Offers in Compromise
Some taxpayers owe so much that an installment agreement (discussed in another article) is not a practical solution. Interest and penalties can accrue so quickly that the liability actually increases, despite the monthly payments. One option to consider is an "Offer in Compromise” (OIC). In 2012, the IRS adopted more flexible and friendly terms for OIC's under its "fresh start" initiative in order to help struggling taxpayers.
For all practical purposes there are only two grounds for such compromises -- "doubt as to liability" (handled by the IRS Examination Division) and "doubt as to collectability”. As the vast majority of submitted offers are based on doubt as to collectibility, which are investigated by the IRS Collection Division, this article will focus on this type of offer.
The IRS will accept an OIC only if it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects collection potential. The goal is to achieve collection of what is potentially collectible at the earliest possible time and at the least cost to the government.
An OIC must include all of the taxpayer's liabilities. Therefore, for income taxes, any unfiled returns must be prepared and filed so that the full liability can be determined. For withholding taxes or trust fund recovery penalties, assessments must be made for all quarters for which the taxpayer is potentially liable. If there are unfiled returns the IRS typically will not consider the offer anyway because the taxpayer is not in "current compliance", which is a requirement.
Submitting an Offer
An OIC is filed using IRS Form 656, accompanied by Form 433-A OIC and/or 433-B OIC. Note: The IRS made revisions to each of these forms in January, 2014, so be sure to submit the revised form(s). The 433 forms are collection information statements that provide complete financial and other information that form the basis for the IRS to evaluate the offer. The form(s) must be completed (including required attachments) in its entirety. Along with the offer, most taxpayers must send a $186 application fee. In addition, if the taxpayer makes a “lump-sum” cash offer (see below) 20% of the amount offered must be included with the offer. This amount is not refundable, even if the IRS rejects the offer. If the taxpayer makes an offer to pay the liability in installments, the first payment must be made with the offer, and future payments must be timely made while the offer is being evaluated. If there is a default in a payment, the offer will be returned without any appeal rights. The IRS is required to act upon the offer within two years, or the offer will be considered accepted. The ten-year statute on collecting the tax is suspended while the offer is being considered.
There are two types of payment plans:
Lump-sum cash offer – The offer amount must be paid within five or fewer months from the date of acceptance;
Periodic payment offer – 20% initial payment with your application with balance to be paid in successive months not to exceed 24 months from the date of acceptance.
Calculation of Amount to Offer
The minimum amount the IRS will accept (except in special circumstances) is based on the taxpayer’s reasonable collection potential (RCP). The RCP is 1) the total value of the taxpayer's assets less encumbrances which have priority over the federal tax lien (minus the exemptions allowed for certain assets) PLUS 2) the difference between monthly income and allowable expenses multiplied by a factor based on the type of plan and the time period in which the payments will be made. In a lump-sum cash offer paid in 5 or fewer months, the factor is 12; if paid in 6-24 months, the factor is 24. All offers must be fully paid within 24 months. For this reason it is highly advisable for a taxpayer to make the payments over 5 months. There are published national, regional, and local standards (updated annually) that the IRS uses to determine the allowable expenses to be deducted from the taxpayer’s monthly income to arrive at the pre-factor amount. It is the policy of the IRS to not deviate from the prescribed standards absent a clear showing that it would be detrimental to the taxpayer’s health and well being.
The IRS considers offers processable unless one or more of the following problems exist:
The taxpayer or tax liabilities are not properly identified;
An out-of-date Form 656 is used;
No amount of money is offered;
Required financial statements are not provided or are incomplete;
The amount offered is less than the value of the taxpayer’s assets;
A Social Security number or employer identification number is missing or incorrect;
The offer is not properly signed; or
The offer is submitted to delay or impede IRS collection efforts
Investigation of an Offer
The IRS recently announced that its employees will be allowed to consider a taxpayer’s current income and potential for future income when investigating an OIC and negotiating an offer amount. It has been the practice to judge an offer based on a taxpayer’s earnings in prior years or periods. Now it may require that a taxpayer entering into an offer must agree to pay more if his or her financial situation significantly improves.
In determining a taxpayer’s RCP, an investigator must determine his or her ability to pay based not only upon assets and available income, as previously mentioned, but other factors such as age, health, education, and occupation. It is trying to determine whether future income may increase. Conversely, the IRS should not use past or recent earnings if there is a legitimate expectation that those earnings will not continue.
If an Offer is Rejected
The tax law requires the IRS to perform an independent administrative review of the rejection before notifying the taxpayer that the offer has been rejected. If the rejection is sustained the taxpayer will be notified by mail. He or she then has 30 days to request an Appeals hearing. While the taxpayer cannot contest the rejected offer in court, he or she can submit another offer.
If an Offer is Accepted
In addition to celebrating the victory, the taxpayer must:
Promptly pay any unpaid amounts due under the terms of the agreement;
Notify the IRS if not able to comply with the agreed upon terms;
Timely file all tax returns for the next five years and pay all taxes in full;
Forfeit any overpayments that may be due for the year in which the offer is accepted.
DEAL BREAKER: Failure to follow the above requirements can result in a previously accepted offer being terminated and a taxpayer being required to pay the remaining tax balance in full.
An OIC is a contract. It is conclusive and binding on both the IRS and the taxpayer, and precludes further inquiry into the matters it covers. In the absence of fraud or mutual mistake, the courts have denied either party recovery of any part of the consideration given. However, an offer which was accepted under a mutual mistake as to a material fact, or because of false representations about a material fact, may be set aside.
Resolving Your Tax Debt: An Introduction
Federal Tax Liens
How the IRS Collection Process Works
The Taxpayer Bill of Rights