An Offer in Compromise (OIC) is an agreement between the Internal Revenue Service and a taxpayer to settle a debt for less than what is owed. The goal of the program is to offer people a “clean slate” and provide a solution that strikes a balance between the best interest of the IRS and the taxpayer.
An appropriate offer represents the amount that the taxpayer has the true ability to pay. Submitting an offer does not guarantee that it will be accepted; however, it does begin a process of evaluation by the IRS to determine how much you can afford to pay.
The rationale behind an Offer in Compromise is that the successful applicant is offering to pay more than they could pay otherwise during the remaining Collection Statute Expiration Date (CSED).
Three Types of Offers in Compromise
1. Doubt as to Liability (Form 656-L)
Doubt as to liability exists when a taxpayer genuinely disputes the existence or amount of the actual tax liability, as the law applies to them. This type of offer is seldom used but is useful as a way to challenge the basis of the liability. Doubt as to liability does not exist if the tax debt has been established by a Court’s decision or final judgement.
A taxpayer must provide documentation to support the reason they doubt the liability. Typically, this method is used if a taxpayer was unable, for some reason, to dispute the liability during the time allowed by the IRS. Reasons for this include: the Examiner made a mistake, the Examiner failed to consider evidence, or new evidence is available to support the correct liability.
2. Doubt as to Collectibility (Form 656)
Doubt as to Collectibility is the most common form of Offer in Compromise submitted and exists when the taxpayer can demonstrate that his assets and income, when combined, are not enough to pay off the taxes in full within the Collection Statute Expiration Date. This type of Offer will not be accepted if the taxpayer has the ability to pay in full, which makes sense.
3. Promote Effective Tax Administration
The most rare form of Offer in Compromise, this agreement would be entered into to promote effective tax administration when the Secretary determines that although the taxes could be collected, it would cause the taxpayer economic hardship within the meaning of Section 301.6343-1.
Before submitting an Offer, a taxpayer must:
- File all required returns.
- Make required estimated payments for the current tax year.
- Make all required federal tax deposits up to the current quarter if a business owner.
Further, a taxpayer cannot be in an open bankruptcy proceeding. However, it is possible to file bankruptcy to discharge some tax debt, then submit an Offer for any remaining liability after the bankruptcy has been closed or discharged.
How It Works
It is important to understand how an Offer in Compromise works. Doubt as to Collectibility will be discussed in this section. This Offer is the most popular form submitted and is discussed below.
1. Determine the Minimum Processable Offer Amount
a. Net Realizable Equity in Assets (Asset Component)
This is a critical calculation that could make a difference in thousands of dollars. Essentially, the IRS wants a total of the net realizable value of your assets. This is not typically the amount paid for the item–it is the reasonable amount that would be realized by the IRS if they were to sell the item quickly. There are certain “exemptions” from this calculation, such as a small cash exclusion, car equity exclusion, etc.
b. Monthly Ability to Pay (Income Component)
All income is considered in this component–wages, social security, child support, interest and dividends, alimony, etc. Deductions are made from this income for items such as current year tax payments, court-ordered payments, reasonable and necessary living expenses, etc. The remaining “disposable” income is multiplied by a factor to determine the amount “available” for the Offer.
c. Minimum Processable Offer
The minimum offer that the IRS will consider is the sum of the asset and income components. Any amount less and the Offer will be returned to the taxpayer. Prior to the Fresh Start Initiative, the disposable income from the income component was multiplied by a factor of 48. This means 4 years of disposable income.
Not many taxpayers were able to make a viable Offer because the sheer size of 4 years of income either made the Offer higher than the tax debt, or the Offer was made too large to afford. Now, the factor multiplied is either 12 or 24, depending on the repayment terms the taxpayer chooses (Lump Sum or Periodic, explained below). This was a breakthrough for taxpayer relief because it made thousands able to make acceptable, affordable Offers in Compromise.
