Tax debtors have numerous options available to them for resolving their unpaid tax liabilities. While the vast majority of tax debtors will be placed into an appropriate Installment Agreement or into Currently Not Collectible (CNC) status, the Offer in Compromise program provides an amazing opportunity for taxpayers to start fresh with the IRS…if they qualify. In this post, we explore the ins and outs of the Offer in Compromise program from a taxpayer representative’s point of view.
What is an Offer in Compromise?
The IRS Offer in Compromise is a program through which the IRS allows taxpayers to settle their tax liabilities for less than what they owe. The authority to accept less than what is owed is granted by 26 U.S. Code § 7122. Under this statute, taxpayers may submit lump-sum Offers in Compromise to settle their tax debts through a lump-sum payment or periodic payment Offers in Compromise to settle their liabilities through a finite number of periodic payments. If a taxpayer submits an Offer in Compromise to the IRS for a lump-sum, he or she will be required to submit an initial payment with the offer. People who submit periodic payment Offers in Compromise must submit the amount of the initial periodic payment with their offers.
Under IRM 5.8.1, the IRS will accept an Offer in Compromise when it deems the tax liability to be otherwise uncollectible. It may also agree to an Offer in Compromise when there is doubt about the liability owed and to support the effective administration of taxes. The goal of the OIC program is to negotiate a legal payment agreement that is in the taxpayer’s and IRS’s best interest.
Doubt about collectibility
The first ground for approving an offer of compromise exists when the IRS doubts its ability to collect the tax debt because of the taxpayer’s financial inability to pay the full amount owed. Doubt about the collectibility of tax debt may be shown when a taxpayer’s income and assets are insufficient to satisfy the full tax liability. this is the most common ground for making an Offer in Compromise. Some taxpayers who submit Offers in Compromise for tax debts that are deemed to not be collectible can settle their liabilities for a fraction of the total owed. Under IRC § 7122(d)(3)(A), the IRS must not deny an Offer in Compromise when their denial is solely based on the amount that is offered.
Under IRS Policy Statement P-5-100, the agency will accept an Offer in Compromise that is based on doubt about collectability when the IRS determines that it is unlikely that it will be able to collect the tax debt in full. However, the amount that the taxpayer offers must be what the IRS believes that it could collect using judicial and administrative remedies. The amount that the IRS believes is collectible is called the reasonable collection potential. To calculate the RCP, the IRS analyzes the basic living expenses of the taxpayer. Under certain circumstances, the agency might accept an offer that is lower than the RCP, but this is rare.
Doubt about liability
The second ground on which the IRS might accept an Offer in Compromise exists when there is genuine doubt about the liability of the taxpayer for the tax debt. Under this type of Offer in Compromise, the amount or existence of the tax debt must be in real dispute under the tax law. To prevail with this type of Offer in Compromise, a tax attorney will need to make a compelling argument that the taxpayer does not owe the claimed debt to the IRS. Doubt about liability will not exist when a court of final jurisdiction has established that the liability exists or has issued a judgment.
The IRS will accept an Offer in Compromise that is based on a genuine doubt about liability when the offered amount is what the IRS believes it might recover in litigation. The IRS will analyze the amount offered by considering the risks of litigation that would be involved in the case if it went to court.
Effective tax administration
The final category of an Offer in Compromise is one that is based on the effective administration of tax. Effective tax administration may be the basis of an Offer in Compromise when no doubt exists that the tax is owed or that the full amount is collectible. The IRS may accept an Offer in Compromise that falls into this category when requiring a full payment would be inequitable, unfair, or would create an undue financial hardship under IRM 5.8.11. This type of Offer in Compromise offers a potential avenue for taxpayers who do not meet the requirements for not being collectible or having a genuine dispute about liability. Exceptional circumstances must exist before the IRS will accept an Offer in Compromise based on effective tax administration.
How much should I Offer in Compromise to the IRS?
The Offer in Compromise program was created to help taxpayers who are unable to pay their tax debt without suffering economic hardship. IRS Offer in Compromise statistics are illuminative. In 2019, the IRS received 54,225 offers in compromise and accepted 17,890. The total value of the accepted offers was $289,422,000. While this demonstrates that the Offer in Compromise can be a good solution for many taxpayers, it is also important to recognize that the IRS rejected more offers than it accepted for a total of 36,335 denied offers. These IRS Offer in Compromise statistics demonstrate the importance of analyzing an Offer in Compromise before determining the answer to “How much should I Offer in Compromise to the IRS?”
