In May of this year the IRS announced some changes to the Offer in Compromise (OIC) program. The IRS changes include:
1. How they calculate future income;
2. Allowing certain student loan payments;
3. Allowing taxpayers payments for delinquent state or local taxes; and
4. Expanding the allowable living expense standard.
I see some practitioners touting these changes as though there is some major shift occurring in how the IRS deals with OICs. I don’t agree. Sure, the IRS’ changes will help some taxpayers and there will be a few more OICs accepted than there were prior to the changes being implemented by the IRS. However, the IRS will still apply a rigid formula in analyzing OICs. The IRS announcement says “In certain circumstances, the changes announced today include…” This immediately tells the reader there are limitations to the IRS changes. The biggest change is that IRS will now calculate future income using a multiplier of either 12 or 24 months, depending on the OIC payment terms, to determine reasonable collection potential. Before the change, the IRS would use a multiplier of 48 or 60 months. Sounds like a big deal, right? Not so fast…
The IRS’ makes a significant omission by failing to explain how future income is calculated. When an IRS offer examiner reviews on OIC they review the file to answer a couple of questions: 1. Does the taxpayer have enough assets to pay in full; and 2. Does the taxpayer have enough income to pay in full through an installment agreement? Many taxpayers fail recognized how this analysis works and as a result have their OICs rejected. The first question is obvious, if a taxpayer can pay, they can pay. Sell the toys and pay the tax. Taxpayer denial is more of the issue here than a true lack of understanding. But, there is a real issue of understanding how future income is used in the OIC formula.
Simply put, if the taxpayer can fully pay a tax debt through an installment agreement within the statute of limitations on IRS collections, then they will be denied an offer in compromise. Internal Revenue Manual (IRM) section 22.214.171.124:
The initial calculation should be completed to determine if the taxpayer can full pay through installment agreement guidelines, based on submitted substantiation (absent special circumstances or effective tax administration criteria), including application of the standards and allowances. It is appropriate to use Decision Point (AOIC) or Decision IA (IRWeb or SERP) to ensure accruals are taken into consideration.
If the initial calculation indicates the taxpayer cannot full pay through an installment agreement, continue the investigation to determine the RCP.
Only if the IRS determines the taxpayer cannot full-pay within the statute of limitations (a.k.a Collection Statute Expiration Date), will the IRS reduce the number of months used to calculate future income to the multiplier of 12 or 24 months. This is a key point that is problematic for many taxpayers. Keep in mind the IRS has 10 years from the time of assessment to collect on a delinquent tax debt. The greater the amount of time left on the statute of limitations, the greater the future income amount is going to be. The IRS denies a large number of offers in compromise because of a future income calculation showing a taxpayer has the ability to full pay tax debts on an installment agreement.
The IRS also states that it will now allow student loans as an allowable living expense. Student loans have always been an allowed expense when they are guaranteed by the federal government.
Here is an IRM section on student loans as it was written prior to the IRS announcement in May 2012:
3. Repayment of student loans secured by the federal government will be allowed only for the taxpayer’s post-secondary education. If student loans are owed but no payments are being made, do not allow them, unless the non- payment is due to temporary job loss or illness.
So, there is no change here at all! Unless, the IRS is trying to say it is sorry and that it will now start following its own rules.
The IRS also says in its announcement that the National Standard miscellaneous allowance is expanded to include expense items like credit card payments and bank fees. Sounds good right? Not really. Including additional expenses as allowed within a category does absolutely no good if the standard expense amount is not increased appropriately. Many of the expenses will continue to be disallowed simply because taxpayers exceed the allowed standard. Although the standards are designed to be guidelines, the IRS applies them in a rigid manner. Because the total expense standard barely increases (a $31 dollar increase from 2011), these expanded expense items will still be disallowed because the total expense standard is unrealistically low.
The IRS does get one thing right by including as an allowed expense payments for delinquent state and local taxes.
The IRS says in its announcement, “this is another in a series of steps to help struggling taxpayers under the Fresh Start initiative.” The changes announced by the IRS are not a serious attempt at giving taxpayers a fresh start since they are likely to have very limited benefit to taxpayers (and the IRS knows this). I see these changes as nothing more than posturing by the IRS to make it appear as though they are the good guy and really making an effort to work with taxpayers. In too many cases, the IRS fails to follow through on its lip service about being more flexible with taxpayers.