Your IRS offer amount must equal or exceed your Reasonable Collection Potential (RCP) (described below). One element of the RCP is your monthly disposable income. That is essentially your monthly gross income less allowable expenses. I periodically receive questions asking if the IRS will accept a state tax liability installment agreement payment amount as an allowable expense.
How the IRS factors state tax plans into an OIC
When you apply for an OIC, the IRS assesses your ability to pay your federal taxes by calculating your Reasonable Collection Potential (RCP). This is the total amount the IRS believes it can collect from you by considering your net equity in your assets and future income. In short, it is the sum of two figures. The first is the net equity in your assets (their current fair market value less the debt secured by that property or asset). The second element is the amount you can pay over 12 months (for a cash offer payable within 5 months of acceptance). If you opt for a periodic monthly payment, the factor is 24 vs 12 months.
A state tax payment plan affects this calculation in the following ways:
- Monthly disposable income: A key component of the RCP is your future income. The IRS calculates your monthly disposable income by subtracting the necessary monthly living expenses from your total income. The IRS publishes annually its Collection Financial Standards that provide the maximum amounts deemed reasonable for several categories of expenses. You can find these on the IRS.GOV website, or simply Google that topic. A state tax payment plan, pursuant to a previously negotiated agreement can be considered a necessary expense and will reduce your monthly disposable income.
- RCP calculation: The IRS typically determines the future income portion of your RCP by multiplying your monthly disposable income by either 12 or 24. That multiplier depends on your choice of the OIC payment option (lump sum or periodic payments). Because your state tax payments reduce your disposable income, they also lower your overall RCP. That reduces the amount of your minimum offer.
- Example: Assume you have $700 in monthly disposable income before accounting for a $300 per month previously negotiated state income tax payment. The IRS would calculate your available income as $400 ($700 – $300). If you propose a 24-month OIC, this will reduce the future income portion of your RCP by $9,600 ($400 x 24). This will reduce the minimum amount the IRS would likely accept.
Here are some other factors to consider:
- Substantiation of Expenses: You must provide the IRS with financial documentation when submitting your Form 433-A (OIC) (Collection Information Statement for Wage Earners) or Form 433-B (for Businesses).
- Comply with filing and current withholding/estimated tax payments.: For the IRS to consider your OIC, you must have all your federal tax returns filed for the past six years. Additionally, you must be current with your federal income tax withholding or estimated tax payments for the current year. Your payment plan with the state will be included in the financial review, so you must comply with its terms as well.
- Timing: The payment options you choose for both your state taxes and your OIC can significantly impact your federal offer. This can be a complicated process. I recommend you retain a tax resolution specialist to help you accurately determine your offer amount and negotiate your OIC with the IRS.
- IRS Counter-Offer: After reviewing your records, the IRS will determine the correct offer amount. If it is more than what you offered, and you have no exceptional circumstances, the IRS will allow you to increase your offer amount. If you do not agree to increase your offer, the OIC will be rejected. If the IRS determines that you can fully pay the liability, you can request an installment agreement. Alternatively, you can appeal a proposed rejection, but timing is crucial.
The IRS reviews OICs for possible fraudulent intent. Submitting an OIC with false information or making a false statement to an IRS employee is considered fraud and may be subject to civil or criminal penalties.