If your client has a large tax liability, you will need to demonstrate that he or she is unable to pay the full amount owed, that he or she does not owe the disputed amount, or that special circumstances exist that make acceptance of the offer in the IRS’s and the taxpayer’s best interests. In general, the IRS will be likelier to accept an offer when it is the greatest amount of money that the IRS could reasonably expect to collect within a reasonable period. The first step in evaluating whether the OIC program is a good tax resolution choice for your client is to consider the eligibility requirements.
Eligibility requirements for an Offer in Compromise
A taxpayer must meet all of the following requirements to be eligible for the OIC program:
- Has no unfiled tax returns
- Has been billed for one or more tax debts that are included in the offer
- Makes current estimated tax payments
- For business owners with employees, makes current quarterly tax deposits
The IRS will also consider several factors when it assesses whether a taxpayer would encounter financial hardship if he or she was forced to pay the entire liability, including his or her income, assets, expenses, and lifestyle. In considering a taxpayer’s lifestyle, the IRS will critically review all relevant information. People who have assets worth substantial amounts are unlikely to be approved for Offers in Compromise based on claims of an inability to pay, for example.
When a taxpayer submits an Offer in Compromise to the IRS, he or she will be required to complete and submit IRS Form 656, IRS Form 433-A, and/or IRS Form 433-B for businesses. While a lot of the information about the taxpayer’s finances will be collected from the data on Form 433, the IRS revenue officer examining the claim will also conduct an investigation. Any unusually high living expenses will need to be justified by special circumstances. However, the IRS will not necessarily force a taxpayer to sell a vehicle or home to satisfy his or her tax liability. For taxpayers who have luxury lifestyles, installment agreements might be a better option than submitting Offers in Compromise. After an OIC has been submitted, the IRS will continuously review your client’s assets and income to determine whether he or she becomes able to pay the tax debt before the offer will be approved, and the process can take months.
Calculating the reasonable collection potential
If your client meets the eligibility requirements and appears to qualify for the OIC program, you will want to calculate the reasonable collection potential to determine the amount that should be offered. IRM 188.8.131.52.1 provides guidance about how the IRS calculates the RCP for a taxpayer’s Offer in Compromise.
To calculate the RCP, you will need to figure out the net equity that is realizable that your client has in his or her assets. This amount will then be added to the amount of your client’s future income. To determine the net realizable equity, you will need to determine the fair market value of the various types of property. Then, you will need to apply any discounts from a quick sale to the property and deduct any loans that are secured against the property. This step might require you to retain an appraiser to receive a formal analysis of the property’s fair market value.
To calculate your client’s future income, your client will need to complete Section 7 of Form 433-A. The expenses that your client claims might be very different than what the IRS normally accepts. The IRS relies on national and local standards when it calculates the RCP. You should compare your client’s expenses to the amounts listed in the standards.
After applying the standards, the amount left over after subtracting expenses from your income is called remaining income.
For a lump sum offer, you multiply remaining income by 12. For a periodic payment offer, you multiply remaining income by 24. This number is then added to your asset number to arrive at your minimum offer amount.
People who do not qualify for the OIC program
The OIC program is popular with many people who have tax delinquencies since it potentially allows people to substantially decrease their tax liabilities. However, some people will not qualify for the OIC program even though they might owe significant tax liabilities. Offers in Compromise are not accepted from taxpayers who have not filed all of their tax returns, have a history of failing to pay their taxes, have deliberately engaged in tax avoidance, are in bankruptcy proceedings, or are tax protesters. The IRS will also not accept an Offer in Compromise from any taxpayer whose tax debt has been referred to the U.S. Department of Justice.
Steps in the OIC process
Understanding the IRS rules for the OIC process is critical. To begin, all of your client’s tax liabilities must be included in his or her Offer in Compromise.
- Prepare and submit any unfiled returns.
This might mean that it will be necessary to prepare any unfiled tax returns and file them so that the full amount of liability will be known. If there are any trust fund recovery penalties or withholding taxes at issue, you will also need to complete assessments for every quarter during which your client may be liable. Unfiled tax returns should be filed before an offer is made because the IRS will not accept an offer from a taxpayer who is currently not in compliance.
- Prepare and submit the right IRS Offer in Compromise form.
Submitting an Offer in Compromise requires you to use the correct IRS Offer in Compromise form. You will need to submit IRS Form 656 together with Form 433-A. If your client is a business owner, you may also need to submit Form 433-B. IRS Publication 1854 contains information about how these forms should be completed. If you complete a Form 656 that is generated by a computer, you must ask the taxpayer to initial each page to certify that it is an exact duplicate.
