Can't Pay Your Entire Tax Debt? Make an Offer in Compromise
An offer in compromise is a little-used tax relief provision that may give you the opportunity to write
off most of your tax debt to the IRS. This option may help to absolve a large amount of the outstanding
debt, leaving you with just a small percentage to repay. Qualifying for an offer in compromise can be very
difficult, though, since the IRS has strict guidelines for eligibility and may not approve your request.
What is an Offer in Compromise?
Put simply, an offer in compromise is just what it sounds like - an offer to pay a certain amount of the
tax debt if the IRS will agree to compromise the remainder of the amount due. Taxpayers who qualify for
this provision typically get by with just paying 25 to 30 percent of their total tax bill and the IRS
writes off the rest. This arrangement is only available for those with legitimate financial hardships that
may prevent them from repaying their debt.
Requirements to Apply
In order to apply for an offer in compromise, you'll have to meet one of three criteria. You must either
1) be doubtful about the accuracy of your total debt, 2) be able to prove that it is extremely unlikely
that you'll ever be able to repay the debt, or 3) make a valid argument that enforcing the repayment of
the debt would create a financial hardship on its own. Usually disabled individuals or elderly taxpayers
qualify for condition 3 since they may be living on a fixed income.
How to File an Offer in Compromise
If you want to file an offer in compromise, you'll have to complete IRS Form 656, which formally requests
the arrangement. On this form, you'll need to offer a percentage of the tax as a condition of the
agreement. Generally, you'll have to include at least 20 percent of your total debt along with this form.
Along with Form 656, you may need to file Form 656-A to provide detailed information about your income
level if you are unable to send in the 20 percent minimum. If you're self-employed or if you own a
business you'll also need to complete Forms 433-A and 433-B.
From the IRS Website
In most cases, the IRS won't accept an OIC unless the amount offered by a taxpayer is equal to or greater than the reasonable collection potential (RCP). The RCP is how the IRS measures the taxpayer's ability to pay. The RCP includes the value that can be realized from the taxpayer's assets, such as real property, automobiles, bank accounts, and other property. In addition to property, the RCP also includes anticipated future income less certain amounts allowed for basic living expenses.
Reasons for the Offer
The IRS may accept an OIC based on one of the following reasons:
- First, the IRS can accept a compromise if there is doubt as to liability. A compromise meets this criteria only when there's a genuine dispute as to the existence or amount of the correct tax debt under the law.
- Second, the IRS can accept a compromise if there is doubt that the amount owed is fully collectible. Doubt as to collectibility exists in any case where the taxpayer's assets and income are less than the full amount of the tax liability.
- Third, the IRS can accept a compromise based on effective tax administration. An offer may be accepted based on effective tax administration when there is no doubt that the tax is legally owed and that the full amount owed can be collected, but requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances.
Forms to Use
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, Offer in Compromise (Doubt as to Liability) (PDF), 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 an application fee for the amount stated on 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.
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 5 or fewer installments within 5 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 application fee. The 20 percent payment is generally 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 6 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 application fee. This amount is generally 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.
Upon acceptance of an OIC, the taxpayer may no longer designate offer payments to any tax liability specifically covered in the offer agreement.
Suspension of Collection
Ordinarily, the statutory time within which the IRS may engage in collection activities is suspended during the period that the OIC is pending, for 30 days immediately following the IRS’s rejection of an OIC, and for the period in which a timely appealed rejection is being considered by the IRS Office of Appeals.
If the IRS accepts the taxpayer's offer, the IRS expects that the taxpayer will have no further delinquencies and will fully comply with the tax laws. If the taxpayer doesn't abide by all the terms and conditions of the OIC, the IRS may determine that the OIC is in default. For doubt as to collectibility and effective tax administration OICs, the terms and conditions include a requirement that the taxpayer timely file all tax returns and timely pay all taxes for 5 years from the date of acceptance of the OIC. When an OIC is declared to be in default, the agreement is no longer in effect and the IRS may then collect the amounts originally owed (less payments made), plus interest and penalties. Additionally, any refunds due within the calendar year in which the offer is accepted will be applied to the tax debt.
Right to Appeal
If the IRS
rejects an OIC, the taxpayer will be notified by mail. The letter will explain the reason that 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.
Return of an Offer
In some cases, an OIC is returned to the taxpayer rather than rejected, because the taxpayer didn't submit necessary information, filed for bankruptcy, failed to include a required application fee or nonrefundable payment with the offer, hasn't filed required tax returns, or hasn't paid current tax liabilities at the time the IRS is considering the offer. A returned offer is different from a rejection because there's no right to appeal when the IRS returns the offer. However, once current, the offer may be submitted again.