Secrets to Settling With the IRS
Settlement of IRS tax debt for less than the full balance is known as an offer in compromise (OIC). In simple terms, the IRS looks at your "net realizable value" of your assets and your disposable income when determing whether to accept your offer or reject it. If you have too much equity in your assets or too much disposable income, the IRS is going to determine that you have the capability to pay them back in full by selling your assets or paying them from your income, or both.
Now, according to the IRS's own statistics, most offers are not accepted by the IRS. Why? Usually, the deciding factor is taxpayers show too much equity in assets. And that's unfortunate because quite often this can be avoided.
In my experience, most taxpayers do not take advantage of the "secret" exclusions for cars, bank accounts, business equipment and personal property that the government allows taxpayers to use when calculating an offer to settle for less than owed. These exclusions can radically "shrink" the value of your assets so that your offer to the IRS is the lowest possible amount that the IRS will accept. These exclusions are revealed deep within the Internal Revenue Manual (IRM) and the Internal Revenue Code (IRC).
If you don’t take full advantage of these exclusions and strategies you will pay a lot more to the IRS than you are legally required, or your offer in compromise will completely fail. So let’s take a look at how to win the lowest possible settlement with the IRS. Keep in mind that my explanations will not be detailed. I just want you to have a general idea of what this is all about.
Reducing the Value of Cars and Trucks
Remember, the idea is to make the net realizable value of all your assets as low as possible, and be seen by t
he IRS as owning little or nothing from which they can collect. So how do you keep the value of your vehicle as low as possible in the eyes of the IRS?
REDUCE FAIR MARKET VALUE TO QUICK SALE VALUE
First, the Internal Revenue Manual, or IRM, allows you to reduce the fair market value of your car or truck to what is called “quick sale value.” This is allowed under IRM 184.108.40.206.1. What this means is that you are allowed by the IRS to value your car or truck as if you had to sell it very quickly, like a fire sale.
In order to calculate quick sale value, you take the Kelly Blue Book (KBB) private sale value of your vehicle and deduct 20 percent. For example, let’s say you have a 2010 Volkswagen Diesel Jetta Wagon with 110,000 miles. The Kelly Blue Book says you could sell the car for $8,300. Quick sale value would be calculated by reducing the price by 20%, or by $1660. So the quick sale value would be $8300 less $1660 = $6640.
However, you can deduct even lower than 20% if it can be demonstrated to the IRS that your vehicle is in fair or poor condition, or is not readily marketable. I’ve had many cases where my client’s vehicle is in less than good condition. If this same VW Jetta were in fair condition, KBB private sale value would be $7280, and then you deduct 20% of the KBB private sale value to arrive at a quick sale value of $5824.
USE THE BLANKET EXCEPTION
Okay, we’re not done yet reducing the value of your vehicle. The IRM 220.127.116.11 allows for a blanket exclusion of $3450 that can be deducted from quick sale value. So using the example of the VW Jetta, if the quick sale value were $5824, we could deduct $3450 to arrive at a value of $2374.
DEDUCT LOAN AMOUNTS
And we’re still not done. If there is a loan on our VW we can deduct that too. So if we owed $2100 to the bank, then the value of the VW is a whopping $274! The IRS is not interested in $274 equity in your vehicle. In fact, I’ve had clients with a lot more equity in their vehicles and we have still obtained extremely low settlements with the IRS.
CONSIDER ANY SPECIAL CIRCUMSTANCES
It’s vital to always remember that each case is unique.
What if the vehicle was a special type of convertible that may sell in the spring or summer, so it is “sale proof” in the fall or winter? That can happen. And it will drive down the quick sale value of the vehicle more than 20% of KBB private sale.
Or what if the vehicle can be discounted in other ways? For example, I had a client who owned a rare 1971 Plymouth Barracuda. On paper the car was worth a lot of money. Yet the car was in pieces. And the original engine was missing too; the collector car had a replacement block. On that basis, we convinced the IRS that the car was worth only a small fraction of its fair market value and my client obtained a killer deal with the IRS.
NEVER USE A COOKIE CUTTER APPROACH
Bottom line, you must be clever, experienced and knowledgeable if you desire the best result. Having complete command of the IRM and IRC is vital. Your financial future depends on it. Let’s now discuss how to keep bank balance values to a minimum.
Reducing the Value of Bank Account Balances
The IRS looks at bank accounts as an asset that can be seized. In fact, bank account balances are routinely seized by the IRS. The IRS is going to consider what you have in the bank in determining whether to take less from you now or reject your offer and seize your checking and saving accounts.
