>>>Financial Analysis<<< Abate Tax is not a Law Firm

5.8.5  Financial Analysis

5.8.5.1  (11-15-2004)
Overview

  1. 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 for the analyzing and verifying of financial information and should be used in conjunction with this section.

5.8.5.2  (11-15-2004)
Verification

  1. A thorough verification of the taxpayer's Collection Information Statement (CIS) involves reviewing information available from internal sources and requesting that the taxpayer provide additional information or documents that are necessary to determine reasonable collection potential (RCP).
  2. Collection issues that have been previously addressed during a balance due investigation by field personnel will not be re-examined unless there is convincing evidence that such reinvestigation is absolutely necessary. It is expected that the results of a previous collection investigation will be used and only supplemented when necessary to make a determination on an offer in compromise. Investigative actions that are less than 12 months old may be used to evaluate the offer in compromise.

    Example:

    If a Revenue Officer has completed a full CIS analysis including verification of assets, income and expenses and has made a determination of Fair Market Value of assets, equity in assets and monthly ability to pay, this information should not be reinvestigated. The Offer Examiner should use the Revenue Officer's (RO) determinations to calculate reasonable collection potential (RCP). If the balance due case file does not provide documentation to indicate the source of the offer amount, the taxpayer will be contacted to determine the source of the offer funds

     

5.8.5.2.1  (11-15-2004)
Internal Sources

  1. Verify as much of the collection information statement (CIS) as possible through internal sources.
  2. When internal locator services are not available, or indicate a discrepancy, request that the taxpayer provide reasonable information necessary to support the Collection Information Statement (CIS).
  3. A full credit report should be requested prior to accepting an offer when the current balance due exceeds $100,000.
  4. Regardless of the amount of the liability the following information sources may be considered:
    Internal Sources Review
    ENMOD and INOLES Identify cross reference TINs for related business activity not declared on the CIS.
    SUMRY, IMFOL and BMFOL Verify full compliance.
    RTVUE (IMF) or copy of the last filed income tax return • Compare the amount of reported income to that declared on the CIS.
    • Identify past sources of income:
    Schedule B — interest and dividends
    Schedule C — self-employment income
    Schedule D — capital gains or losses
    Schedule E — rental or other investment income, net operating loss deduction
    Schedule F — farm income
    IRPTRO and/or copy of older year income tax returns
    •Compare real estate tax and mortgage interest deductions to the amounts declared on the CIS. Higher amounts may indicate present or past real property ownership not declared on the CIS. Lower amounts may indicate property has been recently sold or transferred.
    •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 recently dissipated assets.
    BRTVUE (BMF) or copy of last filed income tax return • Compare the amount of reported income to that declared on the CIS.
    • Compare the value of assets and the amount of reported depreciation to the asset values declared on the CIS.
    State Motor Vehicle Records Identify motor vehicles 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.
    Credit Bureau Report • Identify past residences and employers.
    • Verify competing lien holders, balances due and payment history.
    •Identify property not listed on CIS.

     

