Reasonable Collection Potential
An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayer’s tax liabilities for less than the full amount owed. If the liabilities can be fully paid through an installment agreement or other means, the taxpayer will in most cases not be eligible for an OIC.
In most cases, the IRS will not accept an OIC unless the amount offered by the taxpayer is equal to or greater than the reasonable collection potential (the 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.
The IRS may accept an OIC based on three grounds.
- First, acceptance is permitted if there is doubt as to liability. This ground is only met when there is a genuine dispute as to the existence or amount of the correct tax debt under the law.
- Second, acceptance is permitted if there is doubt that the amount owed is fully collectible. Doubt as to collectability exists in any case where the taxpayer’s assets and income (known as the “reasonable collection potential”) are less than the full amount of the tax liability.
- Third, acceptance is permitted based on effective tax administration. An offer may be accepted based on effective tax administration when there is no doubt that the tax is legally owed and that the full amount owed can be collected, but requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances.
When submitting an OIC based on doubt as to collectability or based on effective tax administration, taxpayers must use the most current version of Form 656, Offer in Compromise , and also submit Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals , and/or Form 433-B (OIC), Collection Information Statement for Businesses.
Taxpayers may choose to pay the offer amount in a lump sum or in installment payments. A “lump sum offer” is defined as an offer payable in 5 or fewer installments within 5 or fewer months after the offer is accepted. An offer is called a “periodic payment offer” under the tax law if it is payable in 6 or more monthly installments and within 24 months after the offer is accepted.
With an offer in compromise, taxpayers pay the IRS only the Reasonable Collection Potential (RCP) instead of the full amount of taxes owed. Therefore, the proper calculation of the Reasonable Collection Potential is the most important aspect of a favorable outcome (an accepted offer at the lowest possible amount).
The reasonable collection potential is the amount of money the IRS thinks they can collect from you for your tax debts. It is basically the liquidation value of your assets plus your monthly disposable income. Your reasonable collection potential is calculated as the total of the following:
- Assets: The amount collectible from your net realizable equity in assets.
- Future Income: The amount collectible from your expected future income after allowing for payment of necessary living expenses.
- Valuing Future Income
- Lump Sum Cash Offers: If the offer is payable in five or fewer installments in five months or less; valuation is projected for the next 12 months or the remaining statutory period, whichever is less.
- Periodic Payment Offers: Projected for the next 24 months or the remaining statutory period, whichever is less.
Net Realizable Equity
: For offer purposes, assets are valued at net realizable equity which is defined as quick sale value (QSV) less amounts owed to secured lien holders with priority over the federal tax lien, if applicable, and applicable exemption amounts.
Future Income Valuation
The IRS will ordinarily value income based on the last tax return, the last three months paystubs or the last six months profit or loss. But this may not tell your whole story and there may problems of which you could use professional representation from Tax Samaritan to make sure that your story is heard and how the IRS ultimately values future income. For example, if you have recently became unemployed or have imminent retirement.
What Is Generally An Acceptable Offer In Compromise – A Reasonable Collection Potential That Can Be Proven
You must offer the IRS an amount of money at least equal to, or greater than, your reasonable collection potential if you want the IRS to approve your Offer in Compromise.
However, if your reasonable collection potential is equal or greater than the amount of tax debts you owe, then you probably will not qualify for an Offer in Compromise.
Our goal at Tax Samaritan is to provide the best counsel, advocacy and personal service for our clients. We are not only tax preparation and representation experts, but strive to become valued business partners. Tax Samaritan is committed to understanding our client’s unique needs; every tax situation is different and requires a personal approach in providing realistic and effective solutions.
If you are considering an offer in compromise for the resolution of your tax liability, please click the button below to request assistance from Tax Samaritan to ensure that your Reasonable Collection Potential (RCP) is properly calculated and to determine whether you have a reasonable offer that has a good chance of being accepted at the lowest possible amount.
Tax Samaritan is a team of Enrolled Agents with over 25 years of experience focusing on US tax preparation and representation. We maintain this tax blog where all articles are written by Enrolled Agents. Our main objective is to educate US taxpayers on their tax responsibilities and the selection of a tax professional. Our articles are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid.
When looking for a tax professional, choose carefully. We recommend that you hire a credentialed tax professional such as Tax Samaritan that is an Enrolled Agent (America’s Tax Experts). If you are a US taxpayer overseas, we further recommend that you seek a professional who is experienced in expat tax preparation, like Tax Samaritan (most tax professionals have limited to no experience with the unique tax issues of expat taxpayers).
Randall Brody is an enrolled agent, licensed by the US Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation, fulfill continuing education credits and adhere to a stringent code of ethics.
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