It's no secret that the IRS will "make a deal" with a taxpayer allowing them to pay "pennies on the dollar" against their tax bill. This is called an offer in compromise, or an OIC. An offer in compromise allows a taxpayer to pay their tax liabilities for less than the full amount owed. However, contrary to what all those commercials and radio ads tell you, most people do not qualify for an offer in compromise.
According to the IRS, only 30.7% of offers in compromise were approved in 2021. This statistic is not meant to discourage you, but rather make you aware of the misinformation being advertised. The IRS doesn't reject the majority of offers it receives because they don't want to help the taxpayer. The majority of offers are rejected because they are bad offers or because the taxpayer didn't qualify in the first place.
So, then the question still stands. Will the IRS accept "pennies on the dollar" to settle your tax debt? It depends! Having an Offer in Compromise accepted requires you to pre-qualify for the OIC program, qualify for one of three types of OIC, and post-qualify for the OIC. The road to acceptance is not usually an easy one.
How to pre-qualify for an Offer in Compromise
The requirements for pre-qualifying are strict. If you do not meet the requirements, the IRS will either reject your offer or return it.
To pre-qualify, you must:
Have filed all required tax returns
If you are a wage earner who receives a W2, you must be withholding enough income tax from your paycheck to prevent a tax bill when you file your tax return next year
You must have received a bill for at least one tax debt that you wish to include in your offer in compromise application
If you are self-employed, you must have paid all of your estimated tax payments for the current year
If you are a business owner with employees, you must have made all required federal tax deposits for the last three quarters
You must not be in an open bankruptcy
If you do not meet the requirements to pre-qualify for an offer in compromise, don't worry. You can get yourself into a position where you do meet all of the qualifiers. Haven't filed all required tax returns? Then work with your tax professional and file them. Behind on your estimated tax payments? Go ahead and pay them. In an open bankruptcy? Well, you're going to have to wait until it is closed.
If I pre-qualify for an Offer in Compromise, what comes next?
The application process has three components:
A $205 (generally non-refundable) application fee. This fee may be waived if you meet the IRS's low-income guidelines or if your application is based on doubt as to liability.
A non-refundable offer payment with your application. If you are applying for an offer based on doubt as to liability or if you meet the low-income guidelines, an offer payment should not be sent in with your application.
Completed IRS Form 656-B, Offer in Compromise Booklet. If you are applying for doubt as to liability, use Form 656-L instead.
Different types of Offer in Compromise
Once you've determined that you pre-qualify for an OIC, you need to figure out the type of offer you need to apply for. There are three different categories:
Doubt as to Collectability
Effective Tax Administration
Doubt as to Liability
Both doubt as to collectability and effective tax administration are submitted using Form 656-B, while doubt as to liability requires Form 656-L to be completed.
Applying for Doubt as to Collectability
The IRS will consider accepting an OIC doubt as to collectability if the taxpayer demonstrates that it would be impossible for the IRS to collect the full amount of tax liability now or in the future. This is determined by evaluating a taxpayer's Reasonable Collection Potential (RCP).
Your RCP is calculated by completing Form 433-A (OIC), or Form 433-B (OIC) if you're a business. When you complete Form 433-A (OIC), you will disclose to the IRS all of your assets, income, and expenses. The form will have you calculate your monthly disposable income by listing out all of your income sources and deducting certain monthly expenses. Depending on which payment option you choose, you will multiply your monthly disposable income by either 12 months (lump sum) or 24 months (periodic payment). From there, you will add in the calculation from your assets. This is your Reasonable Collection Potential/Offer Amount, which must be at least $1.
If your reasonable collection potential shows that you can afford to pay the tax liability in full or close to it, you generally won't qualify for an offer in compromise. However, the IRS may still work with you if you need to set up an installment agreement instead.
Let's quickly discuss the difference between the 12-month Lump Sum Cash option and the 24-month Periodic Payment option.
The Lump Sum Cash option requires an initial payment of 20% of the total offer amount to be sent in with your OIC application. The application fee is not included in this amount. If the IRS accepts the offer, the remaining balance of the offer must be paid within 5 or fewer payments. The payments do not need to be uniform.
The Periodic Payment option also requires an initial payment to be sent in with the application in addition to the application fee. While the IRS is considering your offer, you must also send in monthly installment payments towards the balance of your offer amount. If your offer is accepted, you must continue to pay your monthly installments until the offer is paid in full.
