IRS Offer in Compromise
There are three types of offers in compromise (OIC) that this article will touch upon. An offer in compromise based on doubt as to tax liability; offer in compromise - doubt as to collectibility; and an offer in compromise made to the IRS based on effective tax administration.
Offer in Compromise: Doubt as to Liability
An offer in compromise based on “doubt as to liability” is submitted using IRS Form 656-L - and is the OIC used when the taxpayer is asserting that they, in fact, do not owe the money, that the IRS made some kind of mistake (e.g. you have the wrong person [occasionally happens with common names], I paid this tax bill and am current, there was a fatal procedural error causing the tax lien to be improperly or incorrectly assessed, or no longer owed, etc...).
The doubt as to liability offer in compromise might be based on the fact that the tax liability statute of limitations has run, or was discharged in bankruptcy.
Note: the taxpayer cannot make a “doubt as to liability” offer after the issue has already been adjudicated. If tax court says you owe the tax, can’t try to circumvent that decision by going the offer in compromise route.
Offer in Compromise: Doubt as to Collectibility
An offer in compromise based on “doubt as to collectibility” is submitted using IRS Form 656 - is your IRS tax defense lawyer stating that, while the taxes are owed, based on the taxpayer’s income and assets (with allowable exemptions and expenses) that the taxpayer cannot afford to pay what is owed. Form 656 is the actual offer contract that can be accepted or rejected (or returned) by the IRS. Form 433-A (OIC) is just the financial information that must be submitted in order for the IRS to evaluate whether the offer in compromise can be accepted.
First your IRS tax lawyer will work with you to complete 433-A (OIC) [and 433-B (OIC), if the offer is being made on behalf of a business entity] to determine an appropriate payment term length and amount.
Then the IRS defense attorney will mail both Form 656 and 433A (OIC) [and B, if needed] to the IRS (along with any other exhibits or attachments to help explain the taxpayer’s circumstances and why the offer in compromise should be accepted) in their Centralized Offer in Compromise Unit in Memphis, TN (if you live in Florida + 21 other enumerated states) or the Brookhaven Unit in Holtsville, NY (for all other states).
Two Types of DATC Offers in Compromise: lump sum or short-term deferred.
There are only two types of offers in compromise: lump sum and short term deferred.
If the OIC can be paid off in 5 months, its called a “lump sum” or “cash offer;” or the offered amount can be paid off within 2 years (which is called “short term deferred” offer).
If making a cash offer or lump sum offer to the IRS
If the taxpayer can pay off their calculated obligation within five months the offer in compromise is a “cash offer.” The taxpayer would submit 20% with the cash offer and state that he/she can pay off the balance if the offer is accepted by the IRS.
Cash offers do not need to be made in equal monthly payments. The taxpayer can structure the payments to remit $250 to the IRS for four months (after 20% initially submitted) and then a balloon payment of the balance on the 5th month.
The cash offer formula for an offer in compromise is: [Excess Income x 12] + Available Equity Component = Offer in Compromise Amount (20% of the OIC amount must be sent in with the offer).
Sometimes, the taxpayer cannot afford 20% down and needs to pay the tax obligation off over the course of two years.
If taxpayer needs more time to pay the IRS
All offers in compromise must be completed within two years. All non cash/lump sum offers are referred to as short term deferred offers in compromise.
They offer can be similarly structured to avoid having to pay 20% down, but make small payments for 23 months with a larger balloon payment of the balance owed on the 24th month.
The short-term deferred payment formula for an offer in compromise is: [Excess Income x 24] + Available Equity Component = Offer in Compromise Amount.
However, here, the taxpayer has to continue to make the monthly payments even while the IRS is considering the offer in compromise. Ultimately, of course, the IRS can reject the offer in compromise and then the payments made would be kept by the IRS (but applied to the liability). If the IRS accepts the offer in compromise, the taxpayer would just keep making monthly payments according to the proposed schedule.
If the taxpayer misses a payment, while the short-term deferred offer in compromise is pending acceptance or rejection, the IRS will deem that missed payment tantamount to withdrawing the offer in compromise (IRS keeps the payments that have been made).
What if the taxpayer is making payment on an existing IRS installment agreement and wants to submit an offer in compromise?
