Divorce causes hardship - OIC?

[miatax]

I have a client who is on extension. He owes around $8,500 for 2009.

Last year, his divorce settlement asked him to come up with a given sum of money. His credit got ruined from his x-wife. He had to withdraw everything from his retirement account to pay what he owed on the divorce. Due to that, he owes an early withdrawal penalty on his 2009 1040 and that jumped him up to a much higher tax bracket as well. At the end he owes $8,500 to IRS which he doesn't have as the divorce cleaned him out. He does have a job but still has debt from the divorce.

Would you recommend an offer in compromise? I have never done one of these before.

[JohnH]

Based on the info you provided, he probably does not qualify for an OIC. Howver, he should file the return without payment or with a token payment in order to be sure he doesn't put it off until the last minute and risk a late-filing penalty. When the bill comes in the mail, he can call IRS and set up a payment plan for about $160 per month. this can be done in about fifteen minutes if he owes no other taxes and is current on his filings. The combined interest and FTP penalty will work out to about a 14 per cent APR, and if he can borrow the money at a lower rate he should do that instead. However, you said his credit is shot so this may be his only option right now.

At this rate it will take him about 5 years to pay off the tax debt, but at least he has some certainty and he doesn't have to worry about the IRS knocking at his door or serving a levy on his earnings. During the repayment period, if he gets some extra money or decides he can pay more than the minimum, IRS will gladly accept the extra and he will benefit by paying a little less interest. The mistake most people make when setting up a payment arrangement is in not taking the maximum repayment term. It's smarter to spread it out over the longest possible period in order to keep the payment as low as possible and thus to avoid the risk of default. They can always accelerate payment if circumstances permit.

[jainen]

>>Due to that, he owes an early withdrawal penalty on his 2009 1040<<

Due to what? Using a retirement plan in a divorce settlement does NOT necessarily incur a penalty. There must have been some additional settlement terms, presumably with offsetting concessions.

Well, to answer your question, an Offer in Compromise is a net worth calculation looking forward five years. As JohnH explains, the taxpayer can cover the bill in that time frame. The IRS generally has no reason to accept an OIC for anything less than they can collect anyway.