Offer in Compromise: How to Settle Your IRS Debt
The IRS is willing to work with consumers who have fallen behind on their taxes, but first you must prove you are eligible. Find out what the qualifying standards are for the “offer in compromise” program.
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What is an Offer in Compromise?
An “Offer in Compromise” is a little-known but remarkably effective way that thousands of people in trouble with the IRS routinely eliminate tens of thousands of dollars in tax debts. It is a federal program that allows you to settle your tax debt for less than the full amount you owe. Sometimes significantly less, especially if you are from a low-income family.
Here’s how it works: The IRS is breathing down your neck for $100,000 in back taxes. You don’t have the money. The feds could garnish your wages or take your house.
So you make the IRS a compromise offer you hope they can’t refuse.
You fill out a few forms. You say very nicely to the IRS, “Let’s compromise. I’ll give you $10. You swallow the rest ($99,990). That’s fair, isn’t it?”
You wait awhile. You hold your breath. You pray. Then the IRS says, “Why sure, thanks Mr. Smith for the crisp new Alexander Hamilton. We’ll happily forgive the rest.”
“It sounds too good to be real, but it’s the truth,” said Professor Erin H. Stearns, director of the Low Income Taxpayer Clinic at the University of Denver’s Sturm College of Law, in an interview with Debt.org. “If you owe $100,000, you may get off paying $10.”
What is the Acceptance Rate?
People of all ages and incomes are waking up to the power of an OIC. In 2017, the IRS accepted 25,000 of 62,000 proposed Offers in Compromise. That’s a 40.3% approval rate, amounting to almost $256 million. The average dollar amount of the accepted offers was $10,234.
“It’s kind of a not very well-known tool that’s out there,” Professor Stearns said. “But it’s really great, the gold standard of tax resolution work.”
Let’s look closer to see if you can manage this Houdini escape from the IRS Wheel of Misfortune.
Offer in Compromise Pre-Qualifiers
Because taxes are so important for government and public expenses, there are strict pre-qualifiers to be eligible for a tax settlement:
Before you make an offer to the IRS, check your eligibility and understand what the IRS takes into account.
The first test of eligibility is your reason for requesting a compromise.
The IRS will only consider an offer in compromise if it is for one of the following reasons:
- There is doubt as to whether the IRS correctly determined the amount you owe.
- There is doubt as to whether the debt is fully collectible. This means your assets and income are less than the amount you owe.
- The debt is correct, and you are able to pay the debt in full, but doing so would cause undue economic hardship. This is called effective tax administration.
If you are making an offer in compromise based on the second or third reason, the IRS will take other factors into account.
To determine whether you can pay, as well as how much you may be able to pay, the IRS generally looks at these four components:
- Your ability to pay
- Your income
- Your expenses
- Your assets
In general, the IRS only accepts offers that are equal to the maximum amount you’d be able to pay within a reasonable time period.
It will not consider your offer if any of the following are true:
- You are in an open bankruptcy proceeding.
- You have not filed required federal tax returns.
- You have not made required estimated tax payments.
- You are self-employed, have employees and have not submitted required federal tax deposits.
To find out if you are eligible for an offer in compromise, use the IRS’s pre-qualifier tool. However, even if you do qualify, there is no guarantee that your offer will be approved.
The IRS says the Offer in Compromise program is not for everyone. The agency suggests that taxpayers “explore all other payment options before submitting an offer in compromise.”
Taxpayers who can pay what they owe through an installment agreement or other means, don’t qualify for an offer in compromise (OIC) and the IRS says it won’t accept an Offer in Compromise unless the amount offered is equal to or greater than the reasonable collection potential.
Here are signs you are a good candidate:
- You are a retiree on a fixed income.
- You are in legal trouble with the IRS. They're often looking to settle instead of getting bogged down in a lawsuit.
- You're facing possible bankruptcy, but in fact your major problem is unpaid taxes.
- You can't pay your full tax liability, or doing so creates a financial hardship
- You meet federal low-income guidelines that aren’t so low these days: under $51,950 for a family of three, under $73,550 for a family of five, and so on.
In all of the above cases, the feds weigh your unique facts and circumstances including ability to pay, income, expenses, and asset equity.
