Offers in Compromise When Only One Texas Spouse Owes the IRS

An offer in compromise is a math problem. The IRS adds up what it could collect from you, called reasonable collection potential, and compares it to what you offer. In a separate property state, a spouse who does not owe the tax mostly stays out of that math. In Texas, community property drags the other spouse's income and assets onto the worksheet.

That surprises people. The spouse who owes signs Form 656. The spouse who does not owe never signed anything. Yet the offer examiner asks for that spouse's pay stubs. This guide explains why, how the IRS decides how much of the household to count, and where the rules give you room to push back.

The rule: count what state law makes available

The regulation governing offers, Treas. Reg. 301.7122-1, addresses community property directly. In a one-spouse case, the IRS counts the liable spouse's separate property and income, the liable spouse's share of community property and community income, and any part of the non-liable spouse's share that state law makes available to satisfy the debt. IRM 25.18.4.17 applies that rule to offers, and IRM 5.8.5 tells offer examiners to review state community property law when figuring a taxpayer's interest in assets.

In Texas, state law makes a lot available. As I explain in how the IRS collects against Texas community property, the IRS can reach 100 percent of the liable spouse's sole management community property, 100 percent of joint management community property, and half of the non-liable spouse's sole management community property. Those categories become the starting point for reasonable collection potential.

How the income side works

Future income is usually the biggest piece of an offer. The IRS takes monthly income, subtracts allowable expenses under its Collection Financial Standards, and multiplies what is left: 12 months for a lump sum cash offer, 24 months for a periodic payment offer.

In a Texas one-spouse case, the examiner first decides how much of the couple's combined income is available. If the liable spouse's wages are fully available and half of the non-liable spouse's wages are available, that fraction of total household income goes on the worksheet.

Then comes the expense side. IRM 25.18.4.17 says expenses are allowed in proportion to the income counted. The IRS figures the household's total allowable expenses as if both spouses were making the offer and both were liable, then reduces that total by the same percentage. If 75 percent of household income is counted, 75 percent of household expenses are allowed against it.

That proportional rule cuts both ways. It is fair on its face. But it means every expense you fail to document reduces your allowable expenses on a weighted basis, while the income side rarely gets smaller by accident. Documented, verified expenses are where Texas offers are won or lost.

How the asset side works

Assets go into reasonable collection potential at net realizable equity: quick sale value, minus loans that have priority over the federal tax lien, minus applicable exemptions. IRM 5.8.5 defines quick sale value as what a pressured seller could get, usually within 90 days, which is generally less than fair market value.

For a Texas household, the examiner classifies each asset. A joint brokerage account built from both paychecks is joint management community property, fully counted. A retirement account funded by the non-liable spouse's earnings is that spouse's sole management community property, counted at half. A rental house the non-liable spouse inherited is separate property and should not be counted at all.

Classification mistakes are common, and they almost always run against the taxpayer. If no one shows the examiner that an asset is separate property, it gets treated as community. Bring the deed, the probate papers, the account opening records. Texas presumes property held during marriage is community, and the burden to prove otherwise is yours.

The material and adverse impact rule

Here is the provision too few people use. Treas. Reg. 301.7122-1(c)(2)(ii)(B) says that even where state law makes the non-liable spouse's share of community property available, the IRS will not count it if collecting from it would have a material and adverse impact on the standard of living of the liable spouse, the non-liable spouse, and their dependents.

The IRS reads this narrowly. IRM 25.18.4.17 says the rule will not protect a luxurious or affluent lifestyle, and that in most cases the allowance of necessary living expenses is expected to take care of any hardship. But it is a real regulatory standard, and it matters in households where the non-liable spouse's income barely covers necessities, where there are dependents with special needs, or where a non-liable spouse's modest retirement account is the household's only cushion.

If your facts fit, make the argument in writing with numbers attached. A regulation the examiner has to address is worth more than a sympathetic story the examiner can ignore.

Should the non-liable spouse cooperate?

Often the non-liable spouse asks why they should hand over financial information at all. The practical answer is that the IRS will estimate it if you do not, and estimates are never generous. Household income also determines which expenses are allowed, so leaving one spouse's numbers out tends to distort the expense side too.

The non-liable spouse is not signing up for liability by providing information. Providing financial information on a Form 433-A (OIC) does not make anyone liable for the tax. It lets the examiner apply the community property rules correctly instead of guessing.

That said, nothing here changes the non-liable spouse's own rights. If that spouse signed a joint return for the year at issue, the question becomes whether relief is available, which is a separate track covered in my community property and innocent spouse guide.

Strategy for a Texas one-spouse offer

Here is the sequence I follow. First, confirm which spouse owes which years using account transcripts. Joint years and separate years get different treatment. Second, classify every asset and income stream as separate, sole management community, or joint management community, with documents. Third, build the expense side to the Collection Financial Standards, and claim every allowable item. Fourth, decide whether the material and adverse impact rule applies and argue it if it does.

Then compare the result to what the IRS could collect before the collection statute expires. An offer only makes sense if your reasonable collection potential is less than the balance and there is a real path to fund the offer. My Texas offer in compromise guide covers the general rules, and the firm's main site has an overview of the offer in compromise program.

If the numbers do not support an offer, a partial payment installment agreement or hardship status may fit better. Either way, the community property analysis comes first.

The IRS counts the household. Make sure it counts the household correctly. Let's talk: 813-229-7100.