Filing an Offer in Compromise (OIC) is an excellent way to reduce your delinquent taxes with the Internal Revenue Service. However when making an offer with the IRS the questions always comes up as to whether or not a taxpayer has to cash in their 401 k plan to when making an offer to the government.
In making an OIC with the IRS, the taxpayer has to provide a lot of financial information to the government. This includes not only information on bank accounts, real estate, and vehicles but also on any 401k plans or other retirement plans that a taxpayer may have.
So on the financial disclosure form 433-A, the taxpayer will disclose the value of his 401k plan less any loans he may have against his 401K. Yet if the taxpayer were to take a distribution from his 401k plan, then the taxpayer would be subject to additional federal income taxes and state income taxes. This would then just make the taxpayer’s tax debt increase so what should a taxpayer do?
In this scenario, the taxpayer should disclose on form 433-A the value of his 401k less his loans, less the federal tax and less the state tax. For example let’s assume that John is 45 and is making an OIC to the IRS and he has $40,000 in his 401k plan. John has a $10,000 loan against his 401k plan so his net amount that he could take as a distribution is $30,000.
In regards to the taxes on this potential distribution, John would have to pay a 10% penalty for an early distribution since he is under the age of 59 ½. His federal tax rate is 25% so the total federal taxes associated with this distribution would be 35% and John’s state tax rate is 5%. So the total federal and state tax burden would be 40%.
This would then leave only 60% of the $30,000 or $18,000 as being eligible to pay off the delinquent taxes with an Offer in Compromise. This $18,000 is the dollar amount that John should disclose on form 433-A when he is making his offer in compromise to the IRS.
Preparing a successful offer in compromise is extremely time consuming and technical in nature. If you have delinquent taxes with the IRS and want to settle by making an OIC, then you should seek the professional assistance of an experience professional such as the author of this article, Michael McNamee.