What is an Offer in Compromise: A Lifeline for Tax Debt Relief

Facing a mountain of tax debt can feel overwhelming. Many people don’t realize there are options available to them, and one might wonder, “What is an offer in compromise?” An offer in compromise (OIC) is an agreement with the IRS that lets you settle your tax liability for less than the full amount owed.

It’s a lifeline, but it is not a solution for everyone. This is about finding a path forward when it feels like there isn’t one.

So, what is an offer in compromise exactly, and is it available for the average person? It’s a way to potentially reduce your tax burden, but there are catches.

Understanding the IRS Offer in Compromise Program

The IRS Offer in Compromise program isn’t charity. It’s a practical solution for both the taxpayer and the IRS.

The program allows taxpayers who can’t fully pay their tax liabilities to resolve their debt with a compromise. This benefits the IRS by securing a portion of the debt, money that it may not ever collect in full.

The IRS will typically review a taxpayer’s background through their provided income, expenses, and assets, and review that taxpayer’s potential to pay the debt.

Reasons the IRS May Accept an Offer

There are several reasons why the IRS might agree to an OIC. One is “doubt as to liability.”

This option applies if you believe the assessed tax amount isn’t correct. “Doubt as to collectibility” means you lack the assets and income to pay the full amount.

You could look into “offer in compromise” as an option here. Lastly, “effective tax administration” comes into play when full payment would cause financial hardship or be unfair due to exceptional circumstances.

Is an Offer in Compromise Right For Me?

An OIC might seem tempting, but it’s not a quick fix. It is for those facing serious financial difficulties.

Before exploring this, look at other payment options, such as installment agreements. It’s also smart to consult a tax professional.

You want to review your own financial and tax history and the potential for an offer to actually work to see if this truly is your best course of action.

To get a preliminary idea, you might check out the IRS’s Compromise Pre-Qualifier Tool. This tool runs you through tax scenarios, although, it’s not a guarantee of acceptance.

However, this gives you insights about what might come next.

Eligibility for an Offer in Compromise

To qualify for an OIC, there are key steps to check off. All tax returns must be filed.

You also must have received a bill for at least one tax debt. Pay close attention to detail on this.

Current year estimated tax payments must be made. If you’re a business owner with employees, this also includes federal tax deposits for the current quarter and the prior two.

These rules are set by the IRS. The goal is to reduce the acceptance of offers from taxpayers who are not current with tax obligations.

You also can’t be in an open bankruptcy proceeding. These prerequisites help make sure that taxpayers are up-to-date and not using an OIC to bypass responsibilities.

Breaking Down Reasonable Collection Potential (RCP)

The IRS won’t accept an offer that falls below the Reasonable Collection Potential (RCP). RCP gives insight on your ability to pay the back-owed taxes.

It considers the value of your assets, including your home and car. This also includes things like bank accounts.

Beyond physical items, future income gets considered too. Basic living expenses are factored in, taking an accurate accounting of someone’s present-day situation.

Think of RCP as the minimum the IRS is willing to accept. You could look at it as the minimum “fair value” for your case.

Your offer has to match or exceed this calculated amount.

Calculating Your Offer Amount

Figuring out your minimum offer can feel tricky, although there’s a clear framework to start. If your RCP equals $10,000, your offer must be at least that much.

The calculations on Form 433-A, providing income and finances, factor in determining the actual offer. It considers present-day facts with the potential ability to repay an amount.

The more you make, the more that may impact the offer.

Here’s how to calculate a very basic starting point to offer.

Remember, special circumstances can influence the final decision, but presenting the facts is key.

What if You Disagree With Your Tax Bill?

Sometimes, the issue isn’t the inability to pay, but disagreement on the amount due. If you doubt your tax liability’s accuracy, you would go a slightly different route.

This is referred to as the “doubt of liability” route. Instead of Form 656, you file Form 656-L.

Also, include a written explanation detailing why you believe the tax liability is wrong. Include any supporting documentation.

Applying For an Offer in Compromise

Submitting the application means following very particular steps. The main forms required are Form 656 and either Form 433-A (for individuals) or Form 433-B (for businesses).

Download them directly from the IRS website. These forms want all of the detail; financial history, income details, assets held, expenses, and future potential.

There is also an offer payment requirement, and it must be clear where those funds came from. A non-refundable application fee of $205 is generally required, with a major exception.

If you qualify for low-income certification, the fee is waived. This is set on a threshold amount.

Low-Income Certification Explained

How do you determine if you can qualify for low income certification? The guidelines revolve around income relative to federal poverty guidelines.

If your adjusted gross income (AGI), from your most recent federal tax return, falls at or below 250 percent of the guidelines published by the Department of Health and Human Services, you qualify. There’s another test you might check off.

Take your total monthly household income and multiply it by 12 to determine if it falls under the threshold. Again, you are considered as someone who would qualify.

Payment Options: Lump Sum vs. Periodic Payments

Once the offer amount is settled, how you will pay gets sorted out. With a lump sum offer, you pay in five or fewer installments within five months of acceptance.

Also include a nonrefundable 20% of the total offer with your Form 656. A periodic payment allows for spreading over six or more months, up to 24 months total.

The first proposed installment must be paid when you turn in the compromise paperwork. Even while the IRS is reviewing the request, monthly installments are on-going.

What Happens After Submitting Your Application

After submitting your OIC application, what comes next? While waiting, you need to make the on-going agreed upon payment, if your agreed periodic terms.

But it should be a small amount. You might assume you’d make your on-going scheduled debt payments from other tax situations.

Fortunately, the IRS typically suspends collection activities, so this won’t apply.

Time Frames for IRS Action and Appeal

How much time before you see something back from the IRS on their acceptance decision? It could take up to two years.

But the IRS has also confirmed in the 2023 data book, if it receives an appeal, the deadline changes. You will be informed in writing and notified for any changes.

If they send a rejection, it’s not automatically over. You have a 30-day window to appeal, and the IRS has a great online resource to go through for this process.

Reasons an Offer Might be Returned Without Processing

The IRS doesn’t look at every application. They might reject it; however, you might also be given another shot.

Here are a few key reasons why an offer might be returned:

• Missing Information on the offer in compromise paper work.
• Failing to file required tax returns in advance.
• Forgetting a Tax ID with an included debt on it.
• You didn’t include the fee.
• Your debt being litigated with the US Justice Department.

Being prepared prevents unnecessary delays.

What If Your Offer is Accepted

You followed everything right so far, and your offer in compromise is accepted; you must know your on-going requirement. Strict adherence to tax obligations, not just the reduced amount, takes center focus now.

This is all part of section seven inside Form 656. Understand tax filings get paid for five years, and all returns are due to the date when the compromise began.

Also understand any tax refunds due get applied to the debt. Only when the compromise debt is 100% paid off will any federal liens tied go away.

Conclusion

The road to financial recovery through an offer in compromise involves knowing your options and how they are used for specific scenarios.  

Remember, this a binding agreement that will have future impact. Make sure it is the absolute best approach for your needs.