- 5.8.5 Financial Analysis
- 220.127.116.11 Overview
- 18.104.22.168 Ability to Pay
- 22.214.171.124 Taxpayer Submitted Documents
- 126.96.36.199.1 Verification
- 188.8.131.52.1.1 Verification through Internal Research
- 184.108.40.206.1.2 Securing Credit Reports to Verify Taxpayer Information
- 220.127.116.11.1.3 Verification through Taxpayer Contact
- 18.104.22.168 Equity in Assets
- 22.214.171.124.1 Net Realizable Equity
- 126.96.36.199 Jointly Held Assets
- 188.8.131.52 Assets Held By Others as Transferees, Nominees, or Alter Egos
- 184.108.40.206 Cash
- 220.127.116.11.1 Treatment of Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) Payments on the Asset/Equity Table (AET)
- 18.104.22.168 Securities and Stocks of Closely Held Entities
- 22.214.171.124 Life Insurance
- 126.96.36.199 Retirement or Profit Sharing Plans
- 188.8.131.52 Furniture, Fixtures, and Personal Effects
- 184.108.40.206 Motor Vehicles, Airplanes, and Boats
- 220.127.116.11 Real Estate
- 18.104.22.168 Accounts and Notes Receivable
- 22.214.171.124 Income-Producing Assets
- 126.96.36.199 Inventory, Machinery, Equipment, and Tools of the Trade
- 188.8.131.52 Business as a Going Concern
- 184.108.40.206 Dissipation of Assets
- 220.127.116.11 Retired Debt
- 18.104.22.168 Future Income
- 22.214.171.124 Future Income Collateral Agreements
- 126.96.36.199 Allowable Expenses
- 188.8.131.52.1 Necessary Expenses
- 184.108.40.206.2 Housing and Utilities
- 220.127.116.11.3 Transportation Expenses
- 18.104.22.168.4 Other Expenses
- 22.214.171.124 Conditional Expenses
- 126.96.36.199 Shared Expenses
- 188.8.131.52 Calculation of Future Income
- 184.108.40.206.1 Calculation of Future Income IRC 6503(c) (Taxpayer Out of the Country)
- 220.127.116.11.2 Calculation of Future Income Cultivation and Sale of Marijuana in Accordance with State Laws
- 18.104.22.168 Limited Liability Companies (LLC) Issues
- 22.214.171.124.1 Financial Analysis of an LLC
- 126.96.36.199 Offer in Compromise Submitted on Cases Involving Collection Statute Expiration Date Extensions
- 188.8.131.52 Payment Terms
- Exhibit 5.8.5-1 Periodic Payments Limited by Small Amount Due
- Exhibit 5.8.5-2 Periodic Payments Limited by Application of Payment From Equity in Assets
Part 5. Collecting Process
Chapter 8. Offer in Compromise
Section 5. Financial Analysis
April 10, 2017
(1) This transmits a revision for IRM 5.8.5, Offer in Compromise, Section 5 – Financial Analysis.
(1) IRM 184.108.40.206.2 was added to incorporate Interim Guidance Memorandum SBSE-05-0416-0016, dated April 28, 2016 Calculation of Reasonable Collection Potential in Certain Offers in Compromise Cases.
Kristen E. Bailey
Director Collection Policy
This chapter provides instructions for analyzing the taxpayer's financial condition to determine reasonable collection potential (RCP). IRM 5.15, Financial Analysis Handbook, provides information on analyzing and verifying of financial information and should be used in conjunction with this section.
The ability to pay determination should be made on the liability(s) due at the time the offer was submitted.
The initial calculation should be completed to determine if the taxpayer can full pay through installment agreement guidelines based on submitted substantiation including application of the standards and allowances. It is appropriate to use Decision Point (AOIC) or Decision IA (IRWeb or SERP) to ensure accruals are taken into consideration. This computation should be completed prior to initial financial analysis.
If the initial calculation indicates the taxpayer cannot full pay through an installment agreement, continue the investigation to determine the RCP. Refer to IRM 220.127.116.11, Doubt as to Collectibility involving situations when the calculated amount potentially received through a PPIA, which does not fully pay the liability, approximates the outstanding balance.
Document the history supporting your determination.
Collection Information Statements (CIS) and related documentation submitted with an OIC should reflect current information as of the date of the OIC submission.
If during the investigation, the financial information becomes older than 12 months and it appears significant changes have occurred, a request for updated information may be appropriate. Prior to contacting the taxpayer, attempt to secure the necessary verification through internal sources. If taxpayer contact is required, contact via telephone is preferred to expedite case processing.
In certain situations, information may become outdated due to significant processing delays caused by the Service and through no fault of the taxpayer. In those cases, it may be appropriate to rely on the outdated information if there is no indication the taxpayer's overall situation has significantly changed. Judgment should be exercised to determine whether, and to what extent, updated information is necessary. If there is any reason to believe the taxpayer's situation may have significantly changed (i.e. change of employment, loss of job, etc.), and substantiation cannot be secured via internal research, secure a new CIS.
A thorough verification of the taxpayer's CIS, Form 433-A(OIC) and/or Form 433-B(OIC), involves reviewing taxpayer submitted documentation and information available from internal sources. As a general rule, additional documentation should not be requested when the information is readily available from internal sources or it would not change the recommendation.
Collection issues that have been previously addressed during a prior investigation will not be re-examined unless there is convincing evidence that such reinvestigation is absolutely necessary. Investigative actions that are less than 12 months old may be used to evaluate the OIC, unless the taxpayer indicates there has been a material change or there is evidence indicating his financial situation has changed in the intervening months.
If a Revenue Officer has completed a full CIS analysis, including verification of assets, income, and expenses, and has made a determination of the fair market value (FMV) of assets, equity in assets and monthly ability to pay, this information should not be re-investigated. The OE or OS should use the RO's determinations to calculate the RCP. However, any differences between the taxpayers and the RO's CIS should be resolved by contacting and inquiring with the taxpayer, by phone, if possible.
Prior to accepting an offer, it may be appropriate to contact the taxpayer to determine the source of the offer funds.
Verify as much of the CIS as possible through internal sources.
The following internal and external information sources should be considered. Discuss any major discrepancies with the taxpayer/POA and document the history. This list is not all inclusive.
Internal Sources Review to ENMOD and INOLES Identify/research cross reference TINs for related business activity not declared on the CIS. SUMRY, IMFOL and BMFOL Verify full compliance and determine if there are any open control bases or freeze codes. RTVUE (IMF)/ BRTVUE (BMF), TRDBV, or TDS Compare the amount of reported income and expenses declared on the CIS to verify the amounts are within reason. IRPTRO
Compare real estate tax and mortgage interest deductions to the amounts declared on the CIS. Discuss any difference with the taxpayer to determine the reason for the increase or decrease.
Identify accounts not reported on the CIS, such as certificates of deposit or investment accounts.
Verify sources of income, such as employers, bank accounts, and retirement accounts.
Identify recent transferred or disposed of assets, such as stocks and bonds.
State Motor Vehicle Records Identify motor vehicles currently registered to the taxpayer but not declared on the CIS. Also check for ownership in business names. Real Estate Records
Identify real property titled to the taxpayer but not declared on the CIS.
Identify property held by transferee, nominee, or alter ego. Also check for ownership in business names.
Accurint Identify other aliases, related business entities, UCC filings, properties, judgments, and vehicle registrations. In most instances, the OE/OS should only be using current information to verify the taxpayer's ownership or interest in assets. Credit Bureau Report
Identify past residences and employers.
Verify competing lien holders, balances due and payment history.
Identify property not listed on CIS.
Based on your discretion and judgment, consider securing a full credit report to assist in locating taxpayer assets, verifying financial information, and/or determining an alternative resolution to an OIC. The case history must be documented with the reason(s) for the request.
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All credit report requests require managerial approval.
When computing equity in real estate or allowable motor vehicles, and the taxpayer has not submitted substantiation of loan balances claimed on the Form 433-A(OIC), OE/OS should request a credit report and use the loan balance information to determine the current balances of any relevant loans from commercial lenders. If the loan is from a private source, it may be necessary to contact the taxpayer/representative for the information.
Procedures for destruction of credit reports for OICs should be as follows:
For rejected cases, all credit reports should be destroyed upon closure of the case after the 45-day period for appeal has passed. If the taxpayer files for appeal, the credit report should remain with the file and be forwarded to Appeals. Appeals will then be responsible for pulling and destroying the report. This is in accordance with IRM 18.104.22.168.2.8, Disposal of Credit Information.
For accepted cases, the credit report should be destroyed after all approving signatures have been obtained.
For all other closures (returned, withdrawn, terminated), all credit reports should be pulled after the managerial review and approval.
In all cases, where a credit report was secured, the case history must be documented that a credit report was secured and reviewed. The documentation must include a summary of any information relevant to the offer recommendation.
If not present in the file when assigned for investigation and internal sources are not available or indicate a discrepancy, appropriate documentation should be requested from the taxpayer either verbally or in writing, to verify the information on the CIS. A request for additional information and verification should be based on the taxpayer’s circumstances and the information must be necessary to make an informed decision on the acceptability of the taxpayer’s OIC. Do not make a blanket request for information that would have no impact on the case resolution. Do not request any information that is available internally.
