How to Understand Offer in Compromise: IRS Tax Debt Settlement Explained

Definition of an Offer In Compromise

An Offer in Compromise (OIC) is a potential solution for those burdened with tax debt and unable to pay the full amount owed to the IRS. It allows taxpayers to settle their tax liabilities for less than the total amount owed. Essentially, it is an agreement between the taxpayer and the IRS, where the taxpayer agrees to pay a reduced sum to fulfill their tax obligations.

Imagine you owe $50,000 in taxes but are experiencing severe financial hardship that prevents you from making full payment. With an Offer in Compromise, you may have the opportunity to negotiate with the IRS and agree on a lower settlement amount, such as $25,000, which can help alleviate your financial strain.

The Process and Package Application

To initiate the Offer in Compromise process, taxpayers must complete an application package. This package typically includes Form 656(s), offering a compromise on tax liability, along with forms 433-A or 433-B that provide detailed information about your income, expenses, assets, and liabilities. Additionally, there is an application fee of $205.

The application requires thorough documentation and accurate financial disclosure. It is important to provide all required tax returns and make any necessary estimated tax payments before applying for an Offer in Compromise. Other requirements include not being in an open bankruptcy proceeding and ensuring you have a valid extension for current year return (if applicable). Employers must also make tax deposits for the current and past two quarters.

Different payment options are available within the Offer in Compromise program. The Lump Sum Cash option requires an initial payment of 20% of the total offer amount, followed by paying off the remaining balance in five or fewer installments. Alternatively, the Periodic Payment option necessitates providing an initial payment with your application and monthly installments until the entire offer is paid off.

It’s worth noting that low-income individuals may be exempt from paying the application fee or making monthly installments during the review process. This can provide relief for those facing significant financial challenges.

During the evaluation period, non-refundable payments and fees are applied to the tax liability, and other collection activities are temporarily suspended. However, it’s important to be aware that a Notice of Federal Tax Lien may be filed during this period, and your legal assessment and collection period will be extended.

If your Offer in Compromise is accepted by the IRS, it is crucial to meet all the terms outlined in the agreement. This includes filing any required tax returns promptly and making payments as specified in the offer. Failure to adhere to these terms may result in the rejection or revocation of the settlement.

Eligibility Criteria for an Offer In Compromise

Before diving into the intricacies of an Offer in Compromise (OIC), it’s essential to understand the eligibility criteria set by the Internal Revenue Service (IRS). To qualify for an OIC, several conditions must be met. Firstly, you should have filed all required tax returns and made estimated payments for the current year (if applying for a current year OIC). Additionally, you must not be in an open bankruptcy proceeding. Furthermore, having a valid extension for the current year’s tax return is necessary if applying during that time. Lastly, it’s crucial to have an employer who has made tax deposits for the current and past two quarters before submitting your application.

The eligibility criteria mentioned above sets a baseline to ensure that taxpayers meet specific requirements before pursuing an Offer in Compromise.

Now that we are aware of the eligibility criteria, let’s explore the factors considered by the IRS when evaluating an Offer in Compromise.

Consideration Factors in Evaluation

The IRS evaluates several factors when considering whether to approve or reject an Offer in Compromise (OIC) application. These factors include the taxpayer’s ability to pay, income, expenses, and asset equity. The IRS aims to determine if accepting the offered amount would be more beneficial than continued collection efforts or legal proceedings.

When assessing ability to pay, the IRS considers various aspects such as the taxpayer’s future income potential and anticipated changes in financial circumstances. Income refers not only to wages but also includes dividends, rental income, and other sources of revenue. On the other hand, expenses take into account necessary living expenses like housing costs, transportation, food, and healthcare. Lastly, asset equity examines the value of assets owned by the taxpayer, including real estate properties or vehicles.

It is essential for taxpayers to present their financial situation accurately and transparently during the evaluation process.

By analyzing these factors, the IRS can determine whether accepting the proposed offer reasonably reflects the taxpayer’s ability to pay their outstanding tax debt. It’s crucial to note that each case is evaluated on an individual basis, and there is no one-size-fits-all approach.

For instance, let’s consider a hypothetical scenario where a taxpayer earns minimal income and possesses limited assets. In this situation, it may be more reasonable for the IRS to accept a lower offer amount compared to someone with higher income or significant asset equity.

Understanding the factors considered by the IRS during evaluation provides insight into the complexity of determining an appropriate offer amount. Let’s explore this calculation process next.

  • According to the IRS data book of 2019, out of 54,225 Offers in Compromise received by the IRS, only 17,890 were accepted – a success rate of approximately 33%.