- Choose a lump-sum or deferred payment offer.
The IRS prefers that taxpayers make lump-sum cash offers. If your client cannot make a lump-sum payment, the IRS may allow him or her to enter into an installment agreement. Under IRM 184.108.40.206, making a cash offer means paying the offer within five payments after you receive notification that the IRS has accepted the offer. While submitting a deposit with a lump-sum Offer in Compromise is not required, it is strongly encouraged.
Deferred or periodic payment offers include those when any portion of the amount that the taxpayer offers will be paid more than six months after the offer is accepted. In general, a deferred payment offer will not be extended for more than two years after acceptance. If your client makes an acceptable offer that will be paid within two years or less, it should not be rejected unless there are exceptional, documented circumstances that establish the need for a shorter repayment period. If your client needs to make a deferred payment offer, its term should be clearly stated. It is much more difficult to receive approval for a deferred payment offer as compared to a lump-sum offer. However, it is still possible if your client’s circumstances require it.
After the IRS receives the Offer in Compromise
After you submit an Offer in Compromise, the IRS Revenue Officer will complete an initial screening to determine whether the offer can be processed. The IRS sends back many offers that it determines to be unprocessable, which can be very frustrating. Under IRM 220.127.116.11, the following circumstances will result in a determination that an offer is unprocessable:
- Lack of an offer amount
- Unidentified taxpayer
- Unidentified liabilities
- Missing signatures
- Failure to submit financial statements
- Net equity is not reasonably reflected in the offer
- Use of an old Form 656
- Altered or deleted terms
If an Offer in Compromise is returned because it is unprocessable, the taxpayer will not be able to file an appeal with the IRS Appeals Office. However, there is a process for correcting a deficient or incomplete offer package.
If an offer is determined to be processable, it will be forwarded to a Revenue Officer. The assigned officer will carefully review all of the documents that have been submitted line-by-line to look for red flags. An investigation will also be completed into the taxpayer’s financial circumstances. If the Offer in Compromise is approved, a notification will be sent. The taxpayer will then have to honor the offer that he or she has made within the specified time frame.
Can employment taxes be compromised?
Many business owners ask about compromising their employment taxes. These types of tax liabilities are frequently staggering and cannot be discharged through bankruptcy. However, it is difficult to secure approval of an Offer in Compromise for employment tax liabilities. In most cases, the IRS will refuse any offer for an amount that is less than the taxes owed. However, if you can convince the IRS that it is in its best interests to accept the offer, and the taxpayer is remaining current with the employment taxes, it might accept an offer for less than the taxes owed if it reflects the reasonable collection potential.
Denials of offers because of public policy considerations
When the IRS accepts an Offer in Compromise, the acceptance must be publicly disclosed. This means that the agency will sometimes reject Offers in Compromise if it believes accepting them will adversely impact others’ voluntary compliance with U.S. tax laws. Liabilities that are caused by fraud are an example of an offer that might be rejected based on public policy considerations even when the offer exceeds the reasonable collection potential amount. Even though the IRM states that an offer will not be denied solely because of a taxpayer’s criminal prosecution for a tax violation, these offers are frequently rejected. Similarly, Offers in Compromise made by federal employees are likewise routinely rejected.
Other reasons an offer might be rejected
There are several common reasons why an Offer in Compromise might be rejected, including collectibility, accumulating new tax debt, filing a frivolous OIC, or failing to pay an accepted offer as agreed.
Offers that are rejected based on collectibility are common. If this is the reason that your client’s offer is denied, the IRS has determined that the offered amount is too low based on your client’s ability to pay. The IRS will consider your client’s potential ability to earn an income as well as his or her current income when it calculates the reasonable collection potential.
Once your client has submitted his or her Offer in Compromise, he must stay current with his or her taxes as they accrue. If your client instead continues to accrue more tax debt and does not make his or her estimated tax payments, the IRS will likely deny his or her Offer in Compromise. This is because the IRS will assume that your client will not comply with the terms of the offer that he or she made.
If your client submits a frivolous Offer in Compromise to try to delay the IRS’s collection efforts, the IRS will immediately deny it. Typically, these types of OICs will be for substantially less than the taxpayer’s calculated reasonable collection potential. Frivolous offers freeze the statute of limitations and add 30 days to it, making them against your clients’ best interests.
Finally, if the IRS previously accepted an Offer in Compromise, it can reject it retroactively if your client fails to pay. People must file and pay their taxes on time for five years after the acceptance of an Offer in Compromise. If they fail to do so, the OIC can be rejected, meaning the full liability will be restored.
What is the effect of an OIC acceptance?