5.8.5.2.2  (11-15-2004)
Taxpayer Submitted Documents

  1. Collection Information Statements (CIS) submitted with an offer in compromise should reflect information no older than the prior six months. If during the processing of the offer, the financial information becomes older than 12 months, contact should be made with the taxpayer to update the information. However, in certain situations information may become outdated due to significant processing delays caused by the Service, 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, secure a new CIS.
  2. Do not make a blanket request for information. Tailor your request to each taxpayer’s specific situation. Do not require the taxpayer to provide information that is available from internal sources.
  3. Offer Investigators may receive offers (other than those identified by the "Screen for Obvious Full Pay" process) where the taxpayers have not provided, either proof of payment for certain monthly expenses claimed in Section 9 of Form 433-A, or statements showing current real estate mortgage or motor vehicle loan balance. Often the taxpayers are not actually paying claimed expenses, or they are not allowable under offer program guidelines. For example, taxpayers frequently list their unallowable credit card bills under secured debt or other expenses. While a taxpayer may have a liability for a court ordered judgment that is senior to the Notice of Federal Tax Lien (NFTL), unless they are actually making payments on that liability it is not considered as an allowable monthly expense.
  4. If taxpayers do not substantiate claimed expenses for Form 433-A categories of health care expenses, court ordered payments, child/dependent care, life insurance, other secured debt or other expenses, Offers Investigators will complete the IET assuming that the taxpayer is not making any payments for the particular unsubstantiated expense, except for health care. In those cases, refer to LEM 5.3.1.
  5. 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, Offers Investigators should rely on credit report 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.
  6. If not present in the file when assigned for investigation, appropriate documentation from the chart below should be requested to verify the information on the Collection Information Statement (CIS).
    Taxpayer Documentation Review
    Wage Earner — wage statements for the prior three months A statement with current year–to–date figures is also acceptable. • Compare average earnings to the income declared on the CIS.
    • Verify adequate tax withholding.
    • Identify payroll deductions to ensure the expense is necessary and not claimed again on the CIS.
    •Identify deductions to savings accounts, credit union accounts or retirement accounts.
    Self-employed — proof of gross income (invoices, accounts receivable, commission statements, etc.) for the prior three months. • Compare average earnings to the income declared on the CIS.
    • Identify deductions to ensure the expense is necessary and not claimed again on the CIS.
    Three (3) current months of bank statements that show the monthly transactions, withdrawals and deposits. Compare deposit amounts to income reported on the tax return and CIS. Question deposits that exceed reported income and unusual expenses paid. Consider asking for the cancelled checks and deposit items for a specified time frame if questionable items cannot be adequately explained.
    Retirement account statements and brochures, brokerage account statements, securities or other investments Identify the type, conditions for withdrawal and current market value.
    Life insurance policies •Identify the type, conditions for borrowing or cancellation and the current loan and cash values.
    • Verify the amount of the required premiums and ensure payments are being made.
    Motor vehicle purchase or lease contracts, statements from the lender indicating the payoff amount Verify equity and monthly payment expense.
    Real estate warranty deeds, mortgage deeds, HUD closing statements, statements from the lender indicating the pay off amount Identify the type of ownership, amount of equity and monthly payment expense.
    Homeowners or renters insurance policies and riders. • Compare the insured value to the value declared on the CIS.
    • Identify high value personal items such as jewelry, antiques or artwork.
    Financial statements recently provided to lending institutions or others. Compare the financial information on the CIS to those submitted to other lending institutions.
    Divorce court orders. Verify disposition of assets in the property settlement.
    Court orders for child support and proof of payment. Verify responsibility for child support, that the payments are actually being made, and the length of time payments are required to be made.

     

5.8.5.3  (11-15-2004)
Equity in Assets

  1. Proper asset valuation is essential to determine reasonable collection potential (RCP).
  2. Field calls may be made to locate or personally ascertain the condition of assets.
  3. Assets will not be eliminated or valued at zero dollars simply because the Service may choose not to take enforcement action against the asset, even though the net result is rejection of the offer and reporting the case currently not collectible.

5.8.5.3.1  (11-15-2004)
Net Realizable Equity

  1. 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.
  2. Quick sale value (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) but greater than forced sale value (FSV). FSV is defined as no less than 75% of FMV.
  3. Normally, Quick Sale Value (QSV) is calculated at 80% of Fair Market Value (FMV). A higher or lower percentage may be applied in determining QSV when appropriate, depending on the type of asset and/or 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 of a percentage other than 80%. Generally, it is the policy of the Service to apply QSV in valuing property for offer purposes.
  4. When a particular asset has been sold (or a sale is pending) in order to fund the offer, no reduction for quick sale value (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 net realizable equity (NRE) of the asset.

5.8.5.3.2  (11-15-2004)
Jointly Held Assets

  1. 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.

