What Is the IRS Reasonable Collection Potential?
Understand the IRS's formula for evaluating a taxpayer's finances. This calculation is key to determining your ability to pay and qualifying for tax relief.
The Internal Revenue Service (IRS) uses a specific calculation to determine a taxpayer’s ability to pay an outstanding tax debt, known as the Reasonable Collection Potential (RCP). It represents the amount the IRS can realistically expect to collect from an individual or business before the statutory time limit for collection expires. The RCP figure is used to evaluate tax resolution options, forming the minimum acceptable amount for an Offer in Compromise (OIC) and helping determine if a taxpayer qualifies for Currently Not Collectible (CNC) status, where the IRS temporarily pauses collection efforts due to financial hardship.
Components of the RCP Calculation
The RCP calculation begins with an analysis of a taxpayer’s financial situation, focusing on assets and income. The asset component centers on the Net Realizable Equity (NRE) of everything the taxpayer owns. This is based on a Quick Sale Value (QSV), which the IRS considers to be 80% of an asset’s market value, less any outstanding loans or liens against it. Common assets reviewed include cash, bank account balances, real estate, vehicles, and retirement accounts.
After assessing assets, the IRS examines the taxpayer’s gross monthly income from all sources. This includes wages from employment, self-employment earnings, rental income, and any other regular cash inflows. This income is then reduced by a set of allowable living expenses to determine how much is available to pay the tax debt over time.
Determining Allowable Monthly Expenses
The IRS does not accept a taxpayer’s actual monthly spending, but instead uses a standardized system of allowable expenses. The first category is National Standards, which cover basic necessities like food, clothing, housekeeping supplies, and personal care items. These are fixed amounts determined by the IRS based on family size and are not tied to a taxpayer’s actual spending.
A second category involves Local Standards, which account for expenses that vary by geographic location. These standards cover housing and utility costs, with specific amounts set for each county. Transportation expenses also fall under Local Standards, with allowances for vehicle ownership or public transportation based on the taxpayer’s location.
The final category is for other necessary expenses required for a family’s health, well-being, or the production of income. This includes costs such as monthly health insurance premiums, out-of-pocket medical expenses, court-ordered payments, and childcare. For these expenses to be allowed, they must be deemed reasonable by the IRS and substantiated with documentation.
Information and Documentation for the IRS
To assess a taxpayer’s RCP, the IRS requires a comprehensive financial disclosure, which is submitted on Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals. For businesses, the equivalent form is Form 433-B (OIC). It is important to use the most current version of these forms from the official IRS website.
Preparing this form involves gathering supporting documentation to verify every figure reported. This includes:
- Recent pay stubs for all working members of the household
- Bank statements for all accounts
- Statements for any investment or retirement accounts
- Documentation for assets, such as property deeds and vehicle titles
- Proof for all claimed expenses, like utility bills, mortgage statements, and rent receipts
How the IRS Finalizes the Calculation
The IRS synthesizes the financial data using the formula: RCP = Net Realizable Equity in Assets + Future Income Potential. The NRE in assets is the sum of the quick sale value of all assets after subtracting any associated debts. This represents the amount the IRS could collect immediately by liquidating the taxpayer’s property.
Future income potential is determined by calculating the taxpayer’s monthly disposable income, which is their gross monthly income minus total allowable monthly expenses. This net amount is then multiplied by a specific factor. For an Offer in Compromise paid as a lump sum within five months of acceptance, the monthly disposable income is multiplied by 12. If the offer is to be paid over a six to 24-month period, the multiplier increases to 24.
Finally, the IRS may adjust the calculation for dissipated assets. If a taxpayer sold, transferred, or spent assets on non-essential items shortly before or during the collection process, the IRS may add the value of those assets back into the RCP calculation. The final RCP amount represents the minimum the IRS will accept to resolve the tax debt.