Offer in Compromise: Is It Right for You?

man writing a check to the IRS for his Offer in Compromise payment

Everybody out there has heard an advertisement on the radio while driving or on TV late at night for the IRS programs where you can settle for pennies on the dollar or get forgiveness of your tax debt. The program that they are referring to is called the Offer in Compromise. This is a program where you can see a reduction in the tax debt, sometimes a substantial reduction. 

But what is an Offer in Compromise, how does it work, and is it a good option for you?

 

What is an Offer in Compromise?

The actual definition from IRS.gov is an offer in compromise is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayer’s liability for less than the amount owed. Obviously, this is a great program, but it does not mean that everybody can settle their debt for less just because the program exists.

Taxpayers who can pay the tax debt in full or can pay the tax debt through an installment agreement typically wouldn’t qualify for the Offer in Compromise (OIC). 

To qualify, a taxpayer must be compliant in terms of filing requirements. This means all required years with income have been filed up to date. Also, they must have proper withholdings or estimated payments set up for the current tax year. If the debt is business tax debt, the business must have made all required federal tax deposits for the current quarter.

 

How Does the IRS Decide Whether to Accept or Reject an Offer in Compromise?

The IRS bases its decision for an Offer in Compromise on a taxpayer’s “RCP”, or “reasonable collection potential”. The reasonable collection potential is how the IRS measures the taxpayer’s ability to pay. The RCP includes the value of the taxpayers’ assets such as real estate property, automobiles, bank accounts, and other property. In addition to the property, the RCP also includes future income less certain amounts allowed for basic living.

So in short, the person who qualifies for the Offer in Compromise truly cannot pay the tax debt back and does not have assets more valuable to the debt. 

One major right that a taxpayer has is the right to pay their allowable monthly expenses. If you are somebody who is paycheck to paycheck and could not afford the amount required for an installment agreement, then you may qualify for the Offer in Compromise. This is the main reason the IRS would accept a compromise on the debt. The IRS officially calls it “doubt as to collectability”. 

The second reason the IRS may accept a compromise is “doubt as to liability”. This is when there is a valid dispute over the existence or the amount of the tax debt. 

The third reason the IRS may accept a compromise is called “effective tax administration”.  This is when there is no doubt that the tax is legally owed and that the full amount could be collected but requiring a payment would create an economic hardship or would be unfair and inequitable because of exceptional circumstances.

 

How is an Offer in Compromise Paid?

There are two types of ways to pay an Offer in Compromise: as a lump sum or in installment payments. A lump sum is defined as an offer payable in five or fewer payments over five months. To apply for a lump sum offer, the taxpayer must submit a 20% nonrefundable deposit with the application. If the IRS rejects the offer, the 20 percent payment is not returned but applied to the full balance of the tax liability. 

The second type of offer is called a “periodic payment offer.” This consists of an offer paid over 6 or more monthly installments within 24 months of when the offer is accepted.

When applying for the Offer in Compromise it is especially important to know the ins & outs of the program before applying. Especially with the fact that a 20% non-refundable deposit must be included with the offer, it is important to have somebody who knows these programs. There is nobody better to help you with this than a federally licensed IRS Enrolled Agent. 

Typically, an enrolled agent will have worked for the IRS or at least have demonstrated knowledge equivalent to such a level through testing. This knowledge of what the IRS is looking for is especially important not only in the prequalification process, making sure that it is worth applying for, but also in the presentation of the financial situation to get you approved. 

 

Drawbacks to Applying for an Offer in Compromise

There are some drawbacks to applying for the OIC in terms of collection law. During the period while the IRS is determining whether to accept or deny your offer there is a hold on collection activities. Since there is a hold on collections, there is also an extension on the legal assessment and collection period for the tax debt. 

Also, during that time a Federal Tax Lien may be filed on your person or properties. It is so important to know these things and consult with a true tax professional before applying. A good example of why is if you are planning to sell a property and hope to settle your tax debt before selling since a federal tax lien will remain in place for some time even after the Offer in Compromise is paid in full. 

Also, many other avenues and hardship programs can have better results than the Offer in Compromise that are based on your ability to pay and make good use of the tax debt statute of limitations. If you apply for the Offer in Compromise, it puts that statute on hold and gives the IRS longer to collect against you. With a tax professional doing an investigation of your situation, a strategy can be laid from start to finish with a way to get you out of as much of the debt as quickly as possible using all these different rules to your benefit.

 

Should You Deal With the IRS Directly?

While you certainly can deal directly with the IRS, the following is a great example of why it may not always be wise to do so. A client that I helped last year had been trying to work with the IRS for several years on settling a $100,000 tax debt he owed. He felt he had rights to the Offer in Compromise and had applied for it 3 different times over the course of a 5-year period. He had also tried many payment arrangements with the IRS over a period of about 5 more years but was never able to afford them. This gentleman was just on social security income with a small pension and could not afford to pay his tax debt balance. While this is a major contributing factor for qualification with the IRS for the OIC, other factors do go into as well. 