     

  2. See IRM 5.8.5.3.11(4) for a discussion of assets held as tenancies by the entirety.

5.8.5.3.3  (11-15-2004)
Income-Producing Assets

  1. When determining the reasonable collection potential (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 is determined that an asset or a portion of an asset is necessary for the production of income, it may be 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 .
  2. 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.
    A taxpayer borrows against an asset that is necessary for the production of income, and devotes the proceeds to the payment of the offer Consider the effect that loan will have on future expenses and the future income stream.
    The taxpayer is either unable or unwilling to secure a loan on the equity in income producing assets Compare the equity in the assets with the income produced by those assets. Determine if an adjustment to income stream is appropriate to account for the potential loss of the assets.
  3. These considerations should be fully documented in the case history. For example:
    If… Then…
    A self-employed construction tradesman sells a truck, which he used to haul materials, and devotes the proceeds to the offer Consider allowing the expected cost of delivery services as a business expense.
    A tradesman borrows against the truck instead of selling it and devotes the proceeds to the offer Consider allowing the loan repayment as a business expense.
    A loan cannot be secured and loss of the truck would create an economic hardship When special circumstances warrant acceptance of less than RCP, document the circumstances and recommend acceptance to the authorized official in Delegation Order 11.
    An outside salesman has a luxury car when all that is necessary is a moderate value sedan The equity should be included in the offer. Consider allowing only a portion of the loan repayment that would be required to purchase a moderate value replacement vehicle.
    An outside salesman has a luxury car but no ability to make installment payments for purchase of a moderate value replacement vehicle The equity should be included in the offer. When special circumstances warrant acceptance of less than the RCP, document the circumstances and recommend acceptance to the authorized official in Delegation Order 11. Determine the acceptable amount of a special circumstances offer by allowing the taxpayer to retain only enough equity to purchase a moderate value replacement vehicle.
    A business owns a vacation property, which is used for annual board meetings. The equity should be included in the offer. Do not allow any loan repayment.

     

5.8.5.3.4  (11-15-2004)
Assets Held By Others as Transferees, Nominees or Alter Egos

  1. 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.
  2. When these issues arise, apply the principles in IRM 5.17.1, Legal Reference Guide for Revenue Officers or request a counsel opinion.
  3. It is not necessary to actually seek or obtain any specific legal remedy in order to address these issues in an offer.
  4. If the taxpayer has a beneficial interest in the asset or income stream then the value should be reflected in the reasonable collection potential (RCP).

5.8.5.3.5  (11-15-2004)
Cash

  1. Review checking account statements over a reasonable period of time, normally three months.

    Note:

    Determine if there are funds in the account that are not spent on a monthly basis. Generally this would be the amount reflected on each month's statement when the account is at its lowest point. Treat overdrafts as a zero balance. This should represent the amount available in the account each month after all deposits and withdrawals. Average the lowest daily ending balance on each of the three statements and use this amount as the value of the account. This amount will be added to the AET as an asset, however, it cannot be valued for less than zero.

     

  2. Determine the taxpayer’s interest in bank accounts by ascertaining the manner in which they are held and applying the principles described in IRM 5.17.1, Legal Reference Guide for Revenue Officers.
  3. If analysis of the bank statements and/or discussions with the taxpayer reveal that an adjustment to the balance is appropriate based on unusual expenses that are necessary for the production of income or the health and welfare of the taxpayer, consider adjusting the balance. The case file should clearly document these determinations.
  4. Analyze the statement for any unusual activity, i.e. deposit in excess of reported income, withdrawals, transfers, or checks for expenses not reflected on the Collection Information Statement (CIS). The Offer Investigator should question these inconsistencies, as appropriate.
  5. Review savings accounts statements over a reasonable period of time, normally three months.
    • If the account has little withdrawal activity use the ending balance on the latest statement 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) through (4) above to determine its value.

     

  6. If analysis of the bank statement reveals recently dissipated funds, see 5.8.5.4 for a full discussion of the treatment of dissipated assets.
  7. If the taxpayer offers the balances of accounts to fund the offer, allow for any penalty for early withdrawal and the expected current year tax consequence.
  8. Verify whether deposits in escrow or trust accounts are actually held for the benefit of others.
  9. For funds on deposit with the offer in compromise, allow as an encumbrance any amount borrowed under the provision that, if the offer is not accepted, it must be repaid.

