You just received a letter from the IRS notifying you that they are rejecting your offer in compromise. Enclosed with your letter are the IRS calculations, detailing why your offer was rejected.
The IRS might as well be speaking a foreign language – what do all their calculations mean? And do you have a good reason to appeal the rejection?
One reason the IRS rejects an offer in compromise is because they think that you can pay them in full from your future income. The IRS defines your future income as the amount you earn, less your necessary living expenses.
The IRS has schedules of what your necessary living expenses should be. And if your actual expenses are greater than the IRS allowances, the IRS will cut you short on expenses. This creates more future income to IRS, increases the value of your compromise, and can result in a letter proposing rejection.
Here’s an example of how the IRS living expense allowances work:
Let’s say you live in Cincinnati, Ohio and have a family of four. The IRS will allow you a monthly housing and utility expense of $1,942.
But what if your housing and utilities – mortgage payment, gas/electric, water, sewer, trash, cable, and phone bill – total $2,300/month?
The IRS won’t allow you to deduct your full monthly living expense in their offer in compromise calculation, and will cap the expense and allow you only their number, $1,942. The result is that the IRS calculations have you at $358 more left over every month to pay them than you actually do ($2,300 actual – $1,942 allowed).
This is what I call phantom cash flow – you don’t have it, can’t afford to pay it to the IRS, but they will use that $358 a part of what is collectible from your future income in their offer in compromise calculation.
These expense limitations are known as IRS Collection Financial Standards.
The IRS limits other expenses under their Collection Financial Standards, including the amount you can spend on food, clothing, entertainment, your monthly auto payment, monthly auto operating expenses, credit card payments and retirement plan contributions.
Your budget may show that you have little money left over every month to pay the IRS – that should make for a great offer in compromise settlement, right? But that could change after the IRS collection standards limit your expenses, and creates cash flow that you do not have.
Do not presume that the IRS applies their Collection Financial Standards correctly. They are human, and make errors in the application of their own guidelines. The Internal Revenue Manual contains many, many parts on how the Collection Financial Standards are to be applied. The Internal Revenue Manual also contains reasons to deviate from the standards. Remember that you do not have to accept a rejected compromise – you have appeal rights to dispute it.
The amount you earning also impacts the success of your compromise. Sometimes, the IRS miscalculates your earning potential. This also has the effect of increasing the amount collectible from your future income.
You can get whipsawed – the IRS disallows some of your living expenses to reduce what you spend, and increases your earnings over what you actually make.
The problem in valuing your earnings is that the IRS will often look at a very short window of time – usually the last 3-6 months of your income.
But what if your current income is higher than usual – you have received overtime that you do not usually get, and the IRS is treating you as always getting it?
Or what if you are self-employed, and you just completed a large job that temporarily increased your income, but your income is usually not as high as it is now?
Or what if you expect your income to decrease, or you will be retiring, or have a medical trauma that will effect your ability to work in the future?
The IRS will consider how these factors impact your future cash flow, but only if you make the case. They will not ask. They will take the short route – looking at your recent income, which may not tell them the whole story.
The value of your compromise could change – and the rejection turn into acceptance – if the whole story was properly told.
The IRS can make a lot of errors in its compromise analysis. Your have a right to appeal the rejection and get things set straight. The IRS rejection letter is final only if you let it be final. The rejection allows you a 30 day window to appeal and dispute the IRS’s calculations; nothing is final until your appeal is heard. Do not presume that the IRS is correct. Even if they are correct, that does not mean that you do not have other options for resolution, such as bankruptcy, to consider.