Income for Offer in Compromise Purposes

How do I determine income for Offer in Compromise purposes?

When determining income for offer in compromise purposes, IRS must consider each taxpayer’s individual and unique circumstances including special circumstances.

IRS will consider factors such as age, health, marital status, number and age of dependents, level of education or occupational training, and work experience.

What methods are accepted by IRS in computing income for offer in compromise purposes? 

• Income as reported on the last tax return filed with IRS

• Current Year-to-Date Income 

• Three Year Average of Net Business Income 

• Future Income

Taxpayers should use the method that results in the lowest value of income to achieve the best result in an offer in compromise.

Current Income

In general, IRS uses “current income” in arriving at Reasonable Collection Potential.

Current Income is defined as:

• Year to Date Paystub

• Social Security and Pension Award Statements stating annual benefits

• Year to Date Profit and Loss Statement from the taxpayer’s business 

• IRS Wage and Income Transcripts

• Alimony and child support pursuant to a court ordered divorce agreement

• Distributions in excess of net business income from the taxpayer’s business 

These items must be substantiated as deposits and net deposits into the taxpayer’s personal bank accounts.

If taxpayers are unable to verify the source of deposits into their bank accounts, IRS will include the deposits as income for offer in compromise purposes.

3-Year Average of current earnings and income

In certain instances, it is acceptable to use a “3-year average” of current earnings and current taxes.   This is allowable only when there are fluctuations in income (income goes up and down) not in situations where income is steadily increasing.

IRS does not allow for income averaging of W-2 wages unless the taxpayer can demonstrate that there are fluctuations pertaining to bonuses, overtime, and/or the wages that are received from the taxpayer’s business, which also has fluctuating income.

The following is an example of fluctuating income for a single taxpayer who would qualify for a 3-year average of earnings and current taxes:

Tax Year	2025	2024	2023	Total	Total Annual Average	3 Year Average Monthly
W-2 Wages	50,000	40,000	60,000	150,000	50,000	4,167
Net Business Income	25,000	15,000	30,000	70,000	23,333	1,944
Total Income	75,000	55,000	90,000	220,000	73,333	6,111

Tax Year	2025	2024	2023	Total	Total Annual Average	3 Year Average Monthly
Federal	11,090	6,606	15,832	33,528	11,176	931
FICA/Medicare	3,825	3,060	4,590	11,475	3,825	319
New Jersey State	2,594	1,546	3,609	7,749	2,583	215
Total Income	17,509	11,212	24,031	52,752	13,759	1,147

Accordingly, the 3-year average of earnings is $ 6,111 and current taxes are $ 1,147 for IRS Reasonable Collection Potential.

Future Income 

When taxpayers have a change in circumstances, IRS may use future income in arriving at Reasonable Collection Potential.

A change in circumstances must not be “temporary” in nature and must not be short-term (for a period of less than six months).

The following examples would require IRS to use future income in arriving at Reasonable Collection Potential:

• A change in employment status or occupation – Income would be based upon a secured employment letter from the future employer and/or current year to date paystub. This is essential when taxpayers have a significant decline in earnings when they change professions and their income has been reduced significantly.   

• Temporary Unemployment – Income would be based upon future secured employment.   Otherwise, currently uncollectible status might be a better option until a permanent source of income is secured.

• Retirement is Eminent - Income would be based upon income through the date of retirement.  Future income would be based upon income from the retirement date through the present date.  A taxpayer must provide proof of a letter issued to his current employer with his intent to retire within the next 12 months.

• A taxpayer is at or above the full retirement age to receive social security benefits and has decided to continue working.  This means that IRS may include Social Security Benefits when taxpayers are eligible to receive the benefits during the offer consideration period of 24 months. 

Income Excluded from IRS Reasonable Collection Potential

When is it appropriate to exclude income from Reasonable Collection Potential?

• Net Business Income is excluded when IRS includes net equity of the operating business in Reasonable Collection Potential, because it would be double counting.

• Extraordinary income that is nonrecurring or temporary in nature: 

  • Retirement fund distributions

  • Unemployment Compensation

  • Overtime that is sporadic and not regular and customary

  • Bonuses that are discretionary in nature and not guaranteed

  • Gain on Sale of Business, Investments, Property, etc.

  • Cancellation of Indebtedness (COD) Income

• Deposits that are not considered to be income for IRS purposes:

  • Gifts from family and friends

  • Loans from family and friends to pay for basic necessary living expenses when taxpayers are experiencing a financial hardship position 

  • Transfers between bank accounts are not considered to be income if the income has already been included in Reasonable Collection Potential.

  • Personal banking transactions between friends and family 

    
    

It should be noted that taxpayers will be required to obtain a confirming letter or email from the person(s) who provided the deposits into the taxpayer’s bank account.  The letter or email must provide the date, amount, and the nature of the funds and must be signed by the person with their mailing address and phone number.   This is necessary to exclude non-income deposits from Reasonable Collection Potential.

However, taxpayers should be aware that any future loan repayments to family and friends will not be an allowable basic necessary living expense for offer in compromise purposes, because loans between family and friends are not secured in nature and deemed to be personal.