Tax Attorney View: Future Income Collateral Agreements

When a taxpayer asks the IRS to eliminate their tax debt through an offer in compromise, the IRS will look at the persons assets and past income to determine if an IRS collateral agreement is warranted. If there is a likely chance that the taxpayer will be able to pay back the total tax owed they may reject the offer or allow the offer and require more to be paid. In some cases, if the taxpayer’s income history has been variable, the IRS will want to get a portion of the future income above certain thresholds. This is known as a future income collateral offset agreement. It is not a typical request, but it is sometimes part of the settlement with the IRS. The good news is that this may cause the deal to be accepted by the IRS, so it is worth considering.

Collateral Income Agreements- In General

While this arrangement has certain complexities, the overall idea is that the taxpayer may be able to afford more in the future than what they show they can afford today (as shown on a form 433(OIC), and within certain limits, that they can pay more than the total amount offered if it was paid overtime. While this money is not a certain guaranteed payment to the IRS, it may cause the IRS to be willing to accept the deal with the hope that in the future they may get more. From my experience, the IRS will only look to the next few years (under 5), so it would not be the case that five years from now they are still trying to get money from you.

IRS Collateral Agreement- Examples

A. The taxpayer is looking to make a deal to settle their tax debt, so often these additional monies being paid to the IRS is workable to most people. As an example of this concept, say a person owes $100,000 in back taxes (including interest and penalties). They may be currently working and making $60,000 a year from their wages. They have a 401(k)-retirement plan that is worth $20,000, but that after taxes are paid, they will net about $11,000. It is clear that will not be able to pay back the whole $100,000 owed since the $60,000 in wages only covers normal living expenses. Say the person offer the value of their retirement account of $11,000 plus an additional $4,000, for a total offer of $15,000. It may be that the IRS accepts such an offer if it was made by someone in their sixties, but they would not if the person was forty years old. In the case of the forty-year-old, the IRS may accept the lump-sum of the $15,000 and then ask for twenty percent of the monies earned for the next three years greater than the wages of $60,000 a year. If the person makes, for instance, $80,000 for the next three years, the IRS will receive the initial $15,000 plus $12,000 ($80,000-$60,000 times 20%), or $27,000, in total.

B. As a second example, a taxpayer owes $15,000 in back taxes, fees, and penalties, but is currently unemployed and engaged full time to provide care to an ailing parent. The parent has very significant assets and that taxpayer is the sole beneficiary in the will so the collateral agreement makes sense for all concerned. The taxpayer makes a reasonable but small offer in compromise of $1,000 with the collateral of 15% of the eventual inheritance which has an estimated value of $100,000 and will likely come to him/her within 1-3 years based on the health of the parent. After that period, if the parent survives the IRS gets $1,000, the debt is settled, the taxpayer is clear. If the parent died, the IRS gets all money owed (the $15K)

As with many tax debt solutions with the IRS, the future income collateral agreement only works in some cases, but it can be a useful tool and not viewed in a negative way especially if the IRS views your financial criteria in a harsh light. The goal is always to find a way to reduce the amount you must repay since it often includes a substantial amount of interest and penalties that can be avoided by submitting and having the IRS accept an offer in compromise.

Therefore, when a taxpayer and their tax attorney decide to go with an offer in compromise in order to settle the taxpayer’s debt to the IRS, the deal needs to be approved. Sometimes, other things are on the table which can affect whether or not the IRS accepts the offer. One of those lesser known, but perfectly valid items is what is called a Future Income Collateral Agreement.

While complex in some ways, the basic idea is that the taxpayer offers the IRS the possibility of payment over and above the total amount being offered in compromise. However, that money isn’t necessarily guaranteed. The idea is that the taxpayer has a reasonable expectation that within three to five years of the offer in compromise being accepted, they will have a stronger income either in the form of regular earnings, inheritance, a trust, or sale of a large asset.

The taxpayer and tax attorney is suggesting to the IRS that if they accept the offer in compromise and this sort of promissory note, they will pay the IRS the full amount of the offer plus a percentage of the increased income. The idea from the standpoint of the taxpayer is that the collateral agreement sweetens the deal for the IRS and causes them to accept the offer in compromise when they otherwise might not have, due to the fact that it was a much smaller amount than they were looking for.

As you can see, this is one of those situations that would likely only work in a small number of cases, but it is legitimate, and the IRS is looking more favorably upon such arrangements these days.

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