  • The same report suggests that the average settlement amount in an Offer in Compromise was around $10,000, significantly less than the average tax debt of $36,000 for impacted taxpayers.

  • A Taxpayer Advocate Service Report indicates that taxpayers who earn under $30,000 per annum are more likely to get their OIC accepted. Conversely, those with higher income and/or assets have a significantly lower acceptance rate.

Calculation of Offer Amount

When it comes to settling IRS tax debt through an Offer in Compromise (OIC), the first step is to calculate the offer amount. The IRS follows a specific formula that takes into account various factors, such as your financial situation, assets, income, and expenses. The aim is to determine a reasonable amount that you can realistically pay towards your tax debt without causing significant hardship.

The IRS calculation for the offer amount involves two different methods depending on the desired timeframe for repayment: one for settling within five months and another for settling within twenty-four months. Under the five-month payoff method, the formula is (available income per month x 12) + amount of available assets = Amount IRS will accept. On the other hand, for a twenty-four month payoff, the formula becomes (available income per month x 24) + amount of available assets = Amount IRS will accept.

It’s important to note that qualifying for an OIC relies on ensuring your financials align with the IRS OIC formula. If you have more assets than the tax balance due, you may not be eligible for an OIC. Additionally, the IRS evaluates whether your expenses are considered reasonable based on the Collection Financial Standards and allows inclusion of expenses falling off over the next five years in the calculation of available income.

Now that we understand how the offer amount is calculated, let’s explore how your financial circumstances impact the offer you can propose to the IRS.

Impact of Financial Circumstances on Offer

Your financial circumstances play a crucial role in determining the offer amount that you can present to the IRS. The goal is to show that paying your tax debt in full would cause severe economic hardship or be financially unfeasible given your current situation.

The IRS evaluates factors such as income, expenses, and available assets to assess your ability to pay. They consider your monthly disposable income after accounting for necessary expenses, which must align with the Collection Financial Standards established by the IRS. If your expenses exceed those standards, it could be challenging to convince the IRS that you are unable to pay the full debt.

Additionally, the IRS examines your assets and their value at quick-sale prices. If the value of your assets is significantly higher than the balance due, it may suggest that you have sufficient resources to pay off the tax debt and may affect your eligibility for an OIC.

For instance, if you have a high-value asset like a second home but lack steady income or adequate liquid assets to cover your tax debt, it could strengthen your case for a lower offer amount.

It’s crucial to present a comprehensive picture of your financial circumstances while highlighting any hardships or limitations that make paying the tax debt in full unattainable. Being transparent about your situation will help you demonstrate to the IRS why they should consider accepting an offer in compromise as a viable resolution.

Payment Options and Low-Income Exemptions

When it comes to settling tax debts through an Offer in Compromise (OIC) with the IRS, understanding the available payment options and low-income exemptions is crucial. The IRS provides two primary payment options for OICs: a lump sum cash option and periodic payments.

The lump sum cash option requires the taxpayer to make a one-time payment for a reduced amount that is agreed upon in the settlement. This can be advantageous for individuals who have access to a significant sum of money and would like to resolve their tax debt swiftly. On the other hand, periodic payments allow taxpayers to make smaller installment payments over time until the full agreed-upon amount has been paid. This option may be more suitable for those who cannot afford a lump sum upfront but have the means to make regular installments.

It’s important to note that individuals with low income may be eligible for certain exemptions when it comes to making payments during the review process. This can provide financial relief and make pursuing an OIC more feasible for those experiencing financial hardship. Qualified low-income individuals may be exempted from paying the application fee of $205 and making monthly installments while their offer is being evaluated.

For instance, consider Sarah, who has accumulated substantial tax debt due to unexpected medical expenses. She is currently living on a limited income and finds it challenging to meet her basic needs while also dealing with her tax obligations. In Sarah’s case, qualifying for low-income exemptions could significantly alleviate her financial burden and allow her to pursue an OIC without facing additional costs during the review process.

Keep in mind that if your offer is accepted by the IRS, it is essential to fulfill all terms of the agreement. This includes filing all required tax returns and meeting any future tax obligations promptly. Failure to comply with these terms could result in the offer being revoked, leading back to the original tax debt and potentially triggering collection actions by the IRS.

By offering payment options and low-income exemptions, the IRS aims to provide some flexibility and assistance to taxpayers who are struggling with overwhelming tax debt. These options can help individuals manage their financial obligations while seeking a reasonable resolution through an Offer in Compromise.