If you owe back taxes to the IRS, the offer in compromise (OIC) program could help you settle your tax debt by paying less than what you owe. You’ll have to fill out Form 656 to make an offer in compromise to the IRS, which will include the details of your repayment offer. This article will expand on eligibility requirements for OICs, benefits for low-income filers, how to fill out a Form 656, and what you need to send to the IRS along with the form.
If you owe back taxes to the IRS, the offer in compromise (OIC) program could help you settle your tax debt by paying less than what you owe. An OIC is a good option for some taxpayers dealing with IRS debt. These offers are approved about 40% of the time. You’ll have to fill out Form 656 to make an offer in compromise to the IRS, which will include the details of your repayment offer. The catch is you'll have to prove that you don't have enough income or assets available to pay off your IRS debt in full.
This article will expand on eligibility requirements for OICs, benefits for low-income filers, how to fill out a Form 656, and what you need to send to the IRS along with the form.
Are You Eligible To File An Offer In Compromise?
If you’re considering filing an offer in compromise, you’ll first need to find out if you're eligible for one. The IRS does not want to sift through OIC offers from people who are ineligible. If you can answer "yes" to the following questions, you’re eligible to file an OIC:
Have you filed all the federal tax returns that you're legally required to file?
Not everyone is required to file an income tax return every year. For example, if your total annual income doesn't go over certain IRS income limits, then you don't have to file an income tax return for that tax year.
Have you received an IRS bill for at least one tax debt that can be included on your offer in compromise?
You must owe the IRS unpaid taxes before you can make an offer in compromise. If you don't pay the IRS the full amount of your taxes when they are due, you'll receive a bill for the amount you owe. This bill starts the collection process, which continues until your tax debt is paid off or until too many years have passed and the IRS is no longer able to collect on your tax debt.
Have you submitted all of your required estimated taxes for the current tax year?
While most people's employers automatically deduct income tax from their paycheck, in some circumstances, people will need to make estimated tax payments. This is especially true for self-employed individuals, alimony recipients, or wage earners who don't have enough taxes withheld from their salary.
If not enough income tax is taken out from a person's salary or retirement income, or if they receive interest, dividends, alimony, self-employment income, capital gains, prizes, or award income, they may need to make estimated tax payments. Also, business owners will generally need to make estimated tax payments.
If you're a business owner with employees, have you made all of your required tax deposits for the current quarter?
If you have employees, you must report the income you pay to them. You're also required to withhold and deposit federal, social security, and Medicare taxes for each employee. If you don't you'll have to pay a trust fund recovery penalty.
When Can’t You File An Offer In Compromise?
Some people are not eligible to file an offer in compromise. If any of these financial situations apply to you, you won't be able to file an OIC:
You are in active bankruptcy proceedings.
You are being audited by the Internal Revenue Service.
You are subject to an innocent spouse claim.
You can afford to pay your tax liability in full.
You can use the IRS's pre-qualifier tool to find out if you qualify to make an OIC. After entering your financial information, including your household income and federal tax filing status, the tool will calculate a basic offer amount. You can use this as a starting point to make an offer to pay off your tax debt.
Fortunately, the IRS offers special benefits to low-income taxpayers who file for an offer in compromise. The OIC's Low Income Certification is available to individuals and sole proprietors only. Low-income OIC applicants may be exempt from fees, down payments, and installment agreement payments while the IRS considers their OIC application.
You may qualify to make a low-income certification if your adjusted gross income (AGI) on your most recent income tax return (IRS Forms 1040 or 1040-SR) is less than the maximum yearly incomes listed on the chart at the top of page 2 of IRS Form 656. The maximum incomes listed on the chart are based on your household size and where you live.
To figure out your income and see if you qualify for a low-income certification, take your income from the IRS Form 1040 you most recently filed and multiply it by 12 times the gross monthly income you've listed on IRS Form 433-A. (We'll talk more about the IRS Form 433-A and its sister form, 433-B, later on.)
If you don't qualify for the low-income certification based on your adjusted gross income, you can ask for a waiver based on your current household's gross monthly income from Form 433. If you qualify, you're not required to submit any application fees.