The reason he was repeatedly denied was because he owned a home. He finally reached out to us for help and while we could certainly step in and give him an end date to all of this, it wasn’t an end date as soon as it could have been if he had contacted us sooner. 

By showing his inability to pay, we were able to get him into smaller payments on the tax debt. With this partial pay arrangement, he will only have to make a small monthly payment until the debt expires after the 10-year statute of limitations. Due to applying for the Offer in Compromise so many times, the statute date had been extended by a little over 3 years which unfortunately added to the payment term for these small payments. 

Sad to say, he always qualified for this partial payment arrangement and had forked over thousands of dollars that he could not afford as he struggled with the payment arrangements the IRS had offered him. While he was extremely happy that we could step in and save him so much money and finally give him an end date to his tax debt and payments, we both agreed that we wished we had spoken years ago and saved him the money and the aggravation of trying to deal with this on his own.

 

Beware of Offer in Compromise Scams

Unfortunately, in every industry, when someone is in a vulnerable situation, you have companies that prey on them. Some companies operate what the IRS calls “Offer in Compromise Mills”. These are companies that will get you on the phone with a salesperson and right off the bat he or she will make promises of settlements pennies on the dollar without really knowing anything about your situation. 

The only way to know if one could qualify for the Offer in Compromise is by doing not only a careful full review of one’s financial situation but also accessing IRS records before ever relaying to clients what the possible outcomes could be. While the OIC is real and it’s a great provision, not everybody qualifies for it. 

Fortunately, in this day and age of the internet, if you investigate these companies through Google or research their BBB ratings, it will quickly become clear if they’re a company you should stay away from. The good thing is that there are many honest and ethical tax relief companies that will look out for your interests first. 

 

What If You Don’t Qualify?

In conclusion, the Offer in Compromise is a great program if you can qualify for it. And like everything else in life, you can certainly try it on your own. But if this is not something that you have studied or done hundreds of times, it would probably financially benefit you to seek representation when dealing with the IRS. 

As mentioned earlier, even if you do not qualify for the miracle cure of the Offer in Compromise there are many other tax relief programs available that can at least limit your exposure to the tax debt. With these programs, you may not see the steep reduction that you had hoped for but at least you won’t significantly overpay on the tax debt with penalties, fees, and interest.

 

IRS Offer in Compromise: What It Is and How It Works

IRS Offer In Compromise form

Offer in Compromise is an IRS program that enables taxpayers to get a fresh start with the Internal Revenue Service. In doing so, they have the chance to settle their tax debt for less than the overall amount of money they owe. Therefore, if you are struggling to pay your federal or state tax debt, this could be a useful program to consider. In 2018 alone, the IRS accepted around 24,000 offers (up 24% from 2010) while rejecting just as many.

So, how can you determine if Offer in Compromise (OIC) is an initiative that could solve your tax issues? How can you get an offer accepted? How much should you offer to the IRS? We give you all the necessary details and answer these concerns below.

How Much Should I Offer in Compromise to the IRS?

This is perhaps one of the most challenging parts of submitting an Offer in Compromise. On the one hand, you don’t want to come forward with an unrealistically low offer that could ruin your acceptance chances. On the other hand, you do aspire to pay as little as possible to the IRS so that you can finally settle your tax debt. Given that each case is different, there is really no magic formula. In fact, it requires a lot of experience to be able to recognize when an offer is too low.

That being said, there ARE some ways to get some idea of how much is probably enough when you make an Offer in Compromise. Let’s start with the basics – the bare minimum offer sum. Note that it will NOT guarantee that your offer gets accepted by the IRS. It will, however, give some confidence that your offer is in the right ballpark.

What the IRS is primarily focused on is to receive offers of at least the same amount of the taxpayer’s Reasonable Collection Potential (RCP). This is a number the IRS uses to determine your ability to pay the owed taxes, and takes into consideration several liabilities, such as your:

  • Assets
  • Monthly living expenses
  • Monthly income

So, generally speaking, you can begin with an estimate of 12 months’ worth of your disposable income. Then, calculate any additional cash you can get from selling valuable assets and submit an offer with an amount higher than your RCP. This is critical, especially if you are planning on submitting an Offer in Compromise on the basis that you are unable to pay the due tax (as opposed to Effective Tax Administration or Doubt as to Liability).

The problem lies in calculating your Reasonable Collection Potential. Here are some steps to follow:

  • Estimate the income you have from all sources within a month and then subtract the full sum that corresponds to your living expenses (the necessary ones only, such as car payment, groceries, utilities, rent, etc.). The number you will get is your monthly disposable income.
  • Multiply your monthly disposable income by 12 to get your annual disposable income.
  • Add to that amount any assets that you could sell, such as valuable collectibles, investments, and an extra car. At this point, note that determining how much these assets are worth is a point of negotiation with the IRS for many taxpayers.

The result of these calculations will give you the bare minimum you can offer.

Should You Pay Installments or All At Once?