The chart below provides guidance to the types of information that may be needed to verify the CIS if not included or addressed with the original Form 656, 433-A(OIC), or 433-B(OIC). This list is not all inclusive.
Generally, current is defined as 3 months as of the date the Form 656 was signed, not the date the Form 656 was received.
Taxpayer Documentation Review to Wage Earner — three months of wage statements or a current wage statement with year–to–date figures
Compare earnings to the income declared on the CIS.
Verify adequate tax withholding.
Identify payroll deductions.
Identify deductions to savings accounts, credit union accounts, or retirement accounts.
Self-employed – proof of gross income, profit and loss (P&L) statement from the most recent 6 - 12 month period, Compare earnings to the income declared on the CIS Bank statements – three current months showing the monthly transactions, withdrawals, and deposits for IMF accounts and six months for operating businesses Compare deposit amounts to income reported on the tax return and CIS. Question deposits that exceed reported income and unusual expenses paid. Retirement account statements and brochures, brokerage account statements, securities, or other investments Identify the type (mandatory/voluntary), conditions for borrowing, conditions for withdrawal, and current market value. IRM 22.214.171.124, Retirement or Profit Sharing Plans. Life insurance policies Identify the cash value of the policy. IRM 126.96.36.199, Life Insurance. Motor vehicle statements from the lender Verify monthly payment and payoff amount. IRM 188.8.131.52, Motor Vehicles, Airplanes and Boats. Real estate lender statements Identify the payoff amount and monthly payment expense and verify the property address on the real estate or lender statement. IRM 184.108.40.206, Real Estate. Court orders and court ordered payments for child support/alimony Verify responsibility for child support/alimony, that the payments are actually being made, and the length of time payments are required to be made.
Proper asset valuation is essential to determine RCP. In some cases, it may be necessary to review the following documents to determine undisclosed assets or income and assist in valuing the property:
Divorce decrees or separation agreements to determine the disposition of assets in the property settlements;
Homeowners or renters insurance policies and riders to identify high value personal items such as jewelry, antiques, or artwork;
Financial statements recently provided to lending institutions or others to identify assets or income that may not have been revealed on the CIS.
For an on-going business, field calls should be made to validate the existence and value of business assets and inventory. This may require an Other Investigation (OI) to a Collection Field revenue officer. If a field call has been previously made and assets have been valued and documented, a field call would not be required. The offer specialist should make the field call, if practical, or initiate an OI to request that a field call be made by another RO if the taxpayer operates outside the offer specialist's commuting area.
Field calls may be made on non-operating businesses or individuals’ after all internal research has been exhausted. In those cases, a Form 2209 or ICS Other Investigation may be issued. Issuance of other investigations in these instances should be rare.
Assets should not be eliminated or valued at zero dollars simply because the taxpayer is unable to borrow against the equity in the asset or the Service chooses not to take enforcement action against the asset. However, in some situations based on the facts of the case, special circumstances may be present that will allow an offer to be accepted for less than RCP, in accordance with IRM 5.8.11, Effective Tax Administration.
For offer purposes, assets are valued at net realizable equity (NRE). Net realizable equity is defined as quick sale value (QSV) less amounts owed to secured lien holders with priority over the federal tax lien, if applicable, and applicable exemption amounts. See IRM 5.17.2 ,Federal Tax Liens for more information on lien priorities.
QSV is defined as an estimate of the price a seller could get for the asset in a situation where financial pressures motivate the owner to sell in a short period of time, usually 90 calendar days or less. Generally, QSV is an amount less than fair market value (FMV) . For purposes of determining the taxpayer's reasonable collection potential (RCP), information provided by the taxpayer and third party sources available to the OE/OS should be reviewed to arrive at an appropriate FMV of the property.
If the OE/OS determines the FMV of an asset to be greater than the amount listed by the taxpayer, a discussion with the taxpayer/representative is required to determine if the taxpayer has any additional information to assist in correctly determining the FMV of the asset. If the OE/OS cannot reach agreement with the taxpayer on the appropriate value of an asset, a discussion with the manager should be held to determine if any additional resources are available to verify the correct valuation is being used in the calculation of RCP.
Normally, QSV is calculated at 80% of FMV. A higher or lower percentage may be applied in determining QSV when appropriate, depending on the type of asset and current market conditions. If, based on the current market and area economic conditions, it is believed that the property would quickly sell at full FMV, then it may be appropriate to consider QSV to be the same as FMV. This is occasionally found to be true in real estate markets where real estate is selling quickly at or above the listing price. As long as the value chosen represents a fair estimate of the price a seller could get for the asset in a situation where the asset must be sold quickly (usually 90 calendar days or less) then it would be appropriate to use a percentage other than 80%. Generally, it is the policy of the Service to apply QSV in valuing property for offer purposes.
When a particular asset has been sold (or a sale is pending) in order to fund the offer, no reduction for QSV should be made. Instead, verify the actual sale price, ensuring that the sale is an arms length transaction, and use that amount as the QSV. A reduction may be made for the costs of the sale and the expected current year tax consequence to arrive at the NRE of the asset. Consider reviewing a lender statement that estimates proposed closing costs.
When the value of an asset is other than the QSV, document the case history defining the decision and the basis for the value used.
When taxpayers submit separate offers but have jointly owned assets, allocate equity in the assets equally between the owners. However:
If… Then… The joint owners demonstrate their interest in the property is not equally divided Allocate the equity based on each owner's contribution to the value of the asset. The joint owners have joint and individual tax liabilities included in the offer investigation Apply the equity first to the joint liability and then to the individual liability.
For property held as tenancies by the entirety when the tax is owed by only one spouse, the taxpayer’s portion is usually 50% of the property’s NRE.
It may be necessary to review applicable state law, including the effect community property and registered domestic partnership laws have on property ownership rights in order to determine the taxpayers interest in assets that should be included in RCP.
A critical part of the financial analysis is to determine what degree of control the taxpayer has over assets and income in the possession of others. This is especially true when the offer will be funded by a third party.
When these issues arise, apply the principles in IRM 5.17.14, Fraudulent Transfer and Transferees and Other Third Party Liability, or request a Counsel opinion. Document the valuation and reason for including any assets held by a transferee, nominee or alter ego, including the identification of any documents which substantiate the determination. The taxpayer/representative should be contacted to discuss the findings, preferably by telephone to expedite the process, and if necessary, request any additional documents or verification.
If the taxpayer has a beneficial interest in the asset or income stream, then the value should be reflected in the RCP. Document the valuation and reason for including any assets held by a transferee, nominee or alter ego, including the identification of any documents which substantiate the determination. This may require the taxpayer to submit completed financial statements for the entity identified.
If the taxpayer is unwilling or unable to provide the financial information requested; consider assigning a value based on available information. If information necessary to determine whether the taxpayer’s offer should be accepted is not provided, consider a return as discussed in IRM 220.127.116.11.2.4, Return for Failure to Provide Information. The return recommendation should include a thorough discussion on the reasons for returning the taxpayer's offer including the documents requested and why they are necessary to make the offer recommendation.
Prior to returning an offer because documents relating to the transferee/nominee/alter ego issue(s) are not submitted, review documents already provided by the taxpayer and consider if the existing information is sufficient to calculate the RCP. Document the valuation and reason for including any assets held by a nominee or alter ego, including the identification of any documents which substantiate the determination. If the value of the taxpayer's assets, other than transferred property, is greater than the offer amount, the offer should be recommended for rejection. If a rejection recommendation is made, the taxpayer’s failure to provide requested information and discussion of the transferee/nominee issues should be included in the closing narrative in the ICS history or AOIC remarks.
If the request for information is a request for verification of possible additional income and the offer has already been determined to be a full pay, proceed with rejection of the offer. If a rejection recommendation is made, the taxpayer’s failure to provide requested information and discussion of the transferee/nominee/alter ego issues should be included in the recommendation narrative.
It is not necessary to actually seek or obtain any specific legal remedy in order to address these issues in an offer. However, the offer file must be clearly documented with the basis for including the value of a transferred asset in the RCP. Care should be taken so that the determination to include assets held by others is reasonable. The case decision should be documented.
Use the amount listed on the Form 433-A (OIC) for the amount of cash in the taxpayer’s bank accounts. Reduce the total amount listed by $1,000.
Review checking account statements over a reasonable period of time, generally three months for wage earners and six months for taxpayers who are non wage earners.. Look for any unusual activity, such as deposits in excess of reported income, withdrawals, transfers, or checks for expenses not reflected on the CIS. The OE/OS should discuss any inconsistencies with the taxpayer.
(1) The taxpayer lists $10,000 on Form 433-A (OIC) The taxpayer’s allowable living expenses are $3,000. Include $6,000 ($10,000 less $1,000 less $3,000) as an asset value on the AET.
Review savings account statements over a reasonable period of time, generally three months.
If the account has little withdrawal activity, use the ending balance on the latest statement, less $1,000 if not previously applied to another account, as the asset value for the AET.
If it is apparent that the account is used for paying monthly living expenses, treat it as a checking account and follow the instructions in paragraphs (1) and (2) above to determine its value.