This financial break can be very helpful if your income has dropped since you filed your most recent IRS Form 1040. And because of the COVID-19 pandemic, many people have lost their jobs or had their work hours reduced. But, remember that you must have filed all of your legally required returns or the IRS will reject your offer in compromise.
It's also a good idea to submit a low-income certification to the IRS if you haven't been legally required to file a tax return for several years. If you only receive Social Security benefits, are claimed as a dependent on someone else’s tax return, or meet other IRS requirements, you may not need to file an income tax return.
Types Of Offers
There are 3 types of offers in compromise available to qualified taxpayers. They are:
Doubt as to Collectibility
Doubt as to Liability
Effective Tax Administration (ETA)
Doubt As To Collectibility Offers
Doubt as to collectibility OICs are the most common, so we'll focus on them first. These are also called a personal offer. In addition to being the most popular type of OIC, they are also the easiest to get accepted. Even if you think you have a chance at making a successful effective tax administration or doubt as to liability offer, you still should do a doubt as to collectibility offer.
Doubt As To Liability Offers
If you believe the tax amount you owe to the IRS is wrong, you would do this type of offer in compromise by submitting a completed form. If you think that there was a mistake with your audit or after your audit you have new information to support the deductions claimed on your tax returns, you can consider submitting a doubt as to liability offer.
Effective Tax Administration (AKA Exceptional Circumstances)
Effective tax administration, also known as exceptional circumstances, is usually a taxpayers' last resort. You might consider submitting this offer if you don't think you'll qualify for a doubt as to collectibility OIC.
Also, make sure you have enough to pay your tax liability in full, but you'll have to convince the IRS that because of your circumstances, it would cause you extreme economic hardship or be unfair for you to have to pay the full amount you owe to the IRS. It's hard to get accepted but it may be worth a shot if you can't qualify for the other 2 offer types.
What Do You Have To Send In With Your Form 656?
Along with your Form 656, you’ll need to submit supporting forms, a filing fee, a down payment (unless you're a qualified low-income filer), and other documentation, such as IRS Forms 656, 433-A, and 433-B.
IRS Form 433-A
Let's start with IRS Form 433-A. You can use this form if you earn wages, are self-employed, or are an independent contractor. IRS Form 433-A is a 6-page form that is used to collect personal and financial information. This helps the IRS determine what you can afford as a monthly payment to settle your tax debt.Be sure to carefully read and follow the instructions on the form and to list your social security number correctly. While the IRS won't leave you without enough money to live according to its list of allowable monthly expenses, it will go over the specific amount you need to meet your monthly living expenses.
IRS Form 433-B
If a company is treated as a corporation by the IRS, or if there are major shareholders and the company owes taxes to the IRS, then Form 433-B is required. But if you're filing an offer in compromise as a partnership member, you'll have to file a Form 433-A.
Just like Form 433-A, IRS Form 433-B is 6 pages long and requires you to give details about your businesses' finances to the IRS.
To submit an OIC to the IRS, most taxpayers are required to pay a $205 application fee. But if you make a doubt as to liability offer or submit a low-income certification stating your income is below the IRS guidelines, you don't have to pay the application fee. If you are required to pay, you can submit the fee by check or money order written out to the United States Treasury.
When you submit your Form 656 you must include an initial payment (down payment) along with your application fee. Applicants who qualify as low-income do not have to make this initial payment. If your offer amount isn’t accepted, the IRS will not return your initial payment. Instead, it will be applied to your tax debt.
Documentation Required To Accompany Form 656
You must submit detailed financial information to the IRS with your OIC using Form 433-A (for individuals) or Form 433-B (for businesses). This is a time-consuming process. You’ll need to gather your pay stubs, bank records, information about child support or alimony payments, vehicle registrations, and other documents to back up your offer amount. Once you have all of your paperwork, you'll be in good shape to make your minimum offer to the IRS.
Form 656 — Line By Line
Let's go over each section of Form 656 so you'll know what to do and have the best chance of getting your offer accepted.