Many taxpayers wonder if they should pay the offer amount in installments rather than with one lump sum payment. Although the IRS enables monthly payments for this purpose, it is best to pay the offer in fewer than five monthly installments if it is possible. This is because the IRS will use 24 months of your disposable income for anything beyond five installments to calculate your Reasonable Collection Potential (with five or fewer installments, they will use 12 months of your RCP). If that happens, the amount the IRS will want from you will essentially double.

How To Get An Offer in Compromise Approved

As already mentioned, the IRS is highly likely to turn down offers that do not meet (even better, exceed) the taxpayer’s RCP. That being said, some factors play a leading role in making an Offer in Compromise quicker. These include:

  • Low Income W2 Earnings – You make less than $30,000 annually, and your only income source is a wage-earning job.
  • Fixed Retirement Income – You are a 55+ years of age retiree and receive a fixed income.
  • Social Security/ Disability Income – You only get a Disability or Social Security income.

Some factors, on the other hand, can contribute to longer-than-average decisions about your Offer in Compromise, such as:

  • High Balance – Offers with balances $25,000+ usually take much longer to process than those with lower balances.
  • Self-Employment – The IRS conducts in-depth research on your expenses, making sure you don’t mix your personal and business expenses.
  • Initial Rejection – If you have already submitted an offer that got rejected and want to have it reevaluated, you could be adding up to six more months to the overall procedure.
  • Other Circumstances – If you own multiple vehicles, have lots of loans, or many different deposits all over the place, you will need to do some explaining to the IRS. This pushes the process further back in time.

So, is everything lost? Not at all. You can still boost the Offer in Compromise process by doing the following:

  • Ensure you have all the necessary details – The IRS will request things like bank statements. Check that the ones you submit have all the pages, even those that you may find useless (i.e., a blank page). Then, send your Offer.
  • Provide good explanations – If your financials, for some reason, does not look right, make sure that you give a sound reason for it in the cover letter.
  • Reply fast and accurately – It is paramount that you respond to IRS requests for further clarification as timely as you can. The information you provide should also be accurate.
  • Propose the presumed maximum amount of money – The IRS expects to collect some money from you within a reasonable time period. Offering them the max sum of the presumed amount will most likely get your offer approved

To get there, ensure that you have filed all tax returns, made the required estimated tax payment for the current year, and include a bill of one or more tax debt in your offer. Business owners with employees must have made the needed federal tax deposits for the current quarter.

Besides what is reported to Form 433-A, the IRS will investigate several other factors, such as your level of education, age, asset equity, expenses, income, Collection Statute Expiration Date, and, of course, your lifestyle. If something about the way you live is contradictory to the fact that you are unable to pay your taxes, the IRS may reject your offer.

How Can I Submit An Offer In Compromise Application?

To apply for an Offer in Compromise, you will need the following Offer in Compromise Forms:

    • Form 656 – You need this to make your offer.
    • Form 433-A – This Collection Information Statement for Wage Earners and Self-Employed Individuals helps the IRS determine whether you are facing financial strain and to what extent.
    • Form 433-B – This is the same as with Form 433-A with the difference that it is a Collection Information Statement for Businesses. It serves the exact same purpose as Form 433-A.

Common Mistakes to Avoid when Filling out your OIC Application

The IRS will get all the information they need about your financial situation from Form 433-A (see above). It is, therefore, crucial that you ensure you don’t make any math errors on that form, although the form indeed requires a considerable amount of complex calculations. You certainly don’t want to put your OIC process to a halt to have incorrect calculations sorted out.

Other mistakes on OIC forms we usually see and either cause confusion or have a dramatic impact on a case are as follows:

  • Leaving empty/blank spaces – Never leave a field on a 433 or 656 empty. It is best to write “N/A” in these spaces.
  • Writing negative equity – It is essential that any negative equity is reported as zero. Many tax accountants subtract the negative equity from the taxpayer’s NRE (Net Realizable Equity) when the taxpayer’s asset (property, in this case) is worth less than they owe on it, which is wrong.

 

How Long Does It Take To Get a Response From the IRS?

Although there are no set timelines for exactly how long it will take the IRS to decide whether to reject or approve an Offer in Compromise, our experience has shown that it usually requires between 4-9 months. However, some more complex Offers in Compromise may need much more time to get resolved, which could reach 48 months from the day the OIC process was completed, which usually takes roughly 6 months. The most common factors that could drag a response from the IRS are related to self-employment. Regardless, the IRS does respond within two years.

If the IRS accepts your offer, you need to stick to your part of the deal and pay the agreed sums. Now, if your offer gets rejected, know that you can file an appeal via Form 13711 (hence, renegotiate your OIC under more favorable terms) within 30 days of the rejection notice date.

Is an Offer In Compromise the Best Option for You?

Although an Offer in Compromise is an excellent collection solution, it is not the only option you could consider. To determine that, you will need to have a trusted tax professional evaluate your tax situation, the IRS collection alternatives, and your personal finances as a means to develop the optimal approach to repay your debt. Don’t hesitate to call or contact us for a free tax consultation to see how we can help you get out of debt as painlessly and swiftly as possible while negotiating the best terms for you.