The IRS says it “will generally approve an offer in compromise when the amount offered represents the most we can expect to collect within a reasonable period of time.”
Check here to see whether you meet their guidelines: www.irs.gov/advocate/low-income-taxpayer-clinics/low-income-taxpayer-clinic-income-eligibility-guidelines
What is the Minimum Offer Amount on an OIC?
Obviously, you’ll want to offer as little as possible. Of course, it’s not that simple. How small of an offer the IRS will accept will depend on your financial condition, and you will need to reveal that in great detail on Form 433-A (for wage-earners and the self-employed) or 433-B (for businesses).
How detailed? In addition to income and expenses, be prepared to reveal:
- If you have declared bankruptcy
- If you are the beneficiary of a trust, estate or life insurance policy, and how much and when you might receive the money
- What’s in your safe deposit box
- Contents of your personal bank accounts, investments, available credit, life insurance policies that have a cash value
- Real estate, personal vehicles and even intangible assets such as licenses, domain names, patents and copyrights that still have value
More bad news: The IRS generally will not allow you to count college or any private school expenses, charitable contributions, voluntary retirement contributions or payment on unsecured debts.
Once you’ve done that, the minimum offer calculation breaks down like this: The IRS will expect your available assets plus a year to two years’ worth of your income above what it considers acceptable expenses. Even if your secured debt and expenses exceed your assets, the IRS will demand you pay something.
Submitting an Offer
When you apply for an offer in compromise, you’re responsible for completing and including several forms. In addition to the actual offer, you must include a collection information statement for individuals and/or businesses.
In most cases, you must also include a $150 application fee, as well as the first payment of your offer.
If you offer to pay one lump sum, your initial payment should be 20 percent of the total offer amount. Then, if you receive written notice that your offer has been accepted, you must pay off the remaining balance in five or fewer payments.
If you offer to pay over the course of a payment plan, your first payment should be the monthly amount suggested in your plan. Make this payment once a month until you receive notice from the IRS. At that point, if your offer has been accepted, continue making the monthly payments until your balance is paid in full. This must take no more than 24 months after the offer is accepted.
You do not need to pay a fee if your offer is based on a doubt of liability.
You also do not have to pay the application fee or initial down payment if you meet the Low Income Certification guidelines. This depends on the size of your family and your household’s monthly income, as well as where you live. For example, if your family is made up of three people and your household income is less than or equal to $3,997 per month, your initial fees are waived.
For step-by-step instructions and all the necessary blank forms, including qualifications for low income, read the IRS’s booklet on offers in compromise.
Reasons Why an OIC Might Be Rejected
It pays to be meticulously careful. Common reasons for rejection include
- The offer is too low, and the government believes it can get payment in full from your future earnings – in which case the IRS will tell you what it thinks you can pay.
- Failing to provide enough information substantiating your financial condition.
- Failing to be current on tax payments for the current year, because if you’re continuing to fall behind on paying your taxes, you’re a poor risk to pay the OIC.
- You’ve been convicted of a serious crime.
Options for Rejected Offers
The IRS accepts less than half the offers in compromise it receives, so it’s likely your pitch will be rejected.
There are two ways to respond to IRS rejecting an OIC. One is to resubmit an offer. If you do it less than a month from the first offer, a new Form 656 isn’t necessary, just a letter increasing the amount of money you’re offering.
If you wait longer or significantly change the offer, fill out a new Form 656. To appeal the rejection, file Form 13711 within 30 days of the rejection letter, identifying what parts of the rejection you dispute and providing your reasons.
Consider Hiring an Attorney
You can file on your own, but Professor Stearns recommends against it. If your income qualifies, a Low Income Taxpayer Clinic will guide you through an OIC for free. There are 135 of these federally-supported clinics in the United States, at least one in every state but North Dakota.
You can find one in your region on a U.S. map at the Taxpayer Advocate’s web site: https://taxpayeradvocate.irs.gov/about/litc
If you don’t pass that income test, consider hiring a so-called tax resolution firm.
There are many reputable tax firms. Oxford Tax Partners, headquartered in Chicago with offices around the country, generally gets good customer reviews. So does Travis W. Watkins in Oklahoma City and Dallas.