If analysis of the bank statement reveals large amounts of recently expended funds, IRM 18.104.22.168, Dissipation of Assets, for a full discussion of the treatment of dissipated assets.
If the taxpayer offers the balances of accounts (for example, certificate of deposit, savings bonds, etc.) to fund the offer, allow for any penalty for early withdrawal and the expected current year tax consequence.
Include any deposits made with the offer as an asset on the AET. Deposits are refundable, and must be considered an asset.
For funds on deposit with the OIC, allow as an encumbrance any amount borrowed if the monies must be repaid. Appropriate documentation must be provided.
Document AOIC or ICS with how the value of cash listed on the Asset/Equity Table was determined..
Do not include any TIPRA payments (lump sum or periodic) as a separate asset on the AET.
Payments in excess of any required TIPRA payment(s) are treated as a tax payment and will not be included on the AET, unless designated as a deposit by the taxpayer.
Financial securities are considered an asset and their value should be determined and included in the RCP when investigating an offer.
When the taxpayer will liquidate the investment to fund the offer, allow associated fees in addition to any penalty for early withdrawal and the current year tax consequence.
To determine the value of publicly traded stock, research a daily paper, other internal sources, or inquire with a broker for the current market price. Then, allow for the estimated costs of the sale to arrive at the QSV.
To determine the value of closely held stock that is either not traded publicly or for which there is no established market, consider the following methods of valuing the company and assign the applicable portion of the company's value to the taxpayer's stock or other interest:
Secure and verify a CIS.
Review recent year’s annual report to stockholders.
Review recent year’s corporate income tax returns.
Request an appraisal of the business as a going concern by a qualified and impartial appraiser.
When a taxpayer holds only a negligible or token interest, has made no investment and exercises no control over the corporate affairs, it is permissible to assign no value to the stock.
Additional considerations involving offers from closely held entities:
Compensation to Corporate Officers – Wages and/or other compensation, (i.e., draws) paid to corporate officers in excess of applicable expenses allowable per National and Local standards should generally not be allowed as business expenses. The OS should use judgment in determining whether the officer compensation is deemed excessive. The officer's ownership interest in the business and any control over the compensation received should also be a consideration.
Stock Holder Distributions and Repayment of Loans to Officers – These expenses are discretionary in nature. Distributions of this nature made after the incurrence of the tax delinquency should be evaluated under the dissipated asset provisions. Loans to officers should be considered an account receivable and valued according to their collectibility.
Stock Held by Beneficial Owner - The value of stock ownership in a closely held corporation/LLC should be included in the RCP of a taxpayer submitting an offer to compromise their individual liabilities. The value of the stock should not be excluded from RCP solely on the basis that an offer was also submitted by the closely held entity.
Identify the type, conditions for borrowing or cancellation, and the current loan and cash values.
Life insurance as an investment (e.g., whole life) is not considered necessary.
When determining the value in a taxpayer's insurance policy, consider:
If… Then… The taxpayer will retain or sell the policy to help fund the offer Equity is the cash surrender value. The taxpayer will borrow on the policy to help fund the offer Equity is the cash loan value less any prior policy loans or automatic premium loans required to keep the contract in force. See IRM 22.214.171.124, Conditional Expenses, for allowance of the payment.
Reasonable premiums for term life policies may be allowed as a necessary expense. Verify the amount of the premiums and ensure payments are being made.
Funds held in a retirement or profit sharing plan are considered an asset and must be valued for offer purposes.
Contributions to voluntary retirement plans are not a necessary expense. Review of the retirement plan document may be necessary to determine the taxpayer's benefits and options under the plan.
It may be necessary to secure a copy of the plan to determine the taxpayer’s vested interest and ability to borrow.
When determining the value of a taxpayer's pension and profit sharing plans consider:
If… And… Then… The account is an Individual Retirement Account (IRA), 401(k), or Keogh Account The taxpayer is not retired or close to retirement Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable. The account is an Individual Retirement Account (IRA), 401(k), or Keogh Account The taxpayer is retired or close to retirement
Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable.
The plan may be considered as income, if the income from the plan is required to provide for necessary living expenses.
The contribution to a retirement plan is required as a condition of employment The taxpayer is able to withdraw funds from the account Equity is the amount the taxpayer can withdraw less any tax consequences and early withdrawal penalty, if applicable. The contribution to an employer's plan is required as a condition of employment The taxpayer is unable to withdraw funds from the account but is permitted to borrow on the plan Equity is the available loan value. Any retirement plan that may not be borrowed on or liquidated until separation from employment The taxpayer is retired, eligible to retire, or close to retirement Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable,or consider the plan as income if the income from the plan is necessary to provide for necessary living expenses. The plan may not be borrowed on or liquidated until separation from employment and the taxpayer has no ability to access the funds within the terms of the offer The taxpayer is not eligible to retire until after the period for which we are calculating future income The plan has no equity. The plan includes a stock option The taxpayer is eligible to take the option Equity is the value of the stock at current market price less any expense to exercise the option.
The taxpayer's declared value of household goods is usually acceptable unless there are articles of extraordinary value, such as antiques, artwork, jewelry, or collector's items. Exercise discretion in determining whether the assets warrant personal inspection.
There is a statutory exemption from levy that applies to the taxpayer's furniture and personal effects. This exemption amount is updated on an annual basis.
When determining the value consider the following:
If… Then… The taxpayer qualifies as head of household, single, or married Grant a reduction in the value of personal effects for the levy exemption amount. The property is owned jointly with any person who is not liable for the tax Determine the value of the taxpayer's proportionate share of property before allowing the levy exemption. Some of the furniture or fixtures are used in a business They are not personal effects, but they may qualify for the levy exemption as tools of a trade. If the property has an encumbrance with priority over the NFTL Allow the encumbrance in addition to the statutory exemption.
Equity in motor vehicles, airplanes, and boats must be determined and included in the RCP. The general rule for determining NRE, as discussed in IRM 126.96.36.199.1, Net Realizable Equity, applies when determining equity in these assets. Unusual assets such as airplanes and boats may require an appraisal to determine FMV, unless the items can be located in a trade association guide. The case file should document how the values were determined.
It is not necessary to personally inspect automobiles used for personal transportation. When it appears reasonable, accept the taxpayers stated value. If the taxpayer failed to provide the value or the value appears to be unreasonable, consult a trade association guide. Generally, the Private Party or equivalent value should be used. In most cases, the vehicle will be discounted for the FMV to 80% to arrive at the QSV.
Exclude $3,450 per car from the QSV of vehicles owned by the taxpayer(s) and used for work, the production of income, and/or the welfare of the taxpayer’s family (two cars for joint taxpayers and one vehicle for a single taxpayer).
When these assets are used for business purposes, they may be considered income producing assets. See also, IRM 188.8.131.52, Income Producing Assets, for a full discussion on the treatment of income producing assets.
Verify types of ownership through warranty and mortgage deeds.
The FMV of the property must be established. FMV is defined as the price at which a willing seller will sell and a willing buyer will pay for the property, given time to obtain the best and highest possible price. When a question of value arises, a discussion with the taxpayer and/or representative may be necessary to establish an accurate value. In most instances, the following information, available through internal research, should be used to verify the FMV listed on the Form 433-A(OIC)/433-B(OIC) or provided by the taxpayer:
Real estate tax assessment.
Recent purchase price.
If internal research does not provide an accurate valuation, the OE/OS may request additional documentation including:
An existing contract to sell.
Homeowner’s insurance policy(s).
Once the FMV of real estate is established, a determination regarding a reduction of value for offer purposes must be made. Procedures outlining reduction to QSV are discussed in IRM 184.108.40.206.1, Net Realizable Equity.
Equity in real estate is included when calculating the taxpayer's RCP in an acceptable offer amount. See IRM 220.127.116.11, Income Producing Assets, relating to taxpayers whose sole business is real estate rental/leasing and/or development.
The OE/OS should document what methods were used in determining the value of the property and the reason for applying any value other then the QSV.
For real estate and other related property held as tenancies by the entirety when the tax is owed by only one spouse, the taxpayer's portion is usually 50% of the property's NRE.
Accounts and notes receivable are considered assets unless a determination is made to treat them as part of the income stream when they are required for the production of income. When it is determined that liquidation of a receivable would be detrimental to the continued operation of an otherwise profitable business, it may be treated as future income.
Accounts Receivable – Value all accounts receivable at 100% of the balance due, unless the taxpayer can substantiate the account has been delinquent over 90 days. Accounts receivable that are current (i.e. less than 90 days past due) generally should not be discounted at Quick Sale Value (QSV). If the account is determined to be delinquent it may be discounted appropriately based on the age of the receivable and the potential for collection. However, supporting documentation is required to substantiate accounts the taxpayer claims are delinquent over 90 days; such as a request for the taxpayer to provide an aging report. If the account is over 90 days and the taxpayer fails to provide substantiation, it will be valued at 100%.
To determine the value of accounts receivable:
When the receivables have been sold at a discount or pledged as collateral on a loan, apply the provisions of IRC 6323(c) to determine the lien priority of commercial transactions and financing agreements.
