If you or your business have gotten behind with the IRS, a tax settlement, also known as an Offer in Compromise (OIC), might be the best way to get rid of your tax liability—if you qualify. There are three general categories of OICs: Doubt as to Liability (I don’t actually owe this tax), Effective Tax Administration (I could pay the tax liability off, but it would cause a hardship), and Doubt as to Collectability (I owe it, but I can’t afford to pay it back). Far and away, the vast majority of OICs are settled on the basis of Doubt as to Collectability. How to get a tax professional to settle a Doubt as to Collectability OIC for “free” is the topic of this article.
Qualification for an OIC Tax Settlement
First, you need to have an idea of whether you might be a good candidate for a Doubt as to Liability Offer in Compromise (which, for the sake of simplicity, I will just refer to as “OIC” for the rest of this article). To do so, ask yourself the following questions:
1. If I were to liquidate my investments and sell everything I own that isn’t a standard household item or necessary for the production of income, would it generate enough money to full pay my tax liabilities including penalties and interest?
2. Are my living expenses significantly higher than that necessary to live a relatively modest lifestyle in my county of residence?
3. After I pay the necessary living expenses for myself and my family each month, is there enough left over to make a monthly payment to the IRS of at least 2% of the total tax liability including penalties and interest?
4. If it is a business liability, is the business generating enough net income to make monthly payments equal to at least 2% of the total tax liability owed including penalties and interest?
5. If it is a business liability, does the business own assets that are not necessary for operations, which could be sold and used to full pay the tax liability?
If you answered “no” or “maybe” to each of the above questions, I would strongly encourage you to consult with a tax professional. You might be a strong candidate for an OIC. Some people and businesses do, indeed, settle their tax liabilities for pennies on the dollar, and you might be one of those people or businesses.
Many tax resolution companies offer a free consultation during which a knowledgeable representative can help determine whether you or your business might be a good candidate for an OIC. My firm, Fortress Financial Services, takes it a step further, and will allow you to consult with a licensed tax attorney before you are under an obligation to pay fees.
Take advantage of a free consultation, whether with Fortress or another firm. Just be careful. There are some less reputable firms out there who will falsely tell you that you qualify for an OIC in an effort to pick your pocket. If someone tells you that you qualify for an OIC but doesn’t ask you about your income, expenses, and assets, hang up the phone! It is impossible to evaluate whether you are a good OIC candidate without first gathering some information about your financial circumstances.
Also check the firm out with the Better Business Bureau. If the firm has been around for at least a few years and has an “A” or better rating with the BBB, you should be relatively safe. If you still have doubts after speaking with one firm, call another and get a second opinion.
So, let’s say you do your homework, find a reputable firm, have your free consultation, and it is determined that you are a strong candidate for a tax settlement (OIC). How do you get the firm to negotiate your settlement for free? Obviously, tax professionals have to charge fees for their services. However, due to the way the IRS determines an acceptable settlement amount, the fee that many qualified OIC candidates pay to their tax professional winds up being money that they won’t have to pay to the IRS. Thus, the taxpayer effectively gets free services from his or her tax professional.
To illustrate this concept, assume the following:
• You owe the IRS $25,000
• You have a mortgage of $160,000 on a $200,000 home, and your housing and utility expenses are within the maximum allowable for your county of residence
• You have $7,500 in savings
• You have no other investments
• Aside from typical household items, you have no equity in any of your other assets
• You live modestly, and have no money left over at the end of each month after you pay living expenses for yourself and your family (in other words, your gross income minus allowable living expenses is zero).
The IRS uses the following mathematical formula to determine an acceptable settlement amount: (Net Realizable Equity in Assets) plus [(gross income minus allowable expenses) times 12]. If that sounds confusing, read on. It will make better sense once you see how it plays out.
The first component of this formula is Net Realizable Equity in Assets (NRE). To determine NRE in a home (as well as many other non-liquid assets), take 80% of the home’s market value ($200,000 times .8 = $160,000) and then subtract the senior encumbrances (here, the $160,000 mortgage). In this example, the NRE in your home is $0. Since your savings account is a liquid asset, you then add $7,500 to the $0 NRE of the home, and arrive at $7,500 NRE. In this example, $7,500 is also your total NRE as you have no other assets with equity except for your household items, which are exempt.
