An offer in compromise allows you to settle your tax debt for less than the full amount you owe. It may be a smart move if you can’t pay your full tax debt. The IRS will generally approve an offer in compromise if the amount represents the most they can expect to collect within a reasonable period of time. However, the Offer in Compromise program is not for everyone. Hiring a tax professional can help you navigate the complex rules of the Offer in Compromise program. If you do decide to hire a tax relief professional to help you file an offer, make sure you check their qualifications.
What happens when you mix a few poor financial decisions with unemployment, medical bills, and other monthly expenses? You’re left with a huge tax bill that you can’t pay.
You want to pay your tax bill, but you simply can’t afford it. If this sounds familiar, don’t worry — you’re not alone.
In fact, the internal revenue service (IRS) assessed more than $33.8 billion in additional taxes from returns not filed on time in 2019 and collected more than $1.8 billion from delinquent returns.
You don’t want to become part of that statistic, though. Avoiding your taxes amidst exceptional circumstances will only make the problem worse. So rather than letting your tax bill continue to grow, find a way to resolve your tax liability for less than the full amount you owe using a seldom-used tactic.
So here’s everything you need to know about offers in compromise, who qualifies, how to apply, and how it can give you a fresh start without tax debt.
What is an IRS offer in compromise OIC?
An offer in compromise is a settlement or agreement between you and the IRS, where they accept an offer amount less than the full tax liability you owe. If you qualify, you go into a sort of partnership agreement, and you make the agreed payments, your tax balance is wiped clean.
The IRS accepted 17,890 offers of the 54,225 offer in compromise requests received in 2019, totaling $289.4 million.
That translates to a 33% acceptance rate or a 67% rejection rate depending on if you’re a glass half full or half empty kind of person.
How to apply for an offer in compromise?
The IRS has a strict process for considering and approving offers in compromise. This is how it works:
- First, you must complete and include Form 656, Offer in Compromise (download).
- Complete and sign Form 433-A (OIC) (download), Collection Information Statement for Wage Earners and Self-Employed Individuals, if applicable.
- Fill in and sign Form 433-B (OIC) (download), Collection Information Statement for Businesses, if you own a business.
- Pay the $205 application fee unless you meet Low-Income guidelines.
- Deposit the initial offer payment based on the payment option you choose. You may be able to waive this requirement if you meet Low-Income guidelines.
Note that the IRS will not consider your offer in compromise if you don’t provide the signed and completed forms.
Why does the IRS offer this solution?
As with any other creditor, the IRS wants its money pronto—and getting some of it is better than nothing, especially if you are in financial hardship and don’t know what your future income will look like.
Taxpayers struggling with debt may give up completely and stop filing their annual tax returns. Giving otherwise productive taxpayers a fresh start through a reasonable payment plan is a smart use of taxpayer dollars and makes for a better user experience.
Plus, they only have 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 will be paid.
The IRS can garnish your wages, levy your bank accounts, and put a lien on your property. However, some assets are off-limits. It is best to consult a tax professional to work out an installment plan based on your ability to pay and make sure your offer is accepted.
In cases where taxpayers don’t have many assets or large incomes, an offer in compromise may be their best chance of getting some revenue from a delinquent taxpayer.
Also, they will not seize your property if you have an offer in compromise under consideration. But the same cannot be said about liens.
Does the IRS charge an application fee to consider an OIC payment plan?
Yes, the IRS charges a $205 application fee (as of 2021). However, you can get the fee waived if you meet the Low-income Certification Guidelines.
Two types of offers in compromise
There are two types of offers in compromise based on how you decide to pay.
The “lump sum” offer in compromise requires taxpayers to pay the agreed amount within five months of approval. For the IRS to consider the offer, taxpayers must make a 20% down payment when they submit it.
Warning: The 20% down payment is non-refundable, so you may want to think long and hard about whether they are likely to accept the offer. Your best bet may be to consult with a tax relief professional.
Periodic payment offer
The “periodic payment” offer in compromise must be paid within six to 24 months. The first payment of the installment plan should be included with the application.
What forms do you need to submit?
You’ll have to provide detailed information about your sources of income, bank accounts, investments, and living expenses. It’s easy to make expensive mistakes when completing these forms.
Hire the services of a qualified and experienced tax relief firm before providing the financial information.