5.8.5.3.6  (11-15-2004)
Securities

  1. Financial securities are considered an asset and their value should be determined and included in the reasonable collection potential (RCP) when investigating an offer.
  2. When the taxpayer will liquidate the investment to fund the offer, allow any penalty for early withdrawal and the current year tax consequence.
  3. To determine the value of publicly traded stock, research a daily paper or inquire with a broker for the current market price. Then, allow for the estimated costs of the sale to arrive at the Quick Sale Value (QSV).
  4. 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 a proportion of the company's value to the taxpayer's stock:
    • Secure and verify a Collection Information Statement.
    • 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.

     

  5. 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.

5.8.5.3.7  (11-15-2004)
Life Insurance

  1. Life insurance as an investment is not considered necessary. However, reasonable premiums for term life policies may be allowed as a necessary expense.
  2. 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.

     

5.8.5.3.8  (11-15-2004)
Retirement or Profit Sharing Plans

  1. Funds held in a retirement or profit sharing plan are considered an asset and must be valued for offer purposes.
  2. Contributions to voluntary retirement plans are not a necessary expense. Review of the retirement plan document is generally necessary to determine the taxpayer's benefits and options under the plan.
  3. 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 expense for liquidating the account and early withdrawal penalty.
    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 expense for liquidating the account and early withdrawal penalty. The plan may be considered as income, if the income from the plan is necessary 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 expense associated with the withdrawal
    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.
    The plan 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 expense for liquidating the account and early withdrawal penalty, 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 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.

     

  4. When the taxpayer will liquidate the retirement plan to fund the offer, allow any penalty for early withdrawal and the current year tax consequence.

5.8.5.3.9  (11-15-2004)
Furniture, Fixtures, and Personal Effects

  1. 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.
  2. There is a statutory exemption from levy that applies to the taxpayer's furniture and personal effects. This exemption applies only to individual taxpayers. This exemption amount is updated on an annual basis.
  3. 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.

     

5.8.5.3.10  (11-15-2004)
Motor Vehicles, Airplanes and Boats

  1. Equity in motor vehicles, airplanes, and boats must be determined and included in the reasonable collection potential (RCP). The general rule for determining net realizable equity (NRE), as discussed in IRM 5.8.5.3.1, applies when determining equity in these assets. Unusual assets such as airplanes and boats may require an appraisal to determine Fair Market Value (FMV), unless the items can be located in a trade association guide. The case file should document how the values were determined.
  2. Generally, it is not necessary to personally inspect automobiles used for personal transportation. When it appears reasonable, accept the taxpayers stated value. No further investigation is required except for vehicles that are three years old or newer with no lien. For these vehicles, consult a trade association guide and discount the Fair Market Value (FMV) to 80% to arrive at the Quick Sale Value (QSV).

    Example:

    When investigating an offer in the year 2003, a 2001 model year is 3 years old or newer.

     

  3. When these assets are used for business purposes they may be considered income producing assets. See IRM 5.8.5.3.3 for a full discussion on the treatment of income producing assets.

5.8.5.3.11  (11-15-2004)
Real Estate

  1. Equity in real estate is included when calculating the taxpayer's reasonable collection potential (RCP) and in an acceptable offer amount.
  2. When determining equity in real estate, the fair market value (FMV) of the property must be established. FMV is defined as the price a willing buyer will pay for the property, given time to obtain the best and highest possible price. The following methods may be used to establish FMV:
    • Recent purchase price or an existing contract to sell
    • Recent appraisals
    • Real estate tax assessment
    • Market comparable
    • Homeowners insurance replacement cost

     

  3. Once the Fair Market Value (FMV) of real estate is established, a determination regarding a reduction of value for offer purposes must be made. Procedures outlining reduction to Quick Sale Value (QSV) are discussed in IRM 5.8.5.3.1. If the value of real estate is reduced beyond 80% or if FMV is not reduced to QSV, the case file should document the basis for the value used.
  4. 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 net realizable equity (NRE).

5.8.5.3.12  (11-15-2004)
Accounts and Notes Receivable

  1. 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.
  2. To determine the value of accounts receivable:
    1. Consider discounting the value of accounts that are over 90 calendar days past due.
    2. 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.
    3. Examine closely accounts of significant value that the taxpayer is not attempting to collect, or that are receivable from officers, stockholders or relatives.

