This is Part II of a two-part article on secrets to settling with the IRS for the lowest possible amount. Remember, the IRS considers your monthly net income and the equity in your assets when determining what amount, if any, it will settle your tax liability. Perhaps the biggest mistake people make when trying to settle with the IRS they overlook the exclusions found in the Internal Revenue Manual (IRM) and the Internal Revenue Code (IRC). These exclusions can dramatically lower the value of your assets and therefore lower the amount for which you settle your tax debt.
Reducing the Value of Business Equipment
If you’re in business and you own tools or business equipment, then your tax professional must be familiar with IRM 22.214.171.124, “Income-Producing Assets,” before submitting an offer in compromise. It’s vital that you do not include both the net realizable equity in business equipment and the revenue that the equipment generates when calculating an offer in compromise. The IRS has the discretion to include either the equity in the business equipment or the income the business equipment generates, but not both.
The key factor whether business equipment can be excluded from the value of the settlement is whether the asset is critical to business operations. In simple terms, what would happen to your business if someone took the equipment? How important is the equipment or tools to your business? This will be a case by case, fact based determination, and your tax professional must be prepared to fight the IRS tooth and nail on this point. And if necessary, even appeal the issue all the way to tax court.
Example: A business depends on a machine to manufacture parts and cannot operate without this machine. The equity in the machine is $200,000. The machine produces net income of $8,000 every month or $96,000 a year. When calculating the settlement offer, the income produced by the machine should be included, but not the equity of $200,000. Equity in this machine will generally not be included in calculating the offer to settle because the machine is critical to generate income.
However, if the business did not need the machine, or the machine produced minimal revenue, the IRS would include the value of the equipment in the compromise, but would exclude the income it generated for purposes of calculating a settlement offer.
As you can see, it’s an “either or” proposition. The IRS will take the value of the asset or the income it generates, but not both. It’s vital to also review the Internal Revenue Code (IRC) because it also provides additional methods to exclude smaller equipment and tools of a business from the value of an offer in compromise. IRC Sec. 6334(a)(3) exempts from levy books and tools of the trade, profession, or business up to $4,470 in value. If the IRS cannot seize and collect from property, then the equity in that property is excluded from calculating an offer in compromise. Also see IRM 126.96.36.199, “Inventory, Machinery, Equipment, and Tools of the Trade,” that recognizes the exemptions of IRC 6334(a)(3) to exclude the value of small business equipment and tools in an offer in compromise.
Example: Let’s say you are a contractor or plumber who has tools of the profession such as ladders, hand tools, miscellaneous equipment, a laptop, a printer, etc. and all of it is valued at $6,200. Even though the small tools and equipment are worth $6,200, the net realizable equity for purposes of the compromise would be shown as $490. The calculation is as follows: FMV = $6,200. Quick Sale Value = $4,960 (20 percent reduction). Now deduct the $4,470 exclusion allowed by IRC 6334(a)(3) and IRM 188.8.131.52. This equals $490 net realizable equity.
Reducing the Value of Household Goods and Personal Belongings
A big mistake I see among so-called “tax resolution” companies is that they make the assumption that the IRS is actually interesting in seizing your personal stuff, like furniture, clothing, appliances and even jewelry. They’re typically not interested in having a garage sale to sell your stuff. From a practical standpoint, there is little value in your household goods and personal belongings. Therefore, when negotiating with the IRS to settle for less than owed, this leverage point must be kept in mind at all times.
Furthermore, even if the IRS wanted to take your stuff, the law says the IRS cannot levy your personal property and leave you without basic essentials. Sec. 6334(a)(2) of the Internal Revenue Code lists specific types of property that are protected from seizure, such as household furniture and belongings. As of this writing IRC Sec. 6334(a)(2) protects $8,940 in value of household goods and personal effects per taxpayer. So if you’re married you double this amount. Sec. 6334(a)(1) of the Internal Revenue Code allows you to keep all necessary clothing. Although the key word is “necessary” the practical reality is that the IRS is usually not interesting in taking your clothes.
It’s important to apply these protections when calculating an offer in compromise. In valuing clothing, household goods, and personal effects, fair market value is equal to “garage sale value.” If you’re married with three children, and you live in a four-bedroom house, you may have accumulated a lot of stuff over the years, but does it really have any value if you were to sell it at a garage sale? Remember, garage salve value is the value you will use to arrive at fair market value. It’s probably not going to be worth anywhere near what you paid for it.
Example: You are single, and you believe that you could get $10,000 for your household goods and belongings at a garage sale, how would the IRS view your stuff when considering an offer in compromise? Well, the $10,000 value is over the protected amount of $8,940. However, the equity for purposes of the compromise would be zero because the garage sale value (FMV) would be decreased by 20% so that you arrive at “Quick Sale Value.” $10,000 FMV less 20 percent QSV = $8,000. If you were married, your stuff would be protected up to $17,880 ($8940 times 2). So if you and your spouse believed you could sell your stuff for $20,000, you would reduce this amount by 20% to arrive at QSV of $16,000. When you apply the exemption for married couples of $17,880, you are left with no equity, and therefore your household goods and personal belongings would not create value for purposes of an offer in compromise.
Questions? Call Me!
If you have more questions about settling with the IRS, I would love to speak with you. Remember that an offer in compromise is not the only solution to eliminate tax debt. I’ll be happy to discuss all solutions with you, and tell you which ones fit best for your unique situation.
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