Each year, the IRS accepts thousands of offers in compromise with taxpayers regarding their past-due tax payments. Essentially, the IRS reduces the tax debt owed by a taxpayer in exchange for a lump-sum payment.
The average offer in compromise the IRS accepted in 2020 was $16,176. How do we get to that amount? In 2020, the IRS approved 17,890 offers in compromise with a total value of $289.4 million (source). Divide $289.4 million by 17,890, and, presto, you get an average offer in compromise of $16,176.
Of course, that number is meaningless. The real question is, “how much will the IRS settle for in my case?” Not some hypothetical average. This article will look into how the IRS determines eligibility for the Offer in Compromise program and how it calculates the minimum offer it can accept.
What is an offer in compromise?
The Offer in Compromise program is a powerful tax relief program designed by the IRS to reduce the tax liability of struggling business owners or individual taxpayers. It is also referred to as the federal tax settlement program. When used correctly, it can save you thousands of dollars because you pay less than the full amount due (your “offer amount”). Unfortunately, not everyone with tax debt qualifies for the program.
In a nutshell, the OIC is a settlement or agreement between you and the IRS. The IRS is like any other creditor. If you can convince them that you can’t afford to pay your entire debt, they prefer you pay something over nothing. Let’s say you owe the IRS $50,000, and there is no way you can afford to repay that amount before the 10-year statute of limitations (the period of time the IRS has to collect taxes). You have two options: 1) You can wait out the 10-year statute of limitations or 2) pay an OIC.
Although just waiting for the statute of limitations to expire may seem like an attractive option, few people go down that road. Remember, the IRS can seize all your assets, including your wages and savings, and you will probably have bad credit for years. The risk of just waiting is too high, so the offer in compromise is often a better path because it allows the IRS to assess your collection potential.
What are the chances that the IRS will approve my request for an OIC?
In 2019, the IRS received 54,225 offers in compromise and accepted only 17,890 of them — that’s a success rate of roughly 33%.
Professional tax relief firms often have acceptance rates of 90% and higher. This is because they only submit applications when they know the taxpayer meets the requirements and they know the IRS is likely to say yes. The best tax relief companies have tax lawyers and enrolled agents on staff, provide a money-back guarantee and charge competitive rates. Using a professional tax relief company could help you save time and money on pointless applications.
How does the IRS calculate the minimum offer it will accept?
The IRS formula to calculate your OIC is a two-step process based on your monthly income and the value of your assets, so the IRS can estimate your “reasonable collection potential.” The OIC formula, which determines what you’re able to pay, looks like this:
Let’s break that formula into its two main components.
Let’s break that formula into its two main components: cash flow and assets.
First, the IRS needs to determine how much you can pay every month if you were to arrange a standard installment agreement or payment plan. To calculate this, the IRS reviews your income by asking for your pay stubs or a recent profit and loss statement if you own a small business.
The IRS then needs to know the dollar amount of all of your allowable living expenses, such as housing, utilities, car (non-luxury) payments, clothing, and food. Notice the IRS may require you to limit your living expenses to levels it considers “reasonable.”
The IRS then subtracts your allowable living expenses from your income to assess your ability to pay. This amount, your monthly disposable income, will be used to determine the offer amount for your OIC.
Note that you will need to gather information about your entire household‘s average gross monthly income and actual expenses. This includes all those in addition to yourself who contribute money to pay expenses relating to the household.
Second, the IRS estimates the value of your assets. Assets include categories like your car, house, retirement plan, jewelry, and all other family valuables. How are your possessions valued? First, the IRS deducts any loans or mortgages you have on each asset and reduces its value by 20%. Let’s say you own a house worth $200,000, but you still owe $195,000 on it. For the purposes of your offer amount, your house is worth $4,000 ($5,000 x 0.8).
What payment methods does the IRS accept for offers?
The IRS lists several payment method options for taxpayers on their website. Offers can be paid by check or money order made payable to the United States Treasury. You may also make your payment(s) through the website Electronic Federal Tax Payment System (EFTPS) .
What does an offer in compromise success story look like?
Not all offers in compromise are accepted. In fact, only three out of every 10 offers in compromise are approved. However, there are plenty of success stories out there for taxpayers looking to reduce their tax debt and participate in the offer in compromise program.
Dave L. wrote about his OIC success story on a review for Optima Tax Relief on our reviews page.
We just completed an “Offer in Compromise” with the help of Optima Tax Relief. It turned out to be a very complicated and time-consuming affair. The situation had really gotten out of hand, and we were being attacked from all directions. Optima stepped in and stopped the calls and letters right away, as representation seems to make all the difference. After that, the process became a series of steps where we were guided through what the IRS wanted, and what Optima needed from us. As the steps progressed, we started to see some results and we were kept in the loop as to where we were and what was needed next. This was NOT an instantaneous process, but we believe that we were serviced to the best of their ability throughout the journey…. A little over 4-years later, part of the problem disappeared through the statute of limitations, and finally, we were told that the IRS had accepted what we offered for the remainder of the debt. We ended up sending them approx. 10% of what the bill had grown to. We are very happy with the result and feel that they provided the service they promised, and stuck to it for the long haul.
Though it could be an arduous process, there are success stories of taxpayers who reduce what they pay the IRS after reaching an offer amount.
What do I need to know as a low-income business owner with tax debt?
If you have a past-due tax bill for your business and personal tax returns, it’s important to know how to pay the IRS. This depends on the legal structure of your business.
One IRS form 656 may be used if your business is a sole proprietorship linked to your social security number. A separate offer, with an application fee and offer payment, is needed if your business is not a sole proprietorship linked to your social security number.
Additionally, the updated Form 656 includes new low-income certification guidelines and instructions. If you qualify for the low-income status, you are not required to submit any payments of the application fee upon submission or during the consideration of your offer.
Should you apply by yourself or hire a professional tax relief firm?
If the amount you owe is less than $5,000, you probably should try to negotiate your tax bill with the IRS directly to arrive at an offer amount. Although tax relief firms are valuable to have on your side when negotiating a settlement amount with the IRS, their cost can outweigh the savings they generate when dealing with small tax debt clients.
However, if your tax bill amount is larger or you’re concerned about a tax audit, you should seriously consider hiring a tax attorney or a tax relief firm that has tax attorneys on its staff. Click here to get a free consultation with a senior tax pro.
The cost of these services can be well worth it to taxpayers struggling to navigate the IRS’s payment process. SuperMoney only recommend tax relief companies that offer affordable fees, provide payment options, and have tax attorneys on staff.
Andrew is the Content Director for SuperMoney, a Certified Financial Planner®, and a Certified Personal Finance Counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.