Taxpayers who owe more money in taxes to the IRS than they could ever reasonably afford to pay may find relief through making an offer in compromise, but their allowable expenses may be much less than the taxpayers normally spend. If the taxpayers make offers in compromise that the IRS considers to be too low, their compromise offers may be rejected, and they will lose the 20 percent downpayment that they made when submitting their offers. If they refile a new offer, they will have to pay an additional 20 percent on the total amount that is proposed. It is important that taxpayers understand the collection standards that the IRS use when it determines whether or not it will accept offers in compromise.
Collection Financial Standards
The IRS wants taxpayers to devote all of their disposable income to pay off their tax debts. The agency considers the available disposable income to be whatever is left after the taxpayers pay their allowable living expenses. These are the expenses that are necessary to pay for the taxpayers’ health, production of income expenses and welfare for both the taxpayers as well as their families. The amounts vary depending on where the delinquent taxpayers live for such things as housing costs, transportation costs and utility costs. Other categories that have national standards applied include the following:
- Food, clothing and housekeeping supplies
- Personal care expenses
- Miscellaneous expenses
- Out-of-pocket medical expenses
The standards that the IRS employs are sometimes much lower than what taxpayers actually pay for these categories, so it is important for taxpayers to understand the standards when they are making their offers in compromise.
Spending Limits and Cash Flow
Offers in compromise do not have income limits attached and are available to taxpayers no matter how much they make. The caveat is that the IRS does have spending limits in place for what taxpayers are allowed to spend in each of the categories under the national and local standards. The IRS will determine whether or not to settle a tax debt by looking at the taxpayer’s cash flow and allowable expenses to determine how much the agency could collect over time from the taxpayer. The IRS figures cash flow by looking at how much the taxpayer makes minus the allowable living expenses. That amount is then multiplied by the number of months that the government has left to collect the tax debt from the taxpayer. The IRS is only able to collect tax debts that are less than 10 years old.
If the amount of the cash flow left after the calculations are performed is less than what the taxpayer owes, the offer is likely to be approved. The caveat is that the allowable living expense standards are often much less than what the taxpayers actually spend on their various expenses, meaning that the IRS may determine that they have cash flows that do not exist.
Allowable Living Expense Examples
The issue that many taxpayers run into is the difference between how much things actually cost in their locations versus what is allowed by the IRS. For example, a two-person family who lives in Cook County, Illinois has a maximum allowable housing and utility cost category of expenses of $2,092 per month. This category includes a large number of individual expenses, including rent or mortgage payments, insurance, property taxes, maintenance and repair expenses, garbage collection, heating oil, water, electric, gas, residential phone service, cell phone service, internet service and cable television. Considering that the average rent for two-bedroom apartments in Chicago was $2,047 as of May 2017, it is easy to see how the allowable living expense categories may be difficult to meet.
This means that while offers in compromise might technically be available for people with higher incomes, their money needs to be eaten up by other things than the categories that are included in the collection financial standards that are used by the IRS. Certain expenses are not limited and are counted in full such as child support payments. In certain cases, tax attorneys are able to seek variances from the IRS standards for living expenses. For example, if a taxpayer has extraordinary expenses for the care of a special needs child, a variance may be possible. There are other things that might also prompt a lawyer to seek a variance from the standards, but documentary evidence will be needed to support the reasons for them.
Making an Offer in Compromise
Before making an offer in compromise, taxpayers should first review the living expense standards that are in place for their location and nationally. They should then complete the cash flow analysis just as the IRS does and determine what an appropriate offer might be. By researching and conducting the proper analysis, it is likelier that a taxpayer will be successful with the offer.
Contact Us Today »