What is an Offer In Compromise? Example And Formula
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Summary:
An offer in compromise (OIC) is a program offered by the IRS that allows taxpayers to settle their tax debt for less than the full amount owed. Understanding how to calculate your offer amount before applying for an OIC is crucial if you want to increase the odds of getting your application approved.
According to recent data from the Internal Revenue Service (IRS), in 2021 Americans owed over $133 billion in back taxes, penalties, and interest. If you’re one of the many that are drowning in tax debt, an offer in compromise may provide the relief you need.
With this program, you can negotiate a repayment plan with the IRS and get back on track with your finances. In this article, we’ll explain what an offer in compromise is, how to calculate your offer amount, and how to apply for this tax relief program.
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What is an offer in compromise?
An offer in compromise (OIC) with the Internal Revenue Service is a program that allows taxpayers to settle their tax liabilities for a smaller amount than what’s owed.
However, to be eligible for an offer in compromise, you must meet several requirements. The IRS has stringent criteria and rejects most OIC applications.
Offer in compromise example and formula
To formulate an offer amount, gather information about your financial situation, including cash, assets, monthly income, monthly expenses, investments, and debt. By providing this information, the IRS can determine how much money you have available to pay your tax debt. If that amount is lower than your tax debt, your offer will likely be accepted.
Next, calculate your available monthly income and the value of personal assets.
- Available monthly income. To calculate your available monthly income, subtract your total monthly expenses from your monthly income. If your total monthly income is $1,600 and your total expenses are $1,100, your available monthly income is $500. See IRS Form 433-A Section 5 to find out what counts as income and expenses.
- Value of taxpayer’s assets. On the IRS Form 433, you’ll need to write down the current market value for each asset you own. This information about your financial assets helps the IRS assess your reasonable collection potential (RCP) — the amount you can pay, given your current financial status. For this example, let’s suppose your personal assets amount to $4,500.
IMPORTANT! To calculate your RCP, make sure you consider the value of your current assets as well as any future income you may receive.
OIC formula
The IRS offers two repayment options: the five-month repayment option (lump sum cash offer) and the 24-month repayment option (periodic payment offer). Here’s how to determine your offer amount depending on the option you choose:
Five-month repayment option
To figure out your offer amount for a five-month repayment plan, plug in your numbers into this formula:
Using the example above, the formula would look like this: ($500 x 12) + $4,500 = $5,100
Since you must pay 20% of the offer amount with your application for this repayment option, you’ll pay $1,020 upfront and repay the remaining $4,080 through five monthly payments.
24-month repayment option
To figure out your offer amount for a 24-month repayment plan, plug your numbers into this formula:
Using the example above, the formula would look like this: ($500 x 24) + $4,500 = $16,500
Your initial payment for this repayment option is the first month’s payment. In this case, it would be $16,500/24 = $687.50
How to apply for an IRS offer in compromise
Here’s what you need to submit to apply for an IRS offer in compromise:
- A completed Form 656
- A completed and signed Form 433-A for individuals (Form 433-B for businesses)
- $205 application fee (unless you meet the low-income certification guidelines)
- Initial offer payment based on the payment option you choose (this could be waived if you meet the low-income certification guidelines)
If you choose the lump sum cash offer where you’ll pay off your IRS debt in five or fewer payments, you must submit an upfront payment of 20% of the total offer amount with your application. If you choose the periodic payment offer, you must include the first month’s payment.
IMPORTANT! For more details on how to apply for an IRS offer in compromise, check out the Form 656 Booklet.
Who is eligible for an offer in compromise?
Do you want to apply for an offer in compromise but are not sure if you’d qualify? To see if you’re eligible, use the offer in compromise pre-qualifier tool by the IRS.
Note that the tool should only be used as a guide. The IRS could still send back your application if any of the following is true:
- You didn’t provide all the requested information on the application.
- You failed to file your tax returns for the previous years.
- You haven’t received a bill for at least one tax debt included in your offer.
- You failed to make the required estimated tax payments for the current tax year.
- You’re currently in bankruptcy.
- You failed to pay your taxes or file your tax returns after submitting your OIC application.
- The IRS sent your case to the Justice Department.
- You didn’t pay the application fee.
If the IRS sent back your application because of one or more of the issues mentioned above, don’t worry. You can resubmit your application once you fix the problem.
Pro Tip
Keep in mind that business owners will likely have to meet different or additional requirements for an OIC. For instance, if you failed to make all required federal tax deposits, you won’t qualify for the OIC program.
What happens if the IRS accepts your offer in compromise
If the IRS accepts your offer in compromise, you must start paying the offer amount in accordance with the terms in the acceptance agreement. Note that the IRS doesn’t release federal tax liens until your offer terms are satisfied.
You must also file your tax returns and fulfill your tax obligations for five years straight — starting from the date that the OIC was accepted. If you fail to make your OIC payments on time or file/pay taxes within the five-year period, your offer in compromise will default.
