An offer in compromise allows taxpayers to settle their IRS tax debt for less than the full amount owed. For those who truly cannot pay their entire tax liability, this program provides a fresh start while allowing the IRS to collect what it can reasonably expect to recover. Understanding how offers in compromise work and whether you might qualify helps you evaluate this potentially valuable option for resolving your tax problems.
What Is an Offer in Compromise
An offer in compromise is an agreement between a taxpayer and the IRS that settles the taxpayer's tax liabilities for less than the full amount owed. The IRS accepts offers when the amount offered represents the most it can expect to collect within a reasonable period. This is not a debt forgiveness program for everyone; it is designed for taxpayers whose circumstances make full payment impossible or impractical.
The IRS accepts offers based on three grounds: doubt as to collectibility, meaning you cannot pay the full amount and have no reasonable potential to do so; doubt as to liability, meaning there is a legitimate dispute about whether you actually owe the assessed amount; or effective tax administration, meaning paying the full amount would create economic hardship or would be unfair and inequitable.
Eligibility Requirements
Before the IRS will consider your offer, you must meet certain eligibility requirements. All required tax returns must be filed, and you must be current on estimated tax payments if self-employed. You cannot be in an open bankruptcy proceeding since tax debts are generally addressed through the bankruptcy process rather than offers in compromise.
Beyond these basic requirements, the IRS evaluates your ability to pay based on a detailed analysis of your income, expenses, assets, and future earning potential. The IRS calculates your reasonable collection potential, which includes both assets that could be liquidated and future income that could be devoted to tax payments. Your offer generally must equal or exceed this amount to be accepted.
Calculating Your Offer Amount
The minimum offer the IRS will typically accept equals your reasonable collection potential. This calculation starts with the equity in your assets, including bank accounts, investments, real estate, vehicles, and other property. The IRS uses quick sale value, typically 80 percent of fair market value, when assessing assets, recognizing that forced sales do not yield full value.
Future income potential is calculated by taking your monthly disposable income and multiplying it by either 12 for lump sum offers paid within five months or by 24 for periodic payment offers paid within six to 24 months. Monthly disposable income is the difference between your gross monthly income and allowable living expenses under IRS standards. The total of asset equity plus future income potential determines your minimum offer amount.
Lump Sum vs. Periodic Payment Offers
When submitting an offer, you must choose between a lump sum offer and a periodic payment offer. Lump sum offers require payment of 20 percent of the proposed amount with your application, and the balance must be paid within five months of acceptance. Periodic payment offers require you to begin making proposed payments while the offer is being evaluated and continue until paid in full within 24 months.
Lump sum offers generally result in lower total payments because the future income multiplier is 12 months rather than 24 months. However, they require having funds available for the initial 20 percent payment and ability to pay the balance quickly. Periodic payment offers work better for those without significant savings who can make monthly payments but not large lump sums.
The Application Process
Submitting an offer in compromise requires completing Form 656, Offer in Compromise, along with Form 433-A for individuals or Form 433-B for businesses detailing your financial situation. An application fee of $205 is required along with the initial payment unless you qualify for low-income certification, which waives both the fee and initial payment requirement.
The IRS reviews your application for completeness before assigning it to an offer examiner. The examiner verifies your financial information, may request additional documentation, and calculates your reasonable collection potential. This process typically takes several months, during which collection activity is generally suspended on the tax periods included in your offer.
Improving Your Chances of Acceptance
Acceptance rates for offers in compromise have historically been relatively low, but properly prepared offers based on realistic assessments of ability to pay fare much better. Ensure your financial disclosure is complete and accurate since discrepancies between your application and IRS information can result in rejection. Support claimed expenses with documentation where possible.
Working with a tax professional experienced in offers in compromise significantly improves your chances. These professionals understand how the IRS evaluates offers, can identify issues that might cause rejection, and know how to present your situation most favorably. Their fees may be worthwhile given the potential savings from a successful offer.
What Happens After Acceptance
If the IRS accepts your offer, you must comply with all terms including making any remaining payments and filing all required returns for the next five years. Failure to comply during this period can result in the offer being defaulted and reinstatement of the original tax debt minus any payments made. The IRS will also file a federal tax lien to secure the offer amount until you satisfy all terms.
Upon successful completion of the offer terms, the IRS releases its liens and considers the tax debt resolved. This fresh start allows you to move forward without the burden of unpayable tax debt and the threat of ongoing collection activity. For many taxpayers, this represents the best possible resolution of a difficult financial situation.
When Offers Are Rejected
If the IRS rejects your offer, you have the right to appeal within 30 days. The IRS Office of Appeals independently reviews your case and may reach a different conclusion than the original examiner. Appeals often result in acceptance or negotiated modifications to rejected offers, making the appeal process worthwhile in many cases.
If your offer is rejected and appeal is unsuccessful, you can reapply when circumstances change. A decrease in income, loss of assets, or other changes affecting your ability to pay may result in a different outcome. Alternatively, other resolution options like installment agreements or currently not collectible status may be more appropriate for your situation.