How Do I Do an Offer in Compromise?

Although it is possible to handle an Offer In Compromise (OIC) independently, the most effective approach is to engage a tax professional for guidance every step of the way. This is crucial because numerous pitfalls can arise during the process. While stories abound of taxpayers successfully settling their back taxes for a fraction of what they owe, what often goes unreported on the TV or radio are the many individuals who offer substantial amounts towards their tax debt only to face rejection. Are you positioning your Offer In Compromise for maximum success? Consulting with a tax professional significantly increases your chances of a favorable outcome.

Do I have a right to reduce my taxes?

Let’s start by establishing one fundamental principle:  no taxpayer has an inherent right to have their tax reduced. According to Internal Revenue Code Section 7122, however, taxpayers do have a statutory right to submit an Offer in Compromise as a potential solution to their tax debts. Now, despite what you might hear in those flashy radio commercials from certain tax companies, there are no “fire sale” deals happening in Washington. When it comes down to it, dealing with the IRS is all about a careful examination of your finances in relation to your debt to determine what you can realistically afford to pay. When it comes to state tax agencies – they tend to be a lot stricter, but there’s still hope.

 

Acceptance rates for IRS Offers in Compromise have actually reached as high as 40% in recent years. Now, that figure might not be exactly what you expected (possibly higher or maybe even much lower), but it’s the reality we’re dealing with.

What are the grounds for making an Offer?  

There are three general reasons for making an Offer in Compromise:

1. The most common type of Offer in Compromise arises when there’s uncertainty about the IRS’s ability to collect the full tax debt, known as “Doubt as to Collectibility.” This occurs when individuals lack the means to settle the debt entirely due to financial hardship or other constraints. In such cases, proposing a compromised amount through an Offer in Compromise can provide a practical solution for both the taxpayer and the IRS.
2. The second type of Offer in Compromise involves special circumstances where requiring full payment would impose an economic hardship or be considered unfair or inequitable, even if the taxpayer has the income or assets to cover the debt. These cases are exceedingly rare, akin to spotting a flock of pterodactyls.
3. The third type of Offer in Compromise pertains to doubt regarding legal liability or situations where the taxpayer disputes owing the bill altogether. This type of Offer provides a statutory right to contest the legal liability before knowledgeable IRS officials, which is more advantageous than audit reconsideration, where IRS discretion plays a significant role. While pursuing this type of Offer often necessitates professional assistance, the potential benefits can far outweigh the costs.

How do I know if I qualify?

Before you start getting your hopes up, it’s a good idea to head over to IRS.gov and take the pre-qualifier online test for an Offer in Compromise (OIC). This test consists of a series of questions designed to assess your eligibility for the program. While it’s a relatively short questionnaire, the results can provide valuable insights into your chances of success with an OIC.

Now, if you happen to fail the test, don’t panic. It’s not necessarily a deal-breaker, but it does mean you’ll need to proceed with caution. Failing the pre-qualifier test could indicate that your financial situation may not meet the criteria for an OIC at this time. However, it’s essential to note that this doesn’t mean you’re entirely ineligible or that you should give up hope altogether. Instead, it’s a signal to proceed thoughtfully and perhaps seek professional guidance to explore alternative options or improve your financial standing before pursuing an OIC further.

What is the next step if I prequalify?

If you pass the pre-qualifier online test, it’s important to understand that you can’t simply pick up the phone and negotiate a deal with the IRS. Qualifying for an Offer in Compromise requires disclosing extensive personal and financial details. To get an idea of the information you’ll need to provide, you should review the latest version of the IRS Form 656 booklet titled “Offer in Compromise,” which is available on the IRS website. This comprehensive booklet contains all the necessary forms, information, and step-by-step instructions you’ll need to navigate the Offer in Compromise process effectively.

How do I submit an Offer?

When individuals decide to pursue an Offer in Compromise with the IRS, they usually do so by completing Form 433-A(OIC), which is specifically designed as the Collection Information Statement for Wage Earners and Self-Employed Individuals. For small business owners, the appropriate form is Form 433-B, known as the Collection Information for Small Businesses.

It’s worth noting that unless you qualify for a low-income exception, there are certain financial obligations associated with submitting an Offer in Compromise. Specifically, applicants are required to pay an application fee of $205, along with making a partial payment towards the Offer. According to the IRS, these financial requirements ensure that the Offer process is taken seriously and helps cover administrative costs incurred by the IRS during the evaluation process.

What does the IRS look at for an OIC?

Submitting an Offer in Compromise (OIC) warrants meticulous scrutiny from the IRS compared to installment agreements. OIC examiners rigorously evaluate every aspect of the Offer, demanding extensive proof and documentation ranging from pay stubs and bank records to credit card statements and medical bills. These documents provide insight into your financial situation and ability to meet the terms of the Offer.

Before proceeding with an Offer in Compromise, it’s crucial to address two fundamental questions:

1. Offer Amount: Determining the appropriate amount to propose in your Offer is paramount. This figure should align with your financial circumstances while also satisfying the IRS’s criteria for reasonable collection potential.
2. Course of Action: Assessing whether submitting an Offer is truly the most advantageous path forward is essential. Depending on your individual situation, alternative options such as installment agreements or other tax resolution strategies may be more suitable.