     

  3. To determine the value of a note receivable, consider the following:
    • Whether it is secured and if so by what asset(s)
    • What is collectable from the borrower
    • If it could be successfully levied upon.

     

5.8.5.3.13  (11-15-2004)
Inventory, Machinery and Equipment

  1. Inventory, machinery and equipment may be considered income producing assets. See IRM 5.8.5.3.3 when it is determined that liquidation of these assets would be detrimental to the continued operation of an otherwise profitable business.
  2. 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.

     

  3. There is a statutory exemption from levy that applies to an individual taxpayer's tools used in a trade or business. This exemption for tools of the trade generally does not apply to automobiles. The levy exemption amount is updated on an annual basis.

5.8.5.3.14  (11-15-2004)
Business as a Going Concern

  1. Evaluation of a business as a going concern is sometimes necessary when determining reasonable collection potential (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.
  2. To determine the value of a business as a going concern consider the value of assets, future income, and intangible assets such as:
    • Good will
    • Ability or reputation of a professional
    • Established customer base
    • Prominent location
    • 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 reasonable collection potential (RCP) analysis is attributable to the value of these intangibles.

  3. Request the assistance of an IRS valuation engineer when a difficult or complex valuation is necessary.
  4. When determining RCP for an individual taxpayer that has an interest in a business entity, flexibility should be used with consideration given to the taxpayer's control over the business.

5.8.5.4  (11-15-2004)
Dissipation of Assets

  1. During an offer investigation it may be discovered that assets (liquid or non-liquid) have been sold, gifted, transferred or spent on non-priority items/debts and are no longer available to pay the tax liability. This section discusses treatment of the value of these assets when considering an offer in compromise.

    Note:

    The scope of an offer investigation should not be expanded beyond the requirements defined in IRM 5.8.5.4, for the sole purpose of attempting to locate dissipated assets.

     

  2. Once it is determined that a specific asset has been dissipated, the investigation should address whether the value of the asset, or a portion of the value, should be included in an acceptable offer amount.
  3. Inclusion of the value of dissipated assets must clearly be justified in the case file. Justification should include an analysis of the following facts:
    • When the asset(s) were dissipated in relation to the offer submission,
    • How the asset was dissipated,
    • If the taxpayer realized any funds from the dissipation of assets,
    • How any funds realized from the dissipation of assets were used,
    • The value of dissipated assets and the taxpayer's interest in those assets.

     

  4. When the taxpayer can show that assets have been dissipated to provide for necessary living expenses, these amounts should not be included in the reasonable collection potential (RCP) calculation.
    For Example:
    • Dissolving an IRA account to pay for necessary living expenses during unemployment
    • Using bank accounts to pay for medical expenses
    • An asset that was dissipated and the funds were used to purchase another asset that is included in the offer evaluation.

     

  5. If the investigation clearly reveals that assets have been dissipated with a disregard towards the outstanding tax liability, consider including the value in the reasonable collection potential (RCP calculation.
    For Example:
    • Dissolving an IRA account to pay unsecured credit card debt
    • Sale of real estate and "gifting" the funds from the sale to family members.
    • A recent refinancing of equity in property and using the funds to pay unsecured debt.

     

  6. If the taxpayer cannot or will not provide information showing the disposition of funds from dissipated assets, consider including a portion or all of these values in an acceptable offer amount.

5.8.5.5  (11-15-2004)
Future Income

  1. 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.
    1. For cash offers — project for the next 48 months.
    2. For short term deferred offers — project for the next 60 months
    3. For deferred payment offers — project for the number of months remaining on the statutory period for collection.

     

  2. Detailed instructions for calculating future income are contained in IRM 5.8.5.5.4.
  3. Consider the taxpayer's overall general situation including such facts as age, health, marital status, number and age of dependents, highest education or occupational training and work experience.
  4. Retired Debts: A taxpayer's ability to pay in the future may change during the period it is being considered because necessary expenses may increase or decrease. Adjust the amount or number of payments to be included in the future income calculation, based on the expected change in necessary expenses.
     

    Example:

    The taxpayer may pay off an auto loan 24 months from the date the offer is accepted. This would increase the monthly future income by the amount of the loan payment. Child support payments may stop before the future income period is complete because the child turns a certain age. It is expected that these retired payments would increase the taxpayer's ability to pay.


