Offer in Compromise - IRS Tax Settlement Agreement, Tax Debt, Tax Liability
IRS Offer in Compromise - How it Works and is it Right For You?
Last Updated: May 4, 2016
If you owe the IRS back taxes and find yourself unable to pay those taxes in full, there may be a program available which allows you to pay back only a portion of the tax liability owed. We are sure you have heard of the debt settlement process for unsecured debts, where credit card companies agree to a reduced payoff amount from individuals experiencing a financial hardship. The IRS has a similar program where a taxpayer can pay only a portion of what they owe in back taxes. The Offer in Compromise allows filers who meet certain conditions to avoid further collection actions if they are able to pay off a certain amount of the tax bill owed.
How Does an Offer in Compromise Work?
An Offer in Compromise (OIC) 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. It is an out of court agreement between the IRS and the taxpayer that resolves the taxpayer's liability. Absent special circumstances, 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. The Internal Revenue Service has the authority to settle or compromise federal tax liabilities by accepting less than full payment under certain circumstances. These circumstances are:
- Is it more likely the IRS will receive payment from the filer if they accept the Offer in Compromise versus continued collection? The IRS will make this consideration based on your financial situation.
- Is there doubt that the tax liability owed is correct? If this is a possibility, the IRS may decide to settle on a lesser amount and consider the debt repaid.
- The taxpayer cannot currently be in the process of bankruptcy and still qualify for an Offer in Compromise.
- All proper documentation must be submitted as well as the application fee of $150 before any requests will be considered.
- All necessary tax returns must have been filed.
The most common resolution for an Offer in Compromise is doubt as to collectibility. The inquiry in this type of OIC is substantially similar to inquires made in a bankruptcy, i.e. Income is lower than acceptable expenses, insufficient assets to satisfy the debt if liquidated, etc. Many taxpayers file an OIC after receiving a discharge in bankruptcy in order to settle non-dischargeable tax debt.
Offer in Compromise Payment Options
In general, a taxpayer must submit a $150 application fee and initial payment along with the Form 656, Offer in Compromise. The amount of your offer will be determined by a basic formula that looks like this: Monthly Disposable Income + Assets. Note, monthly disposable income is determined by subtracting your monthly income by your monthly "allowable" expenses.
Taxpayers may choose to pay their offer in compromise in one of three payment options:
- Cash (paid in 5 months or less).
Offer Amount = Monthly Disposable Income x 48 + Assets
For example: $100 x 48 + $0 = $4,800
Divided by 5 months means your monthly payment would be $960.
- Short-Term Periodic Payment Offer. Payable in non-refundable installments; the offer amount must be paid within 24 months of the date the IRS received the offer. The first payment and the $150 application fee are due upon filing the Offer in Compromise IRS Form 656. Regular payments must be made during the offer investigation.
Offer Amount = Monthly Disposable Income x 60 + Assets
For example: $100 x 60 + $0 = $6,000 offer
Divided by 24 months means your monthly payment would be $250.
- Deferred Payment (payment terms over the remaining statutory period for collecting the tax). Payable in non-refundable installments; the offer amount must be paid over the remaining statutory period for collecting the tax. The first payment and the $150 application fee are due upon filing the Offer in Compromise IRS Form 656. Regular payments must be made during the investigation.
Offer Amount = Monthly Disposable Income x Number of Months Left on Statute of Limitations for Collectibility + Assets
For example: $100 x 120 + $0 = $12,000
Divided by 120 months means your monthly payment would be $100.
Keep in mind, 120 months is 10 long years. And with the Deferred Payment option, the first 5 years are spent in a probation of sorts. If, for instance, you default in your third year, that means all of the penalties and interest you avoided through the Offer In Compromise will be restored and you will be right back where you started. For this reason, consider the short-term period payment offer. Or, better yet, the cash offer you can be done with in 5 months or less.
Offer in Compromise Required Documents
When you file an Offer In Compromise, expect to provide the following forms, information and fees:
- Form 433-A
- Form 433-B (business only)
- Provide at least three months proof of income and expenses.
- Include a check for $150 filing fee.
- If making a cash offer, a check for 20 percent of the offer (non-refundable).
- If making a short-term or deferred payment offer, a check for the first payment.
Please be warned, though, filling out the OIC correctly is critical. If you are unsure how to go about doing this, we advise you get the help of tax attorney.
For more information, here is the IRS publication on How to File an Offer in Compromise.