What is Reasonable Collection Potential and How it Impacts Your Offer in Compromise

Overview

Depending on the amount of taxes, penalties, and interest owed to the IRS, you may be considering an Offer in Compromise (“OIC”). However, to pay “pennies on the dollar,” the Internal Revenue Service (“IRS”) will not accept an OIC unless the amount offered is equal to or greater than your Reasonable Collection Potential (“RCP”).

What is Reasonable Collection Potential?

RCP is the IRS’s measure of your ability to pay any taxes, penalties, and interest owed to the federal government. RCP includes the value that can be realized from your assets, including:

In addition, your RCP also includes anticipated future income less certain amounts allowed for basic living expenses.

How the IRS will compute your Reasonable Collection Potential

First, the IRS will consider the equity you have in the assets listed above. In doing so, the IRS views each asset as something that could be sold or borrowed against in order to pay the taxes owed. However, the IRS will not consider the full value of the assets. Instead, they will look at the quick sale value, which is typically 80% of the asset’s fair market value, minus any debt owed on the property by the taxpayer. The rationale for doing so is that this better (and more conservatively) approximates the IRS’s ability to collect by estimating how much cash you could get out of an asset immediately in order to pay the IRS. This is referred to as “net realizable value.”

In determining your Net Realizable Value, the IRS permits some exclusions. For example, you may reduce your total cash on hand by $1,000 plus one month’s worth of allowable expenses. Additionally, you may reduce the quick sale value of each vehicle (up to two vehicles in a joint household) by $3,450. Ultimately, the remaining equity will be used to help calculate your RCP.

Additionally, the IRS will consider your average monthly income less allowable expenses, with the net difference between them as the amount the IRS will generally demand each month to pay off the tax debt under a traditional payment plan. To calculate your monthly living expenses, the IRS may consider your actual expenses or may use the Collection Financial Standards to limit those that spend excessively. Depending on the category, the Collection Financial Standards may be determined either at a national or local level.

Collection Financial Standards are used for the following categories:

Once the net difference in monthly income and allowable expenses has been calculated, this amount will be multiplied by either 12 or 24 depending on the repayment term chosen by the taxpayer under the Offer in Compromise rules to get “future remaining income .” Future Remaining Income and Net Realizable Value will be added together to determine your “net equity.” Most often, your OIC amount must be at least as much as your Net Equity.

In many cases, however, there is room to negotiate with the IRS regarding Net Realizable Value, Net Equity, assets, and living expenses, all of which impact the final offer amount. Often times, people have special circumstances which limit their ability to offer the amount usually required.

If you owe taxes to the IRS, call The Wilson Firm today to get help settling your tax debt. We will work to negotiate with the IRS to get you an Offer in Compromise that is fair and manageable.