When it comes to settling back taxes — especially for taxpayers who have a potential of earning substantially greater income in upcoming years — the IRS has a problem. One on hand, it is in the IRS' best interest to get a taxpayer to settle their back taxes before the IRS loses the ability to do so because of an expiring statute of limitations on collections. Also, enforced collections such as levies and liens may not be cost-effective.
On the other hand, the IRS is stuck with looking at a taxpayer's Realistic Collection Potential (RCP) when considering an Offer in Compromise. The RCP may show a number that is much too low for them to accept. Fortunately, there is a tool called an Offer in Compromise collateral agreement. This allows protection from the IRS and makes it possible for a taxpayer to settle an IRS tax debt that he would not otherwise be able to do. In this article I will explain how Offer in Compromise collateral agreements work and how you may be able to use it to your advantage.
Let's use a hypothetical situation:
Joe, the Real Estate Developer is trying to settle his back taxes. Could he use the Offer in Compromise collateral agreement?
Here is an example of a situation the IRS does not want to be in. Joe is a real estate developer. Right now, he is upside-down in every property he owns, there is pending litigation, and he hasn't made any deals in years. He has been living off of borrowed funds and his wits. For the last three years, his income taxes have shown losses. Yet, years ago, Joe ran up a tax debt in the millions of dollars from a previous boom. Now, Joe wants to settle his back taxes for $1000 with an Offer in Compromise.
According to the IRS formula, this is a legitimate offer. But the Offer in Compromise Examiner just doesn't understand the complexity of Joe's affairs and rejects his Offer in Compromise, thinking it just wasn't in the best interest of the government. So, Joe takes an Offer in Compromise to an appeal. The Appeals Officer agrees with Joe's attorney, that yes, $1000 is the right amount per the calculations….but the Appeals Officer also knows that Joe's fortunes could dramatically turn around any day.
The Appeals Officer doesn't want to be in the position of agreeing to settle Joe's million dollar liability for a mere $1000, and then have Joe making millions of dollars the following year. Then the IRS would have no claim to that money, other than current tax obligations. So what to do?
The fact is, without this debt settled, Joe will have a hard time making his comeback so he really needs this tax debt gone. On the other hand, Joe understands the IRS' position. It's a deal he wouldn't agree to if he were them. He knows he can make a lot more money if the tax debt was wiped out and the tax liens filed against him were released.
That is where an IRS Offer in Compromise collateral agreement can come into play. It does not increase the amount of an Offer in Compromise. Rather, the Appeals Officer can set a future set of conditions that would cause Joe to have to pay additional sums towards the back taxes only if he came into a considerable amount of money.
I've seen an Offer in Compromise collateral agreement that said "If taxpayer's Adjusted Gross income in the next 3 years, exceeds $150,000, the IRS shall be entitled to 10%, if 200,000 20% of that over 200,000, if 300,000, then 30% of anything over $300,000.00", etc.
What types of Offer in Compromise collateral agreements are there? As this chart below shows, there are other types of collateral agreements that you may benefit from when trying to find a complete solution to a nagging IRS tax debt.
IRS Offer in Compromise Collateral Agreement types:
- As explained in our example with Joe, a future income collateral agreement can give the IRS the ability to collect additional money if your adjusted gross income exceeds a pre-determined schedule.
- If you are compromising the income tax liability of a defunct professional corporation you may be able to use a future income collateral agreement from the majority or sole owner of the professional corporation to collect from their future individual income.
- If you have real or personal property that is being depreciated you can use an Offer in Compromise collateral agreement to reduce the basis of the asset, which will give the IRS the ability to tax the property because it will have a bigger gain.
- If you have net operating losses or capital losses arising from prior years available for deduction in future years, you may be able to use an Offer in Compromise collateral agreement to waive the loss, thus giving the IRS the ability to increase your taxes in future years.
Is an Offer in Compromise collateral agreement right for you? Is an IRS Offer in Compromise even the best solution for you? Read this article about the disadvantages of filing an Offer in Compromise or click below to see the other potentially more beneficial ways of settling an IRS tax debt.