The Five Biggest Mistakes Tax Practitioners Make When Filing an Offer-in-Compromise!
The Internal Revenue Service’s (“IRS”) Offer-in-Compromise program continues to be one of the most popular programs with both practitioners and taxpayers when they are considering a way to resolve their back tax issue. Yet, only 42% of Offers filed by taxpayers are ultimately accepted. Why are less than half of the Offers filed being accepted? Read more about common offer in compromise mistakes.
Mistake #1: Not Checking the Statute of Limitations
There is a ten-year collection statute. What this means is the IRS has ten years from the date it assesses the tax liability to collect that tax. Easy enough. However, taxpayers often do things that may toll or freeze the statute, preventing it from running. These actions include anything that prevents the IRS from taking collection action, including:
- Filing an Offer-in-Compromise
- Filing bankruptcy
- Filing a request for an installment agreement (payment plan)
Practitioners who are considering an Offer-in-Compromise for a client should first obtain power-of-attorney and pull updated transcripts for taxpayers, because it is critical to understand what has occurred and how much time remains on the statute. The reason is that if the ten-year statute is about to run out, then the last thing practitioners should do is file an Offer-in-Compromise. Instead Practitioners should consider filing a Collection Information Statement (Form 433-A) and arguing for a taxpayer to be deemed uncollectable, which does not stop the collection statute from running. Why have the taxpayer incur the expense and stress of fighting for an Offer if we can allow time to take care of the liability? By filing an Offer without considering the statute of limitations, practitioners may be doing extreme harm to their clients, and arguably are committing malpractice.
Mistake #2: Not Dealing With The Taxpayer’s Current Compliance
In order to make a deal with the IRS – any deal – the taxpayer must be in “tax compliance.” “Tax Compliance” means that they have filed all the tax returns required and are making their current tax payments. For businesses, this means they are making their current quarter’s payroll tax deposits. For individual taxpayers, it means they are having either the proper taxes withheld from their pay (wage earners) or have made the current year’s estimated tax payments (if self-employed).
Taxpayers who are not in compliance are not eligible for an Offer-in-Compromise, and any Offer filed will be returned and the filing fee and deposit paid with it kept by the IRS.
Mistake #3: Not Properly Calculating Future Income
So many taxpayers and practitioners list taxpayer’s income and then deduct what the taxpayers are actually spending, the result being the taxpayers show no future income! It’s terrific: the taxpayers have zero future income in their Offer calculation and can offer almost nothing, just like those late night commercials.
Unfortunately, this is not how the Offer process works. The IRS uses a taxpayer’s gross monthly income and then reduces the income for “allowable expenses”, which are frequently less than those actually being paid by the taxpayer. The IRS allowable expense tables are based on the Department of Labor statistics and often represent county or state averages. It is therefore not uncommon for a taxpayer to have negative cash flow when actual expenses are used, but to be positive once the IRS standards are applied. The change can drastically change the results of the Offer calculation and can mean the difference between an Offer that is accepted and another that is ultimately rejected.
Mistake #4: Not Looking at What the Taxpayers are NOT Spending!
As an extension of Mistake #3 above, when a practitioner calculates the taxpayers’ future income based upon IRS allowable expense standards, taxpayers often ends up with a positive cash flow on paper, which can increase the Offer calculation above the point where taxpayers can afford to settle the back tax debt.
By understanding the allowable expense standards the practitioner can help taxpayers. A Practitioner should consider what expenses the IRS allows that the taxpayers are currently not spending already and have them adjust their financial picture accordingly. These “allowable” expenses that taxpayers often do not have include insurance, as many taxpayers in financial trouble drop health their health insurance, life insurance and disability insurance, yet these expenses are not only allowed but are necessary to protect the taxpayer’s health, family and income sources.
It’s important to know that the IRS will only allow those expenses that the taxpayers have a history of paying, meaning for at least three months as reflected by the bank statements or cancelled checks.
Mistake #5: Not Properly Calculating Reasonable Collection Potential
What is “Reasonable Collection Potential,” or “RCP”?
RCP is the amount the IRS calculates it could collect from the taxpayer if it obtained the net equity in the taxpayer’s assets and from twelve months of future income (or 24 months if applying for a differed offer). We discussed the future income calculation in Mistakes #3 and #4. What about the net equity in assets?
The IRS Offer forms contained in the Offer Booklet walk taxpayers through the net equity in assets calculation. The issue arises when taxpayers assume that, because they cannot access the equity in the asset the IRS will not include it in its available equity calculation. This is Mistake #5.
IRC § 7122 authorizes the IRS to agree to a compromise of a taxpayer’s debt, but it does not make the acceptance of a taxpayer’s Offer mandatory. The decision to accept or reject a taxpayer’s Offer rests with the IRS. In fact, the IRS will reject an Offer if the agency feels it is “not in the best interest of the government” to do so.
Practitioners need to remember that, unlike a payment plan or a request to be deemed uncollectable, the Offer-in-Compromise is asking the IRS to write off a debt it is otherwise entitled to, and a debt that most other taxpayers pay every year voluntarily. This is not something the IRS does lightly, and the fact that taxpayers have assets that they cannot access does not change the fact that the taxpayer has assets.