IRS Law Blog

You want to the get the IRS off your back, and are considering an offer in compromise.

After all, at the end of each month, after you pay your bills, you have little money left to pay the IRS back.

Settlement seems logical, right?

Hold on, not so fast.

The IRS may not give you full credit for all of your living expenses, and calculate that you can pay them more than you actually can.  This is because the IRS limits living expenses as part of their offer in compromise analysis.

In other words, the IRS will put you on their budget, and disregard yours.

If your living expense are greater than the IRS’s budget, you will have expenses ignored by the IRS in calculating your ability to pay them back.  This has the effect of increasing your cash flow.  Fewer living expenses and more cash flow result in the IRS calculating an ability to pay which is greater than your reality.   This, in turn, raises the value of an offer in compromise.

The IRS living expense guidelines are known as Collection Financial Standards, 

Let’s do an example, highlighting three areas where IRS will use their collection financial standards to chop up your budget, attack your living expenses, and increase your settlement:

• Credit card payments.  The IRS will not allow you the expense of monthly payments on credit cards in calculating your ability to repay them.  This means if you have $500/month in credit card payments, you actually have $500/month to pay the IRS.  The IRS will disregard this expense, calculate it going to them, and use it to increase the value of your compromise.

• Car payment.  The IRS collection financial standards currently allow a car payment of up to $485/month.  If your car payment is less than that, then the IRS will give you full credit for it in your budget.  But if your payment is, say, $585/month, the IRS will give your credit for $485 and not give you credit for the $100 difference, thus increasing your settlement.

• Housing and utility payments.  Let’s say you live in Dallas County, Texas, you own your house, have a family of four, and your mortgage payment is $2,500/month.  Your gas, electric, water, and trash totals another $500/month, bringing your total mortgage and utility expense to $3,000.  IRS collection financial standards allow $2,016 in total housing and utility payments for you and your family.  That means the difference – $984/month – will be disallowed by the IRS, and added back to increase your cash flow and the amount of settlement.

On these three items alone – your credit cards ($500/month), car payment ($100/month excess) and housing/utilities ($984/month excess) – the IRS will flip your budget by $1,584/month.  In other words, if you are offering them a cash flow position of zero, they will counter-offer at $1,584/month.

Now, let’s review how the IRS will factor your living expenses and cash flow into their offer in compromise valuation:

If you are able to pay the IRS the settlement amount within five months after acceptance, the IRS will take your cash flow and multiply it by a factor of 12.  Your financial reality has you ending each month at a zero budget, with no money left over.  Based on that, it would not be out of the question for you to offer the IRS as little as $100 in the compromise.  You have no cash flow to apply to the 12 multiplier, equaling a very low offer on this basis.

However, the IRS is going to put your living expenses on the cutting board, apply their collection financial standard test, and come out with $1,584/month.  This will increase the value of your settlement from your cash flow to $19,008 ($1,584 by the 12 month multiplier).  But you don’t have $19,008 laying around, and can’t afford to pay the IRS the settlement as their numbers are different from your reality.  The IRS collection financial standards are rearing their ugly head on your settlement hopes, and appear to be dooming it.

As you don’t have $19,008 right now, the IRS will give you another option:  more time to pay to the settlement, up to 24 months.  The IRS will also penalize you for taking more time and change the way they calculate the settlement.  Rather than multiply your cash flow by 12, they will use a multiplier of 24.  This now results in an offer in compromise of $38,016 ($1,584 x 24).

The IRS will allow you to pay the $38,016 at $1,584/month over 24 months.  And this brings about another glitch:  You do not have $1,584/month to pay the IRS over the next 24 months because you are spending that on the living expenses cut out of your budget by the IRS collection financial standards.

Clearly, in compromising with the IRS, it is important to understand that it is their reality that counts, not yours.  This may seem illogical, unfair, or even oppressive. But the important point is to understand that the IRS has guidelines – a budget – which they will impose on you to limit your living expenses, increase cash flow, and possibly overwhelm you with the settlement terms.

The IRS is looking to weed out excessive lifestyles (as they define it), and living expenses that they believe should be paid after them (like credit cards) in computing the value of an offer in compromise.

That being said, the IRS offer in compromise program is real, and does work for the right situation.  You simply have to fit within the IRS settlement guidelines. The takeaway is to know how the IRS works ahead of time, sparing yourself time spent in a compromise that will not work, or will be in amount more than you expect.