The next step in determining an acceptable settlement amount is to add the $7,500 (above) to your excess allowable income times 12. In this example, you have zero excess allowable income. Accordingly, your excess allowable income multiplied by 12 is $0. By adding $7,500 to $0, you derive your acceptable settlement amount: $7,500. In other words, you would settle with the IRS for the sum of $7,500.
Now let’s use this same example and see what would happen if you paid a professional a fee of $4,000 to prepare and negotiate the OIC on your behalf. You would withdraw $4,000 from your savings account in order to cover the professional’s fee. After this withdrawal, you would have $3,500 remaining in savings. Plugging your income, expenses, and NRE into the above formula would now result in a settlement with the IRS in the amount of $3,500.
In the first example, you pay the IRS $7,500 to settle your debt. In the second example, you pay $3,500 to the IRS and $4,000 to a tax pro, for a total of $7,500. As you can see, either way you go about it, you pay a total of $7,500 to get rid of a $25,000 tax liability. So, although your professional services did cost you a total of $4,000 in the second example, it was money you would have had to shell out to the IRS anyway had you gone it alone and negotiated the OIC without professional assistance. Consequently, the net effect is that your professional services wind up being “free.”
Now, you might ask: If I could settle it on my own for $7,500, why not just handle the OIC myself? There are several compelling reasons which I will touch on below.
First, getting the IRS to accept an OIC is a lot more difficult than it sounds. The majority of OICs that the IRS receives are either rejected or returned. Some of the more common reasons why OICs are rejected or returned are as follows:
• The applicant was not a good candidate for an OIC. A good tax pro would have determined this at the outset, and would not have wasted the applicant’s hard earned professional fees as well as many months and a huge number of hours pursuing a lost cause.
• The applicant was not in compliance with the tax laws. A good tax pro would have reviewed the applicant’s compliance and would have helped the applicant get into compliance before or shortly after submitting the OIC.
• The applicant made a technical error filling out the OIC paperwork.
• The applicant failed to understand or properly respond to a request for additional information.
Since a good tax professional has been down the OIC path many times before, he or she would be far less likely to have an OIC rejected or returned for any of these reasons. Thus, the experience of the tax professional, in and of itself, significantly enhances the chances of acceptance.
Second, in the world of OICs, the example I used above was very simple and straightforward. In real life, the OIC process is often complicated and messy. For instance, the fair market value of an asset is often debatable. People and businesses have myriad monthly expenses. Which expenses will the IRS consider “necessary?” Further, income is not always consistent. In fact, with regard to businesses, I would argue that income is almost never truly consistent. Keep in mind that these factors—income, value of assets, and allowable expenses—all play a significant part in the formula for determining an acceptable settlement amount.
If you think that the IRS is going to be objective when it comes to evaluating these factors, think again. I have seen countless examples of the IRS overstating income, overvaluing assets, and disallowing expenses that should have been allowed. By taking this adversarial approach, the IRS effectively manipulates its own formula resulting in the rejection of offers that should have been accepted or the acceptance of a dollar amount that is thousands or tens of thousands of dollars more than it should have been. In these cases, the value of a good professional’s experience negotiating OICs cannot be overstated. A good tax pro knows how to determine when the IRS isn’t playing fairly, and knows exactly how to advocate on behalf of the taxpayer to ensure not only that the OIC is accepted, but that it is accepted for the lowest dollar amount possible.
Third, a good tax pro knows when to take an OIC to Appeals, and how to build and present a strong case to Appeals. This can result in the acceptance of an OIC that otherwise would have been rejected, or the approval of a settlement amount that is a fraction of what the IRS was initially willing to approve.
Finally, dealing with the IRS is time-consuming and often aggravating. Why subject yourself to this? Effectively free professional fees, better results, and far fewer headaches make this one a no-brainer. Do your homework when it comes to finding a reputable and skilled tax professional. Then sit back and let your pro work his “free” magic.