Closely examine accounts of significant value that the taxpayer is not attempting to collect, or that are receivable from officers, stockholders, or relatives.
To determine the value of a note receivable, consider the following:
Whether it is secured and if so by what asset(s),
What is collectible from the borrower, and
If it could be successfully levied upon.
When investigating the RCP for an offer that includes business assets, an analysis is necessary to determine if certain assets are essential for the production of income. When it has been identified that an asset or a portion of an asset is necessary for the production of income, it is appropriate to adjust the income or expense calculation for that taxpayer to account for the loss of income stream if the asset was either liquidated or used as collateral to secure a loan to fund the offer.
When valuing income-producing assets:
If… Then… There is no equity in the assets There is no adjustment necessary to the income stream. There is equity and no available income stream (i.e. profit) produced by those assets There is no adjustment necessary to the income stream. Consider including the equity in the asset in the RCP. There are both equity in assets that are determined to be necessary for the production of income and an available income stream produced by those assets
Compare the value of the income stream produced by the income producing asset(s) to the equity that is available.
Determine if an adjustment to income or expenses is appropriate.
An asset used in the production of income will be liquidated to help fund an offer Adjusting the income to account for the loss of the asset may be appropriate. A taxpayer borrows against an asset that is necessary for the production of income, and devotes the proceeds to the payment of the offer Allow the loan payment as an expense and consider the effect that loan will have on the future income stream.
As a general rule, equity in income producing assets will not be added to the RCP of a viable, ongoing business; unless it is determined the assets are not critical to business operations.
Even though rental property may produce income for the taxpayer, the equity should be included in RCP. An adjustment to the taxpayer's future income value may be appropriate, if the taxpayer will be borrowing against or selling the property to fund the offer.
The following examples provide some guidance in evaluating equity and income produced by assets:
(1) A business depends on a machine to manufacture parts and cannot operate without this machine. The equity is $100,000. The machine produces net income of $5,000 monthly. The RCP should include the income produced by the machine, but not the equity. Equity in this machine will generally not be included in the RCP because the machine is needed to produce the income, and is essential to the ability of the business to continue to operate.
It is in the government’s best interests to work with this taxpayer to maintain business operations, particularly in a bad economy.
(2) The same business in the prior example, but the business can continue to operate without the machine, i.e. the equipment is not used in the process of generating the key product of the business. The machine generates only $500 net monthly income. Consider including the equity in the RCP and remove $500 from the business income
(3) A trucking company has ten trucks. Eight are fully encumbered and two trucks have no encumbrances and $30,000 in equity. The two trucks combined generate net income of $12,000 per year. The net income from the trucks is included in the calculation of Future Income Value. The equity in the trucks should not be included in RCP.
(4) The same trucks described in the previous example generate only $1000 per year in net income, but have $30,000 in equity. If the business can successfully operate without the two trucks, consider removing the income from the RCP and including the equity in the RCP.
(5) A BMF in-business taxpayer owns real property with net equity of $50,000. The equity in the real property should be included in RCP, yet the taxpayer's net income should be adjusted for the loss of any rent/lease payments, or required loan payments.
(6). The property discussed in example (6) is leased and the taxpayer will borrow $40,000 against the equity to fund the offer. The property generates $1,500 of net income each month and the loan will require payments of $1,000 per month. In this instance, the OE/OS will include in the calculation of RCP, the $50,000 equity in the real property, plus the remaining $500 (after allowing for the loan repayment) per month for the number of months based on the terms of the offer.
Based on the taxpayer's specific circumstances, there may instances where the income producing assets in a Subchapter S corporation may be treated similar to assets owned by a taxpayer's sole proprietorship business.
Factors to consider include:
Type of business activity
Current income received from the corporation as salary and the amount of future income that the taxpayer will receive
Current income received from corporation as dividend
Ability of the taxpayer to sell their interest in the corporation.
A taxpayer operates a construction company, as a Sub S corporation, in which his wages from the corporation are $ 60,000 per year. The taxpayer's future income value of $12,000 is based on net income of $1000 per month for 12 months (cash offer). The taxpayer's interest in the corporate assets is equal to $20,000. It is determined all assets are required for the production of income by the corporation. Since the taxpayer shows a net income from the business, the exclusion of income producing assets may be appropriate in this instance.
When considering equity in income producing assets and the effect on income streams and expenses, you must exercise sound judgment consistent with the unique facts of each case.
Each case must be thoroughly documented regarding equity decisions in income producing property
Inventory, machinery, and equipment may be considered income producing assets. IRM 18.104.22.168, Income Producing Assets, when it is determined that liquidation of these assets would be detrimental to the continued operation of an otherwise profitable business.
To determine the value of business assets, use the following:
For assets commonly used in many businesses, such as automobiles and trucks, the value may be easily determined by consulting trade association guides.
For specialized machinery and equipment suitable for only certain applications, consult a trade association guide, secure an appraisal from a knowledgeable and impartial dealer, or contact the manufacturer.
When the property is unique or difficult to value and no other resource will meet the need, follow local procedure to request the services of an IRS valuation engineer.
Consider asking the taxpayer to secure an appraisal from a qualified business appraiser.
There is a statutory exemption from levy that applies to an individual taxpayer's tools used in a trade or business, which will be allowed in addition to any encumbrance that has priority over the NFTL. This exemption for tools of the trade generally does not apply to automobiles. The levy exemption amount is updated on an annual basis.
Evaluation of a business as a going concern is sometimes necessary when determining RCP of an operating business owned individually or by a corporation, partnership, or LLC. This analysis recognizes that a business may be worth more than the sum of its parts, when sold as a going concern.
To determine the value of a business as a going concern consider the value of assets, future income, and intangible assets such as:
Ability or reputation of a professional.
Established customer base.
Well known trade name, trademark, or telephone number.
Possession of government licenses, copyrights, or patents.
Generally, the difference between what an ongoing business would realize if sold on the open market as a going concern and the traditional RCP analysis is attributable to the value of these intangibles.
Request the assistance of an IRS valuation engineer when a difficult or complex valuation is necessary.
When determining the equity to include in RCP for an individual taxpayer who has an interest in a business entity, consideration should be given to the taxpayer's control over the business.
Generally, the value of a business as a going concern would not be included in RCP of a viable, ongoing business, unless the value is substantially greater than the income produced by the business.
The taxpayer operates a business which holds a liquor license which is transferable and valued at $100,000. The net income from the business is $1,000 per month. The value of the liquor license should be included in RCP, yet the taxpayer's net income should be adjusted and/or anticipated additional expenses allowed.
The justification for the value used should be clearly documented in the case history.
Inclusion of dissipated assets in the calculation of the reasonable collection potential (RCP) is no longer applicable, except in situations where it can be shown the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary, or other income) for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or within six months prior to the tax assessment.
Generally, a three year time frame will be used to determine if it is appropriate to include a dissipated asset in RCP. Include the year of submission as a complete year in the calculation.
If the offer is submitted in 2012, any asset dissipated prior to 2010 should not be included.
If the tax liability did not exist prior to the transfer or the transfer occurred prior to the taxable event giving rise to the tax liability, generally, a taxpayer cannot be said to have dissipated the assets in disregard of the outstanding tax liability.
If a taxpayer withdraws funds from an IRA to invest in a business opportunity but does not have any tax liability prior to the withdrawal, the funds were not dissipated.
If it is determined inclusion of a dissipated asset is appropriate and the taxpayer is unwilling or unable to include the value of the dissipated asset in the offer amount, the offer should be rejected as not in the government’s best interest. Although the offer is being rejected under not in the government's best interest criteria, a calculation of an acceptable offer amount based on the equity in assets, the value of future income, and the amount attributable to the dissipated asset(s) should be provided with the rejection recommendation.
Even if the transfer and/or sale took place more than three years prior to the offer submission, it may be appropriate to include the asset in the calculation of RCP if the asset transfer and/or sale occurred either within six months prior to or within six months after the assessment of the tax liability. If the transfer took place upon notice of or during an examination, these time frames may not apply based on the circumstances of the case. In any instance where the inclusion of a dissipated asset is being considered, a determination on whether the funds were used for health/welfare of the family or production of income would be appropriate
See below for examples of the types of situations where it may be appropriate to include, or not include, the value of an asset in the calculation of RCP. The examples provided are not meant to be all inclusive as each case must be evaluated on its own merit.
Examples of situations in which the value of an asset should be included in RCP include, but are not limited to:
Each of the examples in paragraph (5) occurred within three years prior to the offer submission or during the offer investigation, and the taxpayer dissipated the assets after incurring the tax liability, within six months prior to the tax assessment, during an examination, or after receiving notice of an examination.
(1) The taxpayer dissolved an IRA or other investment account to pay for specific non-priority items, i.e. child's wedding, child's university tuition, extravagant vacation, etc. .
(2) The taxpayer refinanced their house and used the funds to pay off credit card and non-secured debt. The credit cards were NOT used for payment of necessary living expenses and/or the production of income.
(3) The taxpayer inherited funds and used the funds for non-priority items (other than health/welfare of the family or production of income).
(4) The taxpayer closed bank/investment accounts and will not disclose how the funds were spent or if any funds remain.
