IRS SHOWS THAT IT HAS A HEART

New Rules Make it Easier for Taxpayers to Settle Old Debts

(By David Schlack & Kelly McGinnity, Schlack &  McGinnity, Chicago, IL, 312-368-1266)

  Without fanfare, on Monday, May 21, 2012, the Internal Revenue Service issued new rules for calculating the amount that a taxpayer must offer to the IRS in order to obtain a settlement of his old tax debts. This process is called an Offer In Compromise.  These new rules make it easier for taxpayers to qualify for Offers In Compromise, and they materially reduce the amounts that many taxpayers will be required to pay in order to settle their tax delinquencies. With the issuance of these new rules, the IRS has opened the door for many delinquent taxpayers to wipe the slate clean and start fresh.  For example, the settlement amount for one taxpayer who owes the IRS $550,000, was calculated using the old rules to be $120,600.  As soon as the new rules were issued, his settlement amount dropped all the way to $36,800.

  In a Memorandum (IR-2012-53) which announced the new rules, IRS Commissioner, Doug Shulman, stated that these changes are “… part of our multi-year effort to help taxpayers who are struggling to make ends meet”, and an “… expansion of the Fresh Start Initiative by offering more flexible terms for the Offer In Compromise program that will enable some of the most financially distressed taxpayers to clear up their tax problems, and in many cases more quickly than in the past.”   The new rules are “common-sense changes to the OIC program”. 

  The IRS’ new rules for Offers In Compromise modify Section 5.8.5 of the IRS Manual.  This Section, which is entitled “Financial Analysis” dictates how the “Minimum Offer Amount” for an Offer In Compromise is calculated.  Prior to the issuance of the new rules, the method for computing a Minimum Offer Amount was fraught with inequities which caused many taxpayers to be ineligible for Offer In Compromise relief.  Or, for those who were able to qualify, the old rules made their calculated Offer Amounts too costly … often times, prohibitively costly.  Now, with the IRS’ new rules, more taxpayers will qualify for Offer relief, and for those who qualify, their Minimum Offer Amounts may be significantly smaller. 

  One of the most important changes under the new rules concerns the method for calculating a taxpayer’s reasonable collection potential. Under the old rules, the IRS required a taxpayer’s Minimum Offer Amount to include 48 months worth of his future income for Offers which are to be paid off within 5 months, or 60 months worth of his future income for Offers which are paid off in 6 to 24 months.   Under the new rules, the IRS will now include only 12 months worth of future income for Offers paid within 5 months, or 24 months worth of future income for Offers paid in 6 to 24 months. [IRM 5.8.5.23] These new multipliers significantly reduce the amount that most taxpayers will be required to pay to compromise their delinquent taxes.

  Another significant change to the Offer In Compromise financial analysis process is the treatment of “income producing assets.” Previously, the IRS considered the equity in a taxpayer’s income producing assets to be a realizable value, and required that this value be included into the Minimum Offer Amount.  In addition, the IRS required that the future income which would flow from the continued use of the income producing assets to also be included into the Minimum Offer Amount. Now, under the new rules, the IRS will no longer include the equity in the taxpayer’s income producing assets unless it is determined the assets are not critical to his continued business operations. [IRM 5.8.5.5.1] The IRS’ new approach to income producing assets recognizes the common sense fact that you cannot slaughter the cow and still expect to get milk.  By adopting this new rule, the IRS appears to have recognized that it is in America’s best interest to work with taxpayers to maintain their business operations, particularly in a bad economy. [IRS 5.8.5.5.1(3)]

  Additionally, under its new rules, the IRS will now allow taxpayers to claim living expense deductions for: (i) federally guaranteed student loan payments; (ii) delinquent state and local income taxes; (iii) credit card payments; and (iv) bank fees. Previously, none of these expenses were considered to be allowable living expenses when calculating a taxpayer’s future income.

  Also, the new rules will now allow taxpayers to exclude the following amounts from their equity in assets: (i) the first $1,000 of cash in the bank; and (ii) $3,450 per vehicle (up to two per family).  Under the old rules, every dollar in the taxpayer’s bank account plus the full amount of the equity in his vehicles had to be included into his Minimum Offer Amount.

  The impact of these new rules can be exemplified by the case of John Q. Smith.  Mr. Smith owes the IRS $550,000 in unpaid personal income taxes from previous years.   He has equity in assets totaling $22,800, and future income of $1,825 per month.  The financial analysis under the old rules resulted in a Minimum Offer Amount of $120,600.  ($22,800 plus $1,825 x 48 months)

  When calculated under the IRS’ new rules, Mr. Smith’s Minimum Offer Amount dropped to only $36,800. This is because the new rules allowed him to exclude $1,000 of his cash in bank, and $6,900 of the equity in his two vehicles. Also, his future income only had to be multiplied by 12 months instead of 48.  Now, upon his payment to the IRS of $36,800, the IRS will write-off the remaining $513,200 of his old tax debt. As this example illustrates, the IRS’ new rules can result in a much lower Minimum Offer Amount for many taxpayers.

  For a taxpayer whose Offer In Compromise has been accepted, once his settlement amount is paid, the IRS will write-off 100% of his remaining tax delinquencies, including all accrued interest and penalties.  However, every Offer In Compromise settlement is conditioned on the requirement that the taxpayer must file and pay all of his federal taxes for the next five years on time.  If a taxpayer fails to satisfy this condition, his settlement can be voided.

  Even with the IRS’ new rules, the process of applying for Offer In Compromise relief remains arduous and time consuming.  It requires precise work, and it involves complicated legal and accounting issues, as well as many complex calculations.  Although this process can be daunting, it can be well worth the effort.  Now, with its new rules, the IRS has brought Offers In Compromise within closer reach of taxpayers who are struggling financially, and who need a fair chance to wipe their slates clean and start fresh.