Fred and Jennifer do not even qualify for an Offer In Compromise and that is without including the net value of any assets. They will receive a rejection letter for their offer. They have lost the $150 OIC fee and the $4,000 deposit they submitted with the offer will be applied to the balance owing. This happens all the time with offers submitted by very inexperienced persons. If you have read this far, you are now much more knowedgeable than them.　

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