2. Lump Sum vs. Periodic Payments
a. Lump Sum
For a “Lump Sum” payment option, the taxpayer includes 20% of the Offer amount with the Offer package. The remaining 80% balance is to be paid with 5 or fewer payments within 5 or fewer months from the date the offer is accepted. For this payment option, the income component is determined by multiplying the disposable monthly income mentioned above by 12. Thus, the income component is equivalent to 12 months of disposable income.
b. Periodic Payments
The option requires the first periodic payment to be submitted with the Offer and the remaining amount to be paid within 24 months, according to the terms proposed and agreed upon. Under this option, a taxpayer must continue to make the periodic payments while the Offer is pending.
With this payment option, the income component is determined by multiplying the disposable monthly income mentioned above by 24. This means that it captures the disposable income earned during the periodic payment term. The periodic payment method inherently increases the Offer amount, all things the same, when compared to the Lump Sum method.
c. Lump Sum vs. Periodic
The most obvious difference between the two options is the difference it creates in the income component of the Offer. Periodic essentially doubles this component. However, a great advantage the Periodic method has is that it does not require 20% upfront, which can be unaffordable for a lot of taxpayers, making the periodic method preferable.
An exception for initial payment exists for both methods. If a sole proprietor or individual meets the Low Income Certification guidelines, they will not be required to make the initial or periodic payments while the Offer is pending.
3. Prepare Forms & Apply
Once eligibility is determined, the minimum processable offer has been determined, payment method established, and funds lined up, it is time to prepare the forms. The forms are complex and require precision and accuracy. A filing fee of (at the time of writing) $186 is included in the package along with the initial offer payment.
Taxpayers who meet the Low Income Certification are not required to pay an application fee or make an initial offer payment. Once submitted, the IRS will begin verifying the information and documentation contained in the Offer.
If the IRS finds the Offer in Compromise acceptable, they will acknowledge acceptance in writing. At this point, it is up to the taxpayer to meet the terms of the agreement and receive their fresh start. Typically, from start to finish, an Offer in Compromise can last up to several months in “simple” cases, longer in more complex cases.
Often, the IRS will require additional documentation to corroborate the financial information provided.
Tax Refunds – The IRS will keep any tax refund for the tax year in which the Offer is accepted. For example, if an Offer in Compromise is submitted and it is accepted in November of 2014, the 2014 tax refund will be applied to the tax due. This will not be considered as a payment toward the Offer.
“Probation” – After the Offer is made, a taxpayer must continue to file and pay all required returns (including quarterly returns), estimated tax payments, and federal payments through the final decision on the Offer. If the Offer is accepted, the taxpayer is on “probation,” meaning they must continue with these requirements for five years following the acceptance, or the Offer is considered “defaulted.” If the Offer is considered defaulted, the full tax liability will be deemed as owed and any payments made will not be refunded.
Statutes Extended – Submitting an Offer in Compromise is considered a “tolling” event, meaning that it extends certain dates, such as the Collection Statute Expiration Date, the Assessment (Audit) Statute Expiration Date, and the bankruptcy dischargeability date.
Tax Lien – The IRS may file a tax lien (called a Notice of Federal Tax Lien) while the Offer in Compromise is pending. This gives the IRS a legal claim against property the taxpayer owns. The lien will be released upon satisfaction of the financial terms of the Offer.
Tax Levy – The IRS may levy a taxpayer’s assets up until the time the IRS signs and acknowledges the Offer as pending. Further, the IRS may keep any proceeds from such levies.
Installment Agreements – If a taxpayer has already entered into an approved installment agreement with the IRS and is making installment payments, then they may stop making payments once an Offer in Compromise is submitted. If the Offer is rejected by the IRS, the installment agreement will be reinstated with no extra fee.
*Footnote: Form 656 Booklet Offer in Compromise is the main reference for this information.
Disclaimer: This information is intended for informational or educational purposes only. It is not intended to supplement or replace legal representation and should not be construed as such. Further, any of the information below is subject to legislative or procedural change by the IRS at any time and without warning.
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