Guide

Offer in Compromise

When a taxpayer accumulates an excessive amount of unpaid taxes, the fallout can be catastrophic. Paying them back should be a priority for the taxpayer to protect the financial future for themselves and their dependents.

Sometimes, however, full repayment of back taxes is entirely unworkable. Due to unforeseen or exceptional circumstances, a taxpayer may be forced to undergo undue hardship if they repay every cent of their back taxes. While rare, these extreme situations pose obstacles that some taxpayers simply cannot surmount.

The IRS has a provision allowing for heavily burdened taxpayers to settle the amount they owe more easily. It’s a component of their Fresh Start initiative called the Offer In Compromise.

Summary

The IRS has a provision allowing for heavily burdened taxpayers to settle the amount they owe more easily.

Keep payments up, during both the application process and the repayment term.

What is an Offer In Compromise?

Offer In Compromise (OIC) is an IRS program that allows those who qualify to pay off back taxes for less than the full owed amount. If an OIC is approved, the taxpayer can settle with the IRS by repaying only a fraction of their assessed debt.

The OIC is a little-known, little-used tool. The primary reason this is true is that many simply don’t qualify for the program. In 2017, 25,000 entities repaid the IRS through the OIC program.

The IRS’s premise is that most are perfectly able to repay their entire tax bills through installment plans like the ones provided in the Fresh Start initiative. The OIC was designed for the very slender sector of taxpayers who cannot feasibly repay the total tax amounts they owe.

An OIC is a possibility when a taxpayer can prove they will be unable to fulfill their back tax obligations through future income or assets before the IRS’s allotted time to pursue collection expires. Generally, that time is 10 years after a tax assessment.


General qualifications for an Offer in Compromise

When deciding to approve an OIC, the IRS considers several aspects of the taxpayer’s current and projected financial status:

  • Ability to pay

    Whether the taxpayer will be able to completely take care of the compromise amount

  • Income

    How, and how much, the taxpayer earns their living

  • Expenses

    How much the taxpayer spends on monthly expenses, such as mortgage or rent, utilities, credit payments, and other bills

  • Asset equity 

    Net worth derived from property, buildings, land, intellectual property, or other major assets

An applicant who submits an OIC must establish proof of at least one of three certain conditions or circumstances:

  • Doubt as to liability

    The debtor claims the amount of back taxes the IRS assesses they owe is incorrect, and that they have not been able to dispute the amount before.

  • Doubt as to collectability

    The debtor believes the IRS will be unable to collect the entirety of their tax bill over the given time. The compromised settlement is arrived at with a formula which reflects the debtor’s monthly income and asset equity.

  • Effective tax administration

    The debtor asserts that repaying the debt in full would create undue financial hardship due to unique, extenuating circumstances — such as advanced age, long-term illness, dependents, employment status, or extraordinary or catastrophic events.

Approval of an OIC is not automatic. Just because an applicant meets certain established guidelines for an OIC, does not ensure that the IRS will consent to the compromise.

Since OICs represent a substantial decrease in the amount of tax owed, the IRS must be satisfied that the applicant will be able to pay the compromise amount in full over the agreed-upon time. Available repayment options in OIC programs fall under two categories:

  • Periodic payment offers

    The taxpayer repays the debt in at least 6 monthly installments within 24 months of offer acceptance.

  • Lump sum cash offers 

    The taxpayer agrees to repay the entire debt within 5 months of the assessment, in no more than five installments.

In either OIC structure, the taxpayer must make an initial, non-refundable payment on the agreed debt amount. With a lump sum cash offer, this payment must equal at least 20% of the offer amount.

Recent changes to Offer In Compromise policies

On April 27, 2020, the application fee for an OIC increased from $186 to $205.  The IRS has the discretion to waive this fee for certain low-income applicants. If an applicant is charged the application fee but fails to make it, the offer is summarily rejected.

The IRS has two years to decide whether to accept or reject an OIC. If those two years elapse with no response from the IRS, the offer is considered to have been accepted.


Submitting an Offer In Compromise

To restate: OICs are intentionally difficult for taxpayers to secure. Many tax professionals urge their clients not to pursue them, citing the excessive documentation required to prove the inability to pay the full back-tax amount, along with the intense oversight the taxpayer must assume over the lifespan of the repayment plan. Be assured the IRS will review every aspect of your financial profile in exacting detail.

If you have decided to propose an OIC to the IRS, take the following steps and precautions during application and repayment:

  • Make a reasonable offer

    The IRS considers one year of expected future income if you apply for the lump sum OIC option; for plans between 6 and 24 months, they consider two years. Frame your offer with an exact projection of your expected income and asset equity.

  • Compute your financial status accurately

    The IRS will scrutinize and verify every number you submit in support of your compromise, typically requiring three months of documentation. The offer you make must correspond to an accurate assessment of your finances. Extremely low offers based on fraudulent or “low-balled” figures on your documentation will be rejected. Extensive, due diligence is vital on your part.

  • Stay on top of your payments

    Keep payments up, during both the application process and the repayment term. The IRS may decide to reject your offer if you do not pay new tax liabilities, even while your approval is still pending.

  • Make all payments on time

    Since your compromise is a fraction of the whole tax amount you owe, faithful and consistent repayment is a core part of an OIC agreement. Never skip or delay an installment.

  • Consult a professional

    In all dealings with the IRS, a taxpayer needs legal support. Even though you can apply for an OIC online, the process involves multiple and labyrinthine steps and conditions. The IRS will not offer clarity or clemency in this regard. Consult early and often with a certified professional, before and during OIC negotiations.


Frequently Asked Questions

  • How Much Do I Have to Owe the IRS to Face Jail Time?

    Generally, the IRS will pursue imprisonment only for tax evasion. Tax evasion, unlike most tax penalties, is a criminal violation in which the taxpayer takes concrete actions to evade payment of taxes at either the federal or state level.

  • Can the IRS Freeze My Robinhood Account?

    It is possible that the IRS can seize or freeze your investing accounts due to back taxes from other income. The IRS tracks all income to collect income tax, including stocks.

  • Should I Pay My Student Loans or Back Taxes First?

    Student loans can be quite overwhelming, but the worst kind of debt to overlook is back taxes. One thing about the IRS that you should always know is that the IRS always gets its money. Regardless of the number of people you owe, always prioritize back taxes.

  • What Should I Know About Taxes Before Having a Baby?

    Having a baby is a blessing, and most people look forward to it. However, most new parents do not know how this affects their taxes. The IRS has some breaks for parents that could help you save some of your tax money as a new parent.

  • How Can a Tax Levy Derail My Plans for Early Retirement?

    If you are struggling to pay your expenses with a salary from your work, retiring will not make things any more straightforward. Generally, retirees may require about 75 per cent of their pre-retirement proceeds to enjoy a comfortable retirement.