When a taxpayer files an Offer in Compromise with the Internal Revenue Service (IRS), they will evaluate the taxpayer’s ability to pay the taxes owed. As part of this evaluation the IRS will look at the taxpayer’s income and expenses. The taxpayer must disclose to the IRS the taxpayer’s income and how much the taxpayer is paying for certain allowable living expenses. In addition, it is common practice for the IRS to require the income information from all members of the household regardless of whether they are liable for the taxes owed. Household individuals, who do not owe the tax, are considered “non-liable parties.” A non-liable party may be a husband, wife, significant other, parent, roommate, friend or anyone else living with the taxpayer.
The IRS requires some expenses to be prorated based on the percentage of income that the liable party has in comparison to the household. This requirement explains the need for the IRS to request the income information from non-liable parties. Once the total household income of the taxpayer and all non-liable parties is determined, the taxpayer’s percentage of total household income can be figured. The taxpayer’s percentage is then used to “prorate” certain shared household expenses between the liable taxpayer and the non-liable parties. Typically, shared expenses are rent, mortgage, utilities and food. Once the IRS determines the prorated amount of expenses, the expense figures used by the IRS for the taxpayer’s Offer in Compromise could change. This is done even though the taxpayer informs the IRS on the Collection Information Statement as to how much they are paying for household expenses.
Taxpayers representing themselves, and many inexperienced practitioners, commonly overlook pro-rating non-liable party income information when making a determination as to whether an Offer in Compromise is the appropriate resolution for their back taxes. On the surface it may appear as though a taxpayer does not have the ability to pay their taxes, but when the household expenses are pro-rated the outcome changes. In such cases, it is the IRS that identifies the non-liable party income issue that can result in the rejection or significant increase of the taxpayer’s Offer in Compromise. Thus, prior to filing an Offer in Compromise, it is important to properly evaluate the taxpayer’s total household income and expenses.