What is an IRS Offer in Compromise?
The IRS Offer in Compromise (OIC) program is designed to help taxpayers who are genuinely unable to pay their full tax debt. It isn’t for everyone, and it isn’t a way to simply avoid paying your taxes. Instead, it’s a mechanism for taxpayers facing serious financial difficulties to potentially resolve their tax obligations.
Background: Why an OIC?
Historically, the IRS recognized that some taxpayers, despite their best intentions, could never fully pay their tax debts. A significant tax debt can lead to financial ruin, which wouldn’t benefit the IRS or the individual. So, the Offer in Compromise program was created as a pragmatic solution, giving a path for taxpayers to start fresh while the government recoups at least some of the taxes owed. It’s a balance between collecting revenue and recognizing taxpayer realities.
How an Offer in Compromise Works: The Process
The OIC process is quite intricate and requires a thorough look into your financial life:
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Application (Form 656): You start by filling out IRS Form 656, detailing your financial information. This includes your income, assets, expenses, and overall financial situation. You need to provide very accurate and detailed information, so you might want to consider seeking help from a professional.
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Initial Payment: You have to pay a non-refundable fee with your application, and you might also have to make an initial payment on the tax debt. This will depend on how you choose to pay the OIC. There are two main payment options:
- Lump Sum: You offer to pay the agreed-upon amount in 5 or fewer months.
- Periodic Payment: You offer to pay the agreed-upon amount in 6 to 24 months.
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IRS Review: The IRS meticulously reviews your application and the information provided. They assess your ability to pay, and verify your financial details. They may request more information or clarification during this process.
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Acceptance or Rejection: Based on the information, the IRS either accepts or rejects your offer. There is no guarantee that your offer will be accepted, even if you have significant financial hardship. If your offer is accepted, you’ll need to adhere to the terms outlined in your agreement with the IRS. If your offer is rejected, you’ll need to find other ways to address your tax debt. You can also appeal the rejection of your offer.
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Terms of Acceptance: If your OIC is accepted, be sure to stick to the repayment plan, and adhere to all tax laws for the next five years. Failure to comply with the agreement or to file and pay your taxes could lead to the reinstatement of the original tax debt, plus penalties and interest.
What Factors Does the IRS Consider?
The IRS doesn’t just randomly accept or reject an OIC. They consider a few key things:
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Ability to Pay: This is the most crucial factor. The IRS will look at your income, assets, and expenses to see what you can reasonably afford to pay. This calculation goes beyond what you think you can afford, and what the IRS thinks you can afford, and is based on formulas the IRS has in place.
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Income: They evaluate your current income and potential future income to see how much you might be able to contribute.
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Assets: They consider the value of your assets like houses, cars, investments, and any other things you own. The IRS looks at the “quick sale” value, which means how much your assets can realistically be sold for, quickly.
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Expenses: They will examine your necessary living expenses to determine what you need to live on.
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Equity: This means what the real-world value of your assets is. For example, if your home is worth $300,000 but you owe $250,000, the “equity” of your home is $50,000.
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Doubt as to Liability: If there is any doubt about whether you actually owe some or all of the debt, the IRS might accept an OIC based on this argument. This has to be a significant doubt and backed up by verifiable information.
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Effective Tax Administration: This means that the IRS might accept an offer if it is in the best interest of the government. In some cases, it is in the IRS’s best interest to accept a smaller payment than to have to spend the government’s resources trying to collect on a debt that cannot realistically be collected.
Who is Eligible for an Offer in Compromise?
Not everyone can get an OIC. Here are some key points regarding eligibility:
- You must have filed all required tax returns: You can’t have any outstanding tax returns that you are legally required to file.
- You must have received a tax assessment: The IRS needs to have assessed you for the tax debt.
- You are not in bankruptcy: If you’re currently in an active bankruptcy, you cannot apply for an OIC.
- Financial Hardship: The IRS will not accept an offer unless you can demonstrate you are experiencing financial hardship and are truly unable to pay your tax debt.
- Your debts must be collectible: The debt needs to be legally collectible to be considered for an OIC. There is a Statute of Limitations on how long the IRS can collect on a debt. If your debt is close to the expiration of the Statute of Limitations, it may not be eligible for an OIC.
Related Tax Concepts & Terms
Understanding these related concepts can help you navigate the world of tax resolution better:
- Tax Lien: A legal claim against your property if you don’t pay your taxes. An OIC can sometimes help resolve a lien.
- Tax Levy: An IRS seizure of your assets to satisfy tax debt. An OIC can potentially stop a levy.
- Installment Agreement: An alternative payment option that allows you to pay off tax debt over time.
- Penalty Abatement: The possibility of having some or all penalties waived for reasonable cause.
- Tax Resolution Specialist: Professional tax experts who can assist you with OICs and other tax issues.
Tips for a Successful Offer in Compromise Application
- Be Honest and Accurate: Do not lie or embellish any information you are providing the IRS. This can get you into much more trouble with the IRS.
- Be Comprehensive: Gather all your financial documentation and provide detailed information. The more accurate your information, the easier it is for the IRS to review your application.
- Consider Professional Help: A tax professional experienced with OICs can greatly improve your chances of success. They know the nuances of the process and can help you navigate it more effectively.
- Be Patient: The IRS OIC process can take several months, even up to a year. Be prepared to wait.
- Understand the Terms: If your OIC is accepted, you must abide by the terms to avoid having your debt reinstated.
Common Mistakes and Misconceptions
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OIC is a “get-out-of-jail-free” card: Many people think they can submit an OIC and get out of all their tax obligations. This is not the case. The IRS will consider an OIC only in cases of severe hardship.
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Every OIC is accepted: The IRS rejects a significant number of OICs because applicants don’t meet the requirements.
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It’s easy to do it yourself: While you can apply for an OIC on your own, it is a very complex process, and many people benefit from professional help.
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Ignoring the problem: Putting off dealing with tax debt can lead to much more significant problems, and an OIC can be one way to deal with the problem. Don’t ignore the IRS – communicate with them.
Final Thoughts
An Offer in Compromise can be a lifeline for taxpayers overwhelmed by tax debt. However, it’s not a simple solution and requires careful preparation, a lot of patience, and the ability to prove your financial hardship. Always seek professional advice to ensure you are making the right decisions regarding your tax liabilities.