Fresh Start and Cash Flow
As stated in my posting on May 14, 2015, determining an offer-in-compromise amount to extinguish debt owed to the IRS is made up of 2 components – net equity and cash flow. These are used by the IRS to determine reasonable collection potential or RCP. RCP represents net equity plus monthly cash flow multiplied by 12 (if offering to make payment in 5 installments or less) or 24 (if offering to make payment in 6 to 24 installments). If the RCP exceeds the amount owed, chances are your offer will be rejected. If it falls below the amount owed, you might have a shot as getting an offer accepted.
In my last posting, I discussed the net equity calculation. In this posting, we’ll take a look at the cash flow calculation.
In most cases, you would think this is pretty easy: “Count the cash I bring in every month and subtract what I have to pay out every month; whatever is left over is discretionary and available for use against, say, amounts due to the IRS.” Unfortunately, the IRS doesn’t quite see it that way.
The IRS appears to start out right by asking you to provide income information supported by pay stubs or a business income statement. Then things take a turn for the worse: The portion that you subtract from this income is not necessarily the amount that you actually pay. Surprised? The IRS has created what are called collection financial standards, which might restrict the amounts you can subtract from your income. The living expenses that are allowable are considered by the IRS to be reasonable amounts that you would otherwise need to spend. Thus, that discretionary amount ends up being higher than you thought. From my past experience, the IRS is pretty rigid when it comes to the standards, but will allow some leeway when the taxpayer has excessive commuting costs, court-ordered payments, medical expenses or education needs for a special needs child. But by no means are they a lay-up. You need to put forth your case for allowing these excessive costs with solid substantiation. By the way, there are some costs which the IRS will normally not allow at all; namely, credit card payments, payments on unsecured debt, private school tuition and charitable contributions.
The key to understanding the logic of the IRS when it comes to determining cash flow is to know about the collection financial standards. Your cash flow bottom line calculation, based on the standards, can make or break your chances of getting to “yes” when it comes to an offer.