In order for the Internal Revenue Service (IRS) to determine whether a taxpayer is entitled to a reduction in their federal tax burden by way of an Offer in Compromise based on doubt as to collectability, the taxpayer’s future income must be determined. How future income is calculated is essentially an estimate made by the IRS of a taxpayer’s ability to pay an outstanding tax obligation based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. Internal Revenue Service, Internal Revenue Manual, 220.127.116.11 (10-22-2010) Future Income, available at https://www.irs.gov/irm/part5/irm_05-008-005.html#d0e1176. Because future income is based in part on necessary expenses, it is important to understand which expenses qualify as necessary and which do not.
How Future Income is Calculated
A necessary expense is defined by the Internal Revenue Manual as ” one that is necessary for the production of income or for the health and welfare of the taxpayer’s family.” Internal Revenue Service, Internal Revenue Manual, 18.104.22.168.1 (10-22-2010) Necessary Expenses, available at https://www.irs.gov/irm/part5/irm_05-008-005.html#d0e1176. The IRS utilizes national and local expense standards in order to determine what are necessary expenses, and thus arrive at the future income calculation, but IRS personnel retain discretion, and if the standard amount is inadequate a deviation is permissible. That said, a deviation will often necessitate underlying documentation to show the national standard is insufficient. Taxpayers with low or no income that retain assets should note that a deviation from national standards is not warranted simply because a taxpayer does not wish to liquidate high-value assets. Also considered are miscellaneous “other expenses,” which must meet the necessary expense test by in some way. That test requires that the expense be one incurred in connection with providing for the health and welfare of the taxpayer and/or the taxpayer’s family or must be for the production of income. In making a determination of whether an expense qualifies, the IRS can look to the entire circumstances of the taxpayer’s situation.
The final integral part of the future income calculation is the amount of months used in the calculation, and the number of months used depends on the type and amount of the payment. For lump sum cash offers, an offer to be paid in 5 months or less or less would project 48 months or until the statute of limitation, whichever is shorter; an offer to be paid in 5 t0 24 months would project 60 months or until the statute of limitation, whichever is shorter; an offer to be paid in more than 24 months would project until the statute of limitations has run. Id.
For more information on the calculation of future income for Offers in Compromise contact an experienced tax professional.
Please keep in mind the information and advice presented in this blog is not intended to be used as formal legal advice. Contact a tax professional for personalized tax advice pertaining to your specific situation. While we try and answer all parts of the question when we write our blogs, sometimes there may be some left unanswered. If you have any questions about your problems with the IRS, SBOE, FTB, or BOE, or tax law in general, call RJS Law at (619) 595-1655.