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Calculating Reasonable Collection Potential in an Offer in Compromise

Worksheet to Form 433-A

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Through an Offer in Compromise, taxpayers agree to pay the IRS only the reasonable collection potential instead of the full amount of taxes owed. Calculating the Reasonable Collection Potential is the most important element in determining the success of your Offer in Compromise.

Reasonable Collection Potential

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 over a period of 4 or 5 years.

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.

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.

Calculating the Reasonable Collection Potential

In a nutshell, your reasonable collection potential is calculated as follows:
  • 100% of your cash, investments, and accounts receivable, plus
  • the "realizable value" of your vehicles, real estate, and personal assets, plus
  • your monthly disposable income over a period of 48 months or 60 months.

Realizable Value of Your Assets

The realizable value of your cars, real estate, and personal property is calculated as follows:
  • Fair market value of the property, times
  • 80% (the quick sale discount factor), minus
  • the balance of any loans secured by the property.

We could write this another way:

  • Fair market value times 80% equals the Quick Sale Value
  • Quick Sale Value minus Outstanding Secured Loans equals the Realizable Value

For example, you may own a home that has been appraised at $120,000. Eighty percent of the appraised value is $96,000 (this is the quick sale value). The balance on your first and second mortgages totals $88,000. This leaves you with a realizable value of $8,000 for your house. This represents the actual amount of cash you could probably realize if you were to sell your house today.

Monthly Disposable Income Over 48 or 60 Months

Your monthly disposable income comes from the budget prepared in Section 9 of Form 433-A. Generally, use the figures for budget #3, using the lower of your actual expenses or the IRS Collection Financial Standards.

Subtract Total Living Expenses (Line 45 of Form 433-A) from Total Income (Line 34). (These amounts are carried to Line 12 of the Worksheet.)

Multiply this monthly figure by 48 months if you plan to pay off your Offer in Compromise within 90 days from the date the IRS notifies you that your Offer has been accepted.

Multiply this monthly figure by 60 months if you plan to pay off your Offer in monthly installments over a period longer than 90 days but less than 24 months.

Total Offer Amount

On IRS Form 656, you must indicate how much money you are willing to pay in return for the IRS approving your Offer in Compromise. This is your Offer amount. Your Offer amount must be equal to, or greater than, your Reasonable Collection Potential as shown on the Worksheet for Form 433-A.

Tips

Very often, what makes or breaks an Offer in Compromise is the monthly budget. That's because the monthly disposable income is multiplied by 48 or 60. So even small adjustments to the monthly budget can have big consequences for the success of your Offer. The key to a successful budget is thorough and comprehensive documentation of all your expenses, together with strong negotiation to ensure that the IRS allows more expenses as part of your necessary living expenses.

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