This is the first in what I intend to be a series on the different options to resolve your tax liabilities.
The Offer in Compromise program through the IRS is the most desired resolution option for back tax liabilities. However, the IRS Offer in Compromise program is not a “let’s make a deal” program similar to negotiating the price of a new car. The program has hurdles, and any ultimate settlement is generally based on a mathematical equation. I am primarily focusing on a “Doubt as to Collectability” (DATC) offer, but I will touch on the other types of Offer in Compromise through the IRS.
First, the taxpayer must be 100% compliant with all filing and deposit requirements. For W-2 employees, this means that all returns are filed and they are having the correct amount of taxes withheld from their current income. The IRS uses a six-year look back period, so this effectively means that the last 6 years of returns must be filed. It’s a bit more complicated for the self-employed and business owners. A self-employed individual must both have his last 6 years of returns filed and must be current with estimated tax payments for the current tax year. Put simply, estimated tax payments are paid to the IRS in place of w-2 withholdings so that no balance will be owed at the end of the tax year. A business owner will have the filing compliance requirement, possibly the estimated tax payments if they have any income through distributions, and a Federal Tax Deposit requirement if they have employees. If the liability is for payroll taxes, the business may also need to pay the Trust Fund portion of the liability prior to being able to negotiate a settlement on the remainder.
Second, the taxpayer must generally prove that the IRS could not collect the full amount owed, with penalties and interest, within the statute of limitation without creating substantial hardship. (There is an exception to this rule, and it will be discussed at the end.) This test is analyzed by evaluating how much could be collected over time through a monthly payment plan based on gross income minus allowed expense and any assets that could be liquidated to pay the IRS within the statute of limitations. The statute of limitations, known as the Collection Statute Expiration Date, on each liability is 10 years from the date it was assessed. There are actions that can stop that clock running, but generally, if you just caught up your filings or were assessed a balance, the IRS has 120 months to collect.
I mentioned “allowed expenses” for a reason. Not everything a taxpayer spends their income on will necessarily be allowed in determining if they qualify for a settlement. The IRS has standards that represent the maximum they will generally allow in certain expense categories. While in rare cases a taxpayer may be allowed above these standards if there are special circumstances, generally these will represent hard caps when negotiating. The IRS also only allows expenses they consider necessary to the health and welfare of the taxpayer and any dependents, or for the production of income for the taxpayer. The expenses also must be “reasonable,” which is a very subjective evaluation
The IRS will consider all assets in determining reasonable collection potential. This can include bank accounts, retirement accounts, real property, vehicles that are considered “extra,” and anything else of value. Some assets may be able to be disregarded because of access limitations. However, most assets, even if not immediately accessible, will be considered in determining reasonable collection potential. For example, if a taxpayer owns a home and has equity, the IRS will consider whether they could pay in full by taking out a loan or selling. The IRS may consider this even if the taxpayer is denied a loan because of credit or other reasons.
Finally, even if a taxpayer can demonstrate an inability to pay the full liability within the statutes, the IRS can refuse to settle because they determine it is not in “the best interest of the government.” This is a very subjective criterion. My experience has been that this is most common with taxpayers who have a substantial history of non-filing and/or non-payment, and there is insufficient proof that they have changed that pattern.
Assuming the taxpayer proves that the IRS could not reasonably expect to collect the full liability and they should not reject based on the best interest of the government, the next step is negotiating a minimum acceptable settlement. Keeping in mind the allowable expenses, the IRS determines what those in the industry call the taxpayer’s “disposable income” and the “quick sale” value of any non-excluded assets. From here, the IRS uses a basic math equation to determine the minimum they will accept as a settlement.
With a DATC offer, there are two types of settlement a taxpayer can offer: a lump-sum cash offer or a periodic payment offer. A cash offer is one that will be paid within five months of acceptance. The IRS determines the minimum settlement they will accept based on the taxpayer’s disposable income, the value of any assets and the repayment period of the offer. The art of negotiating a DATC settlement with the IRS is in knowing what will be accepted and considered reasonable as an expense, how to value assets, and how to most accurately reflect a taxpayer’s real income.
The other types of offers are the “Doubt as to Liability” (DATL), the “Doubt as to Collectability with Special Circumstances” (DATCSC), or “Effective Tax Administration” (ETA) Offers. These types of offers are more rarely accepted than DATC offers. DATL requires the taxpayer to prove that they reasonably should not have been assessed the tax, but for some reason were unable to contest the actual assessment when it was made. Maybe the taxpayer was audited and unaware until several years later. If they have the documents to prove the disallowed expenses, a DATL offer may be an option. Essentially, a DATL offer is like requesting an audit reconsideration.
DATCSC or ETA offers are made when the taxpayer has sufficient means to pay more than is being offered through “disposable income” or assets, but some other factors warrant the government settling. This are usually based on an exceptional hardship, public policy, or equity considerations. DATCSC offers are considered when a taxpayer has an ability to pay more than is being offered using the previously discussed formula, but a lower offer should be considered based on special circumstances. Basically, they qualify for a DATC offer, but their circumstances warrant accepting an offer that is lower than the IRS would normally accept. ETA offers are considered when the taxpayer could full pay the liability through disposable income or assets, but there are special circumstances or policy considerations that warrant accepting an offer.
One can imagine that with the frequent uses of words like “reasonable,” “doubt,” and “special,” there are lots of gray areas to navigate, and negotiations can get very document intensive and complex.
Disclaimer: The information contained in this blog and on this website are for informational purposes only and should not be interpreted to indicate a certain result will occur in your specific legal situation. The information contained in this post and on this site is not legal advice and does not create an attorney-client relationship. The Supreme Court of Illinois does not recognize certifications of specialties in the practice of law.