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Offer in Compromise - Settling Tax Liability With the IRS for Less Than Owed

Last Updated: September 16, 2011

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:

• Doubt as to liability - doubt exists that the assessed tax is correct.
• Doubt as to collectibility (most common) - doubt exists that you could ever pay the full amount of tax owed.
• Economic hardship.

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 chose to pay their offer in compromise in one of three payment options:

1. 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.
   
   
2. 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.
   
   
3. 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 Collectability + 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, and IRS Form 656.

Tax Levies | Types of Tax Levies | Offer in Compromise