To determine whether the IRS will accept an offer in compromise and the amount of the offer, in addition to requiring the taxpayer to pay future income, the IRS requires payment of the net realizable equity in the taxpayer’s assets.
Net realizable equity in assets must be calculated per IRS guidelines. The starting point is to determine the value of the taxpayer’s assets. These assets do not include household furnishings and personal items that have no significant value to anyone other than the taxpayer.[1] Assets include, but are not limited to, real estate, including the taxpayer’s personal residence; vehicles; stocks; bonds; retirement accounts; collections; and other items of value. The taxpayer typically needs to provide some indication of how value was determined. For example, for real estate in Montana, value of real property could be the property tax assessed value. Vehicles could be valued by NADA or Kelley Blue Book.
The IRS next determines the “quick sale value” of the property, which is typically 80% of the fair market value. Quick sale value is based on the idea that the value of the property would be less if it needed to be sold in a hurry. A discount would need to be required to sell property quickly. However, a higher or lower percentage may be used when appropriate, based on market conditions.[2]
After the quick sale value, any of taxpayer’s liens with priority over the lien of the IRS are deducted from the quick sale value to determine the net realizable equity in the property.[3] Any exemptions the IRS allows for some types of property are also deducted.
Thus, the equation to determine net realizable equity is:
- Quick sale value of property (usually determined at 80% of fair market value);
- Less priority liens encumbering the property and exemption amounts, if any;
- Equals net realizable equity.
Generally, the net realizable equity of the taxpayer’s property must be paid to the IRS as part of an offer in compromise. I recommend that a taxpayer contact a tax professional to determine whether the taxpayer qualifies for an offer in compromise and how the taxpayer may calculate net realizable equity so that the taxpayer is not paying more under an offer in compromise than is required.
[1] See IRM 5.8.5.11. The IRS typically accepts the taxpayer’s declared value and applies an exemption.
[2] IRM 5.8.5.4.1(3).
[3] IRM 5.8.5.4.1.