It can happen to the best of us. A couple of poor financial decisions, unemployment, medical bills, and now you’re left with a huge tax bill you have no idea how to pay. You want to pay your fair share of taxes but you simply can´t afford it. Does that sound familiar? If so, you may be a candidate for an offer in compromise.
If you are considering an offer in compromise, you are probably a little confused. Don’t worry. It’s not you. The offer in compromise is the IRS’s most misunderstood and underused tax relief program. The good news is that by the time you finish reading this guide, you will know what an offer in compromise is, who qualifies for one, how to apply – and more importantly – how it can wipe your tax slate clean.
It’s not just that the rules and equations that regulate offers in compromise are complicated, which they are. The offer in compromise option has also been over-hyped by con men who promise to wipe out 80% or more of the tax debt of all customers, regardless of their financial situation. Spoiler alert. They can’t. But that doesn’t mean an offer in compromise is not a legitimate tax relief option for many taxpayers.
The IRS also shares responsibility. Past IRS policies and procedures did not foster the flexible use of the offer in compromise resolution to the extent intended by the IRS Restructuring and Reform Act of 1998: the tax law that created the offer in compromise. (Source).
Despite it all, 28,305 offers in compromise – 40.3% of the applications submitted — were accepted by the IRS in 2015. (Source)
What is an IRS offer in compromise (OIC) & how can it help with Tax debt?
An offer in compromise is a settlement or agreement between you and the IRS, where the IRS accepts less than the entire tax bill. If you qualify and you make the agreed payments, your tax balance is wiped clean.
Why does the IRS even consider an offer in compromise?
Needless to say, the IRS doesn’t do this out of the kindness of its heart. As with any other creditor, the IRS wants its money and pronto. It will only accept an offer in compromise if convinced it’s in the IRS’s best interest. This is a cold and calculated business decision.
An offer in compromise is similar to when a credit company realizes you are nearly broke and will file for bankruptcy long before you can ever repay your $30,000 credit card debt balance. Not to mention the interest and late payment penalties. So the bank bites the bullet and accepts a reduced payment because getting some cash back is better nothing.
Then there is the timing factor. The IRS only has 10 years to collect taxes once a return is filed and research shows that the longer a tax debt is on the books the less likely it is to be paid. On average, the IRS is forced to abate or “forgive” 28% of the back taxes in its taxpayer delinquent account. (Source) True. The IRS can garnish your wages, levy your bank accounts, and put a lien on your property. However, some assets are off limits even for the IRS. In cases where taxpayers don’t have many assets or large incomes, an offer in compromise may the IRS’s best chance of getting some revenue from a delinquent taxpayer.
There is also the issue of future taxes. Taxpayers who are overwhelmed with debt may give up completely and stop filing their annual tax returns. Giving otherwise productive taxpayers a fresh start is a smart use of taxpayer dollars.
Which type of offer in compromise should I submit?
There are two types of offers in compromise based on how you decide to pay.
Lump Sum Offer– The “lump sum” offer in compromise requires taxpayers to pay the agreed amount within five months of the date the IRS approves it. To be considered, taxpayers must make a 20% down payment when they submit the offer.
Warning: The 20% down payment is not refundable, so you may want to think long and hard about whether the offer is likely to be accepted. Determining the likelihood an offer in compromise will be accepted is not easy. Don’t try this without hiring a tax relief professional. Tax attorneys and CPAs are not cheap but it’s money well spent.
Periodic Payment Offer – The “periodic payment” offer in compromise must be paid within 6 to 24 months. The first payment should be included with the application.
Can an offer in compromise stop an IRS levy?
Yes, it can. The IRS will not seize your property if you have an offer in compromise under consideration. However, the same cannot be said about liens. Read these articles for a detailed discussion of federal tax levies and liens.
How to qualify for IRS offer in compromise?
There are three reasons the IRS will consider you eligible for an offer in compromise (OIC).
- The IRS accepts you don’t have the income or assets to pay the full tax debt before the statute of limitations (10 years) ends, and that your situation is unlikely to change.
- You can pay your tax debt in full, but doing so would cause you economic hardship. Heads up. Your definition of economic hardship is probably not the same as the IRS’s.
- There is doubt as to whether you really owe the tax or about the accuracy of the amount.
