Your Legal Guide: IRS Offers In Compromise
Tax debt is a major problem for both American citizens and the U.S. government. Roughly 5 percent of Americans do not pay their taxes or have tax debt. This equates to about $28 billion per year in lost proceeds for the U.S. government. While the IRS has ramped up financial and criminal penalties for those who do not pay their taxes, they have also offered various programs to help Americans pay off their debt.
The good news for taxpayers who have a lot of tax debt and are struggling financially, is that it’s possible to become tax-debt free without going broke. The key is an Offer In Compromise (OIC) settlement with the IRS.
|Warning: Getting an OIC agreement approved by the IRS is difficult. In 2014, out of 68,000 OICs that were submitted, the IRS only approved 27,000. That’s an approval rate of about 40 percent.
Continue reading to learn about common pitfalls, how you can avoid them and other tips that may help get your OIC approved.
What is it? The IRS defines an OIC as “an agreement between a taxpayer and the Internal Revenue Service that settles a taxpayer’s tax liabilities for less than the full amount owed.” Meaning you pay less than the total debt you owe.
Who is it for? An OIC is generally intended for people who are financially unable to pay their entire tax debt amount. This type of OIC is known as Doubt as to Collectibility. There are two other types of OICs:
- Doubt as to Liability: the taxpayer believes that the tax debt has been miscalculated and the current amount owed is incorrect.
- Effective Tax Administration: the taxpayer has tax debt and possible ability to pay, but to do so would cause extreme financial distress.
Insider legal tips:
- Any OIC is not available to those in the middle of bankruptcy proceedings.
- Payroll tax cannot be forgiven in an OIC.
- Our lawyers wouldn’t suggest filing for an OIC if you believe you are not liable for the debt owed. That is because the OIC process is lengthy. Instead by filing for Innocent Spouse Relief or having your lawyer call the IRS and directly submit evidence of your doubt of liability, you can have immediate relief, rather than wait 9-12 months and continue to accrue interest on the debt.
Why does the IRS use OIC?
- Protect individuals for financial hardship.
- Greatest return on investment. The IRS will consent if it believes it’s the greatest amount it can get before the 10 year statute of limitations runs out, which effectively stops the IRS’ ability to collect money from a taxpayer.
For example: Ray had a few bad tax years where he forgot to file his tax return. Due to an illness, Ray has lost a significant portion of his income as he can no longer work full time. To make ends meet, he has had to sell some personal assets and has emptied his 401K to pay bills.
Last week he received a letter from the IRS notifying him of his $65,000 tax debt liability. Because of Ray’s financial hardship and his inability to even enter into other IRS programs like an installment plan, Ray is the perfect candidate for an OIC and files to settle his debt for an immediate payment of $3,000. After reviewing his finances, the IRS accepts his offer as forcing him to pay would cause financial hardship and it is the most money they believe they can collect from Ray before the statute of limitations runs out.
How does it work?
When considering these applications, the IRS will look at a person’s ability to pay, income, expenses and assets. Weighing these factors allows the IRS to determine an individual’s reasonable collection potential (RCP) and whether that person can pay more than what they are offering to pay. In most cases, the IRS won’t accept an OIC unless the amount offered by a taxpayer is equal to or greater than the RCP.
You can calculate your RCP by using this formula:
Step 1: (monthly income – monthly expenses) x 12 (or 24) = Y
Step 2: (assets – loans) x .8 = Z
Step 3: Y + Z = OIC amount
Notes: In step 1, use 12 if you want to pay off your debt in 5 months, or use 24 if you need more time. Using 24 will drive up your total OIC offer because the IRS rewards those who can pay their debt back faster.
For Example: Carrie makes $2,300 a month and has $1,800 in monthly expenses (rent/mortgage, other bills), which leaves her with $500. Carrie thinks she can pay off her debt in five months so she calculate $500 x 12 = $6,000.
To calculate her assets, Carrie subtracts her car loan of $10,000 from her car’s current market worth of $13,000 = $3,000. Carrie has no other assets but her savings account ($2,000) and her 401K ($1,000). Her assets total $5,000 x .8 = $4,000, which she adds to her leftover monthly income (x12) of $6,000 + $4,000 = $10,000.
*** This example only takes into account $1,000 in Carrie’s saving account. That is because the first $1,000 in a bank account is exempt.
Interesting fact: The average OIC the IRS accepted in 2015 was $7,585.
Be warned: using this formula doesn’t guarantee that the IRS will accept your OIC. There are many factors that can influence your OIC calculation that this formula cannot take into account, such as how close you are to the statute of limitations, i.e., how much longer the IRS can try to collect on your debt.
Important: The IRS is limited by the statute of limitations (also referred to as CSEDs), which says that the IRS only has 10 years to collect to your tax debt. If the 10 years are up, then the IRS cannot legally collect money from you. Read more about why calculating your CSED is extremely important to resolving your tax debt here.
What this means is that older debt will have greater bargaining power with the IRS, as they see your OIC as a last chance to collect some money from you before the statute of limitations runs out.
