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December 23, 2019

Treatment of Monetary Gifts When Filing an Offer-In-Compromise with the IRS

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As tax attorneys and professionals in Columbus, Ohio, we assist taxpayers in utilizing the Internal Revenue Services’ (the “IRS”) available collection alternatives to help manage their federal tax liabilities. These alternatives, including Installment Agreements and the Offer-in-Compromise process, can help reduce or eliminate tax liabilities arising from an IRS examination or audit.

When considering the payment plan proposed by a taxpayer filing an Offer-in-Compromise, the IRS will investigate several months of the taxpayer’s bank statements, and scrutinize any item that is not explained or does not have supporting documentation. For example, if a taxpayer claims to have more expenses in a month than they have income, the IRS will question how the taxpayer is able to pay their monthly expenses. If the expenses are paid in full, the IRS may suspect that the income reported on the Offer-in-Compromise is lower than the taxpayer’s actual income. This would prompt the IRS to investigate the account further. If no reason is given for the discrepancy, the IRS may deny the Offer-in-Compromise.

In practice, it is relatively common for paid expenses to exceed earned income. When a person is in financial difficulty, they may receive help from friends and family to make ends meet, with or without concern that the money will ever be paid back. To the IRS, this can be seen as unexplained funds entering the taxpayer’s financial accounts from seemingly random sources. It is best to disclose the source of these funds so that the IRS does not deny the Offer-in-Compromise by default. However, this raises an interesting question:

Are these monetary gifts considered income on an Offer-in-Compromise?

The short answer is ‘no.' Per the Internal Revenue Manual, Section 5.6.5.20, there are certain items that the IRS cannot consider when estimating a taxpayer’s future income, which is used to determine a taxpayer’s ability to pay the underlying tax liability. Within this section of the manual are a number of examples for the IRS to follow when considering an Offer-in-Compromise. This includes the following example for a taxpayer receiving monetary gifts from related parties:

The taxpayer has been receiving gifts from their parents to meet current living expenses for the past six months. The taxpayer has no guaranteed right to the funds in the future, and the amount does not appear to be based on the transfer of assets to the parents. Do not include the gift amount as income.

This example contains a few conditions to be aware of.

  • The gifts have been received over a relatively short term period (in this example, six months). If the taxpayer has been receiving gifts consistently for a long period of time, the IRS may consider them as a stable source of funds available to satisfy the tax liability.

  • The taxpayer has no guaranteed right to receive future funds. This is an important distinction. If, for example, monetary gifts were received through the disbursement of a trust – one which would have a defined amount and period of time in which the funds are paid out to the taxpayer – then the IRS may very well consider such a gift as a stable source of funds to satisfy the tax liability.

  • The taxpayer did not receive funds due to a transfer of assets. This is, again, an important distinction: the case where a taxpayer indebted to the IRS sells or gifts a car to a family member for a fraction of its value opens up an entirely different conversation, where both the taxpayer and the benefiting family member may be subject to IRS investigation for attempting to hide assets.

In general, the IRS will not consider monetary gifts given to the taxpayer to help with monthly expenses as part of future income. As the IRS will investigate several months of bank statements when reviewing an Offer-in-Compromise, the taxpayer should include a narrative that explains the monetary gifts.

However, this is only the case when considering future income. When disclosing bank account information to the IRS as part of the Offer-in-Compromise, the IRS will consider the total amount in the taxpayer’s bank accounts as funds available to pay the tax liability. In this case, it does not matter how the money was received: if the amount is available in the bank account, the IRS may request a larger payment or deny the Offer-in-Compromise. So, if monthly gifts received exceed the expenses being paid, the excess can be considered as available funds to pay off outstanding tax liability.

So, in summary, monetary gifts to the taxpayer to assist with monthly expenses are generally not considered income when proposing an Offer-in-Compromise. Monetary gifts in excess of the amount spent, however, will likely increase the proposed payment amount on the Offer-in-Compromise.

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December 23, 2019

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