Typically for an offer in compromise based on inability to pay the income tax owed, the IRS requires the taxpayer to pay over the equity of the taxpayer’s assets, including cash bank accounts and investment accounts, in order to settle the tax debt. There are exceptions to this general rule and taxpayers are urged to consult with a tax professional for further advice.
A taxpayer may decide that he would rather spend down his assets in advance of filing an offer in compromise so that the IRS does not get the asset. Unfortunately for the taxpayer, the IRS has the right to look back three years and recapture the value of dissipated assets when valuing an offer in compromise.
However, the IRS does not “recapture” assets in all circumstances. The IRS does not look for dissipated assets in the calculation of the reasonable collection potential of the taxpayer:
except in situations where it can be shown the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary, or other income) for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or during a period of up to six months prior to or after the tax assessment.[1]
This means the IRS will not recapture the value of dissipated assets if the assets were spent on the production of income or the health and welfare of the taxpayer.
The downside of spending assets and having the IRS determine that assets have been dissipated is onerous. The taxpayer will be required to include the value of the dissipated asset into the reasonable collection potential analysis and thus, absent an exception, forced to pay that amount to the IRS under an offer in compromise. Of course, since the taxpayer no longer has the asset to use for payment, the taxpayer must look to other sources for the increased payment.
Practice Point: A taxpayer must carefully analyze whether he or she may spend down assets without the risk of an IRS determination of dissipation of assets. If the assets are spend on an impermissible purpose, the IRS will make the taxpayer pay over the value of the assets.
In part 2 of this article, we will review some common scenarios where dissipation of assets may not be found.
Taxpayers are encouraged to contact Jared Le Fevre to discuss offers in compromise and whether spending of assets may constitute dissipation.
About the Author: Jared M. Le Fevre is a tax attorney and 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 5.8.5.18.