So how can you protect cash in the bank? How can you legally minimize the value of what you have in the bank so it does not get in the way of the IRS agreeing to settle for a lot less? A number of ways, actually.
USE ASSET PROTECTION PLANNING STRATEGIES
First, when considering an offer in compromise, the IRS will usually require a minimum of three months checking account and bank statements. I advise my clients, however, to assume that the IRS is going to back at least 180 days in examining your bank records. So the government is going to be looking to see whether you withdrew funds or paid out unusual expenses in the months before your offer is submitted to the IRS.
It is quite possible – and legal – to withdraw funds or make expenses that reduce your bank account balances. However, to keep these withdrawals or payments under the radar, it may be necessary to do it at least 90 days prior to submitting the offer in compromise to the IRS. Now, this does not mean you hide money or transfer money to third parties in order to defraud the IRS. That can make the situation much worse.
What it does mean is that it’s possible – and legal – to protect assets like bank accounts by planning in advance. Where allowed, an asset that could be seized by the IRS is converted into an asset protected (exempt) by law. For example, IRM 18.104.22.168 allows certain assets to be excluded from the value of an OIC. Furthermore, Section 6334(a)(2) lists specific types of household property – like clothing, furniture, appliances, etc. – that are protected from the IRS and not subject to seizure. So if you have excess cash in the bank, it may be possible to take that cash and purchase assets that are protected (exempt) with assets that would otherwise not be protected (non-exempt). Therefore, these protected assets need not be considered by the IRS for purposes of determining an acceptable offer.
CLAIM MAXIMUM EXCLUSIONS
Okay, so assume you do your best to decrease what is in your bank accounts using the asset protection strategies allowed by the IRM and IRC. Now what?
Don’t offer the IRS the full value of the bank account balances in your account. Instead, be sure to claim the value exclusion for bank account balances found in Internal Revenue Manual (IRM) 22.214.171.124. These exclusions apply to both checking accounts and savings accounts.
For savings accounts, IRM 126.96.36.199 provides an exclusion of $1000 from the cash balance in the account. Again, the IRS will usually require for review the last three months’ bank statements. The IRS will consider the balance of the most recent statement if account activity is minimal. Keep in mind that nothing prevents the IRS from going back further than 90 days to review account activity.
For example, let’s say Jane and Jim have a checking account balance of $3000. Jane has a car, but Jim does not. Jim takes $2000 from this savings account and uses it as a down payment to purchase a car for $10,000. He finances $8000 of the car. This leaves Jim with $1000 in his savings account and he deducts the $1000 from the savings account balance leaving him with -0- in the account, and no net realizable equity. Jim and Jane wait 6 months from the date they withdraw $2000 from their bank account to submit their offer in compromise.
Unlike savings accounts, checking accounts entitle taxpayers to exclude one month’s allowable living expenses from the value of your offer. And if you don’t have a savings account, you can add another $1000 to that exclusion. By the way, these exclusions apply to personal accounts, not business accounts.
Typically, the IRS will want to look at the last 90 days’ checking account statements. The IRS will use the average daily balance in your checking account over 90 days to determine value for purposes of considering your offer.
The question you may be asking is what constitutes “one month’s allowable expenses”? The IRS calculates on month’s allowable exceptions as those expenses that are within the IRS allowable expense standards. So a clever tax professional is going to take one months of mortgage payments, utilities, vehicle payments, food expenses, clothing and even entertainment expenses and add these together; and then subtract this number from the checking account balance.
For example, Jim and Jane don’t have a savings account. They do have a checking account with an average balance of $8000 over the last 90 days. Jim and Jane need to replace certain household items and so they use $2000 in their checking account to purchase these necessary items. This leaves $6000 in their checking account. Their living expenses are $4500 leaving $1500. Jim and Jane then reduce it by $1000 taking advantage of the unused savings account exclusion. This leaves net realizable equity of only $500.
SO IT’S VITAL…
You never over value a bank account balance. You start by considering how you can reduce what’s in the accounts by purchasing assets which are exempt from IRS seizure. Then you apply the exclusions allowed by the Internal Revenue Manual (IRM) to reduce the net realizable equity even more and obtain the very best settlement possible, saving as much of your hard earned money as possible.
If you have questions about settling with the IRS, give me a call for free at 800 659 0525.
In Part II we will discuss how to minimize the value of business equipment, household goods and other personal property.