What is an IRS Offer in Compromise?

An Offer in Compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service (IRS) that allows the taxpayer to settle their tax debt for less than the full amount owed. This program is designed to help taxpayers who cannot pay their full tax liability or for whom paying the full amount would cause financial hardship.

The IRS offers this program to ensure taxpayers facing financial difficulties have a reasonable solution for settling their tax obligations. An OIC is not guaranteed, and the IRS carefully reviews each case to determine if the taxpayer’s financial situation qualifies for this settlement option.

Eligibility Criteria for an Offer in Compromise

The IRS does not approve every OIC application. To increase your chances of acceptance, it’s crucial to understand the eligibility criteria.

Basic Requirements

Before considering an Offer in Compromise, ensure you meet the following basic requirements:

• Filing Status: All required tax returns must be filed. The IRS will not accept an OIC from a taxpayer who has not met their filing obligations.
• Billing: You must have received a bill for at least one tax debt included in the offer. This shows that the IRS has already assessed your debt.
• Estimated Tax Payments: You must be current on estimated tax payments for the current year. This requirement is essential to prove you are actively working to comply with tax obligations.
• Federal Tax Deposits: If you are a business owner with employees, you must have made all required federal tax deposits for the current and past two quarters. This ensures that you are fulfilling your business tax responsibilities before submitting an OIC.

Situations Considered by the IRS

The IRS considers OICs based on three primary situations:

1. Doubt as to Liability: There is a genuine dispute about the accuracy of the assessed tax debt. This applies if you believe you do not owe the full amount of tax assessed.
2. Doubt as to Collectibility: The taxpayer’s assets and income are less than the full amount of the tax liability. In this case, the IRS determines that they are unlikely to collect the full tax amount from you before the statute of limitations expires.
3. Effective Tax Administration: The tax is legally owed, but requiring full payment would create economic hardship or would be unfair under exceptional circumstances. This category is reserved for special cases such as severe medical issues or unexpected life events.

Calculating Your Offer Amount

Understanding how to calculate your offer correctly is crucial. If your offer is too low, the IRS is likely to reject it.

Reasonable Collection Potential (RCP)

The IRS uses the Reasonable Collection Potential (RCP) to measure a taxpayer’s ability to pay. RCP includes:

• Value from your assets such as real estate, vehicles, and bank accounts.
• Anticipated future income, minus allowable living expenses. The IRS follows specific guidelines to determine acceptable expenses.

The goal is to present an offer that reflects what the IRS believes is the most they can reasonably expect to collect from you.

Offer Amount Formula

Offer Amount = (Monthly Disposable Income x Number of Months) + Net Realizable Equity in Assets

• Monthly Disposable Income is calculated by subtracting allowable monthly expenses from your total monthly income.
• Net Realizable Equity in Assets is the quick-sale value of your property minus any debts owed on those assets.

Example Calculation:

If you have a home worth $100,000 and owe $50,000 on the mortgage:

($100,000 x 0.80) – $50,000 = $30,000

The IRS expects the $30,000 equity to be included in your offer amount. Calculating this accurately will improve your chances of acceptance. To simplify the process and ensure precision, use our Offer in Compromise calculator for accurate results.

Payment Options

You have two payment options when submitting an OIC:

1. Lump Sum Cash Offer: Requires 20% of the offer amount with your application. The remaining balance must be paid within five months. This option is often faster but may require a larger upfront payment.
2. Periodic Payment Offer: Requires the first proposed installment payment with your application. The remaining balance must be paid within 24 months. This option may be easier for taxpayers who need more time to pay.

Application Process

Required Forms

To apply for an OIC, submit the following forms:

• Form 656: Offer in Compromise. This form outlines your offer amount and the reason you are requesting an OIC.
• Form 433-A (OIC): Collection Information Statement for Wage Earners and Self-Employed Individuals. This form details your income, expenses, and assets.
• Form 433-B (OIC): Collection Information Statement for Businesses. If you own a business, this form outlines your business income, expenses, and assets.

Application Fee

• The non-refundable application fee is $205 unless you qualify for the low-income exception. To qualify for this exception, your income must fall within IRS low-income guidelines.

Initial Payment

• Lump Sum Cash Offer: Pay 20% of your total offer amount with the application.
• Periodic Payment Offer: Submit the first proposed installment payment with your application. These payments are applied to your debt, even if the IRS rejects your offer.

Submission

Mail your completed forms, application fee, and initial payment to the IRS address provided in the Form 656-B booklet. Be sure to follow the instructions carefully to avoid delays.

After Submission: What to Expect

IRS Evaluation

The IRS will:

• Review your financial situation to determine if your offer amount is reasonable.
• Assess the proposed offer amount to ensure it reflects your ability to pay.
• Ensure all submitted information is accurate and complete. Providing false information can result in penalties and your offer being denied.

Possible Outcomes

1. Acceptance: The IRS will accept your offer if they determine it is the most they can reasonably expect to collect.
2. Rejection: The IRS may reject the offer if they believe you can pay more. You have 30 days to appeal a rejected offer using Form 13711.
3. Return: The IRS may return your offer without evaluation if you fail to meet initial filing requirements or if you fail to file current tax returns or pay estimated taxes during the process.

Potential Implications and Considerations

Tax Liens

Even if your OIC is accepted, existing tax liens may remain until your offer terms are fulfilled.

Refunds

The IRS will keep any tax refunds owed for the calendar year your offer is accepted. Ensure you factor this into your financial planning.

Future Compliance

You must stay current with all future tax filings and payments for five years following your offer acceptance. Failure to comply may result in the reinstatement of your original tax debt.

Common Mistakes to Avoid

• Submitting Incomplete Forms: Ensure every required section is filled out. Missing information can result in delays or rejection.
• Incorrect Financial Information: Mistakes can delay processing or lead to rejection.
• Failing to Maintain Compliance: If you miss tax filings or payments during the OIC process, your offer may be returned.
• Underestimating Offer Amount: Offering too little may result in rejection. Carefully calculate your offer using the IRS formula to avoid this mistake.

Conclusion

An IRS Offer in Compromise can be a powerful tool for resolving tax debt, but it requires careful preparation. By understanding eligibility, calculating your offer correctly, and following the application process carefully, you can improve your chances of having your offer accepted. Consider consulting with a tax professional if you’re unsure about the process or your eligibility.