It makes sense on the surface: You are unemployed, owe the IRS money, and are considering an offer in compromise to settle your tax debt.
Before you jump in, it is important to know that being unemployed is not always enough for success in an OIC.
You are correct that the starting point is that you have no income and cannot currently pay the IRS. Nothing from nothing is nothing, right?
But by law the IRS usually has 10 years to collect a tax debt. In an offer in compromise, the IRS wants to know how much could you pay over the time they have to collect (10 years). Your current circumstances of unemployment are relevant only if it can be extrapolated into the future.
In other words, in an offer in compromise, the IRS will look at the now, but will also look forward to determine what your future income will be.
This potential unknown – your unemployment – must be quantified for the IRS. The key is proving if your employment is short-term or long-term, how long you will be unemployed, if you will return to work, and if so, what your income will be.
The rules in valuing your future income when you are unemployed are laid out in the Internal Revenue Manual 22.214.171.124, and are as follows:
1. You are short-term unemployed and will return to work at your previous level of income, then expect the IRS to use the level of income expected if you were fully employed.
Example: You are a construction worker, currently not employed due to lack of work during the winter months, and this loss of employment during the winter is normal for you, The IRS will consider you temporarily or recently unemployed. Expect the IRS to use your previous income to determine your usual and customary earnings going forward.
2. You are short-term unemployed and will return to work but not at your previous level of earnings. Internal Revenue Manual guidelines call for an offer in compromise examiner to figure out what your income will be when you do return to work.
Maybe you have been downsized, and the market has closed for your skills or profession. Or maybe market conditions created the void – a good example could be a mortgage broker in the go-go days of home mortgage financing before the housing collapse.
Either way, the IRS will need to accept that your change is permanent. In this regard, it can be better to have some job showing your new earnings than none.
That’s right, being employed can be better than being unemployed in an offer in compromise as it quantifies your earnings. Proving your future income possibilities when you are unemployed is demonstrating something that does not completely exist – it is vague, and the IRS likes their evidence concrete and quantifiable. If you have that job, the proof is there – income is quantified, and the question of what your income will drop to has been resolved.
3. You are long-term unemployed and do not expect to return to work. If you have minimal potential to return to work, the Internal Revenue Manual directs the IRS to use your current income when calculating future income.
Example: You have been unemployed for over one year. There are currently no employment opportunities for you, and your household is living on one income. The IRS can use your current income (zero), but may request an agreement that if you return to work, you may have to later increase the value of your compromise.
This, too, is a facts and circumstances test. Clearly, the longer you have been unemployed, the better your case. But even at that, expect some need to demonstrate why your unemployment has lasted so long and will continue indefinitely.
Were you hurt on the job or have other injuries that prevent you from working?
Is age a factor?
How about health considerations?
Or maybe you are raising the kids and your spouse now works ans is the source of the household income.
Even if you are long-term unemployed, an offer in compromise is best filed with the ability to demonstrate why your income will not return to prior levels.
Expect the IRS to need any unemployment to be quantified on length, chances of return to work, and income when work starts back up.
And for that reason going into an offer in compromise with no job can be more challenging than settling with that lower paying job in hand. Unemployment, standing alone, is not as simple of a path to compromise success as it may appear on the surface. Think about it: In an offer in compromise, the IRS is making a permanent decision on what you will be earning for the remaining time they have to collect.
The IRS has a need to quantify your future income, and being unemployed quantifies it for them only if you can prove it is long-term and permanent. Anything that is short-term and temporary involves more negotiation to quantify your future income and job possibilities.