An IRS offer in compromise is available to virtually anyone who owes the IRS back taxes. But it is important to avoid confusing the program’s widespread availability with success in getting your offer accepted.
After all, the last thing you want to do is waste time and money with the IRS on an offer that has no chance. The offer in compromise program does work – but only in the right situation. To have success with an IRS compromise, you have to understand the IRS guidelines for analyzing your offer.
Is there a point where you could earn too much money to get a compromise accepted, and as a result have to consider other options with the IRS (installment agreements, tax bankruptcy).
There are two rules to follow when considering how your income could affect the success of your offer in compromise:
The first rule is that the IRS has no set rules that limit an offer in compromise to certain income levels. There are no earnings caps to the availability of an offer in compromise. Whether you make $25,000 or $250,000, the IRS compromise guidelines will not, standing alone, make you ineligible for settlement.
The second rule, though, is that the IRS does have living expense guidelines that limit how much you can spend to get to “yes” in a compromise.
Sure, the IRS says, go ahead and make $250,000 – but if you spend it in a way that is different from what the IRS guidelines permit, your compromise could run into trouble.
The IRS determines the amount of your settlement by figuring out how much they think they can collect from your cash flow over the time they have to collect your tax debt from you.
Cash flow is defined by the IRS as your earnings less your monthly living expenses (remembering that the IRS has guidelines that limit your living expenses). The IRS has 10 years to collect a debt from you, beginning on the date you initially owed the IRS the money.
If your monthly cash flow, after being multiplied by the amount of months the IRS has left to collect the debt from you, is less than what you owe, then your in the game for an offer in compromise. If your monthly cash flow, as defined by the IRS, can full pay what you owe, then your offer will be rejected.
But here is the catch in getting to your monthly cash flow: The IRS will apply its living expense guidelines to your offer in compromise, and the result is often a disallowance of some of your expenses. They have limits – called IRS Collection Financial Standards – that can spin your budget around and leave you with an ability to pay that is much greater than what you think it is.
In other words, the IRS cash flow analysis creates phantom cash flow – money the IRS thinks you should have to pay them, but you don’t. You don’t have it because you are spending it on living expenses. But those living expenses could are slashed by the IRS in their compromise analysis, leaving you with cash flow that you don’t really have. But the IRS says you should have it.
In an offer in compromise, it is often your world vs. the IRS’s world. You need to fit into the IRS’s world to have success settling your tax debt with an offer in compromise.
Here is an example of some of the IRS Collection Financial Standards and how they can create phantom cash flow and increase the value of your offer in compromise:
$1,513/month This is what the IRS will allow a family of four for groceries, clothing, eating out, travel, entertainment, going to the movies, haircuts – in other words, your costs to live every month.
$1,942/month The monthly amount the IRS will allow you for housing and utilities (rent, mortgage payment, gas/electric, cable, internet, phone, water, trash) for a family of four living in Cincinnati, Ohio. (It varies based on where you live.)
$295/month The IRS allowance for monthly auto operating expenses (gas, maintenance, insurance) if you live in Los Angeles, California. Double it to $590/month for two cars. This can be higher or lower based on your locale.
$517/month If you spend more than $517/month on a car payment, forget it. The IRS will only allow up to $517 per taxpayer; the excess you are paying is considered money you can pay to the IRS.
$60/month Medical expenses the IRS will automatically allow per member of your household – for prescriptions, doctor visits, well care, etc. If you pay more than this, the IRS will allow it, but you will have to verify the expense.
Other expenses the IRS will allow: All of your health insurance (must be verified), a reasonable amount for life insurance (usually $200 and under), your child care/day care, a percent of a payment plan on state or local tax back tax debts, all of your child support or alimony payments, and student loans for your education.
Expenses the IRS will not allow in an offer in compromise: Any expense over the Collection Financial Standards listed above, payments on credit cards, private school tuition, college expenses for a dependent, and charitable contributions, to name a few.
Sometimes, arguments can be made for the IRS to vary from their guidelines – for example, if you drive a distance to work that requires a gas expense more than the IRS Collection Financial Standard, there may be leniency in allowing it. Private education for a special needs student could likewise be permissible.
But the IRS Collection Financial Standard expense limitations could likely create a cash flow scenario that significantly raises the value of your compromise from the phantom cash flow the IRS will attribute to you.
It’s not what you make that matters in an offer in compromise as much as what you spend. An offer can be done at higher income levels, but it becomes more dependent on items like child support eating up your cash flow (which is allowed in full) rather than your other living expenses (which will be limited and create phantom cash flow).
For these reasons, at higher income levels, the IRS analysis is geared to make compromising more difficult.
If your cash flow – whether real or phantom – results in the IRS determining that they can get paid in full over the remaining time left to collect from you, your compromise will be rejected. There would be no need to waste time with an offer in compromise – the better plan would be alternative remedies like a payment plan over the remaining collection time period, or possibly even bankruptcy.
Before jumping in with an offer in compromise, it is important to know that although the IRS does not have limitations on how much you earn, they do have limits on how much you can spend. And it is an understanding on the limits on spending – the Collection Financial Standards – that make a difference.
You can make any amount under the sun to file an offer in compromise, but for success with the offer you have to spend it in a manner that is consistent with the IRS compromise guidelines. When considering an offer in compromise, it is important to know how the IRS analyzes a compromise, and how that analysis impacts your specific situation.