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While it is not a myth that some taxpayers can settle significant tax debt with the IRS for considerably less, the circumstances which support this type of resolution are quite specific. In fact, the IRS accepts less than 30% of all submitted offers in compromise each year. This article explores which taxpayers might qualify to settle with the IRS via the offer in compromise and describes what that process entails.
What is an IRS Offer in Compromise?
An offer in compromise (OIC) is an agreement between the taxpayer and the Internal Revenue Service IRS that settles the taxpayer’s outstanding tax liabilities for less than the full amount owed.
The IRS may accept an OIC based on any of the following grounds:
- Doubt as to Liability: Where there is a genuine dispute as to the existence or the amount of the correct tax due under the law.
- Doubt as to Collectibility: Where the taxpayer’s assets and income projected over time are less than the full amount owed.
- Effective Tax Administration: Where there is no doubt as to the amount due or whether the IRS could collect the full amount of tax due, yet requiring payment in full would create an economic hardship or would be unfair and inequitable due to exceptional circumstances.
This article will focus on the OIC based on doubt as to collectibility. Generally, the IRS will accept an OIC in this case when the offer amount represents the most the IRS can expect to collect within a reasonable time. For simplicity, the information herein applies to individual taxpayers looking to submit an offer not entities that are taxed as corporations or partnerships.
The IRS reviews and approves OICs on a case by case basis taking the unique financial circumstances of each applicant into consideration. The factors it considers include the taxpayer’s:
- Ability to pay
- Asset equity
In order to evaluate whether you will be successful in pursing an OIC based on doubt as to collectibility, you must understand how the IRS interprets your financial information to arrive at your reasonable collection potential.
Do You Qualify for an Offer in Compromise?
In order for a taxpayer to qualify for a settlement with the IRS via offer in compromise, the taxpayer must be in compliance, the taxpayer’s financial circumstances must support the offer, and the offer amount must be reasonable as per the IRS guidelines.
You will be deemed eligible to apply for an OIC if you:
- Filed all required tax returns and made all required estimated tax payments, which may include a valid extension for the current year return if applying for the current year.
- Are not in an open bankruptcy proceeding.
- Are an employer and made tax deposits for the current and prior two quarters.
If a taxpayer applies and is not eligible, the IRS will return the application as well as the offer application fee and will apply any offer payment that was included in the application toward the balance due.
Also, the IRS will return an application if it is missing necessary information, if you failed to include the application fee, or if you have not received a balance due notice from the IRS for at least one of the tax periods set forth on the application.
If the IRS returns your application for an offer in compromise, you can reapply after you have fixed the error or once the tax periods at issue are in active collections.
Financial Circumstances Requirement
The IRS will not settle with a taxpayer who could pay the full amount of tax due within the time the IRS has to collect the debt (collection statute of limitations period) based on the taxpayer’s current financial circumstances.
For example, if your current monthly household income and expense information suggest that you could make monthly payments via an installment agreement with the IRS that would completely pay the tax due, including interest and penalties projected out through the life of the installment agreement, the IRS will not accept an offer to settle for less.
In determining ability to pay, the IRS will consider taxpayer’s income offset by necessary living expenses. “Income” is interpreted broadly and will include:
- Wages for taxpayer and spouse (W2)
- Net business income (e.g., as per profit and loss statement based on 1099 income)
- Interest and dividend income
- Net rental income
- Distributions (e.g. from an IRA or via k-1)
- Pension and social security income of the taxpayer
- Social security income of the spouse
- Child support
- Other income (e.g., gift)
As per the IRS guidelines, necessary living expenses include those that are required for living and carrying on daily life. For several categories of living expenses, the IRS has national standards that are based on the size of the household and the applicable county in which the taxpayer lives which represent a ceiling in terms of allowable expense.
The expense categories that the IRS recognizes for purposes of determining ability to pay include food, clothing, housing, utilities, vehicle ownership and operating costs, health insurance, out-of-pocket health care costs, court ordered payments, child dependent care, life insurance, taxes, and secured debts. There are specific expense categories that are excluded from this analysis, including education costs and payments toward credit card debt.
