How Is IRS Reasonable Collection Potential Calculated?

The Internal Revenue Service (IRS) uses the Reasonable Collection Potential (RCP) to determine a taxpayer’s ability to pay a delinquent tax liability. This calculation is used when the IRS considers collection alternatives, such as an Offer in Compromise (OIC), which allows a taxpayer to resolve their tax debt for less than the original amount. The RCP represents the amount the IRS expects it can collect from a taxpayer’s assets and future income.

Components of the RCP Calculation

The RCP calculation centers on three financial elements: assets, income, and allowable expenses. The IRS evaluates a taxpayer’s equity in their assets, which includes:

• Real estate
• Vehicles
• Bank accounts
• Retirement funds
• Other investments

For valuation, the IRS uses a measure known as “Quick Sale Value” (QSV), calculated at 80% of the asset’s fair market value. This lower valuation reflects the amount the IRS could obtain if it had to seize and sell the asset quickly.

All sources of a taxpayer’s income are considered, including wages, self-employment earnings, and rental income. From this gross income, the IRS permits the deduction of necessary living expenses. These are standardized amounts, not always the taxpayer’s actual costs. The IRS uses National Standards for items like food and clothing and Local Standards for housing and transportation. Other conditional expenses, such as court-ordered payments or healthcare costs, may also be allowed.

The RCP Calculation Formula

The financial components are combined into a specific formula to determine the final RCP amount: RCP = Net Realizable Equity in Assets + Future Income Potential. This figure serves as the minimum amount the IRS will accept in an Offer in Compromise.

Net Realizable Equity in Assets is the QSV of a taxpayer’s assets after subtracting any outstanding loans or liens. For example, a home with a fair market value of $300,000 and a $200,000 mortgage would have a QSV of $240,000 (80% of $300,000), resulting in a net realizable equity of $40,000 after the mortgage is subtracted. This part of the formula establishes the value that could be accessed by liquidating assets.

Future Income Potential is determined by calculating monthly disposable income, which is the taxpayer’s gross monthly income minus their allowable living expenses. The IRS then multiplies this monthly disposable income by a set number of months to project future earnings. For an Offer in Compromise, this multiplier is 12 or 24 months, depending on the payment terms of the offer.

Required Financial Disclosures

To substantiate the figures in the RCP calculation, taxpayers must provide financial disclosures to the IRS. The primary document for this is Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals. When completing the form, you must report the Quick Sale Value for your home, not its fair market value.

A package of supporting documentation must accompany the form, including:

• Recent pay stubs
• Bank statements from the last three to six months
• Estimates for property valuation
• Vehicle registrations
• Statements for any loans

Proof of expenses, such as utility bills or medical invoices, is also necessary to validate the amounts claimed as allowable living expenses.

Submitting Your Financial Information

The complete application package must be submitted to the IRS. This includes Form 656, “Offer in Compromise,” the completed Form 433-A (OIC), and all supporting documents. You must also include the required application fee and an initial payment, with the amount depending on your offer’s terms. For a lump-sum offer, you must include a non-refundable payment of 20% of the total offer amount. For a periodic payment plan, you must include the first monthly payment and continue making payments while the IRS evaluates your offer.

Before submitting, it is important to ensure all required tax returns have been filed and you are current with any estimated tax payments.

After the IRS receives the submission, the case is assigned to an examiner who will conduct a review of the financial information provided. This review process can take six to twelve months, during which the examiner may contact you to request clarification or additional documentation. Promptly responding to any inquiries from the examiner is recommended to keep the process moving forward. The IRS will ultimately decide whether to accept, reject, or propose a different amount for your Offer in Compromise.