 

What is the minimum the government will accept?

Determining the minimum Offer amount involves a concept known as reasonable collection potential (RCP), which represents the lowest sum the IRS will consider acceptable. This figure is calculated based on your monthly disposable income and assets, projected over a period of up to two years. The goal is to ensure that the Offer aligns with your financial capabilities while satisfying the IRS’s criteria.

Offer examiners play a critical role in this process. While some may adopt a cooperative approach, others may act as gatekeepers, potentially complicating the Offer process. Following the instructions outlined in Form 433-A (OIC) provides clarity on how the IRS arrives at the minimum Offer amount.

Essentially, your Offer must equal or exceed the net realizable value of your assets, in addition to your excess monthly expenses after deducting your monthly income. This total is then multiplied by either 12 or 24, depending on whether you opt for a five-month or two-year payment period.

Strategically, offering more than the minimum amount doesn’t necessarily provide an advantage and may even work against you. If the Offer specialist believes you can afford to pay more, they won’t hesitate to inform you. Therefore, it’s essential to carefully consider your Offer amount to ensure it aligns with your financial situation and maximizes your chances of acceptance.

How do I pay my OIC?

When submitting an Offer in Compromise (OIC), you’ll encounter two payment options:

1. Lump Sum Payment Option: This option entails paying 20% of the total Offer amount upfront with the initial submission of the Offer. If the IRS accepts your Offer, you’re then required to settle the remaining balance within a five-month period.
2. Periodic Payment Option: Unless you qualify under the Low Income Certification guidelines, you’ll need to make an initial payment along with your Offer submission. Following acceptance, you’ll then need to pay off the remaining balance over a period ranging from six to 24 months.

Choosing between these options depends on your financial circumstances and ability to make lump sum payments versus periodic installments. It’s essential to evaluate both options carefully and select the one that best aligns with your financial situation and preferences.

How do I calculate the value of my assets for an OIC?

To determine the net realizable value of your assets, you’ll need to list them in the appropriate section of Form 433-A(OIC). Household furniture and personal effects don’t require valuation, but luxury items like jewelry and artwork must be included. Additionally, if you own real estate, whether it’s a home or rental property, it must be disclosed on your Offer in Compromise (OIC) form.

The IRS applies a discount of 20% to the fair market value of assets when calculating their net realizable value. While valuation can be subjective, the IRS often cross-references information using platforms like Zillow for property valuations.

All retirement plans must also be disclosed, but you can discount their value by the amount of income tax and early withdrawal penalties you would incur. 

The second part of the reasonable collection potential (RCP) test involves calculating how much you can pay the IRS on a monthly basis. This is done by deducting your monthly expenses from your monthly income, as outlined in Form 433-A(OIC). Depending on the current federal funds rate, every $100 of disposable income available increases the acceptable Offer amount by approximately $5,000.

Are there reasons I wouldn’t want to do an Offer?

Even if you’re eligible for an Offer in Compromise (OIC), it’s essential to carefully consider whether submitting one is the right choice for you. Here’s why:

The IRS typically has a ten-year window to collect on back taxes. However, when you submit an Offer, it tolls or pauses this collection statute during the period the IRS evaluates your offer, which can take up to two years. If you submit an Offer in year eight or nine of the collection statute, you could inadvertently extend the time frame during which the IRS can pursue collection efforts, ultimately disadvantaging yourself. On the other hand, if you wait until year ten, you might be in the clear without having to pay anything beyond what you already have.

Another factor to consider is the legal landscape in your region. For taxpayers in California or Nevada, where the Ninth Circuit Court is located, there’s a more debtor-friendly environment. In this district, many taxpayers can discharge income and sales tax debts through bankruptcy, provided they meet certain timing rules, typically within three years of filing their tax returns.

Ultimately, there’s a “sweet spot” where an Offer in Compromise becomes a viable option for resolving tax debts – typically when the tax debt is between four to seven years old. However, it’s worth noting that both bankruptcy and the expiration of the collection statute can often be more cost-effective solutions compared to pursuing an Offer. Therefore, it’s crucial to weigh all your options carefully and consult with a tax professional to determine the best course of action based on your individual circumstances.

What else do I need to know about Offers?

When preparing your Offer in Compromise (OIC), it’s crucial to include a detailed narrative that provides context to your financial situation. Remember, anything negative can actually work in your favor. Obtain clear and comprehensive written reports from medical professionals to substantiate any health issues that impact your earning capacity. Your narrative should also cover any bankruptcy information, adverse financial circumstances, or personal challenges such as divorce or family issues.

To ensure the efficient processing of your Offer, avoid leaving any sections blank on the forms. If a section doesn’t apply to you, be sure to indicate “n/a.” Don’t overlook any signatures or dates, especially if you’re submitting the Offer as a married couple – both spouses must sign. One common mistake is failing to enclose the required application fee or initial payment, so double-check these details before submitting your Offer.

