If you’re trying to qualify for an Offer in Compromise (OIC) with the Internal Revenue Service but aren’t sure about your odds of success, consider what the IRS calls your reasonable collection potential (RCP). It determines how much to offer the IRS to settle your back tax debt.
Key Takeaways
- Reasonable Collection Potential Defined: The IRS’s measure of what it can realistically collect, based on assets and future income.
- Assets: Valued at quick-sale (about 80% of market value) minus debts = Net Realizable Equity.
- Income: Disposable income after allowable expenses × 12 (lump-sum OIC) or × 24 (periodic OIC).
- OIC Requirement: Offers must generally equal or exceed RCP, unless special circumstances apply.
- Example: $20k in assets + $200 monthly disposable income → $22.4k lump-sum OIC, $24.8k periodic.
How Do You Calculate Reasonable Collection Potential?
RCP is your assets’ net realizable equity (NRE), 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 your offer amount equals or exceeds 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 can 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 vehicles for a joint household.
The QSV of other assets, such as life insurance policies, retirement plans, and profit-sharing plans, is more complicated to calculate. If you are unsure how to factor these into your chances of securing an OIC with the IRS, consider consulting with a tax professional.
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 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, which 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 filing your Offer.
Special Circumstances
Sometimes, special circumstances exist that justify accepting an Offer below your RCP. Some factors the IRS will consider include the taxpayer’s age and employment status, illness, or special medical needs of the taxpayer or a family member. 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.
Frequently Asked Questions
What assets are included in RCP?
RCP considers assets such as cash, bank balances, investment accounts, vehicles, retirement accounts, cash value of life insurance, personal property, business interests, and real estate. The IRS typically values assets at their quick-sale (forced sale) value, not full market value.
How does the IRS verify the values used in RCP?
The IRS relies on documentation you provide, such as bank statements, pay stubs, appraisals, and account statements. They may also use third-party data, property records, or credit reports to confirm asset values and income levels.
How does future income factor into RCP?
The IRS projects your monthly disposable income after allowable expenses, either over 12 or 24 months, depending on your OIC payment option. This future income is added to your asset value to calculate RCP.
Can medical expenses lower my RCP?
Yes. If you have necessary, out-of-pocket medical expenses that exceed the IRS’s standard allowance, you can request that they be included in your financial analysis, reducing your disposable income and overall RCP.
Is RCP the same for everyone?
No. RCP varies based on each taxpayer’s financial situation, income, and assets. Two taxpayers with the same tax debt may have very different RCP calculations and settlement offers.
How does the IRS handle jointly owned property if my spouse doesn’t owe the IRS?
If you own property jointly, there are instances when only your proportionate share of the equity is used in the RCP calculation. For example, you have back tax debt from before your marriage. You and your wife jointly own your home and live in Florida, a non-community property state. Only your half of the equity is generally counted.