How to get an offer in compromise approved
There are three reasons you may be eligible for an OIC.
- You can’t afford the full amount. The IRS accepts that you don’t have the income or assets to pay the full tax debt before the statute of limitations (10 years) ends.
- Economic hardship. You are able to prove that paying the full amount would cause you economic hardship.
- Doubt over what you owe. There is doubt as to liability, doubt as to collectibility, or doubt about the accuracy of the information.
You may wonder why anyone would pay a portion of tax debt if there are doubts about whether he or she even owes it or if the amount is accurate.
If you feel it would be unfair and inequitable and you doubt the information is correct based on your monthly income and your ability to pay, wouldn’t it be better to appeal the decision in court? Going to court is sometimes the right move. On the other hand, though, 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, could be cheaper and certainly less time-consuming than appealing to a judge. Before making a decision, talk to an experienced tax lawyer, enrolled agent or CPA. The tax relief companies below all have enrolled agents or tax attorneys on staff.
Eligible taxpayers must also:
- 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 be in an open bankruptcy proceeding.
How do they determine eligibility for an OIC application?
First, the IRS determines whether taxpayers can afford to pay their tax debt in total. To do this, the IRS has a tool to calculate their reasonable collection potential (RCP).
If the RCP is less than the total tax debt and the taxpayer meets other requirements for an OIC, the IRS will consider the offer.
Second, the IRS determines whether the offer in compromise is the maximum amount the taxpayer can afford to pay. based on compensation. This is why it’s important to gain information and understand policies and procedures, and certification guidelines.
The IRS also requires applicants to not be involved in an open bankruptcy proceeding.
An experienced tax relief professional can help you calculate the lowest possible amount the government will accept and reach an installment agreement before your offer is rejected.
How much should I offer in compromise to the IRS?
The IRS will settle for nothing less than the maximum amount you can afford. Of course, how much you can afford is not a straightforward question. A lot depends on your income, the size of your family, where you live, and your health. So, the big question is, how does the IRS decide how much you can afford and what payment plan is best for you?
How does the IRS calculate the amount you can afford to pay?
The formula that the IRS uses to determine your reasonable collection potential (RCP) is also known as “net realizable value.” It varies slightly depending on what assets you own, whether you own a business, the type of offer in compromise you apply for, payment options, and other factors.
These calculations are best left to a tax relief professional, but below is a simplified version of the formula to give you an idea of how it works.
IRS reasonable collection potential formula
RCP = Reasonable collection potential.
QSV = Quick sale value or 80% of the fair market value of the asset.
MDI = Monthly disposable income (the balance after you pay for necessary living expenses).
If you make the payments within, the RCP is the quick sale value of your assets (property, jewelry, vehicles, etc.), plus your monthly disposable income, multiplied by 12.
RCP = QSV + (MDI x 12)
Periodic payment offers
For periodic payment offers, where the OIC is repaid in 6 to 24 months, the formula for the RCP is the quick sale value, plus your monthly disposable income, multiplied by 24.
RCP = QSV + (MDI x 24)
10 things to consider when negotiating an OIC with the IRS
- Providing detailed financial information to the IRS can have serious consequences. Consult with a tax relief professional if you have a large debt, or you may run the risk of being audited.
- Make sure you can realistically pay the monthly installments of your OIC. If you miss your payments, you could end up back at square one with additional interest and penalty fees.
- The statute of limitations on collecting taxes is put on hold while an OIC is being assessed. Consider this if you are close to the end of the 10-year period that the IRS has to collect on a tax return.
- Don’t pledge more than you can afford when paying all at once. This amount is non-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 IRS approves the offer in compromise. 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 two 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.
- 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.
Take control of your tax debt
Not having enough money to pay your taxes isn’t a crime, but lying to the IRS is. So always file your tax returns (even if you can’t afford to pay your taxes). An offer in compromise can be a great option if you are struggling with tax debt. However, with a 63% rejection rate, an OIC isn’t the easiest tax relief option to qualify for. So it’s wise to gain information and consult with a licensed tax professional before you submit an offer in compromise.
The best tax relief companies have tax lawyers and enrolled agents on staff, provide a money-back guarantee and charge competitive rates. Check out which tax relief company is the best fit for you.