Additionally, it’s essential to ensure you’re in current compliance with all tax filings. This includes filing all tax returns for the past six years and staying up to date with quarterly estimated payments for the current year. If you have payroll, ensure that the last two quarters’ payroll taxes are paid in full.

By following these guidelines and providing a thorough narrative alongside your Offer, you can strengthen your case and improve the likelihood of a successful resolution to your tax debt.

What are the advantages and disadvantages of an OIC?

There are both advantages and disadvantages to pursuing an Offer in Compromise:

Advantages:

1. While not as cost-effective as bankruptcy, an accepted Offer can still save you money compared to paying the full tax debt.
2. Your stress levels may decrease while the Offer is being evaluated and processed.
3. All collection actions by the IRS are suspended during the Offer evaluation period, providing relief from aggressive collection tactics.
4. If your Offer is accepted, your credit may improve as the IRS files a Release of Federal Tax Lien.

Disadvantages:

1. Submitting an Offer tolls the ten-year collection statute, potentially extending the time the IRS has to collect your taxes.
2. An accepted Offer can be revoked if you fail to remain in compliance with tax obligations for five years. It’s important to maintain compliance to avoid this risk.
3. There’s no guarantee that your Offer will be accepted. In contrast, Chapter 7 bankruptcy offers a more certain path to discharge tax debts if you meet the qualifications.

Considering these pros and cons can help you make an informed decision about whether pursuing an Offer in Compromise is the right choice for resolving your tax debt.

What happens after you submit your application for an OIC?

There are two processing centers designated for handling Offers in Compromise. The current addresses can be found in the instructions provided with the Form 656 Offer booklet. Once your Offer passes an initial review, it will proceed to the processing stage. An OIC Examiner from one of these centers will then reach out to you, typically requesting additional documentation to support your case. Alternatively, your case may be assigned to a Revenue Officer in an IRS office near your location.

The documentation requested typically includes income tax returns for the past two years, bank statements covering three to six months for all your accounts (both personal and business), evidence of major living expenses like rent or mortgage payments, medical bills, property deeds and mortgages, vehicle titles, and details of any non-wage income such as unemployment benefits or retirement plans.

The evaluation process for an Offer in Compromise typically takes between six and eighteen months for the IRS to reach a decision. During this time, it’s crucial to ensure that you remain in current compliance with all tax filings and estimated payments. Failure to do so may result in the rejection of your Offer. The IRS is required to formally accept or reject your Offer within 24 months of submission; otherwise, it is deemed accepted by default.

What do I do if my Offer is rejected?

If your Offer in Compromise is rejected, the IRS is obligated to provide you with a clear explanation for the decision. Typically, the reason cited for rejection is that the Offer amount does not reflect reasonable collection potential. The IRS assesses factors such as equity in assets and potential income to determine your ability to pay the taxes owed with disposable income. However, it’s common for taxpayers to perceive this evaluation as flawed or unreasonable.

In some cases, Offer Examiners may impose arbitrary deadlines for submitting additional documentation, and missing these deadlines—even by a day—can result in rejection. This practice can be frustrating for taxpayers, leading them to perceive Offer Examiners as obstructive rather than facilitative.

If you disagree with the findings of the Offer examination, you have options for recourse. You can attempt to negotiate with the Offer Examiner by offering to increase your Offer amount. Alternatively, if this approach proves unsuccessful, you have the right to submit a formal written letter within 30 days outlining your objections to the calculations. For example, you may argue that certain necessary living expenses were not properly accounted for in the assessment.

Can I file an appeal if my OIC is rejected?

In addition to addressing objections directly with the Offer Examiner, you have the option to file a formal appeal to challenge the IRS’s rejection of your Offer in Compromise. This appeal process commences with the submission of IRS Form 13711, the Request for Appeal of Offer in Compromise. In this form, you articulate the specific reasons why you disagree with the findings of the Offer Examiner.

It’s important to note that the Appeals division within the IRS operates independently of the field, providing you with the opportunity to have your case reviewed by a fresh set of eyes. This can be advantageous, as it offers a chance for a more impartial assessment of your situation.

To ensure your appeal is considered, it must be submitted within 30 days of the rejection of your Offer. This deadline is crucial, so it’s essential to act promptly if you choose to pursue this avenue.

Are there other options?

When deciding to file an Offer in Compromise (OIC), it’s worth considering doing so within a Collection Due Process (CDP) hearing. This strategic approach can offer certain advantages in case your Offer is arbitrarily rejected by the Appeals division.

If your Offer is rejected without valid reason during the Appeals process, you have the option to file a Tax Court Petition for Abuse of Discretion. While it’s unlikely that your case will proceed to trial, initiating this petition can provide leverage in negotiations with the Appeals division. Essentially, it signals your willingness to challenge their decision and can prompt a more careful review of your case.

By utilizing the CDP hearing and subsequent Tax Court petition strategically, you can strengthen your position and potentially improve the outcome of your Offer in Compromise.