(5) A taxpayer filed a CAP to avoid the filing of a NFTL and insisted the lien would impair his credit and his ability to successfully operate his business. After the non-filing was granted, the taxpayer fully encumbered his assets, used the funds for non-priority items (items not necessary for the production of income or the health and welfare of the taxpayer and/or their family) and then submitted an OIC.
Situations may occur in which the transfer happened over 3 years prior to the offer submission, yet because of the timing of the transfer (within six months prior to or six months after the tax assessment or after notification of an examination), the inclusion of the asset in RCP may be appropriate
The taxpayer filed tax returns for five years (2001 - 2005) in February of 2007, which were assessed in March 2007. In January of 2007, the taxpayer transferred real property to a family member for no consideration. An offer was submitted in January 2012. In this instance, since the transfer was within six months of the tax assessments, it may be appropriate to include the value of the real property in RCP.
The taxpayer received notification the IRS was beginning an audit of their 2008 tax return in January of 2010. The taxpayer transferred an investment account to a family member in February 2010. Additional tax liabilities based on the audit were assessed in March 2012. An offer was submitted in March 2013. In this instance, since the transfer took place after notification of the audit, it may be appropriate to include the value of the account in RCP.
Examples of situations in which the value of an asset should NOT be included in RCP, include but are not limited to: .
(1) When it can be shown through internal research or substantiation provided by the taxpayer that the funds were needed to provide for necessary living expenses, these amounts should not be included in the RCP calculation.
(2) Dissolving an IRA during unemployment or underemployment. Review of available internal sources verified the taxpayer’s income was insufficient to meet necessary living expenses. In this case, do not include the funds up to the amount needed to meet allowable expenses in the RCP calculation.
(3) Substantial amount withdrawn from bank accounts. Taxpayer provided supporting documentation that funds were used to pay for medical or other necessary living expenses. This amount will not be included in the RCP calculation
Prior to including the dissipated asset in the RCP, the taxpayer should be contacted (preferably by telephone) and afforded the opportunity to explain or verify the dissipation of the asset.
The case history must be clearly documented with the basis for your decision regarding the dissipated asset.
Retired debt is an expected change in necessary or allowable expenses. The necessary/allowable expenses may decrease, which would change the taxpayer’s ability to pay.
Inclusion of retired debt should not be automatically included in the calculation of the RCP. The OE/OS should use judgment in determining whether inclusion of the retired debt is appropriate based on the facts of the case; such as special circumstances or ETA situations.
Do not retire the first $400 of a loan payment on a vehicle (Limited to one vehicle for a single taxpayer and two vehicles for a joint offer).
The case histories must be documented to support the inclusion or exclusion of the retired debt.
Future income is defined as an estimate of the taxpayer's ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. IRM 22.214.171.124, Calculation of Future Income, table for calculation.
As a general rule, the taxpayer’s current income should be used in the analysis of future ability to pay.
Consideration should be given to the taxpayer's overall general situation including such facts as age, health, marital status, number and age of dependents, level of education or occupational training, and work experience.
Situations that may warrant placing a different value on future income than current or past income indicates are discussed in the table below. Additionally, securing a future income collateral agreement based on the taxpayer’s earnings potential may be appropriate and are discussed in more detail in IRM 126.96.36.199, Future Income Collateral Agreements, and IRM 5.8.6, Collateral Agreements.
If… Then… Income will increase or decrease or current necessary expenses will increase or decrease Adjust the amount or number of payments to what is expected during the appropriate number of months. A taxpayer is temporarily or recently unemployed or underemployed Use the level of income expected if the taxpayer were fully employed and if the potential for employment is apparent. Each case should be judged on its own merit, including consideration of special circumstances or ETA issues.
Unemployed – The taxpayer is a construction worker who currently is not employed due to lack of work during the winter months. Since this loss of employment during the winter is normal for the taxpayer, use the taxpayer’s previous annual income or you may use income averaging to accurately determine the taxpayer’s income.
Underemployed – The taxpayer is a teacher and is currently employed at a lesser paying job, yet will begin or return to work as a teacher when the school year begins in the fall, the taxpayer is considered to be currently underemployed. Use the anticipated income once the taxpayer is fully employed.
A taxpayer is unemployed and is not expected to return to their previous occupation or previous level of earnings Contact the taxpayer to discuss the expected future level of income. When considering future income, also allow anticipated increases in necessary living expenses and/or applicable taxes. A taxpayer is long-term unemployed Do not income average. The taxpayer’s current income should be used in the future income calculation. If there is a verified expectation the taxpayer will be securing employment then the use of anticipated future income may be appropriate. Anticipated future income should not be used in situations where the future employment is uncertain. A taxpayer is long-term underemployed Do not income average. Use the taxpayer’s current income.
The taxpayer was previously employed in a manufacturer plant making $75,000 per year. There are currently no opportunities for the taxpayer to secure employment making the same rate of pay as their prior job. Their income is now $25,000 per year with no anticipated increase. Use the current income only.
A taxpayer has an irregular employment history or fluctuating income Average earnings over the three prior years. The use of a time period other than three years should be the exception and only when specific circumstances are present.
The taxpayer is a stock broker whose income in 2011 was $150,000 and income in 2012 was $25,000. In this case, you should consider income averaging the prior three years or secure a future income collateral agreement if the offer is accepted.
A taxpayer is in poor health and their ability to continue working is questionable Reduce the number of payments to the appropriate number of months it is anticipated the taxpayer will continue working. Consider special circumstance situations when making any adjustments. A taxpayer is close to retirement and has indicated they will be retiring If the taxpayer can substantiate retirement is imminent, adjust the taxpayer’s future earnings and expenses accordingly. If it cannot be substantiated, base the calculation on current earnings. At this point, it may be appropriate to discuss other options available to the taxpayer, for example an installment agreement.
(1) The taxpayer is 65 years of age and has indicated they will retire at the age of 66. They provide copies of documents that have been submitted to their employer discussing their retirement date. Use the taxpayer’s current income until the taxpayer’s anticipated retirement date, then adjust the taxpayer’s income to reflect the amount expected in retirement.
(2) The taxpayer is 62 years of age, the taxpayer is in good health, and their income has remained stable for the past three years. The taxpayer states they would like to retire at age 65. Use the taxpayer’s current income and if the RCP exceeds the offer amount, discuss the option of securing an installment agreement until the taxpayer actually retires, at which time an offer may be appropriate.
A taxpayer will file a petition for liquidating bankruptcy Consider reducing the value of future income. The total value of future income should not be reduced to an amount less than what could be paid toward non-dischargeable periods, or what could be recovered through bankruptcy, whichever is greater. When considering a reduction in future income, also consider the intangible value to the taxpayer of avoiding bankruptcy. Refer to IRM 188.8.131.52, Bankruptcy.
Judgment should be used in determining the appropriate time to apply income averaging on a case by case basis. All circumstances of the taxpayer should be considered when determining the appropriate application of income averaging, including special circumstances and ETA considerations. Below are some examples of when income averaging may not be appropriate.
(1) Taxpayer’s spouse has not worked for over two and one-half years and has no expectations of returning to work. Do not average income for the spouse's past employment.
(2) Taxpayer has been unemployed for over one year and provided proof that Social Security Disability is the sole source of income. Do not apply income averaging in this case but use current income to determine the taxpayer’s future ability to pay.
(3) The taxpayer was incarcerated and may have been involved in the transfer of assets. If the OE/OS is unable to complete a thorough asset investigation, consideration should be given whether it would be in the best interest of the government to reject the offer and reassign the case to the field for a determination on any hidden assets.
In situations where the taxpayer’s income does not appear to meet their stated living expenses the difference should not be included as additional income to the taxpayer, unless there are clear indications additional income not included on the collection information statement is being received and will continue to be received by the taxpayer. Discussion with the taxpayer/POA and a review of documents submitted by the taxpayer must take place to determine how the taxpayer is paying current expenses and the appropriateness of including an additional amount in the calculation of future income. Verification of the source of unexplained bank deposits or statements from the source of gifts may be required to correctly determine the taxpayer’s current income. Telephone contact is recommended to expedite the case processing.
(1) The taxpayer has been receiving gifts from their parents to meet current living expenses for the past six months. The taxpayer has no guaranteed right to the funds in the future and the amount does not appear to be based on the transfer of assets to the parents. The gift amount should not be included as income.
(2) The taxpayer has been receiving an amount each month that only began recently, which they state is a gift from a friend. Further research has determined the taxpayer is in business with the friend and the amount is from their business. This amount should be included as income to the taxpayer. Additionally, consideration should be given to referring the taxpayer and the business income tax return to Examination.
(3) The taxpayer had gambling winnings over a period of time, but is not consistent. Do not include those winnings as additional income on the IET. This does not apply to professional gamblers.
(4) The collection information statement (CIS) submitted by the taxpayer included $3.000.00 of monthly income, which is verified by paystubs. The CIS submitted by the taxpayer includes $4,000.00 of expenses. An additional $1,000.00 should not be added to the taxpayer’s income based solely on the fact it appears the taxpayer has been meeting the living expenses included on the CIS. Discussion with the taxpayer or representative is necessary to clarify the discrepancy prior to including the amount as additional income.
