Using an Offer in Compromise to Settle a Tax Debt

An Offer in Compromise or OIC is a debt settlement with the Internal Revenue Service (IRS). It’s an opportunity to resolve tax debts by paying back less than you owe. An OIC is available to both individuals and businesses. But, the IRS will not agree to strike a deal with just anyone. It’s not a bartering tool to low-ball the agency. 

For the IRS to offer tax relief, the taxpayer must pass a rigorous screening process and submit a lot of proof. Applicants must be in serious tax debt and the IRS must agree it has no way of collecting it. In deciding whether to accept the offer, the IRS will consider whether paying back taxes would cause the taxpayer (i.e. you)  “exceptional economic hardship” and other factors. 

This article will explore what it takes to qualify for an OIC and what to expect from the process. If you owe for more than one tax year and have no way of paying the amount off in the foreseeable future, an OIC may be a good option.

When Is an OIC the Best Choice for Me?

Eligibility for OIC is deceptively simple. It states that if you can’t meet your full tax liability or doing so will cause serious financial hardship, you can file an OIC. The IRS considers each case differently but will only accept three reasons for filing:

• Doubt as to Tax liability (how your taxes were assessed)

• Doubt as to Collectibility (IRS’s hope of getting that money)

• Doubt as to Effective tax administration (special circumstances)

Showing an error in how your tax liability was assessed can be hard to prove without a knowledgeable accountant and/or tax lawyer. Proving special circumstances is also difficult because you have to prove that exceptional circumstances have caused such an economic hardship that paying what you owe would be unfair. Basically, your financial situation must be so dire that IRS collection would undermine the public’s faith in the agency. 

The second reason is the most important: 

Do you have too much tax debt to reasonably catch up? 

To qualify, you need to show the IRS that you have no possible way of paying your tax debt, even over time. If the IRS sees that you have no reasonable collection potential, you have a chance. Even if you can’t afford anything right now, you still may not qualify for OIC. 

For those who do not qualify, there is an alternative. It’s called Currently Not Collectible (CNC) status. In this process, the IRS will first create an installment agreement based on what you can afford to pay. To qualify, the IRS then calculates your monthly payments under this installment agreement and how much you would still owe after an OIC. If you’re eligible, CNC will halt tax payments for 6 to 12 months. After that, the IRS will reevaluate your case.

Am I Eligible For An OIC?

Even before entering the eligibility phase, the IRS filters out people it won’t consider for an OIC. So even if you have crippling tax debt, no ability to pay, and face extreme financial hardship, you will not qualify for OIC if any of the following describe you: 

• You haven’t filed all your tax returns for previous years

• You have an open bankruptcy proceeding

• You’re being audited by the IRS

• You weren’t yet billed for any of the tax debts covered by the offer

• You haven’t made the required estimated payments for the current year

• You’re currently subject to an innocent spouse claim

An innocent spouse claim is made when a couple filed a joint return but all of the tax liability is due to the actions of only one spouse. These may include claimed deductions and tax credits and underreported income. If the IRS has approved an OIC, you cannot file an innocent spouse claim for that year. 

If none of these apply, you can use the IRS offer in compromise pre-qualifier tool to see if you’re eligible for the OIC program.

Do I Need Help Filing an OIC?

If you qualify, filling out the forms to apply for an OIC can be pretty confusing. We break down the requirements below. It will take some knowledge of tax forms and tons of proof. If, like most people, income taxes are over your head, it may be worth investing in a tax professional. They deal with this stuff every day. Just make sure to check the person’s qualifications. Only hire a tax attorney, certified public accountant (CPA), or an enrolled agent. An enrolled agent bears the IRS’s stamp of approval to represent taxpayers. So an enrolled agent who used to be an IRS agent is a great choice.

The drawback of hiring a law or accounting firm is the expense. The good ones can be costly and some are scams. But if carefully screened, qualified people with expertise in the area can improve the odds that your offer will be correctly filed and accepted.