You may ask yourself why anyone would pay a portion of a tax debt if she had doubts about whether she owed it or about the accuracy of the amount. Wouldn’t it be better to appeal the decision in court? Going to court is the right move in some cases. On the other hand, the IRS wins 80% of its cases. Also, an offer in compromise is no longer an option when your debt has been established by a final court decision. In other words, paying a chunk of your tax debt, even when you don’t agree with it, may be cheaper and certainly less time-consuming than appealing to a judge. Before making a decision talk to an experienced tax lawyer or CPA.
Eligible taxpayers must also satisfy the following requirements:
- File all required tax returns
- Be up-to-date with estimated tax payments (self-employed and business owners)
- Be up-to-date with federal tax deposits (businesses with employees)
- Not currently in an open bankruptcy proceeding
How does the IRS determine eligibility for an OIC?
Obtaining an offer in compromise is a two-step process.
First, the IRS needs to determine whether taxpayers can afford to pay their tax debt in total. To do this, the IRS calculates their “reasonable collection potential.” If it’s less than their total tax debt and they meet the other requirements for an OIC, the offer is considered.
Second, the IRS determines whether the offer in compromise is the maximum amount the taxpayer can afford to pay. This is where understanding IRS policies and procedures is important. An experienced tax relief professional can help you calculate the lowest possible amount the IRS will accept.
How does the IRS calculate your “reasonable collection potential?”
The formula the IRS uses to determine your reasonable collection potential, also known as “net realizable value,” varies slightly depending on whether you own a business, what assets you own, the type of offer in compromise you apply for, and other factors. These calculations are best left to a tax relief professional, but this simplified version of the formula will give you an idea of how it all works.
In the case of lump-sum offers that are paid in five or fewer months, the reasonable collection potential is the quick sale value of your assets (property, jewelry, vehicles,…) plus your monthly disposable income x 12.
RCP = QSV + (MDI x 12)
RCP = Reasonable collection potential
QSV = Quick sale value or 80% of the fair market value of the asset
MDI = Monthly disposable income. I.e. what is left after you pay for necessary living expenses. Again, what you consider necessary may be different to what the IRS considers necessary.
In the case of periodic payment offers, where the offer in compromise is repaid in 6 to 24 months, the formula for the reasonable collection potential is the quick sale value plus your monthly disposable income x 24.
RCP = QSV + MDI x 24
The IRS requires applicants to complete Form 656 and Form 433-A (433-B for businesses) to obtain the financial information it needs to determine eligibility. Hiring a tax relief professional is paramount at this stage. The IRS rules for calculating the fair market value of an asset and your monthly disposable income are complicated and fraught with gray areas. An experienced tax attorney or CPA can help you minimize the cost of your OIC while staying on the right side of the law.
How much will the IRS settle for? How to calculate an offer in compromise?
The IRS will settle for nothing less than the maximum amount you can afford. The big question is how does the IRS decide how much you can afford?
It uses a similar formula to the one used to calculate your reasonable collection potential. The only difference is that once the IRS establishes you cannot afford to pay the debt it allows applicants to claim additional deductions and exemptions. For example, taxpayers can claim a $1,000 balance in their bank account, an exemption of $8,790 for fuel, furniture, and personal effects, $3,450 toward the value of a vehicle, and up to $4,400 for tools of the trade.
If your goal is to pay as little as possible in taxes – yeah we thought so – you need to minimize the value of your assets and claim as many eligible living expenses, without lying to the IRS. Remember. Not having enough money to pay your taxes is not a crime. Lying (on purpose) to the IRS is.That is a fine line to walk. One you shouldn’t attempt without the assistance of a tax relief professional. Even if your application is rejected, a tax relief professional can request a transcript of your tax account to see what financial documents the IRS is basing its assessment on. This will reveal if there are any mistakes or inaccuracies in your tax account you need to correct.
IRS Offer in compromise pre-qualifier tool
The IRS’s Offer in Compromise Pre-Qualifier tool (Link) is a six-page survey that can help you determine whether you meet the basic requirements for an OIC. The questionnaire is anonymous and asks questions such as “are you filing for bankruptcy?” Or “are your tax returns and estimated tax payments up-to-date?” It will also ask about your assets (home, investments, rental property, and vehicles), your income, and your living expenses.
This tool can help you know whether you are likely to qualify for an OIC. However, it cannot tell you whether you “should” apply. Before submitting an offer in compromise, consult with a licensed tax professional and consider what options are best for your circumstances.