     

  5. Some situations may warrant placing a different value on future income than current or past income indicates:
    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 unemployed or underemployed Use the level of income expected if the taxpayer were fully employed.
    A taxpayer has a sporadic employment history or fluctuating income Average earnings over several prior years. Usually this is the prior 3 years.
    A taxpayer is elderly, in poor health, or both and the ability to continue working is questionable Adjust the amount or number of payments to the expected earnings during the appropriate number of months.
    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. When considering a reduction in future income also consider the intangible value to the taxpayer of avoiding bankruptcy.

     

  6. In some instances, a future income collateral agreement may be used in lieu of including the estimated value of future income in reasonable collection potential (RCP). When investigating an offer where current or past income does not provide an ability to accurately estimate future income, the use of a future income collateral agreement may provide a better means of calculating an acceptable offer amount. Future income collateral agreements should not be used to enable a taxpayer to submit an offer in a lesser amount than the current or past financial condition dictates. However, if the future is uncertain, but it is reasonably expected that the taxpayer will be receiving a substantial increase in income, it may be appropriate.

    Example:

    A taxpayer is currently in medical school and it is anticipated that upon graduation income should increase dramatically. See IRM 5.8.6.3.1 for instructions on completing collateral agreements

    : .

5.8.5.5.1  (11-15-2004)
Allowable Expenses

  1. Allowable expenses as defined in IRM 5.15.1, Financial Analysis Handbook, are those expenses that are necessary for the production of income or for the health and welfare of the taxpayer's family. That handbook also contains national and local standard expense amounts designed to provide accuracy and consistency in determining a taxpayer's basic living expenses. The standards are updated periodically based upon Bureau of Labor Statistics and Census Bureau information.
  2. National and local expense standards are guidelines. If it is determined that 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.

    Example:

    A taxpayer with physical disability or an unusually large family requires a housing cost that is not anticipated 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.

     

  3. 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.

    Example:

    Foster children or children for whom adoption is pending.

     

  4. A deviation from the local standard is not allowed merely because it is inconvenient for the taxpayer to dispose of excessively valued assets. In some situations, taxpayers may be expected to make life-style choices that will facilitate collection of the delinquent tax.

5.8.5.5.2  (11-15-2004)
Conditional Expenses

  1. Conditional expenses are defined in IRM 5.15, Financial Analysis Handbook, as those that may be allowed when the tax will be paid in full by an installment agreement. For offers purposes, the full amount of the tax will not be collected; therefore, the rules for conditional expenses are different.
  2. 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.
  3. The purchase of discretionary investments is not allowed.

    Example:

    Payroll savings plans, purchase of whole life policies, mutual funds or voluntary retirement plan contributions.

     

  4. Repayment of loans incurred to fund the offer and secured by the taxpayers’ assets are allowed when those assets are of reasonable value and necessary to provide for the health and welfare of the taxpayer’s family. The same rule applies whether the equity is paid to tax before the offer is submitted or will be paid upon acceptance of the offer. See IRM 5.8.5.3.3, Income-Producing Assets, to determine when to allow repayment of loans on those assets used to fund the offer.
  5. Repayment of student loans secured by the federal government is allowed only for the taxpayer's higher education. If student loans are owed but no payments are being made, do not allow them.
  6. Education expense is allowed only for the taxpayer and only if it is required as a condition of present employment. Expenses for dependents to attend colleges, universities or private schools are not allowed unless the dependents have special needs that cannot be met by public schools.
  7. Child support payments for natural children or legally adopted dependents may be allowed, based on the taxpayer's situation, even when they are not court ordered. Regardless of whether they are court ordered, if no child support payments are being made, do not allow them.
  8. Monthly payments to state or local taxing agencies should not be allowed as a necessary expense, even if the state or local taxing agency has a lien that was choate prior to our lien or is collecting funds via a wage attachment or approved installment agreement. State and federal lien (regardless of priority) attach simultaneously to after acquired property. In general, if the federal tax lien attaches to after acquired property simultaneously with a competing perfected lien, the federal tax lien will take priority (see Legal Reference Guide 5.17.2). Since future earnings of the taxpayer are after acquired property the Service has first right to the earnings. Explain to the taxpayer that although the payment may be allowed in an installment agreement where the tax will be paid in full, it will not be allowed for computation of an acceptable offer amount because the Federal government has priority rights to the funds.