If the IRS accepts an Offer in Compromise, a contract is formed. The contract is binding on the taxpayer and the IRS and prevents further inquiry into the included matters. Unless a mutual mistake or fraud led to the contract, both parties will be denied any attempt to recover any of the consideration that was given. However, an Offer in Compromise that was accepted because of a mutual mistake about a material fact or because of false representations about material facts can be set aside.
An accepted Offer in Compromise will include the IRS’s agreement to accept the offer as a full settlement of the taxpayer’s liability. It will also include the taxpayer’s agreement to pay the offered amount and the IRS’s release of liens that have been filed. Other promises are included in an accepted Offer in Compromise, including the promise to remain in compliance with the tax laws for the subsequent five years as previously described. The taxpayer will also agree to offset any tax refund that he or she might be due for the current or previous years. If the taxpayer receives a tax refund for the year in which the offer is accepted, the taxpayer must return it. If he or she fails to do so, the offer may be retroactively denied and the tax liability reinstated.
Can accepted offers be renegotiated?
After an Offer in Compromise has been accepted by the IRS, some clients will be unable to pay the amounts that they offered. This might happen when the IRS increases the payment amount during negotiations above what the taxpayer can pay. In some cases, the evaluation of the offer takes a long time, and the taxpayer’s circumstances may have changed during the interim. If one of these situations occurs, you can try to renegotiate the accepted offer by sending a proposal in a letter in which the circumstances are detailed. The amount that is renegotiated must be paid in full before the IRS will accept the proposal. The IRS uses similar standards to evaluate a proposal for a renegotiated offer as it does when it evaluates an initial Offer in Compromise.
Remedies on appeal when an Offer in Compromise is rejected
If an offer is deemed to be processable but is subsequently denied after an investigation, the taxpayer can request an independent review. This review is conducted by the IRS Appeals Office. The notification that is sent by the IRS when an offer is rejected will include information about how to request the independent review. The taxpayer must file a written protest of the IRS’s decision within 30 days. This written protest can be sent on Form 13711. You can include new information with the written protest for evaluation by the examiner. However, the case file and protest are frequently just forwarded to the Appeals Office.
Under IRM 8.23.4, examiners also prepare Form 1271, which is a rejection memorandum. It includes a narrative report that details why the Offer in Compromise was rejected. If the offer was based on doubt about collectibility, the narrative will include detailed facts about an acceptable amount and term. This might be used as a basis for negotiation during an appeal.
You will not be sent this form automatically. However, because of its value in preparing for an appeal or creating a new offer, you should try to secure a copy either by making a request under the Freedom of Information Act or by asking the offer examiner directly for a copy.
When an offer is rejected, the taxpayer’s deposit will be refunded. However, the taxpayer can authorize the IRS to apply the deposit against his or her tax liability.
When you file your appeal, you must include the specific grounds. You will need to compare your Form 433-A with the income and expense and asset tables. You should include supporting documents for each point of disagreement that you identify.
If your case qualifies, an appeals conference will be scheduled. This conference is an informal process and is conducted through correspondence, phone, or an in-person meeting. The appeals office focuses on trying to settle tax controversies before they reach litigation. In many cases, a rejected Offer in Compromise can be renegotiated and settled through the IRS Appeals Office. However, it is better to try to negotiate a settlement before a case reaches the appeals stage.
How to negotiate an appeal
If you will be appealing a denial of your client’s Offer in Compromise, you will need to gather evidence and records to support your position. During the appeal, the Appeals Officer will communicate with you on your client’s behalf. To win your client’s appeal, you will need to be able to rely on your documentation, the IRM, case law, and the Internal Revenue Code.
Appeals Officers are prohibited from communicating with the examiner who rejected your client’s offer. This allows you to present your original case to the Appeals Officer if you believe that it is supported with enough evidence. You can also make the case stronger by submitting additional evidence before it is sent to Appeals.
The Offer in Compromise program offers taxpayers an opportunity for a fresh start. However, the IRS rejects a greater number of offers than it accepts each year. This makes it important for you to carefully consider whether it is the best strategy for resolving your client’s outstanding tax liabilities. If your client appears to qualify under one of the three categories and is eligible, paying careful attention while you are completing the forms and assembling all of the supporting documents can increase the chances that your Offer in Compromise package will be accepted. Taxpayers who want to submit Offers in Compromise will also need to remain in compliance with their current tax obligations as they accrue while the offer is pending and for five years after an acceptance is received. By meeting all of the requirements, the taxpayer can enjoy a new start while paying much less than his or her outstanding tax debt.