Employees need to exercise good judgment when determining future income. The history must be clearly documented and support the known facts and circumstances of the case and include analysis of the supporting documents. Each case needs to be evaluated on its own particular set of facts and circumstances. The history must clearly explain the reasoning behind our actions.
In some instances, it may be difficult to calculate the taxpayer’s anticipated income. While the use of income averaging is one method available to calculate future earnings it may also be appropriate to use the taxpayer’s current income and secure a future income collateral agreement. The use of a future income collateral agreement will protect the government’s interest in any substantial increase in the taxpayer’s earnings.
A future income collateral agreement is most appropriate in situations where the taxpayer’s future income is uncertain, but it is reasonably expected that the taxpayer will be receiving a substantial increase in income.
A future income collateral agreement should not be used to accept an offer for a lesser amount than the calculated RCP. See IRM 184.108.40.206.1.1, Form 2261/2261-A Completion, for instructions on completing future income collateral agreements.
(1) A taxpayer is currently in medical school; upon graduation income should increase dramatically. Consider securing a future income collateral agreement.
(2) A taxpayer recently secured a job as an attorney with a starting salary of $80,000 per year, with potential for significant increases in salary. Consider securing a future income collateral agreement.
(3) A taxpayer is a real estate agent who has had two years of high income and the current income is significantly diminished. Based on the current real estate market, it may be appropriate to use the taxpayer’s current income and secure a future income collateral agreement in lieu of income averaging.
(4) A taxpayer’s RCP is $12,000 but has offered $10,000 plus a future income collateral agreement. A future income collateral agreement is not appropriate in lieu of the taxpayer increasing their offer to the RCP amount. If the taxpayer is not willing to increase their offer to the RCP amount, the offer should be rejected.
Allowable expenses consist of necessary and conditional expenses, as defined in IRM 5.15.1, Financial Analysis Handbook, and further discussed below. Use the amount shown in the expense standard schedules unless that amount would result in the taxpayer not having adequate means to provide for basic living expenses. Once allowable expenses are determined, they are used to calculate the amount that can be collected from the taxpayer's future income. See IRM 220.127.116.11, Future Income, for additional information on future income.
A necessary expense is one that is necessary for the production of income or for the health and welfare of the taxpayer's family. IRM 5.15.1, Financial Analysis Handbook, discusses the national and local expense standards, which serve as guidelines to provide accuracy and consistency in determining a taxpayer's basic living expenses. The standards are available on the IRS web site and are periodically updated.
Taxpayers are allowed the National Standard Expense amount for their family size, without questioning the amount actually spent. If the total amount claimed is more than the total allowed by the National Standards, the taxpayer must provide documentation to substantiate and justify that the allowed expenses are inadequate to provide basic living expenses. All deviations from the national standards must be verified, reasonable and documented in the case history.
National and local expense standards are guidelines. If it is determined a standard amount is inadequate to provide for a specific taxpayer’s basic living expenses, allow a deviation. Require the taxpayer to provide reasonable substantiation and document the case file.
National Standard Expense amount is $1,100. The taxpayer’s actual expenditures are: housekeeping supplies - $100, clothing - $100, food - $700, personal care products - $100, and miscellaneous - $200 (Total Expenses - $1,200). The taxpayer is allowed the national standard amount of $1,100, unless the higher amount is justified as necessary. In this example the taxpayer has claimed a higher food expense than allowed. Justification would be based on prescribed or required dietary needs. The taxpayer must substantiate and verify only the food expense. The taxpayer is not required to verify expenses for all five categories if a higher expense is claimed for one category. The standard amounts will be allowed for the remaining categories.
The taxpayer is living in a home with a $2,250 monthly housing expense, including utilities. The present fair market value of the house is approximately equal to the mortgage balance. The local standard allowance is $1,800 per month. If the taxpayer remains in his home, income and expenses are approximately equal, leaving no disposable income in the calculation of future income value. If the taxpayer is unable to restructure their mortgage payment and the equity in the property is insufficient to pay the costs of selling their current home, related moving expenses, and purchasing or renting a new home that would allow for monthly payments within the national standard, the taxpayer may be allowed a housing amount that exceeds the standard.
See IRM 18.104.22.168, Allowable Expense Overview.
Generally, the total number of persons allowed for national standard expenses should be the same as those allowed as dependents on the taxpayer's current year income tax return. There may be reasonable exceptions. Fully document the reasons for any exceptions.
A deviation from the standards should not be considered merely because it is inconvenient for the taxpayer to dispose of high value assets. In some situations, taxpayer's may be expected to make life-style choices that will facilitate collection of the delinquent tax.
When determining a taxpayer’s housing and utility expense, use an amount sufficient to provide for basic living expenses. Use the amount shown in the expense standard schedules as a guideline unless such use results in the taxpayer not having adequate means to provide for basic living expenses. If it is determined that a standard amount is inadequate to provide for a basic living expenses, allow a deviation. If the amount of the payment cannot be verified through other sources (such as, bank statements), require the taxpayer to provide reasonable substantiation. Deviations from the expense standards must be verified, reasonable, and documented in the case history. Below are two examples, which are not all inclusive. Each decision should be based on the merits of the particular case.
A taxpayer with a physical disability or an unusually large family requires a housing cost that is not covered by the local standard. Require the taxpayer to provide copies of mortgage or rent payments, utility bills and maintenance costs to verify the necessary amount.
A taxpayer has owned their home for several years and the payment is above the established standard. Your investigation indicates the taxpayer would not be able to rent an apartment for less than their current loan payment. In that case, you should consider allowing the full amount of the loan payment. Document the case history.
Absent special circumstances, when determining a taxpayer’s housing and utility expense, use the amount that is claimed or the standard, whichever is less.
Transportation expenses are considered necessary when they are used by taxpayers and their families to provide for their health and welfare and/or the production of income. Employees investigating OICs are expected to exercise appropriate judgment in determining whether claimed transportation expenses meet these standards. Expenses that appear excessive should be questioned and, in appropriate situations, disallowed.
The transportation standards consist of nationwide figures for loan or lease payments referred to as ownership costs and additional amounts for operating costs broken down by Census Region and Metropolitan Statistical Area. Operating costs include maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking and tolls.
Ownership Expenses – Expenses are allowed for purchase or lease of a vehicle. Taxpayers will be allowed the local standard or the amount actually paid, whichever is less, unless the taxpayer provides documentation to verify and substantiate that the higher expenses are necessary. IRM 22.214.171.124, Retired Debt, for a discussion on situations when the vehicle loan or lease will be paid off during the period of time future income is calculated.
Operating Expenses – Allow the full operating costs portion of the local transportation standard, or the amount actually claimed by the taxpayer, whichever is less. Substantiation for this allowance is not required unless the amount claimed is more than the total allowed by any of the transportation standards.
If a taxpayer claims higher amounts of operating costs because he commutes long distances to reach his place of employment, he may be allowed greater than the standard. The additional operating expense would generally meet the production of income test and therefore be allowed if the taxpayer provides substantiation.
In situations where the taxpayer has a vehicle that is currently over six years old or has reported mileage of 75,000 miles or more, an additional monthly operating expense of $200 will generally be allowed per vehicle (up to two vehicles when a joint offer is submitted).
All deviations from the transportation standards must be verified, reasonable and documented in the case history.
Other expenses may be allowed in determining the value of future income for offer purposes. The expense must meet the necessary expense test by providing for the health and welfare of the taxpayer and/or his or her family or must be for the production of income. This is determined based on the facts and circumstances of each case.
Repayment of loans incurred to fund the offer and secured by the taxpayer's assets will be allowed, if the asset is necessary for the health and welfare of the taxpayer and/or their family, i.e. taxpayer’s residence, and the repayment amount is reasonable. The same rule applies whether the equity is paid to IRS before the offer is submitted or will be paid upon acceptance of the offer. IRM 126.96.36.199, Income-Producing Assets, to determine when to allow repayment of loans on those type of assets if they are used to fund the offer.
(1) The taxpayer has secured a 2nd mortgage against their residence which will be paid toward the offer amount upon acceptance. The payment is reasonable based on the amount borrowed and terms of repayment. The payment should be allowed as an expense on the Income/Expense Table.
Minimum payments on student loans guaranteed by the federal government will be allowed for the taxpayer’s post-high school education. Proof of payment must be provided. If student loans are owed, but no payments are being made, do not allow them, unless the non-payment is due to circumstances of financial hardship, e.g. unemployment, medical expenses, etc.
Education expenses will be allowed only for the taxpayer and only if it they are required as a condition of present employment. Expenses for dependents to attend colleges, universities, or private schools will not be allowed unless the dependents have special needs that cannot be met by public schools.
Child support payments for natural children or legally adopted dependents may be allowed based on the taxpayer's situation. A copy of the court order and proof of payments should be provided. If no payments are being made, do not allow the expense, unless the nonpayment was due to temporary job loss or illness.
In situations where a court order is pending, additional verification may be required. For example, a draft or copy of the court order may be requested.
The taxpayers are separated and a court date has not been established but child support payments are being made and the taxpayer provided verification of payments.