If you have an existing installment agreement with the IRS and you submit an offer in compromise, the taxpayer can stop making installment-agreement payments while the IRS is considering the OIC. If the OIC is rejected, then the taxpayer can just continue making scheduled payments on the installment agreement (the period of time when installment agreement payments were discontinued pending the approval of the offer in compromise wont be deemed a default by the IRS). .
Offer in Compromise: Effective Tax Administration
An offer in compromise made to the IRS, based on “effective tax administration” us made by also using IRS Form 656 and first states that the taxpayer is not eligible to make an offer in compromise based on doubt as to liability or OIC - doubt as to collectibility. If the taxpayer is eligible for either of the other types of offer in compromise, they must go that route.
However, if there is a special circumstance as to why the OIC cannot be made but the taxpayer can offer a lower amount than what the IRS would normally accept in an OIC - doubt as to collectibility situation, and there is a special circumstance, we might file an offer in compromise - DATC and explain the special circumstance - before trying an OIC based on effective tax administration.
So you are agreeing that you owe the money and can afford to pay what is owed but your IRS tax lawyer is arguing that there is some special circumstances or severe economic hardship as to why the taxpayer cannot make payments.
The prototypical example of this is when someone has a significant medical condition that requires the dedication of all the taxpayer’s resources.
Typical Factors that the IRS will Consider when making an Effective Tax Administration Offer in Compromise based on Economic Hardship
Economic hardship factors include: old age (not reasonable to expect they will be able to get a job, medical expenses will probably only increase), taxpayer unable to meet basic living expenses, taxpayer has a long-term serious illness, unable to reach equity in existing assets (perhaps over leveraged or upside down on mortgage), liquidating assets would leave the taxpayer destitute.
How the IRS will apply any payments made by a taxpayer?
The taxpayer must submit money with any offers in compromise. How will the money received by the IRS be credited?
If the taxpayer voluntarily makes a payment to the IRS, the taxpayer has the right to designate where the payment credit will be applied (e.g. current year’s tax liability vs. prior year’s tax liability that is getting closer to the statute of limitations). If the taxpayer does not designate where the credit is to be applied, the IRS will apply it where it is in their best interest.
All payments are deemed a “non-refundable payment of tax.” So, it is impossible to ask for the money back because an offer-in-compromise didn’t work out. As a result, you really only want to make an offer in compromise if its one that the IRS is likely to accept.
All offers in compromise must include a $300.00 “user fee” that does reduced the assessed tax and will not result in a refund of the OIC is rejected and the IRS will apply the credit wherever they please.
Is it possible to get the IRS to waive required payments on an offer in compromise?
Yes, if the taxpayer’s low income results in being below federal poverty levels, the IRS can waive the required fees (20%). In addition, if the taxpayer is disputing the tax liability based on an Offer in Compromise Doubt as to Liability, the user fee can be waived as well.
Streamlined Offer in Compromise Program with the IRS
The streamlined offer in compromise processing is only available to taxpayers who owe less than $50,000.00 in taxes and have no more than $100,000.00 in income. The advantage to using the streamlined offer in compromise program is that it requires less paperwork and is approved relatively quickly when compared to the regular IRS offer in compromise process.
The streamlined OIC program includes a reduced future income calculation. Recall that, when evaluating an offer in compromise, the IRS agent conducts an IRS income financial analysis. The IRS income component of its financial analysis takes the taxpayer’s gross income, reduced by allowable expenses, to reach the taxpayer’s “excess income” for a period of one month.
The streamlined OIC will take 12 or 24 months of excess income (depending on how long the taxpayer needs to pay off the IRS). If the tax liability can be paid off in 5 months, then the taxpayer makes a “cash offer” using the 12 month multiplier x excess income.
If the taxpayer needs longer than 5 months or needs to pay in monthly payments, an offer in compromise can be set to be paid up within, or up to, two years (all offers in compromise must be completed within two years), and will then use the 24 month multiplier on the excess income in the future income calculation.
What Happens When I Submit an Offer in Compromise to the IRS?
After an offer in compromise is sent to the IRS, it must be deemed processable. An offer in compromise, if processable, will stop IRS collection enforcement actions. An OIC will stop a levy but not the filing of an IRS tax lien (tax liens are not considered an enforcement action, only a protection of IRS’s interest).
For an offer in compromise for a business entity to be deemed processable, that means all payroll tax returns have been filed, payroll tax deposits are timely paid for the quarter the OIC is being filed, and trust funds have been paid (or trust fund penalty has been assessed).
