OFFER IN COMPROMISE
I. What is an Offer In Compromise?
At times, certain taxpayers incur tax liability that they are unable to pay to the government as a result of hardship or other reasons. These taxpayers may benefit by submitting an Offer In Compromise (“OIC”) to the IRS in an effort to reduce their overall tax liability. In essence, an OIC is an agreement between a taxpayer and the IRS to settle for and accept less than the full tax amount owed.
Despite a taxpayer’s potential ability to reduce his or her tax liability through an OIC, promises or implications by attorneys or others indicating that they are able to settle a taxpayer’s liability to the IRS for “pennies on the dollar” or substantially less than what is owed are potentially both misleading and inaccurate. The IRS’s process for receiving, reviewing and accepting an OIC does not generally allow for such skewed results.
II. Should You Consider Filing an Offer In Compromise?
A taxpayer may consider filing an OIC if: (1) the taxpayer has more tax liability than he or she is able to pay; (2) the taxpayer has a legitimate reason to dispute his or her tax liability; or (3) other extenuating circumstances exist such that the taxpayer may be able to forgo the tax liability. (See Section III below.) To file an OIC, the taxpayer must submit IRS Form 656, a $150 application fee, and a payment towards satisfying the OIC. Form 656 can be downloaded from the IRS website.
Through the OIC, the taxpayer submits to the IRS the tax amount that he or she is willing and able to pay. The taxpayer must be aware, however, that the IRS will accept an OIC only if the amount offered by the taxpayer is equal to or greater than what is known as the Reasonable Collection Potential (“RCP”). The RCP is how the IRS measures the taxpayer’s ability to pay. To calculate an RCP, the IRS will take into account the realizable value of the taxpayer’s assets including, but not limited to, real property, automobiles, bank accounts, and other potential sources of income. The RCP generally includes estimated anticipated future income less certain amounts needed for basic living expenses. Thus, it is neither prudent nor appropriate to file an OIC that proposes an amount that is unreasonably small. In addition, absent special circumstances, the IRS will accept an OIC only if it believes that the amount offered can be paid as a lump-sum or through a reasonable payment agreement.
III. When are OIC’s Considered Acceptable?
The IRS may accept an OIC based on one of the following three circumstances:
1. Doubt as to Whether the Liability Can Be Collected – The IRS may accept the OIC if it doubts that it will be able to collect the full amount of tax liability owed because of the taxpayer’s inability to pay within the IRS’s statutorily proscribed collection time.
Example: A taxpayer agrees that she owes $15,000 in unpaid tax liability. Her monthly income is less than her necessary living expenses and she does not own any real property. This taxpayer is unable to fully pay her tax liability now or through monthly installment payments.
2. Doubt as to Liability – The taxpayer may have a legitimate doubt about whether the assessed tax liability is correct. The taxpayer may believe that: (1) there is a different but acceptable interpretation of the applicable tax laws; (2) the evidence the taxpayer submitted which would reduce the taxpayer’s liability was not taken into consideration; or (3) the taxpayer has acquired new evidence, which had not been previously considered and would reduce the taxpayer’s liability.
Example: The taxpayer previously ran a corporation and has been assessed a tax penalty, which accrued the year after the taxpayer left the company. Since the taxpayer no longer worked for or ran the company at the time the tax penalty was assessed, there is legitimate doubt that the tax liability is correct.
3. Effective Tax Administration - In this scenario, the taxpayer and the IRS are in agreement as to the tax liability owed and the IRS is in a position to collect the full tax amount. The taxpayer is experiencing an exceptional circumstance, however, that allows the IRS to consider an OIC. The taxpayer must demonstrate that payment of the tax would create an economic hardship or be unfair and inequitable.
Example: Taxpayers A and B have accrued a substantial tax liability, but have sufficient assets with which they could use to satisfy this liability. They also have a dependent child who has a serious long-term illness. Taxpayers A and B provide full time medical care and assistance to this child and they will need to use their assets for their own living expenses as well as medical care for the child.
IV. OIC Payment Options
In order to process an OIC, a taxpayer must submit to the IRS a completed Form 656, a $150 application fee, and an initial payment toward the OIC amount. There are three payments options by which a taxpayer can pay the OIC:
1. Lump-Sum Cash Offer - This offer must be paid in five or fewer installments upon written notice of the acceptance. The taxpayer must send a non-refundable payment of 20 percent of the lump-sum cash offer at the time he or she files Form 656.
If the taxpayer intends to pay the OIC in five or less installments in five months or less, the OIC amount must include the realizable value of assets (see Section 1) plus the amount that could be collected over 48 months of payments, or IRS’s time remaining by statute to collect the tax, whichever is shorter.
If the taxpayer intends to pay the OIC in five or less installments in more than five months and within 24 months, the OIC amount must include the realizable value of assets (see Section 1) plus the amount that could be collected over 60 months of payments, or the IRS’s time remaining by statute to collect the tax, whichever is shorter.
If the taxpayer intends to pay the OIC in five or less installments in more than 24 months, the OIC amount must include the realizable value of assets (see Section 1) plus the amount that could be collected over the time remaining by statute to collect the tax.
2. Short Term Periodic Payment Offer – The OIC is paid in non-refundable installments and the offer amount must be paid within 24 months of the date the IRS received the OIC. The first payment and the $150 application fee are due upon filing the Form 656. Regular payments must be made during the offer investigation.
The OIC amount must include the realizable value of assets (see Section 1) plus the total amount the IRS could collect over 60 months of payments or the IRS’s time remaining by statute to collect the tax, whichever is shorter.
3. Deferred Periodic Payment Offer – The OIC is paid in non-refundable installments and the offer amount must be paid over the IRS’s time remaining by statute to collect the tax. The first payment and the $150 application fee are due upon filing the Form 656. Regular payments must be made during the investigation.
For all of the above payment options, the OIC amount must include the realizable value of assets (see Section 1) plus the total amount the IRS could collect through monthly payments during the IRS’s remaining time by statute to collect the tax.
The IRS is not bound by either the offer amount or the terms proposed by the taxpayer. An OIC investigator will review the taxpayer’s Form 656. The OIC investigator may have follow-up questions regarding the taxpayer’s value of assets or determine that different offer amounts or terms are appropriate. For example, the OIC investigator may determine that the proposed offer amount is too low or the payment terms are long to recommend acceptance. In that event, the OIC investigator may advise the taxpayer regarding a larger amount or different payment terms that would likely result in acceptance.
An offer in compromise payment options comparison table is available for taxpayers to compare the requirements associated with each payment option.
V. Payments and Application Fees
When filing an OIC, two separate remittance documents should be sent, one for the $150 application fee and the other for the required offer payment. All payments should be made by check or money order made payable to the United States Treasury. Practitioners who file multiple OICs at the same time should not combine application fees.
The Form 656-PPV, Offer in Compromise Payment Voucher, included in the Form 656, should be completed and attached to any periodic payment(s) that becomes due. Failure to submit any required periodic payments, after the initial payment has been submitted, will result in the offer being declared withdrawn.
The OIC application fee reduces the assessed tax or other amounts due. The application fee will be returned if the OIC cannot be processed. The $150 application fee must be included with the offer or the IRS will return the offer, unless the OIC has been submitted under doubt as to liability or a completed Form 656-A and Offer in Compromise Application Fee and Payment Worksheet is included with the Form 656.
