IRS Settlement with an Offer in Compromise (OIC)
Settlement with an Offer in Compromise
If you owe money to the IRS, you may be able to reach an Offer in Compromise (OIC) to pay the money that you owe. An OIC provides a way to have a large portion of your tax debt forgiven. You must agree to pay a smaller amount in a timely fashion. Both the amount and the time is agreed upon by both you and the IRS. You may be able to obtain an OIC if you believe the IRS is incorrect as to the amount of taxes you owe or if you are unable to pay back the full amount owed. In the second instance, the IRS will carefully consider the amount owed, your income, your assets, and your living expenses. An OIC is quite difficult to obtain; only about 1% of offers submitted to the IRS are accepted.
There are three different types of OICs. The one for which you may qualify is largely dependent upon your income and assets and the amount you owe. No matter how much you owe the IRS, the amount to be paid is determined by a preset formula. Different options include:
- Cash Offer
- Short Term Deferred Offer
- Long Term Deferred Offer
Though the amount considered will differ for the type of OIC, each will involve values that include the “quick sale value” of your assets, as well as the amount that the IRS could collect from your available income. The calculations are complicated and easily misunderstood without experience in this area of tax law. Be wary of companies that claim to be able to submit an OIC on your behalf. Be especially cautious of companies who make extreme claims of settlement and have no attorneys or CPAs employed with their company. In recent years, there have been an increased number of scams and frauds.
How much should I expect to settle on with my Offer in Compromise (OIC)?
The answer is complicated and depends upon the situation. If a borrower who has a bank loan, guaranteed by the Small Business Association (SBA) , goes into default, the borrower has the option of seeking protection by filing a Chapter 7. However, the SBA (and the bank, who acts as the SBA’s servicing agent) has the option of allowing the defaulted borrower to make an Offer in Compromise (OIC) in lieu of filing Chapter 7 Bankruptcy. The borrower should be aware that an OIC is a privilege, not a right, and the SBA is under no obligation to accept an OIC. The IRS will only do so if the SBA feels it is a good offer, and there is no fraud, concealment or misrepresentation. How the SBA decides this can be confusing. However, there are guidelines, as laid out by the SBA. The compromise amount must bear a reasonable relationship to the amount that could be recovered in a reasonable amount of time through enforced collection proceedings and must be sufficient to protect the integrity of the SBA loan program.
An acceptable OIC is determined by seven (7) general criteria:
1. Size of the deficiency:
The amount of the deficiency is an obvious factor in determining the settlement. However, while there is a belief that the SBA looks to obtain a 20% recovery, there is actually no magic percentage that the SBA will accept. That’s because whether the borrower’s deficiency is $150,000 or $1,500,000 is only meaningful in the context of the other criteria –specifically, what can the borrower actually pay? What are the borrower’s alternatives?
2. Liquidated value of the borrowers assets, should the borrower seek protection in Chapter 7 Bankrupcty (BK)
This is an obvious alternative to an OIC for the borrower. This is a calculation that should be done, and it is very meaningful to present to the bank and/or SBA. Should the borrower have limited exposure in a bankruptcy filing that will have an impact on how the SBA views an OIC. The borrower should remember that even if they have no liability in a bankruptcy filing, and even if their personal guarantee would be completely discharged, the SBA may still require a significant and substantial OIC settlement amount as based on the net worth of the borrower and their ability to pay.
3. Net worth of the borrower if they do NOT seek Bankruptcy protection.
Many defaulted borrowers assume that exempt assets do not factor into the SBA’s review of an OIC. This is not correct. Even though IRAs and 401Ks are “exempt” from consideration in a bankruptcy filing, the SBA will still consider these assets when examining an OIC. Why? Because the OIC is a PRIVILEGE…and so in many cases the SBA officer feels like the borrower should dip into their assets – even exempt assets – to demonstrate good faith.
4. Recovery should the SBA seek wage garnishment over five (5) years
The SBA will also consider the earning power of the guarantors. We recently spoke with a high-powered attorney who was in default on approximately $600,000. The SBA was seeking $300,000 from him, even though if he filed bankruptcy, his exposure was less than $30,000. Why? Because he earns $250,000+ annually. They figure that if they garnished his wages (which they could do if he didn’t file bankruptcy) they would collect $300,000 over five years. In this case, the SBA guessed wrong – the borrower filed for bankruptcy.
5. Borrower’s “desire” to avoid Bankruptcy
Operating in the business world is complicated when the borrower files for bankruptcy and these complications can cost real money over the 10 years that a bankruptcy is reported on a credit report. The cost is estimated to be between $75,000 – $125,000. Stated another way, if the borrower can afford an OIC settlement for less, it is a good idea to settle. However, if the settlement cost is higher, as in the case of the lawyer mentioned above, then the borrower should seek protection through bankruptcy.
6. Other factors – health, age, unusual circumstances
The SBA will take into consideration “other” factors such as age, health, etc. For example, if a borrower is 65 years old, the hidden cost of bankruptcy is negligible since the value of a clean credit report is meaningless for most people nearing retirement. Likewise, significant health issues affecting a borrower will influence the SBA’s consideration of an OIC. Other factors that might influence the SBA would be a sick child, a divorce, or a sudden job loss.
7. Administrative costs
Remember that the SBA and the bank involved are both large, relatively inefficient bureaucratic entities. As such, they have operating expenses, and for them to turn the wheel of progress and actually process an OIC, the offer must be enough to get them interested. For a borrower with NO exposure in a bankruptcy, NO other collateral, and NO liens on personal property, this figure is relatively modest; it may be as low as $10,000 – $15,000. If there are liens on personal property, now the bank must expend resources to have these liens removed (legal expenses) which can drive the cost up another $10,000 or more.
In the end, trying to estimate what a defaulted borrower’s OIC settlement cost will be is an exercise based on multiple factors and criteria. Every situation is different and unique.