Section 1: If you're an individual or sole proprietor you'll provide basic information about yourself like your name, social security number, and mailing address. You'll also write in the types of taxes and tax periods covered by your OIC. If you’re filing an OIC for a business, you’ll provide information like the business name and address. Low-income filers will make their low-income certification in this section.
Section 2: This section is for offers in compromise for corporations, LLCs, and partnerships. It requires a separate $205 application fee and an initial payment.
Section 3: Here you'll check the box and tell the IRS the reason you're making an offer. This is where you'll state if your offer is based on collectibility, liability, or effective tax administration. You also must explain why you chose the offer type.
Section 4: This is the payment terms section. Use the amount you put on your IRS Form 433 to make your minimum offer. Don't make a zero offer—it'll be rejected.
You can offer the IRS a lump sum to pay your tax debt in one payment or offer them periodic payments over time. In this section, you'll lay out the total offer amount, a 20% initial payment, the remaining balance after the initial payment, and the amount of each remaining lump-sum cash payment. If you offer periodic payments in your OIC, check the box if you will pay your offer in full in 6 to 24 months and then list the actual periodic payment amounts you want to make.
Section 5: This is the Designation of Payment section. If you want the IRS to apply your first payment to a particular type of tax debt you may owe, such as Trust Fund Recovery Penalty, you should complete this section. You can also tell the IRS if you want to pay your tax liability through the Electronic Federal Tax Payment System (EFTPS). Be sure to include the offer application fee.
Section 6: In this section, you'll tell the IRS your source of funds, or where you’re getting the money, for the offer you make. Fill out this section carefully because it can be tricky. The IRS wants to find out if you have money stashed away somewhere, like in a trust fund, that they don't know about. You'll also certify that you've filed all your required tax returns and made all your estimated tax payments and federal tax deposits.
Section 7: This section lays out the IRS’s terms and conditions. Read it carefully and make sure you understand it. If you don't understand it, ask a tax professional. Once you've read it, you'll be required to tell the IRS that by submitting the offer in compromise, you accept these terms.
Section 8: Finally be sure to sign your OIC. If you forget to sign your OIC, it will be returned to you without the IRS even considering your application.
How Do You Pay Your Offer Amount?
You have a few payment options. You can make your offer amount or initial payment by mail using a check, money order, or cashier's check made payable to the United States Treasury. You also must include a separate check or money order made payable to the United States Treasury for the application fee. Alternatively, you can pay online for free through the Electronic Federal Tax Payment System (EFTPS).
Like we talked about before, if you completed a low-income certification, you aren't required to pay application fees or to send in the first payment with your OIC.
Your Responsibilities After You File Your Offer In Compromise
After you've turned in your offer in compromise you have important, required responsibilities. First, you must comply with all tax laws. This applies to everyone.
If you've made a lump-sum offer, any other payments you make after your 20% down payment can be made over 5 months after the IRS accepts your OIC.
If you requested periodic payments over 6-24 months and you are not a low-income filer, you’ll have to make payments while your offer is pending. The first payment is sent with IRS Form 656.
Low-income filers may wait until their offer is accepted to begin making periodic payments to the Internal Revenue Service.
If Your OIC Is Accepted
If the IRS shares the good news that your offer in compromise has been accepted, your hard work is not over because you'll have more responsibilities:
You must file all tax returns on time for 5 years beginning from the date the IRS accepts your offer.
You must pay all taxes you’ve incurred on time over the 5 years starting with the date the IRS accepts your offer.
You have to make all required OIC payments on time.
It's very important to make all of your installment payments on time. If you miss just one payment, the IRS could put you in default and cancel your payment arrangement. If you default, you'll be back on the hook for the full tax amount you owed along with any interest and penalties.
In this article, you've learned that an offer in compromise is an offer to pay the IRS less than the full amount you owe in back taxes. You've also discovered that you can offer to pay the IRS less than what you owe to them in a lump sum or with periodic payments.
There are some requirements for eligibility. If you meet them, you can submit an OIC application. If your offer is accepted, you may be able to wipe out your tax debt, save money, and get a fresh start.