What happens if the IRS rejects your offer in compromise
If the Internal Revenue Service rejects your offer in compromise, you have 30 days from the date of receiving the rejection letter to appeal. Follow the instructions in the rejection letter to see how that works.
If you agree with the rejection and don’t plan on appealing it, there are two routes you can take. One option is to pay the IRS your tax debt in full to avoid piling on more interest and penalties. Otherwise, you can request an installment agreement to gradually pay down your tax liability. In some cases, you could also request a “Currently Not Collectible” status.
Pro Tip
If you need help appealing the rejection, contact the person whose name is on the OIC rejection letter, or call the IRS toll-free number 800-829-1040. You can also find more information about the appeal process by visiting the IRS Independent Office of Appeals resource page.
Other tax relief options
If OIC isn’t an option for you, don’t lose hope. There are other tax relief options that could help you get rid of your back taxes and pay down your tax bill.
IRS payment plans
An IRS payment plan, or installment agreement, is an agreement between you and the IRS to pay back taxes owed in monthly installments instead of a lump sum. Depending on the tax debt you owe, you could qualify for a short-term or long-term payment plan.
Remember, IRS payment plans won’t get you out of interest and penalties for late payments. Those will still accrue until you pay down your balance to zero.
Related reading: For more information on IRS installment plans, take a look at our article on the Partial Pay Installment Agreement.
“Currently-not-collectible” status
If you can’t afford to pay your tax debt due to economic hardship, you may qualify for “Currently Not Collectible” status with the IRS. This means that the IRS will not take any action against you or pursue collection of taxes owed until your financial situation improves and you can begin making payments again.
To qualify for this option, you’ll typically need to complete a Collection Information Statement or a Collection Information Statement for Wage Earners and Self-Employed Individuals form.
Hiring a tax relief company
If you’re struggling with significant back taxes, hiring a professional tax relief company can help you navigate the complex IRS regulations. These professionals can often help you set up payment plans with the IRS or see if you qualify for an offer in compromise.
However, remember that you could also do these things yourself. So, only hire a tax relief company as a last resort since it could be costly. To compare different companies to see where you can get the best deal, take a look at the tax relief companies below.
What you should be aware of when applying for OIC
Here are a few things that Logan Allec — certified public accountant and founder of Choice Tax Relief — says you should be aware of before applying for OIC:
- The IRS isn’t more likely to accept your offer in compromise if you’re unemployed. Some people think that being unemployed could reduce their ability to pay. However, this is a misconception. Logan says, “If someone’s young, healthy, and likely to return to work in the near future, the IRS may simply ignore the fact that they’re unemployed when analyzing their offer in compromise.”
- Don’t try to “save up” for your offer. “The more you save up, the more wherewithal you have to pay.” So, instead of saving up for your offer, Logan says you’d be better off “going for an offer in compromise when you don’t have a big lump of cash sitting around.”
- The IRS takes a long time to make a decision on offers in compromise. Logan says you should be prepared to wait “at least six months to a year,” from the time you submit your offer in compromise to receive a decision from the IRS. He advises that you “keep your financial situation (income, expenses, assets, etc.) stable while your offer in compromise is pending.”
FAQs
How hard is it to get an offer in compromise?
Getting an offer in compromise accepted can be difficult. According to the IRS data book, in 2021 only around 30% of offers in compromise were accepted. To increase your chances of getting your OIC approved, consider consulting tax professionals that understand the complexities of tax debt and filing an offer in compromise.
Can you file an offer in compromise if you’re in bankruptcy?
Unfortunately, no. You can’t file an offer in compromise if you’re currently bankrupt. However, you can file an offer once it’s discharged and closed.
What happens if you miscalculate your offer?
If you don’t correctly calculate your offer or if your offer isn’t high enough, don’t fret. The IRS will recalculate it to come up with the correct amount. If the number the IRS calculated is higher than what you offered, they’ll give you a chance to increase your offer amount. If you fail to do so, the IRS could reject your offer in compromise.
Keep in mind that the IRS will review offers for fraudulent activities. This means you could be subject to criminal and civil penalties if you intentionally submit an OIC using false information.
Key Takeaways
- An offer in compromise with the IRS allows taxpayers to settle their tax liability for less than what is owed.
- There are two OIC repayment options: a five-month lump sum cash offer or a 24-month periodic payment offer.
- Before you apply for an OIC, make sure you qualify using the list above.
- To apply for an offer in compromise, you must complete Forms 656 and 433-A or 433-B, submit a $205 application fee, and make initial payments based on the chosen repayment option.
Find the tax relief you need this tax season
If you’re feeling overwhelmed about submitting an offer in compromise on your own, consider seeking help from a tax professional specializing in this field. Don’t panic if your offer is rejected. Consider exploring other tax relief options, like setting up an installment agreement with the IRS, or hiring a tax relief company.
Once you settle your back taxes, be sure to keep up with filing your tax returns on time each year to avoid any future problems with the IRS.
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