An Offer in Compromise submitted may be deemed “non-processable” if it doesn’t meet the payment requirements.
A submitted Offer in Compromise will be (i) returned; (ii) rejected; or (iii) accepted.
When the IRS “accepts” an offer in compromise, that is the same as it being approved. The dollar amount offered to the IRS is accepted and once that is paid off, you will be square with the government. The offered amount is related to what the taxpayer can afford to pay based on the IRS income and asset tests. As a result there may be some negotiation. Before rejecting an offer, they may make a counteroffer to your IRS lawyer, based on a difference of opinion as to collectibility and allowable expenses, etc…
But the offer in compromise has to be realistic. If the offer is for $25,000 and the IRS comes back with “we can only accept the offer in compromise, based on X, Y, and Z if you raise it to $27,000,” your tax professional may advise you to move forward on that basis.
At one point in time, the IRS was so understaffed and behind in processing tax compromises, the law was changed to place some burden on the IRS, to wit: an offer in compromise is “deemed accepted” by the IRS if not rejected before 24 months after the date of submission (assuming there isn’t a bankruptcy or other judicial proceeding, which would serve to toll the 24 month period). It is now rare that the IRS will wait that long to make a decision.
An offer in compromise can also be “returned.”
When the IRS returns an offer in compromise, its because they can’t even consider it. For example, if the taxpayer has just declared bankruptcy, the IRS cannot initially consider offers in compromise (because bankruptcy code says all collections activities must cease). How bankruptcy impacts IRS debts is discussed further at the link.
What Happens if the Offer in Compromise is Deemed Non-Processable by the IRS?
In that case, the offer would be returned to the taxpayer and the taxpayer would be no closer to any form of tax relief or resolution. However, the IRS will keep any money that was sent with the Offer in Compromise - even if the offer is deemed non-processable.
For example, offers in compromise requires 20% of the tax liability down. If you owe $5,000 and you only submit $500 (10%), the offer in compromise is non-processable. Usually, the IRS will give you 30 days to submit the amount needed to make the offer in compromise processable.
For business entities, all payroll tax returns must have been filed and payroll tax deposits must be on file for the quarter of the offer in compromise filing.
Its possible that the offer in compromise is not processable for another reason, such as prior income tax returns that have not been filed (they may also give you 30 days to rectify that issue as well). Again, the IRS will keep any money submitted with the offer in compromise.
When an offer in compromise is returned, the taxpayer has no rights of appeal.
When an offer in compromise is “rejected.”
Similar to when an offer is “returned” the IRS keeps any money submitted with the offer in compromise. However, unlike when an offer is “returned,” when the IRS rejects an offer in compromise, the taxpayer has the right to appeal that rejection. On appeal it is possible to get the offer accepted or enter into an alternative tax resolution mechanism, such as an IRS installment agreement.
Ways to Appeal a Rejected Offer in Compromise
After an offer in compromise is rejected, your IRS tax attorney can discuss the pros and cons of:
- Pursue an administrative appeal
- File a tax court petition -
- if the taxpayer has received a final notice of intent to levy from the IRS (1058 or LT-11), giving them 30 days to request a collections due process hearing (and a hearing is in fact timely requested)
- remember that after 30 days but within a year its called an IRS equivalency hearing, and the taxpayer has no right to go to tax court
- If you go to tax court, the submitted offer in compromise will be part of the file the tax court will be reviewing
- Attempt another tax-remedy option (such as an installment agreement or partial pay installment agreement); or
- The taxpayer can always submit another, more aggressive, offer in compromise that is substantially different than the rejected OIC.
How the IRS projects “future income” when evaluating an offer in compromise?
The IRS looks at whether the taxpayer is employed. If unemployed is it short-term or long-term? Is their industry one that is likely or unlikely to hire someone with the taxpayer’s experience and skill.
See IRS Memorandum 5-0310-012 and the Internal Revenue Manual on how the IRS examines future income for small business or self employed taxpayers and the use of future income collateral agreements.
A future income collateral agreement is where the taxpayer says, “I currently earn $45,000 a year, even though, before I got laid off I earned $85,000 a year. If I ever earn more than $60,000, I will give you, the IRS, 20% of everything I make over $60,000. If I ever earn more than $75,000, I’ll give the IRS 30% of whatever net income exceeds 75K, etc... ”
A future income collateral agreement should increase the likelihood of an offer in compromise being accepted.
IRS Offer in Compromise Resources