How Much Should I Offer the IRS?
One of the hardest parts of submitting an offer in compromise is figuring out how much to offer. You obviously want to pay as little as possible to the IRS in order to settle your tax debt, but you also don’t want to low-ball and ruin your chances for acceptance. So, how do you find the magic number?
Unfortunately, it’s more of an art than science. This is because every case is different, and being able to recognize when a low offer amount will work (and when it won’t) takes a lot of experience.
Even though I can’t give you a magic formula for hitting the nail on the head with your offer amount, I can give you some ways to at least get a ball park figure on how much you should offer. Hopefully it helps.
The Bare Minimum Offer Amount
If you plan to submit an offer in compromise on the basis that you cannot afford to pay the tax owed (as opposed to doubt as to liability or effective tax administration), then your offer amount must be greater than your “reasonable collection potential” (RCP). This is a number used by the IRS to represent your ability to pay the taxes owed. The RCP takes into account your monthly income, monthly living expenses, assets, and other liabilities. Your offer amount has to be greater than your RCP, otherwise it’s guaranteed to get rejected by the IRS.
Calculating your RCP can get complicated, but here’s a basic way to get an idea of your RCP. Start with total monthly income from all sources and subtract all of your necessary living expenses. This means rent, utilities, groceries, gas, car payment, etc. It does not include your budget for going out to dinner every week or the cost of your season tickets. The resulting amount is your monthly disposable income. Take that number and multiply by 12 (which is equal to one year worth of disposable income). This is the bare minimum you can offer to the IRS. They will almost never accept less than this amount. The rationale is that you can afford to pay this amount each month for the next year, so why should they let you off the hook for something less now?
If you have any assets than can be sold, like an extra car, investments, or valuable collectibles, you’ll have to add that amount to your offer as well. Determining the value of these assets can be tricky — and is often a point of negotiation with the IRS. Also, even though you’re allowed to keep your home in most cases, you might have to include the equity in your home if it’s anything significant.
So, that’s the bare minimum you can offer. It’s no guarantee that your offer will be accepted, but at least you know you’re in the right ballpark instead of something that’s laughably low.
Paying the Offer Amount in Installments
Many people I meet with worry that they can’t come up with the offer amount in one lump sum payment. That’s okay. The IRS allows monthly payments of the offer amount, but a lump sum is always preferred.
The most you can break up the offer amount is 24 months, although I don’t recommend doing this. Anything more than 5 months and the IRS will use 2 years of your disposable income instead of just 1 year to calculate your RCP, which would essentially double the amount you’d have to offer. So, I strongly recommend paying the offer amount in 5 or fewer monthly installments if you can, even if you have to borrow the money for your offer. It’s always better to owe money to a friend, relative, or even a bank than to the IRS.
Figuring out the optimal amount to offer the IRS is not easy. It takes a lot of experience to know where the sweet spot lies for any given case. In general though, you can start off with an estimate of 1 year worth of your disposable income and add to that any valuable assets you can sell for additional cash. The IRS is primarily concerned with making sure it gets at least the same amount of your Reasonable Collection Potential, so make sure the offer amount is higher than your RCP in any case.
For more information on the IRS Offer in Compromise program, please see:
- Overview of the Offer in Compromise Process
- Eligibility Requirements
- How the IRS Decides to Accept or Reject an Offer in Compromise
- Alternatives to the Offer in Compromise