If you’re trying to qualify for an Offer in Compromise (OIC) with the Internal Revenue Service, but you aren’t sure about your odds of success, consider what the IRS calls your reasonable collection potential (RCP). It is used to determine how much to offer the IRS to settle your back tax debt.
How Do You Calculate Reasonable Collection Potential?
RCP is the net realizable equity (NRE) in your assets, plus your future remaining income. The IRS uses your RCP to measure your ability to pay the taxes you owe. If your RCP indicates that you can fully pay your tax liabilities with an installment agreement or by some other means, your chances of qualifying for an Offer are slim.
You likely won’t qualify unless the amount you offer is equal to or greater than the RCP.
What Is Net Realizable Equity?
The NRE is how the IRS measures your asset value. The IRS values assets at their quick sale value (QSV) which is usually, but not always, 80% of their fair market value (FMV). Your QSV may be further reduced by the amount of any mortgages, loans, or liens against the property that have priority over the IRS’s claim. For example, a home that appraises for $300,000 with a $200,000 mortgage will have a QSV of $40,000 (80% of $300,000, less the mortgage of $200,000).
You are also allowed certain exemptions for certain assets. For instance, you are permitted to reduce your bank account balance by $1,000 plus one month’s allowable living expenses. There is also a special exclusion of $3,450 from the value of a car, up to two cars for a joint household.
The QSV of other assets, such as life insurance policies, retirement, and profit-sharing plans, is more complicated to calculate. Consider consulting with a tax professional if you are unsure how to factor these into your chances of securing an OIC with the IRS.
What is Future Remaining Income?
The second component of RCP is your future remaining income, which is a multiple of your monthly disposable income (MDI). Your MDI is the amount remaining after paying allowable living expenses. These expenses include such categories as:
- Housing and Utilities
- Food, Clothing and Miscellaneous
- Vehicle Ownership and Operating Costs
- Health Insurance Premiums and Out-of-Pocket Medical Costs
- Current Taxes
- Court Ordered Payments
- Life Insurance
- Certain Other Expenses
Your MDI is multiplied by either 12 or 24 depending on whether you select a lump sum payment option or a periodic payment option. The result is your future remaining income and is added to your NRE to determine your RCP, which typically will be your offer amount.
Payment Options
A lump sum payment option generally requires you to make a 20% non-refundable payment of your offer amount when submitting the Offer and the balance within five months of acceptance. Alternatively, you may select a periodic payment option, which requires you to make your Offer payments over a 24-month period beginning with the filing of your Offer.
Special Circumstances
Sometimes special circumstances exist that justify acceptance of an Offer below your RCP. Speak with one of our CPAs for help submitting and negotiating your Offer in Compromise.
If an Offer in Compromise is not the answer to your back tax debt, the tax resolution specialists at East Coast Tax Consulting Group will find the right solution to your tax problems.