Offers in Compromise: A Comprehensive Guide for Taxpayers

The IRS Offer in Compromise (OIC) program allows eligible taxpayers to settle tax debts for less than the full amount owed. This guide explains the OIC process, eligibility requirements, and how to apply.

What is an Offer in Compromise?

An Offer in Compromise (OIC) is a program established by the IRS to assist taxpayers in resolving their tax liabilities when full payment is not feasible. It allows qualifying individuals to propose a reduced payment amount that the IRS may accept as a settlement for their tax debt. The primary aim of the OIC is to facilitate taxpayers in regaining financial stability while sidestepping more severe collection actions, such as wage garnishments, bank levies, and asset seizures.

The IRS does not accept every offer. Approval depends on demonstrating that you cannot pay your full tax liability or that doing so would cause undue financial hardship.

Understanding the Offer in Compromise Process

The OIC program evaluates offers based on "Reasonable Collection Potential" (RCP), which is the maximum amount the IRS could realistically collect from a taxpayer within a reasonable timeframe, given their financial situation.

Reasonable Collection Potential (RCP)

RCP is determined by analyzing several factors, including:

• Assets: The IRS evaluates the value of different assets owned by the taxpayer, including real estate, vehicles, and bank accounts.
• Income: The taxpayer's current income, as well as their expected future earnings, are taken into account.
• Necessary Living Expenses: Essential living expenses that the taxpayer must cover to maintain a basic standard of living are also considered.

For an OIC to be accepted, it must meet or exceed the taxpayer's RCP. If the proposed offer is lower than the RCP, the IRS is unlikely to approve it.

When Should You Consider an Offer in Compromise?

The IRS recognizes three primary circumstances under which taxpayers may qualify for an OIC:

1. Doubt as to Liability: This scenario applies when there is uncertainty regarding the exact amount of taxes owed. If you believe that you do not owe the tax or have a legitimate dispute regarding your tax liability, you may qualify for an OIC based on this doubt.

2. Doubt as to Collectibility: This is the most common basis for an OIC. Taxpayers who can demonstrate that their financial situation makes them unable to pay their full tax debt may qualify. For instance, if your income and assets are insufficient to cover the tax liability, the IRS may accept your offer.

3. Effective Tax Administration: In cases where paying the tax would create an economic burden or perceived unfairness due to the taxpayer's financial condition, the IRS might consider an OIC under this criterion. Taxpayers must provide an explanation of how settling their tax debt would alleviate financial stress.

Eligibility Requirements for an Offer in Compromise

To qualify for an OIC, taxpayers must meet several specific conditions:

• Filing Compliance: Taxpayers must be current with all tax return submissions. Any outstanding tax returns will disqualify the application for an OIC.

• Bankruptcy Status: Individuals currently undergoing bankruptcy proceedings cannot submit an OIC.

• Financial Disclosure: Applicants must provide evidence that they lack the means to pay the tax debt in full, such as through an installment agreement.

The Application Process for an Offer in Compromise

The OIC application process requires detailed financial information. Complete each step accurately to avoid delays or rejections.

Step 1: Prepare the Required Forms

To initiate the OIC process, taxpayers need to complete IRS Form 656, known as the Offer in Compromise. This form requires extensive financial information, including details about income, expenses, assets, and liabilities. Depending on your taxpayer status, you will also need to fill out one of the following forms:

• Form 433-A (OIC): For individual taxpayers.
• Form 433-B (OIC): For business taxpayers.

These forms provide the IRS with detailed information about your financial situation.

Step 2: Submit the Required Fees and Payments

Alongside your application, you must submit an application fee, which is currently set at $205. This fee may be waived for low-income taxpayers. Additionally, you will need to make an initial payment based on your selected payment option:

• Lump Sum Cash Option: Requires an upfront payment of 20% of the total offer amount.
• Periodic Payment Option: Involves an initial payment followed by monthly payments during the review process.

Step 3: Submit Your Application

After completing the necessary forms and compiling the required financial documents, submit your OIC application to the appropriate IRS address as indicated in the instructions for Form 656.

What to Expect During the Evaluation Process

Once the IRS receives your OIC application, it will begin the evaluation process. This can take several months—often six months or longer. During this review period, the statute of limitations for collection is generally extended. While the IRS typically suspends collection efforts during this time, it may still file a Notice of Federal Tax Lien to protect its interests.

Possible Outcomes of Your Offer

1. Acceptance: If the IRS accepts your OIC, you must comply with all tax filing and payment obligations for five years following acceptance. This includes making timely payments and filing your tax returns on time. Failure to comply with these requirements could result in the revocation of your offer and the reinstatement of your full tax liability.

2. Rejection: If your OIC is rejected, you can appeal within 30 days. Review the rejection reasons carefully and revise your offer if necessary. Many OIC applications are denied, so ensure your offer accurately reflects your financial circumstances and aligns with the IRS's RCP calculations.

Example Scenario

Example: A taxpayer owes $40,000 in tax debt. After evaluation of financial circumstances, the total RCP is $12,000 due to reduced income and medical expenses. The taxpayer applies for an OIC, offering $8,000 to settle the debt. The IRS determines that the offer aligns with the RCP and accepts it. After acceptance, the taxpayer must comply with all tax filing and payment obligations for five years.

State-Specific Considerations for Offer in Compromise

While the IRS oversees the OIC program, individual state tax agencies may have their own rules and procedures for settling tax debts. Taxpayers in states such as Washington and California should familiarize themselves with the specific regional resources available for OIC applications and local tax implications.

Washington State

In Washington, taxpayers seeking assistance with OIC applications can contact regional offices in:

• Bellingham
• Everett
• Seattle
• Tacoma

These offices often provide localized support and resources tailored to the needs of Washington residents.

California

In California, taxpayers can access OIC assistance through offices located in:

• Sacramento
• San Jose

Understanding how state tax laws interface with federal offers can provide additional relief options for taxpayers grappling with tax debts.

Conclusion

An Offer in Compromise allows eligible taxpayers to settle tax debts for less than the full amount owed. Understanding eligibility criteria, the application process, and potential outcomes helps taxpayers make informed decisions. The OIC process is complex, so working with a tax professional can improve your chances of success. If you qualify, act promptly and ensure your application is detailed and accurate.