Will the IRS Settle For Less? How Much Will It Settle For?
The IRS will settle for less than you owe, but in order to convince them to do so, you will have to qualify for either for an offer in compromise, which is an agreement with the IRS to settle your taxes all at once for less than you owe, or a partial-payment installment agreement, which is an agreement with the IRS to settle your taxes over time for less than you owe.
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IRS Settlement Option #1: Offer in Compromise
Under this kind of settlement option, the IRS settles for an amount known as your reasonable collection potential. In Topic No. 204 Offers in Compromise, the IRS says:
“In most cases, the IRS won’t accept an [offer in compromise] unless the amount offered by a taxpayer is equal to or greater than the reasonable collection potential (RCP). The RCP is how the IRS measures the taxpayer’s ability to pay. The RCP includes the value that can be realized from the taxpayer’s assets, such as real property, automobiles, bank accounts, and other property. In addition to property, the RCP also includes anticipated future income less certain amounts allowed for basic living expenses.”
Now, I’ve gone over the calculation of the RCP in great detail in my lengthy article on the offer in compromise formula. But as the IRS is hinting at in the last two sentences of the paragraph above, the RCP has two components — an asset component and an income component — and these two are added together to arrive at your settlement amount in an offer in compromise.
Income Component
The income component is calculated by taking your gross monthly income — taxable or not — and subtracting out your average monthly necessary tax payments such as through W-2 withholding or your estimated tax payments because in order for the IRS to grant you an offer in compromise you must be in compliance with your current year tax liability.
And then from that amount you subtract out your necessary living expenses. And some of these living expenses are capped at certain amounts that the IRS provides. I’m not going to go into that depth here; I have gone to extreme depths on this topic in my offer in compromise formula article, so please read that if you’re interested.
Asset Component
So that’s the income component. Then there’s the asset component to calculating your reasonable collection potential. And taxpayers have all kinds of assets from fine art to complex life insurance vehicles to business interest, but the most common five assets that people own these days, if any, are cash in the bank, brokerage or retirement accounts, vehicles, cryptocurrency, and maybe a primary residence.
And I do go into more detail on valuing these in my offer in compromise formula article, but below I give an overview on how to value each of these assets for IRS offer in compromise settlement purposes.
Cash In the Bank
Cash is cash, so the IRS values cash at face value, but they generally let you knock off $1,000 and one month’s worth of your necessary living expenses as calculated by the IRS’s math that you use to calculate the income component of your RCP.
Brokerage and Retirement Accounts
So for these, the IRS will generally let you take a 20% haircut on the value of your accounts.
So if you have a $100,000 brokerage account, the IRS will generally let you discount that to $80,000 when calculating your reasonable collection potential.
And with retirement accounts — though this is not the Form 433-A (OIC) directly — you do have the option of calculating the net, after-taxes-and-penalties amount you would get out of your retirement account if you hypothetically liquidated it to pay the IRS.
Also, if you have a margin account at your brokerage, you can subtract your margin balance from that reduced, 80% value of the securities in your account.
Also, if you have a retirement account like a 401(k) that is inaccessible — and it says as such in your summary plan document — we can generally get the IRS to ignore that asset for offer in compromise purposes.
Vehicles
For vehicles, the IRS let’s you knock off 20% of the value from the top — keep in mind that the IRS does like using Kelley Blue Book for vehicle valuations.
And from that 80% of fair market value, the IRS also lets you subtract an debt you have against the vehicle as well as an exemption amount that is currently $3,450, though that figure is adjusted annually.
So if you have a car worth $10,000 with a $2,000 loan on it, your includable vehicle value would be $10,000 x 80% = $8,000 less the $2,000 loan less the $3,450 exemption amount for a $2,550 includable vehicle value in your reasonable collection potential.
Cryptocurrency
So, interestingly enough, the IRS does not let you discount your cryptocurrency by 20% when calculating your reasonable collection potential. However, you can reduce the fair market value of your cryptocurrency by any transaction fees or gas or exchange fees or other fees that you may incur when converting your cryptocurrency to fiat.
Primary Residence
So similar to many other assets, the IRS does let you discount the fair market value of your primary residence by 20%, and it allows lets you subtract the mortgage from that amount.
Now, when an IRS offer examiner is looking at your property (digitally, of course), they are probably just going to look at a website like Zillow or Redfin and get the estimate of what it’s worth from there.
But if your home has a lot of necessary repairs or other factors that make it potentially less desirable than the typical home in your area, Zillow is not going to know about that — but you do. So in calculating your reasonable collection potential, don’t be afraid to reduce the value of your home by repairs or other factors. And in some cases, we like to see a professional or professionals get out to the property to point out everything wrong with the home and give an estimate accordingly.