Offer in compromise form
Although it is technically possible to file this forms by yourself, it is not advisable. These forms require detailed financial information about your sources of income, bank accounts, investments, and living expenses. Other tax relief options, such as installment agreements, don’t require taxpayers to provide this much information. Although the IRS can theoretically obtain most of this information, tax law provides taxpayers the right to privacy, which ensures the IRS is no more intrusive than necessary when collecting taxes. To avoid infringing on taxpayers right to privacy, the IRS avoids digging too deep unless it has reason to believe there is something wrong. However, the IRS has no qualms about using the financial information taxpayers voluntarily provide. (Source)
Warning: The IRS can (and will) use everything you include in these forms, if the IRS does not accept your offer in compromise. It is easy to make expensive mistakes when completing these forms. Hire the services of a qualified and experienced tax relief company before providing the IRS with financial information. Once the IRS knows about your sources of income, bank details, employers, and investment funds, they are fair game for collection purposes.
10 Tips to consider when negotiating an offer in compromise with the IRS
- Consider the cost when submitting an offer in compromise. We’re not just talking about the $186 application fee (2016). Providing detailed financial information to the IRS can have serious consequences. Consult with a tax relief professional if you have a large debt or there is a risk the IRS will audit you.
- Make sure you can realistically pay the monthly installments of your OIC. If you miss your payments, you could end back to square one with additional interest and penalty fees.
- The statute of limitations on collecting taxes is put on hold while an offer in compromise is being assessed. Consider this if you are close to the end of the 10-year period the IRS has to collect on a tax return.
- Don’t pledge more than you can afford when paying a lump-sum. The lump-sum is not refundable if the IRS denies your application or if you fall behind in your payments.
- The maximum term for OIC payments is 24 months but you will have to stay current for at least five years after the offer in compromise is finalized. Otherwise, the tax balance will be reinstated.
- If the IRS rejects your offer, you have the right to appeal within 30 days of the denial.
- Tax refunds are automatically kept by the IRS to pay for your tax debt while it considers an offer in compromise submission.
- Keep track of the date you applied for an offer in compromise. The process can be lengthy but if the IRS does not reject, return, or withdraw it within 2 years, the offer is considered accepted.
- If the IRS rejects your offer in compromise, apply again. The IRS’s reply will include the minimum offer you should make based on the financial data in your tax account. Request a transcript of your tax account to see if there are mistakes or omissions you need to correct.
- Submitting an offer in compromise will generally put levies and garnishments on hold. Nevertheless, the IRS may still file a federal tax lien on your property.
How to make a successful offer in compromise to the IRS?
Offers in compromise are not an easy to sell to the IRS. The truth is you have to be going through pretty serious financial difficulties to qualify. Other tax relief options are much easier to obtain. To illustrate, in 2015, delinquent taxpayers negotiated 2.99 million installment agreements. Only 66,600 offers in compromise were submitted. However, there are steps you can take to improve your chances of success when negotiating with the IRS.
- Check the amount the IRS says you owe is correct. This is particularly important if the IRS has filed one or more tax returns on your behalf. In such cases, the IRS will generally “miss” many of the deductions and allowances you are entitled to claim.
- Consult with a tax relief professional to determine which tax relief option is best for you. The idea of reducing or wiping clean your tax debt with an offer in compromise may be attractive but it isn’t always the smartest choice for you.
- Confirm you meet the IRS’s eligibility criteria. Fill in this short form to determine if you qualify for a free consultation with a senior tax relief professional.
- File all your late tax returns and pay your estimated taxes.
- If you do decide to submit an offer in compromise, collect all the information you will need. This includes your income, assets, expenses, debts and other liabilities. Read through IRS Form 656B Booklet and Form 433B, and help your tax relief professional prepare your offer.
Should you hire a tax attorney to negotiate an IRS offer in compromise?
Absolutely. It pays to have a professional on your side whenever you deal with the IRS, particularly if you are in serious debt.
Can you apply for an offer in compromise without the help of a tax professional?
Sure, just like you can negotiate a plea deal on murder charges without the help of a criminal defense lawyer. It doesn’t make it a good idea. Although there are things taxpayers can do by themselves when dealing with the IRS, an offer in compromise is not one of them. To qualify for an OIC you need to be in considerable debt and you must provide detailed financial information to the IRS. Two good reasons to consult with a tax relief professional.