What To Expect During the OIC Process

To get started, you will need the Offer in Compromise Booklet, Form 656-B. This tells you what forms you need in your offer package. For example, Form 433-A, explained below, is for individuals and form 433-b is for businesses. Another Form 656 is for LLCs. With the offer, you must pay a portion of your tax debt up front. You have two choices for the initial payment:

• Lump sum cash (20 percent of the total payment)

• Periodic payment (first monthly installment amount)

One of these must be included with the offer. You can’t just submit the offer alone. The first option allows you to pay the remaining balance in five months. The second gives you up to two years. We discuss which payment plan is best later in the article.

There is also a $205 application fee. You may be exempt from the filing fee and initial tax payment if your monthly household income falls below the amount listed in the table on Form 656. The table is based on family size and is determined by the Federal Income Poverty Guidelines. If you claim the exemption, you must sign the “low income certification” sheet on the second page of the form.

Other than existing tax liens, you can expect tax collection activity to stop while the OIC is pending. Once the IRS receives your application, it will notify you of receipt. The IRS has up to two years to decide if it will accept your offer. If it does not decide within two years of the receipt date, your offer is automatically accepted.

The chances of the IRS accepting your offer are roughly 40 percent. If the IRS rejects your offer, it will explain why in a letter. 

What Kind of Offer Will the IRS Accept?

The IRS will only accept an offer that meets the offer calculation method shown in Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals. It must include the net worth of your all assets and whatever you have leftover each month after subtracting living expenses. Multiply this amount by 12 if you chose the lump sum, five-month payment plan or 24 if you chose the two-year payment plan.

Your net equity in assets includes everything you own, from furniture and jewelry to investment accounts and cryptocurrency. You must include your bank accounts, any real estate, and other financial assets. Then list your monthly expenses like rent, mortgage, and transportation. You must disclose all this information in the form and provide all supporting documentation to prove it. This includes pay stubs, sales receipts, vehicle registration, and attachments for anything you own beyond the lines provided in the form. 

The OIC Calculation Method

Form 433-A provides a table to list all your sources of income to get your net income. Your net equity in assets is the fair market value of the asset minus the IRS allowable deduction. All your actual monthly living expenses must be listed in the table. The IRS has a separate column for which expenses it allows. The difference between the two is used to determine whether you have excess monthly income to put toward the offer. 

After calculating the offer amount, you have to tell the IRS where you're going to get the money to pay for it. This is done on Form 656. Under the section for source of funds, you can explain you will be selling some things or getting loans from your family. The IRS may consider this answer in determining if you have access to more money or future income than your 433-A shows

Then choose a payment plan. Your two payment options are:

• Lump sum cash (20 percent down payment) or

• Periodic payments (first monthly installment)

Choose the first option if you can afford to pay your tax bill all at once or within five months. Choose the second if you can’t. If you’re going to have to sell things or borrow money to pay the offer, the second option gives you more time. 

What Do I Do After an Offer Has Been Accepted or Denied?

If the IRS accepts the offer, you must pay the offer amount according to the terms of the agreement. This means complying with the tax laws for the next five years by filing all required tax returns and paying on time.The IRS will keep your tax refunds through the year when the IRS accepts your offer. The amount will be applied to your tax debt.

If your offer is denied, you have 30 days to appeal. Use the IRS’s request for appeal form to file. 

Remember there are also alternatives to the compromise program such as CNC status, discussed above, or applying for an IRS-determined installment plan. The IRS will look at all your income, assets, and expenses and decide on a monthly payment that you can afford until you meet the total amount. Use Form 9465 to request the installment agreement.

Let’s Summarize…

An Offer in Compromise is a good choice when there's a large debt covering more than one tax year. The IRS will only consider an offer if you meet all the eligibility criteria and the IRS finds that making you pay your entire tax burden would cause extreme financial hardship. 

The only offer the IRS will accept is one that meets the calculation in Form 433-A. That is, your net equity in assets minus any IRS allowable deduction plus any surplus monthly income after subtracting living expenses. The OIC process is arduous and requires significant documentation. 

If the IRS cannot decide on your offer within two years, it will automatically be accepted. If the IRS accepts your offer, you must comply with the tax law for at least five years, filing all the necessary returns and paying on time. If the IRS rejects your offer, you have 30 days to appeal.