One powerful remedy a taxpayer possesses to resolve outstanding tax liability with the IRS, if the taxpayer is unable to pay in full, is an offer in compromise. An offer in compromise offers to settle the tax debt for less than the amount due and owing. The most common offer in compromise submitted to the IRS is based upon the taxpayer’s inability to pay, known as Doubt as to Collectability (DATC). “Doubt as to collectability exists in any case where the taxpayer‘s assets and income are less than the full amount of the liability.”[1]
A DATC offer in compromise is different from a settlement offer that private parties may enter into in order to resolve a dispute. Those settlement offers can be based on the parties’ gut feelings, risks of litigation, financial ability to pay, the stomach for brinksmanship, and pure guesswork. It is not the same with the IRS. The taxpayer cannot hope to succeed with a DATC offer in compromise by pulling a number at random and hope the IRS accepts or by using a silver tongue to talk the IRS into the deal Rather, the taxpayer must carefully follow IRS rules.
The DATC offer in compromise is based on the determination of the taxpayer’s reasonable collection potential. In essence, the reasonable collection potential asks how much the IRS could collect of it levied on the taxpayer and received as much as possible through the levy process, a levy on both wages and property.[2] If the IRS can be paid in full over the collection statute of limitations (CSED), which is typically 10 years from the date of the assessment of the income tax, the IRS will deny the DATC offer in compromise. However, if the IRS will not be paid in full over the CSED, the IRS may compromise the debt by accepting an offer in compromise for less than the full amount of the tax.
The taxpayer’s reasonable collection potential is determined by two financial analyses:
(1) Net Realizable Equity.[3] Net realizable equity in taxpayer’s assets is determined by using the “quick sale value”, which requires taxpayers to pay over 80% of the equity in their assets. The quick sale value of an assets is generally 80% of the fair market value of the assets, less amounts owed to priority security creditors less any exemption amounts.[4] The IRS typically requires that the net realizable equity be paid in on offer in compromise based on doubt as to collectability.
(2) Future Monthly Income. Future monthly income is the taxpayer’s monthly gross income less allowable expenses.[5] Allowable expenses are usually not the taxpayer’s actual expenses. Rather, the IRS has established tables setting forth national and local allowable expenses.[6] For example, under the IRS 2020 guidelines, a single taxpayer living in Yellowstone County, Montana, is permitted for monthly housing and utilities the lesser of $1,492 or the amount actually spent. Only if the taxpayer demonstrates that the “standard amount is inadequate to provide for basic living expenses”[7] will the IRS deviate from the allowable expense. Convincing the IRS to deviate for the expense allowances requires evidence and a convincing argument.
If the IRS can collect the tax in full over the course of the CSED by being paid the net realizable equity and future monthly income, or reasonable collection potential, the IRS will not accept an offer in compromise. However, if the reasonable collection potential is less than that tax owed, the IRS will consider an offer in compromise.
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] 26 CFR § 301.7122-1(2).
[2] IRM Exhibit 5.8.1-1.
[3] IRM 5.8.5.4.1.
[4] IRM 5.8.5.4.1(1), (3).
[5] IRM 5.8.5.20.
[6] IRM 5.8.5.22.1.
[7] IRM 5.8.5.22.2(1)