The Internal Revenue Service (IRS) has a program that allows taxpayers to settle their tax debts for less than they owe. This program is called Offers in Compromise and may be a legitimate option if a taxpayer cannot pay their full tax liability, or doing so creates a financial hardship.
There are advertised promotions implying the IRS will accept these offers for pennies on the dollar. I always remind our clients there are 100 pennies in a dollar. The fact is, few taxpayers actually qualify for this program.
The IRS’ position is that most taxpayers have current assets and can afford a structured payment plan to resolve their case with an agreed-upon settlement. Moreover, taxpayers with short-term economic hardships (usually unemployment) may be better suited to request a “Currently Not Collectible” status (which delays payment) or a payment plan.
Types of Offers in Compromise (OIC)
Doubt as to Collectability
This is most common type of OIC. This offer is appropriate for taxpayers who can’t pay their taxes and want to settle for a payment less than the amount owed. The IRS requires the taxpayer’s financial statements in order to evaluate the offer. IRS Form 656, Offer in Compromise, and financial statement Form 433-A-OIC are the necessary forms for this OIC.
If the taxpayer qualifies for a Doubt as to Collectability offer, they are required to pay off the actual OIC amount. The method is the lump sum payment. This requires the taxpayers to offer their net equity in their assets plus 12 months of their disposable income.
For those who own businesses or are self-employed, the IRS will also require the financial statement Form 433-B-OIC. Note that businesses are usually not successful with submitting an OIC. Usually the largest business debt is payroll taxes that were not submitted. “Responsible Persons” of the business become personally liable for these past taxes. Business have the option of closing or filing for bankruptcy. This is a situation for which the taxpayer needs to consult a competent attorney specializing in distressed businesses and/or bankruptcy.
If the taxpayer does not qualify for a Doubt as to Collectability offer, they must prove they have extenuating circumstances that would allow them to qualify for an OIC based on Effective Tax Administration (described below).
Effective Tax Administration
This option is for the taxpayer who can pay the taxes owed, but paying would cause undue hardship or there are other extenuating circumstances. The IRS will consider all the facts and circumstances, including the taxpayer’s historical record of compliance. This type of offer will not be accepted if the taxpayer has an open bankruptcy filing or if any required federal tax returns have not been filed.
The following are considered economic hardship situations:
- Long term illness or disability of the taxpayer or taxpayer’s dependent(s) which will exhaust the taxpayer’s financial resources
- Liquidation of the taxpayer’s assets that would prevent the taxpayer from meeting basic living expenses
- Taxpayer received erroneous advice from an IRS employee that resulted in an additional tax liability and/or penalty assessment.
Doubt as to Liability
The taxpayer questions the taxes owed according to the IRS. It is the taxpayer’s responsibility to provide adequate documentation to support their position.
OIC Requirements for Prior Year Returns
All outstanding or unfiled tax returns will need to be filed to prove the taxpayer is in compliance and current. This will permit all outstanding tax liabilities to be aggregated into a single OIC filing.
The taxpayer must show enough withholding and/or estimated taxes are paid so they will not owe any additional tax on the next year’s return.
We recommend the taxpayer consider having the last six years’ returns professionally reviewed to determine if any taxes can be lowered and if the taxpayer is eligible for any penalty abatements based on the facts and circumstances.
Reasonable Collection Potential
The IRS uses a basic formula to determine if taxpayers can pay their tax liability with their net assets plus any future disposable monthly income before the Statute of Limitations expires. The IRS calls this the “Reasonable Collection Potential.”
When the IRS applies this formula, the typical issues are the valuation of the taxpayer’s assets and their average monthly income. Regular and necessary allowable monthly living expenses to be included in the OIC are also taken into account. The IRS limits allowable living expenses versus actual living expenses. Some of these criteria are based on the taxpayer’s demographic information.
Taxpayers are required to file and pay any taxes owed for the next five years after the OIC is accepted. Failure to comply will cancel the OIC and all previous and current taxes will due immediately.
A Slow Process
By law, the IRS can take up to a maximum of two years to investigate and analyze a taxpayer’s financial status. An IRS OIC does an in-depth examination of the taxpayer’s filing history, payments compliance, financial history, and all the other components that constitute the OIC. A taxpayer’s credit reports may also be used as an information source.
Taxpayer’s Right to Appeal
If an OIC is rejected, the taxpayer has the right to appeal the decision. The most common appeal reasons are:
- valuation of the taxpayer’s assets
- amount of average monthly income calculated
- which expenses are allowed as necessary living expenses or are above the IRS allowed averages
- if the taxpayer attempted to transfer or dissipate assets in contemplation of filing the OIC.
The taxpayer must provide persuasive documentation to the Appeals Office as part of this process.
Seeking Professional Tax Advice
While it isn’t impossible, obtaining an offer in compromise can be exceedingly difficult. The IRS would much prefer getting all the money due, but even they recognize the blood and stone metaphor.
An experienced tax professional can help taxpayers avoid pitfalls in the OIC application process and establish the most effective collection/payment option with the IRS.
Contact Steinberg Enterprises, LLC (609-443-0469 or Lsteinberg@SteinbergEnterprises.com) if you would like to discuss your situation further. We are here to help.