If there is doubt as to your ability to pay your IRS debt in full within the statute of limitations period the IRS will consider accepting less than the full amount you owe.

The IRS will accept for processing Offers in Compromise in which the amount offered represents the IRS’s reasonable collection potential.

Calculating Reasonable Collection Potential

Reasonable collection potential is calculated using the following algebraic formula:

A + ((B-C)x48) = D

Where:

• A = The equity in the taxpayer’s assets
• B = The taxpayer’s monthly income
• C = The taxpayer’s monthly necessary living expenses
• D = The offer amount

Example:

Eileen Levy is single and owes the IRS $80,000.00 in back taxes, penalties and interest. She owns the following assets and owes the following debts:

• Primary Residence – Fair Market Value $250,000.00**; Mortgage $210,000
• Automobile – Fair Market Value $22,000; debt $24,000
• Jewelry – Fair Market Value $5,000.00; debt zero

** Generally, the IRS uses 80% of the Fair Market Value for purposes of determining collection potential. This is to account for a taxpayer’s closing costs as if they had sold the property. Assume the $250,000.00 is 80% of the true FMV.

Eileen makes $4,000.00 per month working as a nurse and her monthly living expenses are $3,850.00 per month.

Now lets insert these numbers into our Reasonable Collection Potential formula:

A + ((B-C)x48) = D

Calculate A – The equity in the taxpayer’s assets

• Equity in Residence $40,000
• Equity in Vehicle N/A
• Equity in Jewelry $ 5,000
• Total Equity $45,000

Calculate B – The taxpayer’s monthly income

Eileen makes $4,000.00 per month.

Calculate C – Taxpayer’s monthly living expenses

Taxpayer’s monthly living expenses are $3,850

Now all of the variables have been assigned values as follows:

A + ((B-C)x48) = D

45,000 + ((4,000 – 3850) x 48) = 45,000 + ((250) x 48) = 45,000 + 12,000 = 57,000.

Eileen Levy’s reasonable collection potential (assuming she is able to provide documentary proof of the value of her assets, the amount of her debts and her income and expenses) is $57,000.00.

Making the Offer

Eileen should be able to get the IRS to accept an Offer in Compromise (IRS Form 656) on the $80,000.00 she owes for the amount of $57,000.00 thereby saving $23,000.00.

She must provide detailed supporting documentation proving the numbers claimed on her financial statements together with her calculation of reasonable collection potential.

Eileen will have to pay 20% of the offer amount, or $11,400.00 (20% x 57,000), as a downpayment with the offer.

If the offer is not accepted, the IRS will keep the down payment and apply it to the debt Eileen owes.

The balance of the settlement offer, $45,600.00, must be paid in a lump sum within 90 days after the IRS accepts the offer.

Paying the Offer Amount Over 24 Months

If Eileen could not pay the balance in a lump sum she could recalculate the offer amount substituting the number “60″ for the number “48″ in the above formula as follows:

A + ((B-C)x60) = D

The new offer amount using this formula would be $60,000.00. Eileen would then have to pay $12,000 (20% of $60,000) with the filing of the offer and the balance of $48,000.00 could then be paid over a 24 month period.

Taxpayer Warning

Do not trust anyone who tells you that you qualify for an Offer in Compromise unless and until they have asked you about your assets, liabilities, income and expenses and performed the above calculations.