The IRS has a structured process for settling tax debts. This is handled through the IRS’s ‘offer in compromise’ program.
The program itself has several different sections or workstreams. The primary workstream is the ‘doubt as to collectiblty’ workstream. This refers to offers that are submitted by taxpayers based on their inability to pay.
Assuming that the IRS carefully examines the offer, which it often does not, it does actually scrutinize the value of the taxpayer’s assets when deciding whether to accept an offer in compromise based on doubt as to collectibility. Even a few dollars can result in a rejected offer. Substantiation is key.
The Wright v. Commissioner, T.C. Memo. 2008-259, case is an example. It involves a $2,000 offer that was rejected for a $3,000 discrepancy that was not well documented.
Facts & Procedural History
The facts in this case are not complicated. Mr. Wright filed income tax returns for 1993, 1994, and 1995. There were late-filed tax returns. He filed income tax returns for 1996, 1999, and 2000, but failed to pay all of the tax reported on the returns.
The IRS issued Mr. Wright a Final Notice of Intent to Levy for 1993, 1994, 1995, 1996, 1999, and 2000. Mr. Wright submitted a Form 12153, Request for a Collection Due Process Hearing, to contest the proposed levy.
The IRS Settlement Officer requested the following information:
- A completed Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, or Form 433-B, Collection Information Statement for Businesses;
- Copies of bank statements for the past three months;
- Copies of wage statements for the last three pay periods;
- Copies of a mortgage statement or rental agreement; and
- Copies of life and health insurance policies, if applicable.
- Mr. Wright submitted Form 433-A on which he indicated that he was a single, self-employed individual operating “Wright Way Const” and that he had $1,405 of monthly income and $1,955 of monthly living expenses.
As for assets, Mr. Wright submitted: copies of statements of accounts held at a credit union showing deposits totaling $800 and $2,326.52 and statements for a checking account showing no activity. Mr. Write also indicated that he owned two automobiles valued at $1,000 and $500, real estate valued at $40,000 subject to a loan balance of $27,000, furniture/personal effects valued at $750, horses valued at $1,250, and tools used in business valued at $1,500 subject to a loan balance of $1,000.
Mr. Wright intended to submit an offer in compromise for $2,000.
About the IRS’s Offer in Compromise Program
The IRS’s offer in compromise (OIC) program provides a way for taxpayers to settle their tax debts for less than the full amount owed. An OIC based on doubt as to collectibility is when the IRS agrees to accept a reduced payment due to the taxpayer’s inability to fully pay.
To be eligible, the taxpayer must provide documentation of their financial situation, including assets, income, and expenses. The IRS analyzes this to determine the taxpayer’s reasonable collection potential – the most the IRS could expect to collect within the statute of limitations. If the offer amount meets or exceeds this, it may be accepted.
The IRS’s Reasonable Collection Potential
A taxpayer’s reasonable collection potential is the calculation the IRS uses to determine the maximum amount that could be collected from them to pay off tax debts. This involves analyzing their assets, future income potential, and allowable expenses.
Assets – The IRS looks at available cash, equity in real estate, vehicles, etc. Assets that could be liquidated or leveraged to pay taxes are totaled.
Future income – IRS examines a taxpayer’s earnings capacity over the statute of limitations to pay off the tax debt. This accounts for age, health, education, skills.
Allowable expenses – Necessary living expenses per IRS guidelines are subtracted, leaving the net reasonable collection potential.
In determining the taxpayer’s reasonable collection potential, the IRS settlement officer made the following four adjustments to the income and expenses reported by the taxpayer on his Form 433-A:.
- She increased net monthly income from business to $3,700. She calculated the net monthly income from the business by totaling the amounts on copies of 10 checks attached to the
- Form 433-A and dividing the total by 2.75.
- She also increased the monthly housing and utilities expenses to $649, the maximum allowed under the national standards.
- She increased the transportation expense to $300 in accordance with the applicable standards. Finally, she decreased the health care expense to $200.
The IRS settlement officer then subtracted the adjusted monthly living expenses from the adjusted monthly gross income and determined that Mr. Wright had excess monthly income of $1,596.
The IRS settlement officer also conducted an online search to determine Mr. Wright’s assets and found several addresses listed for Mr. Wright and several vehicles registered in the State of Mississippi under the name “Lee Henry Wright.” Based on this, the IRS settlement officer sustained the notice of intent to levy.
Mr. Wright’s representative explained that the only real estate Mr. Wright owned was the property reported on the Form 433-A. He provided an affidavit in which Mr. Wright swore that he at no time owned any of the vehicles registered in Mississippi to “Lee Henry Wright.”
The IRS settlement officer concluded that the reasonable collection potential given Mr. Wright’s assets and future income was $82,908 and she suggested an installment agreement of $1,596 a month. Thus, the IRS settlement officer rejected Mr. Wright’s $2,000 offer in compromise and Mr. Wright asked the tax court to review the case again.
Mr. Wright asked the tax court to review this determination.
The Value of the Taxpayer’s Assets
A taxpayer’s assets form a key component in analyzing their reasonable collection potential. The IRS scrutinizes asset values closely, as even small discrepancies can change a taxpayer’s ability to qualify for an OIC.
However, asset valuations can be subjective. For example, the condition of a home may affect its fair market value. Without proper documentation, the IRS may overestimate the equity available to pay taxes. The value of a home is an example.
The court had this to say about the value of the taxpayer’s home in this case:
Although we have some concern that Ms. Alcorte’s analysis of petitioner’s future income was incomplete and her determination of petitioner’s future income potential was flawed, we do not need to reach this issue in deciding whether her determination to sustain the proposed levy was an abuse of discretion. Petitioner submitted an offer-in-compromise of $2,000. The offer-incompromise was $3,000 less than net realizable equity in real estate and $4,250 less than net realizable equity in real estate and horses he owned when he submitted the offer-in-compromise. We conclude that the offer-in-compromise was less than net realizable equity in petitioner’s assets, and this fact alone justified Ms. Alcorte’s rejection of the offer-in-compromise.
The court noted that Mr. Wright did not substantiate the value of his house, as he failed to properly document the necessary repairs. Thus, the court held that Mr. Wright’s offer in compromise was not accepted as it was less than the equity he had in his assets. The court authorized the IRS to continue with its collection actions.
Getting an Appraisal for Assets
It should be noted that this result could probably have been avoided by having an appraisal for the property.
To avoid issues, taxpayers should substantiate their asset valuations, especially for property. An independent appraisal from a qualified professional can accurately assess condition-based value. This prevents subjective differences with the IRS.
With firm valuation evidence, the IRS can’t unreasonably inflate a taxpayer’s net asset equity and reasonable collection potential. Well-supported figures strengthen the case for a favorable OIC amount.
This case demonstrates the importance of meticulous documentation when seeking an IRS offer in compromise based on doubt as to collectibility. Even minor discrepancies in asset values can derail an otherwise strong OIC submission.
Taxpayers should take steps to remove any ambiguity around their net equity position. For real estate in particular, an independent appraisal from a qualified professional provides objective substantiation of current fair market value and necessary repairs. Relying solely on one’s own estimate leaves room for subjectivity.
By shoring up asset valuations with concrete evidence, taxpayers present an accurate picture of their reasonable collection potential. This prevents the IRS from arbitrarily inflating equity estimates and demanding more than truly warranted.