Offer in compromise: Here’s how to value your income in negotiating with the IRS
If you are considering an offer in compromise with the IRS, the amount of money you make can play a crucial role in your settlement.
In an offer in compromise, the IRS will take what you earn, subtract what you spend (provided it is within government allowances) and arrive out how much money you have every month to repay them. This is your cash flow.
The IRS will then plug your cash flow into a formula they use to arrive at part of the settlement value of your case. The minimum formula the IRS uses is your cash flow multiplied by a factor of 48.
By example, if the IRS finds $100 of cash flow, your settlement value will be at least $4,800 ($100 x 48).
The lesson is clear: Every dollar the IRS calculates you make can increase your settlement.
Since every dollar counts, here are a few tips on making sure the IRS gets your income right in an offer in compromise:
(1) If you are self-employed and run your own small business, the IRS will require a profit and loss statement showing your businesses income and operating expenses.
Make sure you submit a profit and loss statement that is indicative of your true earnings. For example, if you operate a lawn care business, submitting a financial statement in August may overstate your overall income. Very few businesses have income that is the same month to month.
I always request my small business clients to put together a monthly profit and loss statement for the prior 12-18 months, if possible. This allows me to review monthly profit variations to arrive at which timeframe best represents income for the compromise. It can be three months, six months, or a year – it all depends on the business cycle.
It is extremely important for self-employed business owners to make the correct income disclosures and pick the right profit and loss timeframe. To do otherwise could result in an IRS compromise valuation that overstates income – and that means a higher settlement value for you.
(2) If you are employed and have taxes withheld from your income, the IRS will generally want to see your last three month’s paystubs. Presume that the IRS will use this very limited window of time to determine your income.
This can present a problem if your income varies and the last three months overstates what you make. For example, if you just had a big commission month that is not representative of your overall income, three months could make you look like you earn more than you really do.
Submitting the last three months just because the IRS asked for it would not reflect your reality. Even worse, it could lead to an overstatement of your cash flow and increase your settlement.
If your wages vary month to month, you have two choices: First, you could submit a longer time frame of income history to the IRS. The IRS may ask for three months, but do not be shy in providing more to prove your true income. A second option is to wait to file the offer until your income evens out, making sure you submit the compromise and your pay verification when your income supports your reality.
Whether you own your own business or are employed for wages, make sure you understand how the IRS will likely view your income before plunging into an offer in compromise.