How the IRS Processes an Offer in Compromise

How the IRS Processes an Offer in Compromise

Once you submit your Offer in Compromise for processing, the IRS begins it research into your tax case.  They first review to make sure all your required tax returns are filed.  Then, they review to make sure you are up to date on all payments you are required to make, such as Estimated Tax Payments or Federal Tax Deposits.  Lastly, they review all documentation you have submitted, which includes your financial statements, income and expenses.  As the process does take some time, you may be asked to provide updated statements to include a current month.

What Is an Offer in Compromise?

An Offer in Compromise is an agreement between you and the Federal Government to settle your back taxes for less than you owe.

An Offer in compromise is strictly based on numbers; basically, your income versus your expenses and the equity in your assets.

You may be eligible under one of these options:

1.  Doubt as to Collectability. This means you have insufficient assets and income to pay the full amount owed to the IRS in back taxes.

2. Doubt as to Liability. This means there is an error and you do not believe you owe this tax. The burden of proof is definitely on you so be sure you are absolutely prepared to show you are not liable

3. Effective Tax Administration.  This means you could afford to pay the full amount owed (based on IRS formula) but doing so would cause you an extreme hardship due to special circumstances.  For example, you care for someone who is unable to do so for medical reasons and paying the tax in full would jeopardize their care and endanger their health.

Calculating Reasonable Collection Potential

The IRS uses a formula called Reasonable Collection Potential (RCP) to determine your ability to pay. Using this formula will determine if an Offer is to be accepted or rejected as you are able to pay your balances due through other options, such as an Installment Agreement. 

The IRS also uses National Standards to determine what is an allowable amount for necessary expenses.  This standard depends on how many people reside in your household, how many people contribute to the household income, etc. If you are way over on these standard amounts and you submit an Offer showing, for example, you are only able to pay $1,000, the IRS may increase your Offer amount, or say you are able to pay your balances due in full.

For example, you submit an Offer for $1,000.  The IRS reviews all your financial documents, income and expenses and determines your monthly disposable income is $500 per month.  They would take this amount and multiply it by the number of months remaining on your Collection Statute End Dates.  If you have many months left, your Offer could be increased or rejected as the IRS shows you are able to pay your balances due in full, or you could increase your Offer amount as $1,000 was not reasonable.

How the IRS Reviews an Offer in Compromise

In the IRS’ Internal Revenue Manual Section 5.8.5.4, Financial Analysis, Equity in Assets it states: “Proper asset valuation is essential to determine RCP. In some cases, it may be necessary to review the following documents to determine undisclosed assets or income and assist in valuing the property:

1. Divorce decrees or separation agreements to determine the disposition of assets in the property settlements;
2. Homeowners or renters insurance policies and riders to identify high value personal items such as jewelry, antiques, or artwork;
3. Financial statements recently provided to lending institutions or others to identify assets or income that may not have been revealed on the CIS.

In addition, the IRS’ IRM Section 5.8.5.3, Taxpayer Submitted Documents, states:

1. Collection Information Statements (CIS) and related documentation submitted with an OIC should reflect current information as of the date of the OIC submission.
2. If during the investigation, the financial information becomes older than 12 months and it appears significant changes have occurred, a request for updated information may be appropriate. Prior to contacting the taxpayer, attempt to secure the necessary verification through internal sources. If taxpayer contact is required, contact via telephone is preferred to expedite case processing.

A Closer Look at Assets and Expenses

When you file an Offer in Compromise you are asking the IRS to compromise and take a certain amount, less than what you actually owe. Therefore, you can be sure the IRS is going to take a hard look at all your expenses and assets.  Larger items such as boats, planes, exotic or antique cars may require an appraisal to obtain the true value.

The IRS does allow National Standards for some expenses, such as housing and utilities, vehicle expenses, out of pocket healthcare, as some examples. When you submit an Offer, your documents include any expense you have each month. They will review your last six months of bank statements to ensure you are paying these expenses, and they are not paid by someone else.  They will review the last six months of your utility bills to ensure they are in your name and your address and that your mom or someone else is not paying these on your behalf. Here are some examples of the documents you will need to provide, both assets and expenses:

Assets