Why Understanding RCP Is Key to Tax Relief
If you’re applying for an offer in compromise settlement, you need to understand that the IRS doesn’t approve settlements based on how much you owe. Rather, settlements are based on how much you can afford to pay, which the IRS refers to as reasonable collection potential (RCP).
To put it another way, the IRS looks at your application and considers – ‘How much could we collect from this person if we used liens and levies?’ Then, the agency uses that answer to determine your settlement.
From some angles, RCP is just a formula, but there are ways to optimize the situation to reduce your settlement as much as possible. At Wiggam Law, we have extensive experience helping clients get tax settlements, and we can help you understand if this is the right option for you. But first, let’s explain reasonable collection potential and how it applies to IRS tax relief programs.
Key takeaways
- Reasonable collection potential – the amount the IRS could expect to collect using liens and levies.
- When applies – used to determine settlements for offers in compromise and eligibility for currently not collectible and partial payment plans.
- How determined – based on your disposable income and the equity in your assets?
What Is Reasonable Collection Potential (RCP)?
The IRS defines reasonable collection potential as the maximum amount the IRS can collect from you before the tax debt expires on the Collection Statute Expiration Date (CSED). This number helps to determine settlements for offers in compromise, but it also comes into play if you apply for currently not collectible status or a partial payment installment agreement (PPIA).
The IRS determines your RCP based on the information provided on your collection information state, and it includes:
- Equity in assets – typically, the agency uses 100% of the value in cash or cash-equivalent assets and about 80% of the fair market value of most real assets.
- Disposable income – that’s based on your income, minus allowable expenses.
The next section offers a deeper look at both of these concepts.
How the IRS Calculates Your RCP for Offer in Compromise
You can get a sense of your reasonable collection potential with the IRS’s OIC pre-qualifier tool, but keep in mind that it has limitations. If you apply for an offer in compromise, the IRS uses the following calculations to estimate your collection potential.
- Cash and investments – all of the funds in your bank accounts, investment accounts, and digital assets.
- Retirement accounts – 80% of the value of your retirement accounts. The agency may consider a lower amount due to tax liabilities and penalties that you’ll likely incur if you cash out retirement accounts.
- Real property, vehicles, and valuable personal property – 80% of the asset’s fair market value minus the amount owed. For example, if your home is worth $1 million and you owe $300,000, the IRS considers $500,000 as part of your RCP. That’s ($1,000,000 * .80) – $300,000 = $500,000.
- Disposable income – all income sources minus qualifying expenses.
The IRS has very strict rules on which expenses you can subtract from your income. The agency sets financial standards annually, outlining the amount taxpayers should allocate for essential expenses. Standards for food, clothing, and other essential items are set at the national level, while housing and transportation standards vary from county to county. There are two healthcare standards based on your age.
Typically, if an expense is over the standard, you can only subtract the standard amount when calculating your disposable income, and if your expense is under the standard, you can only account for your actual spending. However, in some categories, such as healthcare, the IRS allows you to claim the full amount even if you spend less.
Lump sum offers vs. periodic payment offers.
When you apply for an offer in compromise, you can propose to pay the settlement in a lump sum (which may be split into up to five installments over five months) or in periodic payments (up to 24 payments over a period of up to two years). Here’s how both of those settlements are calculated:
- Lump sum offer: Quick sale/cash value of assets + 12 months of disposable income.
- Periodic offer: Quick sale/cash value of assets + 24 months of disposable income.
Why OICs Are Denied: Common Mistakes About RCP
Offer in compromise applications have very low approval rates. In most years, the IRS approves just under half of all applicants, but the 2024 data book indicates that only about 20% applications were approved in the most recent year.
To protect yourself and boost your chances of approval, avoid these common mistakes:
- Assuming that you and the IRS have the same definition of affordable, you may think that you’re spending as little as possible on rent, clothing, or transportation, but the IRS’s standards may indicate something completely different.
- Listing expenses the IRS won’t consider – The IRS doesn’t think that private school tuition, college expenses, or credit card payments are necessary expenses. They won’t be included in your RCP.
- Overestimating the value of assets – Overinflating the value of your assets will drive up the amount of your settlement. Make sure you’re careful about your estimates. If you have a lot of assets, keep in mind that the IRS may want proof of value.
- Not including all of your assets – Failing to complete these forms correctly may constitute tax fraud, especially if you act willfully or negligently. You’re obligated to include all of your assets on these forms as they are signed under penalties of perjury.
- Failing to include all household income – Even if the income isn’t taxed, you must include it. If you live with people who aren’t in your family or claimed on your return, you may want to consult with a tax professional about how to handle that.
It’s also important to note that although the IRS uses strict financial standards and RCP formulas, there is room for some exceptions. For example, if you need to exceed the financial standards due to a chronic illness, you should include those details in your application.
Also, in cases where it would be inequitable to force you to pay a settlement based on your full RCP, you may be able to get a reduced settlement under the terms of effective tax administration – having an experienced tax attorney can be critical at that point.