Applying for Effective Tax Administration
What happens if your reasonable collection potential is calculated to be much higher than you can actually afford? For example, you're upside down on your monthly disposable income with expenses exceeding income, but your assets (e.g., equity in your home or vehicle) push you into an offer amount that would create financial hardship.
In situations where your RCP would cause financial hardship, you can apply for Effective Tax Administration (ETA). It is important to note that this type of Offer in Compromise is usually rejected. Although it may seem counterproductive to hire professional services when your monthly disposable income is limited, it may be in your best interest to retain a tax resolution practitioner if you have a financial hardship situation.
Examples that may contribute to financial hardship:
Long-term illness
Medical conditions
Disability
Supporting/Caring for dependents that have no other means of income or support
Unable to access equity in assets
Unable to liquidate assets
If you are applying for an ETA Offer in Compromise, you will complete the same forms that are needed for doubt as to collectability found in Form 656-B, Offer in Compromise Booklet. In your application, however, you now have to explain why your offer must be lower than your reasonable collection potential. For example, you must be able to demonstrate that you are not able to access any equity or that selling an asset would be more detrimental to your well-being.
If you are able to take out a personal loan, refinance your home, or sell a vehicle the IRS will not likely accept your ETA offer. And even if you aren't able to, the IRS still isn't guaranteed to accept your offer application. Remember, the IRS only accepts approximately 31% of offers with ETA applications being the least accepted.
Applying for Doubt as to Liability
Unlike Doubt as to Collectability and Effective Tax Administration, to apply for a Doubt as to Liability OIC you will use Form 656-L instead. This type of OIC applies when there is a legitimate doubt that you owe the tax in the first place.
To qualify for this type of Offer in Compromise, you have to prove that the tax bill is incorrect. Maybe you didn't file your tax return one year and the IRS filed one for you through a Substitute for Return (SFR). The SFR did not apply any deductions or credits for you that you may have been able to claim, which left you with a tax bill you shouldn't really owe. You can file an original return for the applicable tax year(s) and prove to the IRS that their original assessment was incorrect.
Remember, you do not send in the $205 application fee or an initial payment with the Doubt as to Liability OIC application.
Refunds while Offer in Compromise is pending
If you applied for an Offer in Compromise and it's still pending, the IRS will keep any tax refunds you are entitled to. They will apply your tax refund towards your tax liability. However, it is not considered a part of your offer amount. If the IRS keeping your tax refund causes economic hardship for you, you can either call the Taxpayer Advocate or the IRS to try to have your refund sent to you.
If your Offer in Compromise is accepted, you will be able to keep any tax refund you are due for the calendar year the offer was accepted.
For example, your Offer is accepted in July 2023, and you are due a tax refund for tax year 2022, which you file in April 2023. The IRS will keep your tax refund and apply it to your tax liability. This offset will not reduce your offer amount. Now say for tax year 2023, you are due a tax refund. You timely file your 2023 taxes next year in 2024. You are entitled to keep that refund.
What happens if the IRS accepts my Offer in Compromise?
If the IRS accepts your offer, congratulations! You are almost in the clear. The next step would be to make sure you make all of your future offer payments on time.
Even after you pay off your offer amount, you are still not done. The IRS can disqualify your offer and require full payment of the tax liability (less any payments you've already made towards it) if you do not meet the post-qualifying requirements.
To post-qualify, you must for the next five years:
Stay current on your tax return filings
Timely meet your payment obligations, whether it's for your tax return, federal tax deposits, or estimated tax payments
Not file for bankruptcy
Not request an installment agreement for any unpaid taxes incurred before or after the Offer was accepted
It is important to know that the IRS can file a lien against you at any time during this process even if the offer is accepted. The lien will be released within 35 days after the IRS receives your final payment on the offer.
The IRS rejected my Offer in Compromise. Now what?
If the IRS rejects your offer, you have the right to appeal the rejection within 30 days of the date on the rejection notice. To appeal the rejection, use Form 13711.
If you would like to increase your chances of having your Offer in Compromise accepted, call our office at (267) 551-1465 or book an appointment online.
Legal Disclaimer: The contents of this blog and all posts within it are for informational use only and are not intended to be legal advice. This blog is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice in any capacity. For specific advice regarding your own tax situation, consult with a licensed tax professional or tax attorney.
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