The average amount that the IRS settles for in an offer in compromise is currently $6,629. Sounds good, does it not? If only an IRS settlement was that easy, every taxpayer would be submitting IRS settlements, right?
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Offer in Compromise information: In 2014, the IRS received 68,000 Offers in Compromise submissions from taxpayers. The IRS accepted 27,000 of those settlement offers. The IRS accepts approximately 40% of the settlement offers submitted. Our tax professionals expect an explosion of IRS settlement submissions in the coming year due to COVID-19.
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The total amount accepted in all Offers in Compromise in 2014 was $179 million which is an average income tax settlement of $6,629.
The above statistics do not mean that a financially struggling taxpayer will settle with the IRS for that amount, or that there is a 40% chance your IRS settlement offer will be accepted.
The IRS uses a very specific and complicated formula in determining the settlement value of an Offer in Compromise and whether or not to accept or reject it. Your success depends on how a taxpayer fits into the IRS formula.
The Offer in Compromise program formula works like this:
- The IRS will figure out how much they think that a taxpayer can pay them every month in an installment agreement. They do this by asking for your pay stubs or, if you are self-employed, a recent profit and loss statement from your business.
- The IRS wants to know about your monthly living expenses. Some of those expenses such as your housing and utilities, car payment(s) and food/clothing will subject to IRS limitations. The IRS calls these limitations Collection Financial Standards, often referred to as allowable living expenses. The IRS is trying to create more cash flow than the struggling taxpayer will actually have by limiting the expenses to amounts the IRS thinks are reasonable.
The taxpayer’s monthly income, minus the allowable living expenses, equals the taxpayer’s monthly cash flow. The IRS is going to put a value on the cash flow for purposes of determining the Offer in Compromise settlement value.
If the taxpayer can pay the IRS the offered settlement within five months after acceptance, the IRS values your monthly cash flow by multiplying it by a factor of 12. $200 of monthly cash flow will equate to an offered settlement valuation of $2,400.
If the taxpayer is unable to pay the settlement in full 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 settlement offer to $4,800. The IRS will give the taxpayer a discount for paying the IRS the offered settlement sooner rather than later.
After determining the value of the settlement offer, the IRS will then turn to a valuation of the taxpayer’s assets, and add that to the value of your cash flow. How much 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 valuation.
Add your cash flow (multiplied by a factor of 12 or 24) to your asset value, and you have your proposed IRS settlement amount.
The taxpayer’s success with an offer in compromise is based on a full understanding of the IRS investigative process into the income, living expenses and assets of the taxpayer. It is not a one size fits all situation. The amount of one taxpayer’s settlement has no bearing on the success of another taxpayer. The IRS does not have a set percentage of settlement to the amount owed.
The taxpayer’s settlement offer depends on convincing the IRS that your financial situation is dismal and that the IRS will never get paid after applying their internal guidelines.
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