Perhaps you’ve seen or heard the television ads, where an individual claims to have their IRS tax debt settled for significantly less than what they owe. How is this possible? Through something called an offer in compromise, or OIC. But what is it and how does it work?
What Is an Offer in Compromise?
An offer in compromise (OIC) is a discretionary program where the IRS will agree to settle a taxpayer’s tax debt for less than the total amount owed. The IRS will only agree to accept a lower amount if it agrees with the taxpayer’s explanation as to why the taxpayer cannot pay the full tax debt amount.
How Do You Apply for an Offer in Compromise?
To be eligible to apply for an OIC, the taxpayer must:
- Must have filed tax returns for the last six years,
- Have received at least one tax debt bill,
- Be current with all current tax year estimated tax payments, and
- Have made all required tax payments for the current quarter (if the taxpayer is a business owner with employees).
Assuming the taxpayer is eligible, he or she will need to complete Form 656 and pay an application fee of $186 (unless the taxpayer meets the Low Income Certification and has a waiver). In addition to Form 656, the taxpayer will also have to complete either Form 434-A (if the taxpayer is an individual) or Form 434-B (if the taxpayer is a business). All three of these forms can be found in the OIC booklet, Form 656-B.
The taxpayer’s offer can come in two forms. The first is the Lump Sum Cash Payment method where the taxpayer will pay its tax debt in five or fewer payments within five months of the IRS accepting the offer. If the taxpayer chooses this method, he or she will need to enclose a check for 20% of the offer amount with Form 656. If the taxpayer is eligible for a waiver, he is not required to send a payment of 20% of the Offer amount.
The second is the Periodic Payment method where the taxpayer pays the offer amount in six or more payments within two years of the IRS accepting the offer. While the IRS is considering the taxpayer’s offers under this method, the taxpayer must continue to make monthly payments as proposed in the taxpayer’s Periodic Payment settlement offer.
Does the IRS Accept All Offers?
No. The IRS only accepts about 40% of all offers received and has the discretion to accept or reject any offer submitted to it. However, there are usually three situations where the IRS will accept the taxpayer’s OIC.
First, there is doubt as to whether can collect the tax debt. This occurs when the taxpayer’s financial situation is so dire that the IRS has no realistic hope of collecting the entire debt.
Second, there are exceptional circumstances where the IRS may be able to collect the entire tax debt, but doing so would be create undue hardship to the taxpayer or otherwise be unfair or inequitable.
Third, there is doubt as to the taxpayer’s liability. This situation may arise if there is uncertainty as to whether the taxpayer is legally liable for the debt or there is legal uncertainty as to the actual amount of taxes owed. If the taxpayer is submitting an OIC under this situation, the taxpayer will need to complete Form 656-L.
Third, there are exceptional circumstances where the IRS may be able to collect the entire tax debt, but doing so would be create undue hardship to the taxpayer or otherwise be unfair or inequitable.
Other Considerations
The OIC process is not simple or easy. Additionally, there are other tax and financial matters to consider before requesting an OIC. For example, if the IRS ultimately accepts the taxpayer’s OIC, the taxpayer must be perfect in filing his or her tax returns and paying all taxes owed for the following five years. If the taxpayer forgets to file a tax return or make a tax payment, the IRS may revoke the offer’s acceptance, resulting in the taxpayer having to pay the original tax debt, including all accrued interests and penalties.
For anyone considering an OIC, obtaining professional tax advice is a very good idea.