Submitting an OIC Application
To be considered, form 433- A (for individuals) or 433-b (for businesses) must be submitted, along with a $186 application fee and an initial payment. However, there are instances where the application fee can be waived and the initial payment varies, depending on which payment option is selected. Read on to discover the differences.
When submitting an OIC based on doubt as to collectibility or effective tax administration, taxpayers must use the most current version of Form 656, Offer in Compromise, and also submit Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals, and/or Form 433-B (OIC), Collection Information Statement for Businesses.
A taxpayer submitting an OIC based on doubt as to liability must file a Form 656-L (PDF), Offer in Compromise (Doubt as to Liability), instead of Form 656 and Form 433-A (OIC) and/or Form 433-B (OIC). Form 656 and referenced collection information statements are available in the Offer in Compromise Booklet, Form 656-B (PDF).
In general, a taxpayer must submit a $186 application fee with the Form 656. Don’t combine this fee with any other tax payments. However, there are two exceptions to this requirement:
- First, no application fee is required if the OIC is based on doubt as to liability.
- Second, the fee isn’t required if the taxpayer is an individual (not a corporation, partnership or other entity) who qualifies for the low-income exception. This exception applies if the taxpayer’s total monthly income falls at or below 250 percent of the poverty guidelines published by the Department of Health and Human Services. Section 1 of Form 656 contains the Low Income Certification guidelines to assist taxpayers in determining whether they qualify for the low-income exception. A taxpayer who claims the low-income exception must complete section 1 of Form 656 and check the certification box.
When an individual submits an OIC, they can choose to pay the settled amount through two payment options. According to the IRS website these two payment options are:
Lump Sum Cash Offer – “Taxpayers may choose to pay the offer amount in a lump sum or in installment payments. A “lump sum cash offer” is defined as an offer payable in five or fewer installments within five or fewer months after the offer is accepted. If a taxpayer submits a lump sum cash offer, the taxpayer must include with the Form 656 a nonrefundable payment equal to 20 percent of the offer amount. This payment is required in addition to the $186 application fee. The 20 percent payment is nonrefundable, meaning it won’t be returned to the taxpayer even if the offer is rejected or returned to the taxpayer without acceptance. Instead, the 20 percent payment will be applied to the taxpayer’s tax liability. The taxpayer has a right to specify the particular tax liability to which the IRS will apply the 20 percent payment.”
Periodic Payment Offer – “An offer is called a ‘periodic payment offer’ under the tax law if it’s payable in six or more monthly installments and within 24 months after the offer is accepted. When submitting a periodic payment offer, the taxpayer must include the first proposed installment payment along with the Form 656. This payment is required in addition to the $186 application fee. This amount is nonrefundable, just like the 20 percent payment required for a lump sum cash offer. Also, while the IRS is evaluating a periodic payment offer, the taxpayer must continue to make the installment payments provided for under the terms of the offer. These amounts are also nonrefundable. These amounts are applied to the tax liabilities and the taxpayer has a right to specify the particular tax liabilities to which the periodic payments will be applied.”
The entire OIC process, from filing the application to an IRS decision, can take up to a year. It’s important to note that interest continues to compound daily while OIC is being contemplated. So it’s important to get it right the first time, otherwise you can end up with more debt than when you started. Additionally, submitting an OIC will suspend your debt’s CSED (the timeframe of collectability).
Taxpayer troubles with getting OIC’s approved
There are many reasons why a person’s OIC offer gets denied by the IRS. Here are some of the most common reasons:
- OIC applications received on or after March 27, 2017, are returned without consideration if taxpayers haven’t filed all required tax returns.
- A taxpayer who can fully pay the liabilities through an installment agreement or other means won’t qualify for an OIC in most cases.
- A person’s RCP is too high, i.e. he/she makes too much money or has too many assets.
- Someone in the middle of bankruptcy proceedings.
- Someone with money in their 401K.
If the IRS rejects an OIC, the taxpayer will be notified by mail. The letter will explain the reason why the IRS rejected the offer and will provide detailed instructions on how the taxpayer may appeal the decision to the IRS Office of Appeals. The appeal must be made within 30 days from the date of the letter.
Hiring a Colorado Tax Attorney
As you have learned here, getting an OIC approved can be difficult, even for a tax professional, as it all depends on a given individual’s financial situation. However, a tax attorney can think of things that may tip the scales in your favor, such as your case’s statute of limitations (which the IRS is notoriously bad at calculating, read more here) and other financial factors.
When possible, our tax attorneys have helped many clients get favorable OICs approved. Below is a graph some of those cases:
Someone who is contemplating an OIC should seriously consider retaining the help of a tax attorney. Unlike CPAs and enrolled agents from debt resolution firms, a tax attorney isn’t just trained in compliance. In addition to knowing the rules, a tax attorney is trained in the art of negotiation and persuasive tactics, which is exactly what an OIC is – a negotiated settlement. Read more about the differences between tax attorneys and debt resolution firms here.
Our tax attorneys have calculated hundreds of RCPs and CSEDs for clients. They also are trained to look at an individual’s whole financial situation, using every legal tool to get their clients the best tax settlement possible. Schedule your free consultation with our Colorado Springs tax attorneys (also located in Denver and Castle Rock); call 303-688-0944 today.