The objective of the IRS’ Offer in Compromise (OIC) program is to accept an offer for less than the amount of tax that’s owed when it is in the best interest of both the taxpayer and the government and promotes voluntary compliance with all future payment and filing requirements.
If you are unable to pay your tax liability in a lump sum or through an installment agreement, and you have exhausted your search for other payment arrangements, you may be a candidate for an offer in compromise.
An offer in compromise is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayer’s tax liabilities for less than the full amount owed. Generally, an offer will not be accepted if the IRS believes that the liability can be paid in full as a lump sum or through a payment agreement.
Unless the amount offered by the taxpayer is equal to or greater than what the IRS refers to as a reasonable collection potential (RCP), it will generally not be accepted. The RCP is how the IRS measures the taxpayer’s ability to pay and includes the value that can be realized from the taxpayer’s assets, such as real property, automobiles, bank accounts, and other property. The RCP also includes anticipated future income, less certain amounts allowed for basic living expenses.
Example: Let’s say that you have assets worth $15,000. Your future income within the collection period less the amount the IRS deems that you need to meet basic living expenses is $10,000. Your minimum offer must be $25,000 ($15,000 + $10,000) for the IRS to take it into consideration.
Don’t be misled by those “pennies on the dollar” promotions that lead people to believe that all tax liabilities can be negotiated. The IRS adheres to their RCP guidelines and generally won’t give the store away. In fact, in the last few years, the IRS’ offer in compromise acceptance rate has been less than 25%.
Grounds for an Offer – The IRS may accept an offer in compromise based on three grounds:
o Doubt as to Collectibility – Doubt exists that the taxpayer could ever pay the full amount of tax liability owed within the remainder of the statutory period for collection.
Example: A taxpayer owes $20,000 for unpaid tax liabilities and agrees that the tax owed is correct. The taxpayer’s monthly income does not meet her necessary living expenses. She does not own any real property and does not have the ability to fully pay the liability now or through monthly installment payments.
o Doubt as to Liability – A legitimate doubt exists that the assessed tax liability is correct. Possible reasons to submit a doubt as to liability offer include: (1) the IRS examiner made a mistake interpreting the law, (2) the examiner failed to consider the taxpayer’s evidence or (3) the taxpayer has new evidence.
Example: The taxpayer was Vice President of a corporation from 2004-2005. In 2006, the corporation accrued unpaid payroll taxes and the taxpayer was assessed a trust fund recovery penalty as a responsible party of the corporation. The taxpayer was no longer a corporate officer and had resigned from the corporation on 12/31/2005. Since the taxpayer had resigned prior to the payroll taxes accruing and was not contacted prior to the assessment, there is legitimate doubt that the assessed tax liability is correct.
o Effective Tax Administration – There is no doubt that the tax is correct and there is potential to collect the full amount of the tax owed, but an exceptional circumstance exists that would allow the IRS to consider an OIC. To be eligible for compromise on this basis, a taxpayer must demonstrate that the collection of the tax would create an economic hardship or would be unfair and inequitable.
Example: Mr. & Mrs. Taxpayer have assets sufficient to satisfy the tax liability and provide full-time care and assistance to a dependent child, who has a serious long-term illness. It is expected that Mr. and Mrs. Taxpayer will need to use the equity in assets to provide for adequate basic living expenses and medical care for the child. There is no doubt that the tax is correct.
In order for your offer in compromise to be considered by the IRS, the following requirements must be met:
• You are not a debtor in an open bankruptcy proceeding.
• You must have filed all tax returns that are legally required.
• If you are making estimated tax payments, they must be up-to-date.
• Pay the $150 application fee with your offer submission, or provide a signed IRS Form 656-A certifying that you meet the fee waiver based upon your family unit size and income. (See Low Income Exemption and Guidelines below)
• Generally, one of the following payments must be submitted with the offer:
o Lump Sum Offer – When making a lump sum offer, you must be able to submit 20 percent of the amount you are offering as payment and be able to pay the balance in five or less payments after the offer is accepted by the IRS.
o Short-Term Periodic Payment Offer – When making a periodic payment offer, you must submit your first payment with the application and continue to make the periodic payment to the IRS while they are investigating and considering your offer. The entire offer must be paid in regular installments within 24 months.
o Deferred Periodic Payment Offer – The offer is payable in non-refundable installments paid over the remaining statutory period for collecting the tax. The first payment is due with the offer in compromise application and regular payments must be made during the IRS investigation and consideration of the offer.
Low-Income Exemption and Guidelines – The application fee is waived if an individual (not a corporation, partnership or other entity) taxpayer’s income falls at or below IRS Low Income Guidelines. Qualifying taxpayers are also exempt from making any OIC payments while the offer is being investigated.
IRS Investigation – The IRS is not bound by either the offer amount or the terms proposed by the taxpayer. The IRS investigator may negotiate a different offer amount and terms, when appropriate. The investigator may determine that the proposed offer amount is too low or the payment terms are too protracted to recommend acceptance. In this situation, the OIC investigator may advise the taxpayer as to what larger amount or different terms would likely be recommended for acceptance.
The Downside – Not only is it a lengthy, drawn-out process, the IRS may ask for a myriad of documents before deciding whether or not to accept your offer. In addition, you will have to disclose all of your assets, making it easier for them to initiate collection actions should your offer be turned down.
Generally, any of the mandatory payments listed above and made in connection with an offer will be applied to the tax liability and will not be refundable if the IRS rejects the offer.
The application fee submitted with the offer will be kept by the IRS unless the offer was not accepted for processing.
The offer is only valid if you comply with all the provisions of the Internal Revenue Code relating to filing of your returns and paying the required taxes for a period of five years or until the offered amount is paid in full, whichever is longer.
Determining if you qualify for an offer in compromise is the first step in the process. There is no need to go to the expense and effort if you clearly do not qualify. Pursuing an offer in compromise can be a complex and time-consuming task that can take anywhere from six months to as long as two years to complete. That is why using a professional to prepare the offer is generally a wise thing to do.
Steve Trojan, CPA is owner of SMT & Associates, Inc. (www.smt-associates.com), a Crystal Lake IL based tax and accounting firm, and Complete Payroll Inc, (www.completepayrollinc.com) a payroll processing firm. He specializes in tax and accounting issues affecting small business owners.