Every tax year, many individuals are unable to pay their taxes in full. The IRS allows some individuals to make monthly payments, called installment payments, until the taxes are paid in full.
Some individuals owe too much money for installment payments to be feasible. In certain circumstances, these individuals are eligible for an IRS offer in compromise.
How Do I Qualify for an Offer in Compromise?
To avoid collection of your tax debt, and to avoid the IRS placing a tax lien on your property, you can reach an agreement with the IRS called an offer in compromise (OIC). An OIC is a written agreement between a taxpayer and the IRS that settles a taxpayer’s tax debt. The agreement settles the debt for less than the full amount owed.
Not every taxpayer qualifies for an offer in compromise. Generally, taxpayers who can pay tax debts by an installment agreement will not qualify for an OIC. Taxpayers with a debt of less than $10,000 are generally approved by the IRS for an installment agreement. The taxpayer must pay off the balance within three years. No minimum payment amount is required on a weekly, monthly, or yearly basis.
To qualify for an OICI, a taxpayer must meet certain minimum requirements. The taxpayer must:
- Have filed all tax returns pertaining to the debt;
- Have made all required estimated tax payments for the current year. According to the IRS, estimated tax payments are taxes on income that is not subject to withholding. Income not subject to withholding includes self-employment earnings, alimony money, dividends, interest, and rental income.
If the taxpayer is a business owner with one or more employees, the taxpayer will only qualify for an OIC if the taxpayer has made all required federal tax deposits for the current quarter.
The IRS will not accept an Offer in Compromise unless the taxpayer offers an amount that exceeds the “Reasonable Collection Potential.” The reasonable collection potential (RCP) is defined as the current liquidation value of a person’s assets, combined with future income. Future income is defined as the amount collectible from your expected future income, after allowing for payment of necessary living expenses. Say an individual earns $5,000.00 a month. Out of this amount,the individual pays $4,000.00 for necessary living expenses. As a result, the individual’s future income is $1,000 per month.
Once the minimum requirements are met, the taxpayer must demonstrate they have a valid reason for requesting an Offer in Compromise. The IRS recognizes three valid reasons:
- There is a doubt as to an individual’s tax liability. This means there is a legitimate dispute between the IRS and the taxpayer as to the amount owed, if any. Disputes may arise for any number of reasons. One example of how a dispute arises is when an individual seeks to deduct certain money from their income. The advantage of doing this is that there will be less income to be taxed. The individual believes, in good faith, that a specific part of tax law, called the Internal Revenue Code, allows the deduction. The IRS takes an opposing view. If both sides have a credible argument for their position, a dispute exists.
- There is no doubt as to the amount owed, but there is doubt as to whether the IRS can collect the full amount. If the sum of a taxpayer’s income and assets equal an amount less than the full tax debt, the individual will be unable to pay the tax debt. Therefore, the IRS will be unable to collect the full amount of the debt.
- An “Effective tax administration” situation exists. Under federal tax law, an effective tax administration exists when the tax is legally owed, and can be collected in full. However, the IRS will accept an OIC because requiring payment in full would either cause economic hardship, or would be unfair to the taxpayer.
An example of an economic hardship that would qualify as an effective tax administration situation is when an individual lives on a fixed income. The person has a disability. Their house has been specially fitted to accommodate the disability. Were the taxpayer required to pay the tax under an installment agreement,the taxpayer would be unable to make monthly mortgage payments.
An example of an “unfairness to the taxpayer situation” is when an individual incurs a tax debt. The reason for the debt is that the IRS did not properly process the individual’s tax return. Had it not been for the IRS mistake, the individual would not have incurred the debt. Under such circumstances the IRS may accept an offer in compromise to remedy the mistake.
There is another “fairness” situation that might result in the IRS agreeing to an offer in compromise. Say a taxpayer, seeking assistance, contacts the IRS and requests advice or instructions. The taxpayer follows the advice or instructions to the best of their ability. However, the advice or instructions turn out to have been made in error. Because of the error, the taxpayer now has a tax debt. The person would not have had the debt but for the faulty advice or instructions. In such a case, the IRS may accept an offer in compromise for the amount the individual would have owed, were it not for the error.
For the IRS to agree to the offer in compromise, the taxpayer must present some kind of documentation. The documents must show when the incorrect advice or instructions were provided. The taxpayer must be able to identify the name of the IRS employee who gave the advice or instructions.
What Must I Do to Submit an Offer in Compromise?
To submit an offer in compromise, an individual must fill out IRS Form 656. The individual must complete the form, pay a fee, and mail the form and the fee to the IRS. In cases where the taxpayer wants the offer in compromise because there is doubt as to how much money is owed, or whether money is owed at all, there is no fee. For certain low-income individuals, there is no application fee.
The IRS then reviews the individual’s application and decides whether to accept the offer in compromise. If the IRS accepts the offer in compromise, the individual can generally pay the amount owed in one of two ways:
The first way to pay is through a lump sum cash offer. This is an offer payable in five or fewer installments, within 5 or fewer months after the IRS accepts the offer in compromise. The second way to pay is through a periodic payment offer. To qualify as a periodic payment offer, the offer must be payable in six or more monthly installments, and within 24 months after the offer in compromise is accepted.
If the IRS rejects the offer in compromise, the IRS will notify the taxpayer by mail. The letter the IRS sends will explain why the IRS rejected the offer. The letter will also contain instructions for how the taxpayer may appeal the decision. The taxpayer must appeal the decision to the IRS Office of Appeals. The appeal must be submitted within 30 days of the date of the rejection letter.
Can a Lawyer Help Me With My Offer in Compromise?
If you are interested in making an offer in compromise, you should contact a tax attorney. A qualified tax attorney near you can discuss whether you qualify for an offer in compromise. The tax lawyer can assist you with submitting the offer and getting it approved by the IRS.