Reasonable Offer Amount
Income offset by expenses will yield monthly household disposable income. If, based on taxpayer’s monthly household disposable income, the IRS could collect the full amount of tax due by the collection statute expiration date (the exact date by which the IRS’ right to collect expires), it will not accept an offer to settle for less.
Alternatively, if, based on taxpayer’s monthly household disposable income, the IRS could not collect the full amount of tax due by the collection statute expiration date, the IRS will consider an offer to settle for less. Typically, a reasonable offer amount is comparable to at least twelve months of the taxpayer’s monthly household disposable income plus a significant percentage of equity that he or she has in assets.
It is advisable to consult with a tax attorney before you submit an offer in compromise to confirm that you are eligible, that your financial circumstances support acceptance of the offer, and to determine appropriate offer amount.
What is Involved in the OIC Process?
The entire OIC process can take several months from the time the application is submitted through the time of acceptance or rejection. The three stages of an OIC include the application, the review, and the decision.
Application Phase: Months 1-3
During the application stage, the taxpayer submits Form 433A-OIC and Form 656 along with the requisite supporting documentation as well as the application fee and the initial offer amount which consists of a percentage of the total offer amount. Thereafter, the IRS will either i) send the taxpayer a letter acknowledging receipt of the application with an indication as to when an offer specialist will be contacting them or ii) return the application and the application fee with a letter advising why the application was returned (e.g., taxpayer was not in compliance or there was an issue with the application itself).
Once the application is received, the IRS will suspend all collection activity, including waiving any obligation you may have to make payments on an existing installment agreement. The statute of limitations period (the time the IRS has to collect on the tax debt) will be extended accordingly.
Review Phase: Months 4-8
During the review phase, the offer specialist assigned to the case will contact the taxpayer or the taxpayer’s representative to obtain further documents and information to aid in their evaluation of the offer. Typically, updated proof of income, expenses, and assets along with updated bank statements must be provided throughout the review phase. For this reason, any change in the taxpayer’s financial circumstances from the time the offer was submitted may jeopardize the offer.
The OIC process involves a high level of scrutiny and becomes something akin to a mini-audit. The taxpayer must be prepared to fully disclose details about all aspects of their financial situation.
Decision Phase: Months 9-12
During the decision phase, the IRS will notify the taxpayer as to whether the offer is accepted or rejected. If the offer is accepted, the taxpayer must meet all offer terms set forth in section 7 of Form 656 including future tax obligations related to filing tax returns and making estimated tax payments. Any refunds due the taxpayer within the calendar year that the offer is accepted may be applied toward the outstanding tax liability. Any tax liens associated with the back taxes will not get released until all offer terms have been satisfied, including payment of the entire offer amount.
If the offer is rejected, the taxpayer will have 30 days from the date on the rejection notice to file an appeal using Form 13711 Request for Appeal of Offer in Compromise.
Do You Need a Tax Attorney?
Given that the circumstances which support a successful offer in compromise are narrow and that the national acceptance rate is very low, it is advisable to consult with a tax attorney with expertise in this area to determine whether you are eligible to settle with the IRS and for what amount. If you are a candidate for the offer in compromise, a tax attorney can submit the application including any requisite forms and substantiation on your behalf and represent you through all stages of the OIC process.
The experienced tax attorneys at Segal, Cohen & Landis have successfully settled many clients’ outstanding tax liabilities for significantly less. We have a 95% success rate for all offers submitted on behalf of our clients because we:
- understand how the IRS determines ability to pay, what offers will be accepted, and the substantiation required to get your offer through;
- are well versed in the forms, filings, and documentation required to submit an offer;
- have extensive experience working with offer specialists and understand the process involves a high level of scrutiny;
- understand the drawbacks to submitting an offer that will ultimately not succeed (extending the time the IRS has to collection on the tax debt).
If you don’t qualify for an OIC, we can present you with alternate resolution options which may include penalty abatement and/or partial pay installment arrangements or hardship status which may also have the effect of reducing the amount you would otherwise owe over the life of the statute.
If you are interested in having a complimentary consultation with one of our partner attorneys regarding your tax matter, please feel free to contact us at 866-505-1872. We would be happy to advise you as to how we can resolve your case and how much it would cost.