How Offers in Compromise Can Help You Settle Overwhelming Tax Debts
An Offer in Compromise (OIC) is a program offered by the Internal Revenue Service (IRS) that allows taxpayers to settle their tax debts for less than the full amount owed. This program is particularly beneficial for individuals who are unable to pay their full tax liability or if doing so would create a financial hardship. The purpose of an OIC is to provide a path for financially distressed taxpayers to resolve their tax liabilities in a manner that is fair and equitable for both the taxpayer and the government.
Purpose of an Offer in Compromise - The primary goal of an OIC is to facilitate tax debt resolution for taxpayers who are unable to pay their full tax liabilities. By allowing taxpayers to settle their debts for less than the full amount, the IRS aims to collect what it can, rather than potentially collecting nothing if the taxpayer declares bankruptcy or remains unable to pay. This program also helps taxpayers avoid the long-term financial strain and stress associated with unresolved tax debts.
Requirements for Filing an OIC - Before submitting an OIC, taxpayers must ensure that all required tax returns have been filed. The IRS will not consider an OIC application if the taxpayer has outstanding tax returns or is involved in an open bankruptcy proceeding. Additionally, taxpayers must be up to date with their estimated tax payments for the current year, and employers must have made tax deposits for the current and past 2 quarters before applying. If these requirements are not met, the IRS will return the application without consideration, although any initial payment submitted with the offer will be applied to the outstanding tax debt.
Application Fee and Partial Payment Requirement - Submitting an OIC requires a $205 application fee. However, this fee may be waived for individuals or sole proprietors whose household gross income meets low-income guidelines. Along with the application fee, taxpayers must make a nonrefundable, up-front payment. For lump-sum offers, 20% of the offer amount must be paid with the application, with the balance paid in five or fewer installments within five months of acceptance. For periodic payment offers, the first payment must be made with the offer, and the remaining balance paid within 6 to 24 months according to the proposed terms.
Possible Upfront Payment Waivers and Low-Income Offers - The Taxpayer First Act amended the Internal Revenue Code to waive the OIC application fee for individuals whose adjusted gross income (AGI) does not exceed 250% of the applicable poverty level. Taxpayers who qualify under these guidelines are not required to make the initial payment with their offer.
Grounds for an OIC - An OIC can be based on doubt as to liability, doubt as to collectability, or to promote effective tax administration.
o Doubt as to Liability - Doubt as to liability exists when there is a genuine dispute about the existence or amount of the tax debt.
o Doubt as to Collectability - Doubt as to collectability arises when the taxpayer's assets and income are insufficient to pay the full amount.
o Effective Tax Administration - Offers based on effective tax administration are considered when collecting the full amount would create an economic hardship or be unfair due to exceptional circumstances.OIC Procedures and Processing - The OIC process begins with the taxpayer submitting a request for an offer in compromise, along with the necessary financial documentation. An offer can be submitted by individuals, including those who are self-employed, or for business entities. The IRS will conduct a thorough analysis of the taxpayer's financial situation, including the taxpayer's income, expenses, assets, and liabilities.
The IRS uses national and local standards to determine allowable living expenses, which are essential for the taxpayer's health and welfare or for the production of income. If a taxpayer's expenses exceed these standards, they must provide reasonable substantiation.
Accepted and Rejected Offers - If the IRS accepts an OIC, the taxpayer will receive written notice, and prompt payment and compliance with the offer terms are required to prevent default. Once the payment terms are met, the IRS will release any Notices of Federal Tax Lien against the taxpayer. For offers involving more than $50,000, a written opinion from the IRS Chief Counsel is required.
Rejected offers are not considered final until the IRS issues a written notice of rejection. Taxpayers have the right to request a meeting to discuss alternative solutions or file a protest with appeals within 30 days of rejection. The application fee is not refunded, but taxpayers can submit another offer with a new application fee.Analysis of a Taxpayer’s Financial Information - The IRS conducts a detailed analysis of the taxpayer's financial information to determine the amount of disposable income available to apply to the tax liability. This analysis includes reviewing the taxpayer's income, expenses, and assets to assess their ability to pay. The IRS expects taxpayers to pay a tax liability equal to the amount over and above necessary expenses.
o Necessary Expense Test - The necessary expense test is used to determine which expenses are essential for the taxpayer's health and welfare or for income production. Allowable expenses include basic living costs such as housing, utilities, food, transportation, and healthcare. Taxpayers must provide documentation for any expenses that exceed the standard amounts.
o Taxpayer Assets and Living Expenses - The IRS evaluates a taxpayer's reasonable collection potential by considering their assets, future income, and allowable living expenses. Assets are assessed at their quick sale value, which is the amount the IRS believes could be obtained from selling the asset quickly. The realizable value is the amount the IRS expects to collect after accounting for any encumbrances.
o Future Income and Necessary Expenses - Future income is a critical component in determining a taxpayer's ability to pay. For OICs paid in five or fewer months, the IRS considers one year of future income, while for offers paid in six to 24 months, two years of future income is considered. Necessary expenses are those that meet the necessary expense test, which defines expenses essential for the taxpayer's health and welfare or for income production.
o Considerations for Unemployed Taxpayers - Unemployed taxpayers may face additional challenges in meeting their tax obligations. The IRS considers the taxpayer's current financial situation, including unemployment, when evaluating an OIC. Taxpayers must provide documentation of their unemployment status, and any unemployment benefits received.Lump Sum and Periodic Payments - Taxpayers can choose between lump-sum and periodic payment options when submitting an OIC. Lump-sum offers require a 20% initial payment, with the balance paid in a short period. Periodic payment offers allow for more extended payment terms, providing flexibility for taxpayers with limited immediate resources.
Tax Liens - The IRS may file a Notice of Federal Tax Lien to protect the government's interest during the OIC investigation. If the offer is accepted, the lien will be released once the terms of the offer are satisfied. Taxpayers should be aware that tax liens can impact their credit and ability to obtain financing.
Filing an offer in compromise with the IRS is a complex and time-consuming process that can significantly benefit from the expertise of a tax professional. Tax professionals are well-versed in the intricacies of tax law and the specific requirements of the offer in compromise program, which can help ensure that the application is completed accurately and efficiently. They can determine the most suitable type of offer for the taxpayer's situation, whether it be doubt as to collectability, doubt as to liability, or effective tax administration. Additionally, tax professionals have experience working with the IRS, which can expedite processing times and provide valuable insights into what the IRS is looking for in a successful offer. By handling the detailed paperwork and potential appeals, tax professionals can save taxpayers time and reduce the stress associated with the process, increasing the likelihood of a favorable outcome. Please contact this office for assistance.
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