How the IRS Evaluates Offer in Compromise

In Zumo v. Commissioner, T.C. Summary Opinion 2013-66, the U.S. Tax Court examined a case involving the Internal Revenue Service’s (“IRS”) rejection of an offer in compromise based on doubt as to collectibility.

An offer in compromise is a request by a taxpayer to settle their tax debt for an amount that is less than the full amount owed. The taxpayer must demonstrate that paying the full amount of the tax debt would create an undue hardship or that there is doubt as to their ability to pay the full amount. In Zumo, the Tax Court concluded that the IRS was correct in rejecting the taxpayer’s offer in compromise.

The case of Zumo v. Commissioner provides a useful overview of the IRS collection process and how the IRS evaluates offers in compromise. The IRS has a number of tools at its disposal for collecting tax debt, including levy and seizure of assets, wage garnishment, and filing a notice of federal tax lien. However, the IRS may also consider an offer in compromise as a way to resolve the tax debt if the taxpayer can demonstrate that paying the full amount would be a hardship or if there is doubt as to their ability to pay. The IRS uses a thorough evaluation process to determine whether an offer in compromise should be accepted or rejected. This process is outlined in the case of Zumo v. Commissioner.

Facts & Procedural History

The taxpayer and his spouse filed joint tax returns in 2007-2010, but did not pay the tax owed. The government made assessments based on the amounts reported on the returns and added additional penalties. The tax debt totaled nearly $67,000 and the penalties totaled nearly $11,000.

The taxpayer is a neurologist with a declining income, owns several properties (including a rental property and a liquor store), and received royalties from a book he wrote.

The government sent the taxpayers a notice that it intended to file a notice of federal tax lien to collect the unpaid liabilities. The taxpayers requested a hearing and submitted an offer in compromise, stating that they were experiencing financial hardship and offering to pay $10,000 to settle their tax obligations. The case was assigned to an IRS appeals officer as part of the collection due process hearing request the taxpayers submitted. This case is about how IRS Appeals handled the case.

The Taxpayers Numbers & IRS Appeals Review

The taxpayers submitted a Form 433-A, Collection Statement for Wage Earners and Self-Employed Individuals, which reflected $9,000 of monthly income $8,850 of monthly living expenses, leaving $150 of disposable monthly income.

IRS Appeals accepted the $9,000 in monthly income, but determined that Dr. Zumo’s allowable monthly expenses were $6,276, leaving a disposable monthly income of $2,724. Appeals reached this conclusion by:

• Increasing Dr. Zumo’s housing expense by $550, as Dr. Zumo had reported $900 and the national standard expense for a four-person family was $1,450 per month.
• Reducing Dr. Zumo’s expenses for two automobiles, public transportation, out-of-pocket healthcare expenses, and total healthcare expenses.
• Disallowing Dr. Zuma’s $500 reported child care expenses given that Dr. Zuma’s wife was a stay-at-home parent.

Appeals also determined that Dr. Zumo had overstated the fair market values of his assets. Appeals ultimately determined that the aggregate fair market value of the assets was $1,000,881 and the assets had an “appeals equity value” of $36,500. Appeals equity value is an asset’s fair market value reduced by 20% of its fair market value and then reduced again by all encumbrances.

In the end, IRS Appeals rejected the taxpayers’ offer-in-compromise, determining that the tax collection potential was more than the $10,000 the taxpayers proposed and that they could satisfy their income tax obligations by paying monthly installments.

IRS Appeals Counter Offer

The IRS Appeals offered the taxpayers the option of paying either installment payments of $700 per month over a period of 72 months or installments of $550 per month over the remaining collection period. These amounts are significantly less than the $77,000 tax and penalties that were owed (and this does not even factor in any interest that would be due).

The taxpayers tentatively agreed to the $700 a-month terms, but eventually declined the offer after the IRS refused to remove the federal tax lien so they could refinance their rental properties. The taxpayers then petitioned the U.S. Tax Court, which sustained the IRS’s position.

How the IRS Analyzes Offers

This case shows how the IRS evaluates settlements submitted as offers.

The IRS uses the information provided on Form 433, Collection Information Statement, to evaluate a taxpayer’s ability to pay their tax debt. The form collects information about the taxpayer’s income, expenses, assets, and liabilities.

Once the IRS has this information, they will verify the accuracy of the information provided and apply national and local standards to determine the taxpayer’s reasonable collection potential (RCP). The RCP is an estimate of the maximum amount that the taxpayer can pay towards their tax debt within a reasonable period of time.

The national standards, which are published by the IRS, provide guidelines for allowable expenses such as housing, food, clothing, and transportation. The local standards, which vary by geographic location, provide additional guidelines for expenses such as utilities and out-of-pocket health care costs.

The IRS will compare the taxpayer’s income and allowable expenses to the national and local standards to determine their disposable income, which is the amount of money the taxpayer has available to pay their tax debt. The IRS will then consider the taxpayer’s assets, such as bank accounts, investments, and property, to determine their ability to pay the tax debt.

Based on this analysis, the IRS will determine the taxpayer’s RCP and may propose a payment plan or other resolution to the taxpayer’s tax debt. As in this case, this often involves an installment agreement if the offer in compromise is not accepted.

The Takeaway

Those who owe the IRS may be able to work out a settlement or payment plan with the IRS. As this case shows, the IRS will focus on the taxpayer’s monthly disposable income and assets. It will apply the local and national standards and make a proposal based on the numbers. If the IRS gets this wrong, taxpayers may have the right to review by the IRS Office of Appeals and, in some cases, review by the U.S. Tax Court.