    Note:

    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.

     

  9. Charitable contributions are not allowed.
  10. Payments being made to fund or re-pay loans from "voluntary " pension 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. Request the taxpayer or their representative estimate the tax ramification of the failure to re-pay the loan or the Offers Investigator may request assistance from the Examination function or Customer Service to determine the tax consequences.

5.8.5.5.3  (11-15-2004)
Shared Expenses

  1. This situation can happen one of two ways:
    1. Separate offers are submitted by two or more persons who owe joint liabilities and/or separate liabilities and who share the same household.
    2. An offer is submitted by a taxpayer who shares living expenses with a not liable person.

     

  2. Generally, the assets and income of a not liable person are excluded from the computation of the taxpayer's ability to pay. One notable exception is in community property states. Follow the community property laws in these states to determine what assets and income of the otherwise not liable person are subject to collection of the tax.
  3. Regardless of community property laws, the Offers Investigator should secure sufficient information concerning the not liable person to determine the taxpayer's proportionate share of the total household income and expenses. Review the entire household's information and:
    1. Determine the total actual household income and expense.
    2. Determine what percentage of the total household income the taxpayer contributes.
    3. Determine necessary and allowable expense amounts using the rules in this chapter and IRM 5.15, Financial Analysis Handbook.
    4. Determine which expenses are shared and which expenses are the sole responsibility of the taxpayer.
    5. Apply the taxpayer's percentage of income to the shared expenses.
    6. Verify that the taxpayer actually contributes at least this amount to the total household expense.
    7. Do not allow the taxpayer any amount paid toward a not liable person's discretionary expenses.

     

  4. When the taxpayer can provide documentation that income is not commingled (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 expense 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 non-liable 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.

    Note:

    In the situation where the taxpayer is renting an apartment or room and the owner of the property is the non-liable person, the rental agreement or signed statement from the owner of the property should support the decision to not require the owner to divulge any personal information regarding income or household expenses. In these cases, the investigating employee should accept the information provided by the taxpayer and make a determination based on that information.

    If an in-house verification is conducted on the non-liable person, this information cannot be relayed to the taxpayer. This is not a Unauthorized Access (UNAX) violation but would be considered disclosure if any information is shared with someone other than the non-liable person in question.

     

5.8.5.5.4  (11-15-2004)
Calculation of Future Income

  1. 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 times the number of months remaining on the statutory period for collection.
  2. For cash and short term deferred offers, when there are less than 48 or 60 months remaining on the statutory period for collection, use the number of months remaining. To determine the amount collectible from future income on a deferred payment offer through the life of the statutory period for collection, take the following steps:
    1. Subtract allowable expenses from the monthly income to determine the monthly installment amount.
    2. Determine the valid Collection Statute Expiration Date (CSED) for each tax period included in the offer.
    3. Sort the tax periods by earliest CSED.
    4. For each tax period, determine the number of months remaining on the statutory period for collection. Begin with the day the offer was determined to be processable and end on the CSED. Round partial months up to the nearest whole month.
    5. For each tax period, determine the number of installments that may be applied before running out available funds. Round partial payments up to the nearest whole payment.
    6. Calculate the number of installments applied to each period. For succeeding periods, do not count months on the CSED that were used for applying installments to prior periods.

      Caution:

      If the allowed payment terms call for the first installment to begin later than 30 calendar days from acceptance, there will be one less month available to apply payments.

       

    7. Add the number of installments applied to all the periods and multiply the sum by the monthly installment amount to arrive at the total amount collectible from future income. For examples of situations where the amount that may be applied to a period is limited, see IRM 5.8.5, Exhibits 5-1 through 5-3.

     

5.8.5.6  (11-15-2004)
Payment Terms

  1. Payment terms are negotiable, but should provide for payment of the offered amount in the least time possible.