How to Evaluate If You Qualify for an OIC
Bottom line, you’ll probably qualify for an offer in compromise if your RCP is lower than your tax liability. The best way to determine if you’re a candidate is to reach out to an experienced tax resolution professional.
But in the meantime, consider:
- Do you have minimal disposable income? If so, are your expenses at or under the IRS’s standards?
- Do you have minimal equity in your assets? More accurately, is the equity in your assets too low to cover your tax liability?
If you answer “yes” to all of those questions, you may want to consider the offer in compromise program. Keep in mind, however, that the IRS doesn’t just consider your RCP. They also want to ensure that you’ll stay compliant with taxes moving forward.
That means the IRS will want to ensure that you’ve filed the last six years of back taxes, and that you’ve taken steps to avoid getting behind in future years. Once you get a settlement, you’re supposed to stay compliant with tax filing and payment requirements – if you default in the next five years, the IRS may retroactively rescind your offer.
Strategic Role of Tax Professionals in RCP Cases
How can a tax professional help you through this process? Take a look at the value they bring to the table.
- Helping you value assets – this can be very tricky, especially if you’re dealing with real estate, art, or collectibles. A tax professional can help you assess value and back up your assertions with comps or formal assessments if needed.
- Substantiating extra expenses – if you need to “overspend” in any of the IRS’s categories, your tax professional can help you present an argument to the IRS proving why your expense should be accepted.
- Understanding when you should increase your spending in certain categories – the right strategy can help you improve your life and lower your offer amount. For instance, taxpayers who don’t have a car don’t get to claim anything in the transportation category (except for public transportation costs), and the unused allowance will be counted as disposable income when calculating their RCP. However, you may be able to lease or buy a car so that you max out your spending in that category, while also reducing your settlement.
- Timing the offer – if you have fluctuating income or are experiencing financial struggles, your tax professional can help you time the offer perfectly so that you get the best settlement possible.
- Approaching state and IRS settlements wisely – Sometimes, you can save money by applying for a state settlement first and an IRS settlement second, but in other cases, it pays to apply with the IRS first. A seasoned tax professional who understands the nuances of both the IRS and your state’s offer in compromise program can help you navigate this step.
A tax professional can also be indispensable if you’re applying for an offer based on effective tax administration (aka when it’s unfair/inequitable to pay in full) or doubt as to liability. Doubt as to liability doesn’t consider RCP, but it requires a significant understanding of the tax code to qualify for these settlements.
Alternatives to Offer in Compromise
So, what if you don’t qualify for an offer in compromise? What if your RCP is too high and you can’t afford the settlement? Or what if your situation is so dire that you can’t afford to pay anything?
Then, you may want to consider:
- Currently not collectible – file a collection information statement showing that you basically have $0 RCP, and the IRS will stop all collection actions until your finances improve.
- Partial payment installment agreement – file a collection information statement, and the IRS will determine a low monthly payment based on your disposable income. Then, you’ll pay that amount monthly until your finances improve and you can pay more, or until the debt expires and the IRS writes it off. Note that if you have significant equity in your assets, the IRS may require you to liquidate those assets.
- Installment agreement – make monthly payments on your tax debt for up to 10 years or until the collection expiration date, whichever is sooner. This allows you to pay off the full tax debt over time. If you owe less than $50,000, you can generally set up a plan without providing any financial details, but if you owe more or have a history of default, you may need to provide a collection information statement. Note that in some cases, the IRS will not require a collection information statement as long as you owe under $250,000 and can pay off the balance before it expires.
Get Help From Wiggam Law
At Wiggam Law, we have successfully helped clients save millions on their tax liabilities. When you contact us, we’ll help you determine if an offer is the best approach for you. If so, we’ll help you optimize your RCP. If not, we’ll help you get back into compliance with another IRS relief option. Don’t wait – contact us for help today.
FAQs – RCP
What counts as an allowable expense when calculating RCP?
The IRS includes housing costs (rent, mortgage, and utilities), transportation (vehicle loan or lease payments, gas, repairs, etc, and/or public transportation costs), food, term life insurance, taxes, and healthcare. There’s also a small amount allocated for random household expenses.
Will the IRS consider my spouse’s income in my OIC?
Yes, the IRS will typically include your spouse’s income. However, that can vary depending on the situation and who’s liable for the tax debt.
What happens if I submit an OIC and it gets denied?
Then, you have a chance to appeal, but appeals are limited and subject to strict deadlines, so you should consider working with a tax professional. If you don’t appeal, your balance is due in full, and you should establish alternative payment arrangements before the IRS takes any other actions against you.
How can I reduce my RCP to improve my chances of OIC acceptance?
Make sure you understand the financial standards. If you’re under the standard in certain categories, it may benefit you to max out that category. Also, don’t overvalue your assets. Work with a tax professional who has OIC experience.
What’s the difference between PPIA and CNC?
Both are IRS relief options for taxpayers who can’t afford to pay much or any of their tax liability. With a PPIA, you make small monthly payments, but with CNC, you don’t make any payments. With both options, if your finances improve, you may have to start making payments or increase your monthly payments. Any debt remaining after the collection expiration date is waived.