Do not allow payments for expenses, such as college tuition or life insurance for children, made pursuant to a court order. The fact that the taxpayer may be under court order to make payments with respect to such expenses does not change the character of the expense. Therefore, that the taxpayer is under court order to provide a payment should not in the ordinary course elevate that expense to allowable status as an offer expense, when the Service would not otherwise allow it.
Substantiation of claimed health care expenses of less than the allowable standard is not required.
When a taxpayer owes both delinquent federal and state or local taxes, and does not have the ability to full pay the liabilities, monthly payments to state taxing authorities will be allowed in certain circumstances.
State or local liens may enjoy a priority in fixed payment streams such as annuity payments. If necessary, consult with Area Counsel to determine lien priorities.
Determine the disposable income on a Collection Information Statement (CIS), Forms 433-A (OIC) or 433-B (OIC). Do not include any amount that is being paid for outstanding state or local tax liabilities in the calculation of the future income value component (FIV) of the reasonable collection potential (RCP). FIV is the difference between gross income and allowable living expenses.
Calculate the dollar amounts for IRS and state or local payments based on the total liability owed to each agency (including penalties and interest to date).
The taxpayer owes the state $20,000 and owes the IRS $100,000, a total of $120,000 ($20,000/$120,000 = 17%; $100,000/$120,000 = 83%). The taxpayer has disposable income of $300 per month. A monthly payment to the State Taxing Authority of $51 may be allowed until the debt is retired. See the If/Then table below for examples.
Seventeen percent (17%) of $300 = $51
Eighty-three percent (83%) of $300 = $249
To determine allowable payments for delinquent state or local tax debts follow the procedures below:
If... And... Then... (1) The taxpayer does not have an existing agreement for payment of the delinquent state or local tax debts, Provides a complete CIS and verification of state or local tax debts, Follow procedures in paragraph (a) above to establish the calculated percentage amount that will be determined as the allowable monthly payment for delinquent state or local taxes. (2) The taxpayer has an existing agreement for delinquent state or local tax debts, which was established after the earliest IRS date of assessment, The payment amount on the state or local agreement is less than the calculated percentage amount, The monthly amount due on the existing state or local agreement will be listed as the allowable delinquent state or local tax payment. Example: The calculation based on the example in paragraph (a) above shows the taxpayer should pay $51 but the State agreement is for $50. Allow the State agreed payment of $50. The payment to IRS will be increased by the amount allowed for the monthly state or local payment when the state or local liability is scheduled to be full paid. (3) The taxpayer has an existing agreement for delinquent state or local tax debts, which was established after the earliest IRS date of assessment, The payment amount on the agreement is more than the calculated percentage amount, The amount allowed as the delinquent state or local tax payment will be the calculated percentage amount. Advise the taxpayer that he/she can use the amount IRS allows for Miscellaneous expenses under National Standards to pay the additional amount due for the delinquent state or local tax payment. Example: The calculation based on the example in paragraph (a) above shows the taxpayer should pay $51 but the State agreement is for $52. Allow the calculated payment of $51. The payment to IRS will be increased by the amount allowed for the monthly state or local payment when the state or local liability is scheduled to be full paid (4) The taxpayer has an existing agreement for delinquent state or local tax debts, which was established prior to the IRS earliest date of assessment The payment is not greater than the taxpayer’s net disposable income Allow the state or local tax agreement.
Generally, charitable contributions are not allowed in the RCP calculation. However, charitable contributions may be an allowable expense if they are a condition of employment or meet the necessary expense test.
Payments being made to fund or repay loans from voluntary retirement plans will not be allowed. Taxpayers who cannot repay these loans will have a tax consequence in the year that the loan is declared in default and that consequence should be estimated and allowed as an additional tax expense on the IET for the required number of months necessary to cover the additional tax consequence. The OE/OS should request the taxpayer or their representative to estimate the tax ramification of the failure to re-pay the loan, or may request assistance from the Examination function or Customer Service to determine the tax consequences.
Current taxes are allowed regardless of whether the taxpayer made them in the past or not. If an adjustment to the taxpayer’s income is made, an adjustment of the tax liability must also be made. Current taxes include federal, state, and local taxes. In a wage earner situation, allow the amount shown on the pay stub. If the current withholding amount is insufficient, the tax expenses should be based on the actual tax expense.
Offers may be received where the taxpayers have not provided either proof of payment for certain monthly expenses claimed on the Form 433-A(OIC)or statements. Often the taxpayers are not actually paying claimed expenses, or they are not allowable under offer program guidelines. If a taxpayer does not substantiate claimed expenses for Form 433-A(OIC) categories of court ordered payments, child/dependent care, life insurance, other secured debt, or other expenses the OE/OS will complete the IET assuming that the taxpayer is not making any payments for the particular unsubstantiated expense.
(1) Taxpayers frequently list their unsecured credit card bills under secured debt or other expenses. Since the miscellaneous allowance in the National Standard expense includes credit card payments, these will not be considered as an additional allowable monthly expense.
Conditional expenses are defined in IRM 5.15.1, Financial Analysis Handbook, as those that may be allowed when the tax will be paid in full by an installment agreement within 6 years. For offer purposes, the full amount of the tax will not be collected, therefore, the rules for conditional expenses do not apply. However, an offer may be accepted for less than the RCP when special circumstances are present in accordance with IRM 5.8.11, Effective Tax Administration.
The one year rule which allows time for a taxpayer to adjust current expenses to meet the terms of an installment agreement is not allowed for Offers in Compromise.
The purchase of discretionary investments is not allowed in the calculation of the RCP.
Generally, a taxpayer will be allowed only the expenses the taxpayer is required to pay. Consideration must be given to situations where the taxpayer shares expenses with another. Shared expenses may exist in one of two situations:
An offer is submitted by a taxpayer who shares living expenses with another individual who is not liable for the tax.
Separate offers are submitted by two or more persons who owe joint liabilities and/or separate liabilities and who share the same household.
Generally, the assets and income of a not liable person are excluded from the computation of the taxpayer’s ability to pay. Treasury Reg. 301.7122-1 (c) (2) (ii) (A) only applies in not liable and does not apply in partially liable situations.
Related offers including both joint and separate liabilities. The amount of both offers should equal the total amount collectable from the shared household. IRM 188.8.131.52, Jointly Held Assets, provides that the equity in jointly owned assets should be applied first to the joint liabilities and then to the separate liabilities.
Below are some examples of joint and separate liabilities.
Community property states. Follow community property laws in these states to determine what assets and income of the non-liable person are subject to the collection of tax. See IRM 25.18, Community Property.
Domestic partnership states. Follow domestic partnership laws in these states to determine what assets and income of the non-liable person are subject to the collection of tax.
If... Then... A joint offer was submitted on joint tax liabilities and a separate offer was also submitted by one spouse with a separate tax liability or separate offers are submitted by joint taxpayers Compute the RCP including the joint income and assets. Allocate the total collection potential to both offers. If the offer is to be accepted, it may be necessary to secure amended Form(s) 656 from the taxpayers reflecting the proportionate amount of the RCP on the joint liability(s) and the remaining amount RCP on the separate liability(s). The total offer amount must exceed the total RCP. A separate offer is submitted by only one taxpayer who owes joint liabilities Compute the RCP based on the taxpayer's separate income and assets using the allocations described in IRM 184.108.40.206, Jointly Held Assets, taking into consideration community property laws, if applicable. A joint offer was submitted from taxpayers residing in separate households Compute two separate RCPs based on their separate income(s) and expenses. If the combined RCP is less than the offer amount, proceed with acceptance.
If the combined RCP is greater than the offer amount or additional information/documentation is needed, contact the taxpayers individually to discuss the RCP based on his or her individual financial analysis, preferably by telephone. Advise him or her that the RCP is based on their individual income and assets and they should discuss the outcome with the related party to determine if an increase in their joint offer amount will be submitted. If they agree to submit a joint offer that is greater than their total individual RCPs secure an addendum to revise the offer amount.
The OE/OS should secure sufficient information concerning the non-liable person’s assets and income to determine the taxpayer’s proportionate share of the total household income and expenses. Review the entire household's information and:
Determine the total actual household income.
Determine what percentage of the total household income the taxpayer contributes.
Determine allowable expense amounts using the rules in this chapter and IRM 5.15.1, Financial Analysis Handbook.
Determine which expenses the taxpayer and others have agreed to share, e.g., taxpayer and non-liable spouse pay their expenses from joint checking account. If there is no agreement, then the expense isn't shared, as is typical for child support, allowable educational loan, or union dues.
Apply the taxpayer's percentage of income to the shared expenses.
Verify that the taxpayer actually contributes at least this amount to the total household expense. National Standard expenses do not require verification unless the taxpayer claims more than the standard amount.
Do not allow the taxpayer any amount paid toward the non-liable person's discretionary expenses.
Shared expense calculations between spouses are used when the parties live in a separate property state or state law permits the parties to separate their incomes and the non-liable spouse does not agree to have their income considered in the repayment of the liable spouse’s tax debt (IRM 220.127.116.11(2)). If the non-liable spouse does not agree to have their income considered in the repayment amount, determine the income percentages as stated in paragraph (4).