Cities and towns are filled with good tax lawyers. Check a firm out with the Better Business Bureau. Scan online reviews. Ask your friends.
But beware the midnight radio ads. You can get scammed.
“OICs are the bread and butter of late-night radio ads,” Stearns said. “The ads say: ‘If you owe $10,000, call us. Do you want a fresh start? ‘Fresh start’ is code for Offer in Compromise.”
A cautionary example, but far from the only one, is J.K. Harris, once the nation’s largest tax resolution company, based in South Carolina wtih 325 offices nationwide. The company went out of business in 2012 after it was sued by 20 state attorney generals for charging clients unethical fees and making false promises.
At tax resolution firms, “the going rate is $5,000 to $8,000” for a retainer, Stearns said.“A lot of them are just fine. Some are not. Truly this is an exercise in filling out a form. If it costs you $20,000 and you owe $100,00, it’s a good deal. If you owe $10,000, it’s not.
“If the place is not reputable, people can really get taken for a ride.”
Appealing a Rejection
The IRS only accepts about a quarter of offers, so it’s likely your offer will be rejected.
If the IRS rejects your offer in compromise, you may appeal the decision. You have 30 days from the rejection date to file an official request for appeal. To do so, complete this form and follow the instructions included with your rejection letter.
What Are the Downsides of an OIC?
Providing the extensive amount of information the IRS demands is unpleasant in itself, but that’s not the only potential drawback. The process can take up to a year, and another several months if you appeal.
You must remain compliant on all your taxes for five years in order for the OIC to become final, and even a little slip-up gives the IRS the right to revoke the agreement and demand full payment of the liability you thought you’d avoided.
An OIC also suspends the 10-year statute of limitations the IRS has to collect taxes from you. If it’s been six years since the IRS assessed taxes against you, it has four years left to collect. If it takes a year for your OIC to be considered and it is rejected, the IRS still has four years to collect against you.
Fresh Start Initiative
The good news – yes, there’s good news – is that this isn’t as bad as it used to be. In 2012, the IRS expanded its Fresh Start Initiative, and OIC acceptance rates are much higher than the previous 25-30% range.
The initiative increased the threshold for placing a tax lien from $5,000 to $10,000. It provided relief from some of the penalties that can be assessed on top of the taxes owed. It also relaxed eligibility requirements for paying back taxes on an installment plan and provided more favorable OIC requirements.
An offer in compromise is often your best option for getting rid of tax debt you can’t afford to pay. However, you do have other options for reducing your financial burden and getting back on the right track.
If you’re not eligible for an offer in compromise or if your offer is rejected, look into debt solutions like settlement and consolidation. Often, they can save you money on other debts, freeing up cash to pay down your IRS debts.
Debt Consolidation and Debt Settlement
Debt consolidation and debt settlement are two terms often linked together, but they are two completely different ways to handle debt.
Debt consolidation means taking out a single loan to cover payments to multiple creditors. This is considered an acceptable way to get out of debt, but there are some drawbacks that should be investigated.
Debt settlement means offering a lump-sum payment to a creditor for less than what is owed. There are severe negative consequences for using this process to get out of debt.
If you can’t afford your bills, seek out professional help today. There are solutions for your debt problems.
Offer in Compromise Success Stories
Typical is an old couple on Social Security. They don’t own a house. They’re renting, with a moderate car and “very low assets,” Stearns said.
If the IRS determines there is no realistic chance of collecting the couple’s $25,000 in back taxes, penalty, and interest, “We will offer $10 in courtesy to make the $25,000 debt disappear, because $1 just sounds insulting,” Professor Stearns said.
The IRS routintely approves such offers.
The IRS factors in geography. If you live in the poorest county in Colorado, the federal algorithms say a single person needs approximately $900 a month to afford a basic living including rent, utilities, cable, and internet. In Marin County, California or New York City, the number exceeds $3,000.
Another option is a collateral agreement with the IRS.
If you’re a 30-something with earning potential and a masters degree, the IRS may forgive significant debt if you agree to make payments in the future, if and when your income reaches your potential.
If you do meet the low-income guidelines, amazing things can happen. At Professor Stearns’ Denver clinic, 80% of OICs are accepted, double the national average, to wipe out IRS debts of $25,000 to $250,000.
The median offer is $10.