When a taxpayer files an Offer In Compromise (OIC), the Internal Revenue Service (IRS) will analyze the taxpayer’s financial condition and attempt to maximize what they determine to be their Reasonable Collection Potential (RCP). One method of maximizing a taxpayer’s RCP is by accounting for a taxpayer’s dissipated assets. A dissipated asset is:
- An asset that
- The taxpayer liquidated, gifted, or conveyed in some manner,
- The taxpayer realizes or should have realized a profit from the transfer;
- The asset was liquidated, conveyed, etc. after the tax liability,
- And the transfer does not fall within one of the IRS determine d exemptions.
The rationale for including dissipated assets in the RCP is that the proceeds from these assets should have been used to pay off the taxpayer’s tax liability. If the dissipated assets were not included in determining the RCP, then any taxpayer seeking an OIC could simply liquidate their assets and spend the proceeds to qualify for an OIC.
If an asset is determined to be a dissipated asset, then the IRS will include any realized profit or other appropriate value and include it in the taxpayer’s RCP.
An asset will only be considered dissipated if it was liquidated after incurring the tax liability. Assets that were liquidated prior to the tax liability will not be considered a dissipated asset. For example, if a taxpayer refinanced his home for $30,000 in 2004 and spent all of the proceeds during that year, then incurs a tax liability in 2005, the refinanced proceeds would not be included in his RCP. However, if the facts are flipped where the taxpayer incurred a tax liability in 2004 and refinanced in 2005, then the $30,000 would be added to the RCP.
When the liquidation of the asset was the cause of the tax liability, it will be considered prior to incurring the tax liability and will not be included in the RCP. For instance, if a taxpayer liquidated his retirement account of $20,000 and incurs a tax debt of $7,000, the $20,000 will not be included in the RCP.
An asset is essentially anything the IRS determines to have value. They do not have to be tangible items. Assets can range from real property, vehicles, jewelry, cash, retirement accounts, stocks, and so on.
If after incurring a tax debt, a taxpayer sells an asset and realizes a profit at the time of the sale, the profit will simply be included in the taxpayer’s RCP. For example, if a taxpayer sells his or her 2005 Lexus LS430 – which he or she owned free and clear – for $30,000, the IRS will include the proceeds from the sale within the RCP. This is, of course, assuming that the $30,000 in proceeds remain in the taxpayer’s bank account. However, if the taxpayer takes the $30,000 and spends it during a wild weekend in Atlantic City, the money is now gone. However, for purposes of the taxpayer’s RCP, he or she is not out of the woods. Instead, the IRS will include the $30,000 as a dissipated asset. By including the $30,000, the IRS is saying that the taxpayer should have used the $30,000 to pay off his or her IRS tax liability instead of wasting it in Atlantic City.
Now, if there is no profit received or the IRS determines that less than fair market value was received, the IRS may instead substitute the quick sale value of the asset in lieu of the actual realized profit for purposes of a dissipated asset. For example, if a taxpayer sells his 2005 Lexus LS430 with a quick sale value of $30,000 and an encumbrance of $1,500 to his brother for $500, the IRS will likely determine that the fair market value was not received for the Lexus. Instead of adding $500 to the RCP, the IRS will add $28,500. The same rule applies to gifts. If the Lexus is instead gifted to his brother, the quick sale value minus any encumbrances will be added to the RCP.
Finally, the IRS does not take into account the loss-over-time of an asset for purposes of its dissipated asset determination. For example, if a taxpayer purchased $20,000 worth of stock in 2005, accrued a tax debt in 2007, and then sold the stock at market price for $5,000 in 2008 and spent the proceeds on gifts for his friends and family, the IRS is going to consider the taxpayer as having a $5,000 dissipated asset from the sale of stock. Notwithstanding the $15,000 loss on the value of stock, the rules concerning dissipated assets apply to the $5,000 in proceeds that the taxpayer
Liquidated assets will not be considered dissipated assets under specific circumstances outlined by the IRS. If the proceeds from the liquidated asset are used for any of the following, they are considered exempt and will not be included in the RCP:
- Child/spousal support – note: has to be court ordered
- Estimated tax payments
- Costs of a civil lawsuit
- Necessary attorney fee s’ related to the underlying tax controversy
- Court ordered payments
- An asset that was dissipa ted and the funds were used to purchase another asset that is included in the offer evaluation –
example: if the client liquidated a savings account to purchase a vehicle, and the vehicle is already included as an asset in the RCP, then the IRS cannot double dip and include both the dissipated asset and the vehicle.
- Other necessary living expenses – note: additional discussion is required to determine what qu alifies as a necessary
- Medical expenses
The above is not a comprehensive accounting for all expenses that can be considered necessary living expenses. Arguments can be made that transportation for work and necessary business expenses, among others, should be considered necessary living expenses. Keep in mind that this exemption typically only applies when the taxpayer’s ordinary income cannot meet his expenses such as when a taxpayer has been unemployed for a period of time and has received no income.
If a taxpayer’s earnings during the period of the dissipated asset can meet all of his expense needs, then the exemption will not apply and the dissipated asset will be included in the RCP.
Common Dissipated Assets
A taxpayer typically realizes a dissipated asset from a refinance of real property, liquidation of a retirement or other investment account, or the sale of tangible assets. The proceeds are then often spent on paying back credit cards or some other unsecured debt. Despite the fact that the taxpayer no longer has the proceeds from the liquidation, the proceeds will still be considered a dissipated asset.
Dissipated assets are a considerable concern when filing for an OIC. Often a taxpayer will not even realize that he has accumulated dissipated assets. In addition, simply claiming that liquidation proceeds were used towards one of the exemptions will not be sufficient. The taxpayer will need to provide documentation that any realized profit was used towards an exempt category.