To obtain an offer in compromise, the IRS looks at two sources of the taxpayer’s finances to determine if the taxpayer can pay the tax liability within the collection statute expiration date (CSED): the net realizable equity of assets and future income. For a self-employed taxpayer that does not receive regular W-2 income but has business equipment used by the taxpayer to earn a living, special consideration must be made to deal with the value of the business equipment and the effect of those assets for earning future income.
The general rule for offers in compromise is that the equity in assets must be paid toward the offer in compromise. But what if the taxpayer uses the assets in his or her business? Fortunately, the IRS provides an exception for income-producing assets so that the value of the assets may not need to be paid out as part of the offer in compromise. For income-producing assets, adjustments are called for to the income stream or the assets as follows:
- No equity in the assets. No adjustment to the income stream.
- Equity in the assets and no income produced by the asset. No adjustment to income stream. Use the equity of the asset in the offer in compromise.
- Both equity in the assets and income stream. Compare the value of the income stream to the equipment and adjust if appropriate.
- Income producing asset will be liquidated to fund the offer. Adjust income to account for loss of assets.
- Taxpayer borrows against income producing assets to fund the offer. Allow the loan payment as an expense.[1]
Notwithstanding the above, the taxpayer must strongly insist that the IRS not require the equity in the income producing asset if the asset is generating income. As stated in the Internal Revenue Manual, “As a general rule, equity in income producing assets will not be added to the RCP [reasonable collection potential] of a viable, ongoing business; unless it is determined the assets are not critical to business operations.”[2]
Practice Point: For the small business or self-employed taxpayer, it is essential that the taxpayer demonstrate that the assets are critical to the business so that the IRS does not require their liquidation or equity to be contributed to the offer in compromise. The self-employed taxpayer should consider using a tax professional to calculate the offer in compromise to protect the rights of the self-employed or small business taxpayer.
Jared M. Le Fevre is a Partner in the Tax, Trusts and Estates Practice Group of Crowley Fleck PLLP. Mr. Le Fevre represents taxpayers before the IRS, IRS Independent Office of Appeals, Tax Court, Federal District Court and state tax agencies throughout Montana, Wyoming, North Dakota, Idaho, and Utah. Mr. Le Fevre is involved in federal and state and local tax audits, appeals, and tax resolution throughout these western states. Mr. Le Fevre also advises clients on the tax effects of business and real estate transactions.
[1] IRM 5.8.5.15.2 (accessed July 2020).
[2] IRM 5.8.5.15.3 (accessed July 2020).