The average amount the IRS settles for in an offer in compromise is $6,629. Sounds good, doesn’t it?
If only it was that easy – everyone would be doing it, right?
The reality is that in 2014, the IRS received 68,000 offers in compromise from taxpayers.
The IRS accepted 27,000 of those offers.
That’s an acceptance rate of 40%. Or, if you are a glass half full kind of person, that’s a rejection rate of 60%.
The total amount accepted in those offers was $179 million.
If you are keeping score, that’s an average settlement of $6,629.
Now, that does not mean that you can settle with the IRS for that amount, or that there is a 40% chance your offer will be accepted. The IRS uses a very specific formula in determining the settlement value of an OIC and whether to accept or reject it. Your success depends on how you fit into the IRS formula.
The IRS offer in compromise formula works like this:
First, the IRS will figure out how much they think you can pay them every month in an installment agreement. They do this by asking for your paystubs or, if you are self-employed, a recent profit and loss statement from your business.
Next, the IRS wants to know about your monthly living expenses. Some of those expenses – like your housing and utilities, car payment and food/clothing – are subject to IRS limitations. The IRS calls these limitations Collection Financial Standards, sometimes also referred to as allowable living expenses. The effect is often to create more cash flow than you actually have by limiting your expenses to amounts the IRS thinks are reasonable.
Your income, less your allowable living expenses, equals your monthly cash flow. The IRS is going to put a value on your cash flow for purposes of determining your OIC settlement value.
If you can pay the IRS the settlement within five months after acceptance, the IRS values your monthly cash flow by multiplying it by a factor of 12. So $200 of monthly cash flow equates to a settlement valuation of $2,400.
If you cannot pay the settlement off within five months, the IRS will grant you 24 months payment terms. However, your monthly cash flow – $200/month in our example – would be multiplied by a factor of 24, increasing the valuation to $4,800. in other words, the IRS gives you a discount for paying them the offer settlement sooner rather than later.
After determining the settlement value of your cash flow, the IRS will then turn to a valuation of your assets, and add that to the value of your cash flow. What is your stuff worth? Your car, house, retirement plan? Subtract any loans to arrive at equity, and in most cases, reduce that by 20% to get to your IRS valauation.
Add your cash flow (multiplied by a factor of 12 or 24) to your asset value, and you have your proposed IRS settlement amount.
That formula yields an average of $6,629 to the IRS. It could result in more or less for you, depending on how your finances fit into the IRS formula.
But keep in mind that the IRS disagrees with taxpayers’ valuations and calculations 60% of the time and rejects those offers.
The reality is somewhere in the middle: success with an offer in compromise is based on a full understanding of the IRS investigative process into your income, living expenses and assets. It is not a one size fits all situation; the amount of one person’s settlement has no bearing on the success of another’s. The IRS does not have a set percentage of settlement to the amount owed. It all depends on convincing the IRS that your financial situation is dismal and that the IRS will never get paid after applying their internal guidelines.