Reasonable Collection Potential - RCP - is the key concept in dealing with the variety of tax debt solutions offered by the IRS. RCP is used by the IRS in evaluating your suitability for participating in various programs including:
- Installment Agreements - where your tax debt is paid off over time
- Offer In Compromise - where the IRS allows for less than full payment in satisfaction of your tax debt
- Currently Not Collectible - where the IRS determines that you cannot currently make any payments and agrees to hold off on collection efforts for a period of time
RCP represents the amount that the IRS determines is available to satisfy your tax debts. It includes an analysis of your assets and your future earning potential - after providing for living expenses.
The IRS has tools available to enforce collection - which include taking property you currently own (through liens and levies) and taking your future income (i.e. through garnishment of your wages).
These means of enforcement are a last resort in the collection process. The IRS does not want to forcibly seize assets or income. The goal of the IRS Collection division is to settle tax debt with the cooperation of the taxpayer. In order to facilitate settlement the IRS first needs a snapshot of your current assets and a view into your future earnings potential. This process is intended to approximate the results of forced collection - i.e. taking your assets and future income.
RCP represents a cash flow analysis. Although the IRS makes this determination it is not based on the determination of taxable income. RCP includes non-taxable income sources (i.e. Social Security income) and non-deductible expenses (i.e. housing costs).
As discussed in previous posts the IRS obtains a “silent lien” against all of your property upon the assessment of your tax liability. It essentially “steps into your shoes” when it comes to your property rights. If you have a right to property the IRS obtains this same right under the silent lien.
For example say you own a home worth $300k. Your mortgage has a current balance of $225k. A sale of the property (assuming no selling costs) would provide you with net proceeds of $75k. Under the silent lien this is also the amount that would be available to the IRS in connection with the settlement of your tax debt.
Let’s also say you are an employee. The IRS could “garnish” your wages - they could legally compel your employer to send a portion of your pay directly to the IRS. With a garnishment you are allowed to keep a portion of your pay in order to provide for basic living expenses.
The concept behind the RCP computation is to provide the IRS with amounts that are similar to what they could obtain through these forced collection efforts.
As discussed this is a cash flow analysis. The starting point in all of our collection cases involves taking an inventory of the value of a taxpayers assets, details relating to current liens against the assets, a detail of household income, and information relating to living expenses.
This represents a pure cash flow analysis of assets and future income. However it is only the beginning point in computing RCP. The IRS uses a number of rules and conventions applied to the cash flow information. As mentioned these are rules specific to the computation of RCP - they differ from rules related to determine taxable income.
Some of the RCP rules are favorable to the taxpayer while other rules are unfavorable - when compared to the pure cash flow analysis.
For example in determining the value of assets the RCP rules provide that the fair market value of the assets be reduced by a factor that accounts for the “quick sale” of the asset. The reduction is typically 20%. Using the example above the quick sale value of the taxpayers home would be $240k ($300k fair market value at 80%). This amount would be compared to the mortgage debt of $225k to arrive at an RCP value of $15k - notwithstanding the fact that the true net value is $75k.
In contrast to this taxpayer friendly rule most of the rules relating to living expenses serve to reduce the amount of actual expenses that are allowed for the RCP determination. For example the deduction for housing and utility costs used for RCP is the lesser of actual costs or the “local standard cost”. Many taxpayers find that their deduction for housing and utility costs is limited to the standard cost - which serves to increase monthly income for RCP over the net amount actually earned by the taxpayer.
The IRS then reviews this information with a view towards determining an approximation of what funds would be available if they seized your assets and made a claim against your future earnings - after providing for an allowance for living expenses.
Another concept important to the RCP computation relates to the application of the so-called “statute of limitations” (SOL). As discussed in a previous blog the IRS has a period of ten years to collect on the tax debt. This period begins on the tax assessment date and usually runs for a ten year period. There are certain events that extend or “toll’ this period but in general ten years after the tax is assessed the IRS is legally prohibited from attempting to collect the tax debt.
In evaluating RCP the IRS looks at the computed value of your assets and your monthly RCP income. The income figure is carried out to the expiration of the SOL. This concept is important in evaluating debt settlement alternatives available in a particular situation. For example if the RCP results in a figure that is in excess of the tax debt the IRS will not allow for the taxpayer to settle the debt (i.e. an Offer In Compromise). However the IRS may allow for payments to be made over time (i.e. an Installment Sale).
As you can see the RCP computation is a key concept in determining your options when it comes to dealing with your tax debt.
In our next blog post we’ll get into the details of the RCP computation.
Link to Outline Slides: RCP Overview Slides
Link to Video: Video - RCP
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