What an Offer in Compromise Actually Is
An offer in compromise lets you settle your IRS tax debt for less than the full amount you owe. It is the closest thing to a deal that the IRS offers. But it is not a magic bullet and it is not available to everyone.
The IRS evaluates offers using a formula called reasonable collection potential. They look at your assets, your income, your expenses, and your future earning potential. If the math shows that the IRS cannot collect the full amount from you, they will consider accepting less.
The Three Types of Offers
Most people only know about one type of offer, the doubt as to collectibility offer. This is the most common type and it is based on your inability to pay the full amount. But there are two other types. Doubt as to liability is for when you genuinely do not owe the tax. Effective tax administration is for when you technically can pay but it would create an economic hardship or would be unfair.
How the IRS Calculates Your Offer Amount
The formula is straightforward. The IRS takes your net equity in assets, adds your future income potential over either 5 or 12 months depending on your payment option, and that is your minimum offer amount. Net equity means the quick sale value of your assets minus what you owe on them. Future income is your monthly income minus your allowable expenses, multiplied by the number of months.
The IRS uses national and local collection standards for allowable expenses. These are published tables that set limits on what you can spend on housing, transportation, food, clothing, and other necessities. If your actual expenses exceed these standards, you need to justify the overage.
Why Most Offers Get Rejected
The IRS rejects offers for three main reasons. The offer amount is too low based on the formula. The taxpayer has unfiled returns. Or the taxpayer is not current on estimated tax payments. You must be in full compliance before the IRS will even look at your offer.
This is where a tax attorney earns their fee. I know how to present the financial information in the most favorable light while staying within the rules. I know which expenses the IRS will allow and which they will challenge. I know how to value assets so the net equity calculation works in your favor.