After determining the percentage of income of the liable taxpayer, that percentage is multiplied against the ALE standard amounts for the household (IRM 18.104.22.168(4)). If the taxpayer’s calculated percentage amount for National Standards for Food, Clothing and Other Items and for Out-of-Pocket Health Care Costs, is less than the standard amount for one person, the liable taxpayer will be allowed the standard amount. For the other ALE expenses (Transportation and Housing/Utilities), the liable taxpayer will be allowed the calculated percentage amount or the standard amount, whichever is less. Consideration should also be given to any separate expenses the liable taxpayer may be solely responsible for paying, such as alimony, child care, etc.
If the non-liable person’s income is not provided or cannot be verified internally, the liable taxpayer should be allowed only the national and local standards for 1 person plus any allowable and verifiable dependents. In those cases where the non-liable person refuses to provide the supporting documentation (if the expenses are reasonable) you may consider allowing up to 50% of the additional necessary household expenses.
If an in-house verification is conducted on the not liable person, this information cannot be relayed to the taxpayer. This is not an Unauthorized Access (UNAX) violation but would be considered an unauthorized disclosure if any information is shared with the taxpayer.
When the taxpayer can provide documentation that income is not mingled (as in the case of roommates who share housing) and responsibility for household expenses are divided equitably between co-habitants (as documented by rental agreements, bank statement analysis, etc.), the total allowable expenses should not exceed the total allowable housing standard for the taxpayer.
In this situation, it would not be necessary to obtain the income information of the other person(s). However, sufficient financial information must be secured to verify the total household expenses and prove that the taxpayer is paying his/her proportionate share. The investigating employees should exercise sound judgment in these situations to determine which approach is most appropriate, based on the facts of each case.
When the taxpayer is renting an apartment or room and the owner of the property is not the taxpayer, the rental agreement or signed statement from the owner of the property should support the decision not to require the owner to divulge any personal information regarding income or household expenses. In this case, the investigating employee should accept the information provided by the taxpayer and make a determination based on that information.
The use of Decision Point or Decision IA is recommended to assist in this calculation. If Decision Point or Decision IA is not available, the below procedures should be followed.
Future income is defined as an estimate of the taxpayer's ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. The number of months used depends on the payment terms of the offer.
If... Then... The offer will be paid in 5 months or less and 5 or fewer payments Use the realizable value of assets plus the amount that could be collected in 12 months. The offer is payable in six to 24 months Use the realizable value of assets plus the amount that could be collected in 24 months.
Generally, the amount to be collected from future income is calculated by taking the projected gross monthly income, less allowable expenses, and multiplying the difference by the number of months applicable to the terms of offer.
For lump sum cash and periodic payment offers, when there are less than 12 or 24 months remaining on the statutory period for collection, use the number of months remaining on the statutory period for collection.
The 16 year limitation from the date of assessment discussed in IRM 22.214.171.124, Case Actions That Can Suspend And/Or Extend A CSED, should also be taken into consideration in the calculation of the taxpayer’s Future Income Value (FIV) as discussed in IRM 126.96.36.199, Calculation of Future Income. These provisions only apply to taxpayers who are cooperative. In situations where the taxpayer is uncooperative, an offer in compromise is not an appropriate case resolution.
If the number of months remaining until the 16 year limitation period is less than the 12 or 24 month factor in certain cash or periodic payment offers, then the number of months remaining until the 16 year limitation period should be used in the FIV calculation. The 16 year limitation period should also be used as the factor in Periodic Payment offer situations where the taxpayer has returned from outside the country and the CSED calculation in accordance with IRC 6503(c) is longer than 16 years.
The value of future income when a taxpayer is involved in the cultivation and sale of marijuana, in accordance with applicable state laws, should be based on the following guidance:
Determine the taxpayer's gross income over a specific time period (normally annually);
Limit allowable expenses consistent with Internal Revenue Code Section 280E, where a taxpayer may not deduct any amount for a trade or business where the trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances;
Only expenses which are allowable on the taxpayer's income tax return based on current federal law will be included in determining future income value.
Contact the Examination Division, if appropriate, for assistance in determining if the cost of the product or any related expenses, may be allowable under current examination guidelines;
Collection from a LLC involves unique issues especially when the liabilities include employment or excise taxes. Refer to IRM 5.1.21, Collecting from Limited Liability Companies (LLC) for a complete discussion on the characteristics of a LLC and issues involving collection of liabilities owed by the LLC.
While investigating an offer in compromise that involves an LLC, knowing the classification for federal tax purposes in necessary. Yet, classification of the LLC for federal tax purposes does not negate state law provisions concerning the legal status of the LLC. For example:
Classification of an LLC as a partnership does not mean the member/owners have liability for LLC debts as would be the case in a state law partnership.
Under certain circumstances, an LLC may be disregarded as an entity separate from its owner. This classification does not mean that an LLC owned by an individual is the equivalent of a sole proprietorship.
As with any entity, sufficient information must be secured so an informed decision can be made on the acceptability of the taxpayer’s compromise proposal.
In all instances, a financial statement will be required from the LLC. This includes employment tax liabilities for wages paid prior to January 1, 2009, where the classification of the LLC is a disregarded entity even though the LLC is not the liable taxpayer.
Financial information of all member owners should also be secured. When a member owner holds only a negligible or token interest, has made no or minimal investment and exercises no control over the corporate affairs, financial information may not be required unless other factors are present to indicate the information is necessary to determine the acceptability of the taxpayer’s offer. Judgment relative to the information required from the member owners should be exercised in situations where a transfer of assets/interest may have taken place.
If the taxpayer is unwilling or unable to provide the financial information requested and the information is necessary to determine whether the taxpayer’s offer should be accepted, consider a return as discussed in IRM 5.8.7, Return, Terminate, Withdraw, and Reject Processing.
Taxpayers that previously extended the CSED in connection with an installment agreement may request approval of an OIC. In accordance with IRM 188.8.131.52 Doubt as to Collectibility, an offer should not be accepted if the liability can be fully paid under current installment agreement guidelines.
On March 24, 1998, the Service issued procedures that limited the length of CSED extensions. See IRM 5.14.2, Partial Payment Installment Agreements and the Collection Statute Expiration Date (CSED), for further instruction on the policy of the Service.
In situations where the extension was granted prior to October 18, 1999, a determination as to whether the taxpayer can fully pay based on the current collection statute is not required.
Payment terms are negotiable, but should provide for payment of the offered amount in the least time possible. If a taxpayer is planning to sell asset(s) to fund all or a portion of the offer, the payment terms for the offer should provide for immediate payment of the amounts received from the sale. If the taxpayer is planning to borrow a portion of the money, the OE/OS should determine when the loan will be received and the payment terms of the offer should provide for payment of the borrowed portion at the time the funds are received.
For those taxpayers who agree to shorter payment terms, fewer months of future income are required:
Payment Type Payment Terms Number of Months Future Income Required Lump Sum Cash 5 or less installments within 5 months 12 months or the remaining statutory period, whichever is less Periodic Payment Within 6 to 24 months 24 months or the remaining statutory period, whichever is less
While a periodic payment offer is being evaluated by the Service, the taxpayer must make subsequent proposed installment payments as they become due. There is no requirement that the payments be made monthly or in equal amounts. However, the Service is not bound by either the offer amount or the terms. While the calculation of RCP and consideration of any special circumstances will assist in determining an acceptable offer amount, in situations where the OE/OS determines that the proposed offer payment terms are too protracted to recommend acceptance, the OE/OS should discuss with the taxpayer what may be appropriate payment terms based on the taxpayer's circumstances.
(1) Acceptable Payment Terms for a Periodic Payment Offer – A taxpayer submits an offer for $10,000. The IRS received date is January 1, 2011. The taxpayer's offer of $10,000 was accepted in November 2011, and the taxpayer remained current on all required payments during the investigation. During the investigation, the taxpayer paid $500. The taxpayer has 24 months from the date of submission to complete the terms of the offer. The terms of the offer were $100 every other month for a total of 23 months and the balance would be due on the 24th month. On the 24th month, January 2013, the taxpayer would then be required to pay the balance of $8,300 ($10,000 less $1,700 [$1,200 in installments plus $500 in installments paid during the investigation]). No adjustments to the terms would be required.
A third party source of funds may be required to make the portion of the monthly payment that is greater than we determined the taxpayer can afford from future income. Document the case history with source of the funds, if relevant to the case decision.
For example the taxpayer accrued the following liability:
The offer was determined processable on May 31, 2013. The taxpayer has no equity in assets and can pay $300 per month.
|MFT–Period||Months on the statute||Installments Due||Installments Applied|
The amount collectible from future income is $300 times 20 months = $6,000.
For example the taxpayer accrued the following liability:
The offer was determined processable on May 31, 2012. The taxpayer has $30,000 equity in assets which he will pay within 90 calendar days and can pay $300 per month which he will begin paying within 30 calendar days.
|MFT–Period||Months on the statute||Installments Due||Installments Applied|
After applying the $30,000 payment for the equity in assets, the amount collectible from future income is $300 times 24 months = $7,200 Reasonable collection potential is $37,200