As part of the Fresh Start program, in May 2012, the Internal Revenue Service (IRS) announced that the offer in Compatibility requirements had been modified to make this option available to a larger group of delinquent taxpayers. An Offer in Compromise is an agreement between the IRS and a taxpayer who has federal tax liability. This agreement settles the federal tax debt for less than the total amount owed.
The minimum amount that the IRS can accept to satisfy a tax debt is carefully calculated based on taxpayer's current and future income and equity in assets. Before the Fresh Start initiative was announced, it was very difficult to resolve a tax debt through an offer in compromise. The IRS applied strict rules to evaluate a taxpayer's financial situation. In addition, factors such as age, education and employment history were taken into consideration by the IRS to estimate the collection potential of a taxpayer. According to the IRS, Fresh Start allows more flexibility for financial analysis of a taxpayer experiencing economic hardship.
To make this possible, the IRS revised its allowable standards for living expenses, which are used to estimate how much a taxpayer can afford to pay to the IRS for the back taxes. These new standards have been increased to allow taxpayers to spend more money on food, personal vehicle, housing, and utilities before paying back outstanding tax liability. Allowable living expenses are used in both Offers in Compromise and Installment Agreement calculations.
Fresh Start also takes into consideration a taxpayer's student loan and state back tax payments. However, such student loans have to be guaranteed by the federal government and must be used for post-high school education. Payments for outstanding state and local taxes can also be considered, but there are some requirements that have to be satisfied.
Another factor in an Offer in Compromise calculation is the future income of a taxpayer. The IRS used to look at four to five years of future income when calculating an Offer in Compromise. These requirements have been changed to just one to two years. If the offered amount is going to be paid in five months or less, the IRS uses one year of future disposable income to calculate the amount of the offer. Another option is to pay the debt in 6 to 24 months, which means the IRS will consider two years of a taxpayer's disposable income.
However, even with these recent changes by the IRS, few submitted Offer in Compromise applications are approved. The IRS has complicated guidelines to follow when considering a proposal to resolve back tax debt. It is often beneficial for a taxpayer to consult a tax debt professional to get advice about the best way to settle their IRS liability, or to negotiate a resolution with the IRS on a taxpayer's behalf.
It is important to remember, when dealing with the IRS, that all future tax payments must be made on time and in full to prevent a default of the existing agreement. Otherwise the Offer in Compromise will be automatically denied by the IRS.