Related: How to Negotiate With the IRS
IRS Settlement Option #2: Partial-Payment Installment Agreement
Now, many folks don’t qualify for an offer in compromise because with an offer in compromise you have to include your equity in your primary residence, whether it’s accessible or not.
This is a classic house rich, cash poor situation in which the taxpayer absolutely cannot pay off their tax debt despite possibly having a six- or seven-figure net worth including their equity in their home. But apart from their home, they don’t have much either in terms of other assets or monthly cash flow.
Why a PPIA?
For these folks, a partial-payment installment agreement (PPIA) is a way to get the IRS to settle their tax debt. A PPIA is an agreement with the IRS to pay them your monthly disposable income over the remaining number of months the IRS has to collect your tax debt, and I’ll give you an example later on so you can better understand what I’m talking about.
So why might a PPIA be feasible for a house-rich-cash-poor individual with IRS debt? Because unlike with an offer in compromise in which a taxpayer’s equity in their home has to be included in their offer amount regardless of whether that equity is accessible or not, the IRS can agree to a PPIA as long as it is able to “address” the taxpayer’s equity in assets.
And when it comes to taxpayers’ equity in their primary residence, we can usually have the taxpayer go out and get a couple loan denial letters showing that no bank is going to lend them money on the equity in their home via a refinance or a HELOC or some other instrument and then we submit those to the IRS so they can sign off on the equity.
PPIA Example
But, of course, even with their equity in their primary residence excluded, the taxpayer still has their monthly disposable cash flow, and with a PPIA, this is what they’re paying to the IRS until their tax debt drops off.
So if a taxpayer grosses $5,000 monthly but has $4,800 in justifiable necessary living expenses — based on the IRS’s guidelines — they have $200 in disposable cash flow.
This means that the IRS will expect this taxpayer to pay them $200 per month in an installment agreement. Now, if they only owe the IRS $10,000 that will drop off in 10 years, the taxpayer would not be eligible for a PPIA because they could fully pay their liability making $200-per-month payments.
But what if the taxpayer owed $100,000 to the IRS that will drop off in only three years? In this case, the taxpayers will make three years — or 36 month — of monthly payments of $200, which amounts to a total of $7,200.
This means that the IRS will settle this taxpayer’s $100,000 tax debt for only $7,200.
IRS Settlement Alternatives
Even if you don’t qualify for a lump-sum settlement like an offer in compromise or a settlement over time like a partial-payment installment agreement, you may qualify for one of these other tax relief options to deal with your tax debt.
1. Currently Not Collectible Status
Currently not collectible (CNC) status is a special status in which the IRS agrees to not take forced collection activity against you as long as you remain in this status.
It’s not technically a settlement with the government because the IRS is not agreeing to settle your debt for a specific amount; it’s simply agreeing to not collect from you while you remain in CNC status.
However, CNC status can result in your tax debt being eliminated because if you remain in CNC status until your tax debt drops off, you never have to worry about it again.
2. Full-Payment Installment Agreement
A full-payment installment agreement is an agreement with the IRS to fully pay your tax debt over time.
This isn’t a very sexy option, but frankly this is the only arrangement many taxpayers will qualify for.
3. Bankruptcy
While bankruptcy can (though it certainly does not always) result in the discharge of your tax debt, it is not technically a settlement with the IRS; it is a legal option administered by the United States Bankruptcy Court and a bankruptcy trustee.
IRS Settlement FAQs
How much will the IRS settle for?
The amount the IRS will settle for in an offer in compromise is your reasonable collection potential.
The amount the IRS will settle for in a partial-payment installment agreement is the amount of your monthly disposable income based on the IRS’s rules multiplied by the number of month’s remaining until your tax debts’ last collection statute expiration date (CSED).
How can I settle my IRS debt?
You can settle your tax debt with the IRS by seeing if you qualify for an IRS forgiveness program and then taking the necessary steps to take advantage of that program.
The most common IRS settlement programs are offers in compromise and partial-payment installment agreements.
Author:
Logan Allec, CPA, Founder and Owner
Logan Allec has been serving taxpayers as a CPA for over 14 years. After leaving his role at a "Big 4" firm, he started Choice Tax Relief to help everyday Americans who have found themselves behind on their taxes. He also educates thousands of people daily about tax relief on his YouTube channel. In addition to his CPA license, Logan also has a Master's Degree in Taxation from the University of Southern California (USC). He lives with his wife and children in the Los Angeles area. Learn more about Logan here.
