Understanding Offers in Compromise

Taxes can be tricky and a bit tedious to discuss, but when we fall behind in the quest to pay them back, things get a little more complicated. It may be tempting to take up an offer you see in an ad from companies who promise to help you erase your total Internal Revenue Service (IRS) debt, but the prospect of this is highly unlikely. 

There may be certain scenarios where creditors will forgive debt from things like student loans or credit cards, but the IRS functions differently. While there are other options for paying down tax debt such as payment plans or installment agreements, an Offer in Compromise (OIC) functions more similarly to debt forgiveness. 

If you’re seeking some form of relief from IRS tax backpay, you’re better off looking into an offer in compromise.  In the below sections, we will discuss offers in compromise in further detail so that you can decide whether or not this is a good option for you. 

What is an offer in compromise?

If you owe more to the IRS than you can afford to pay back, you might be able to get relieved through what is referred to as an “offer in compromise.” An Offer in Compromise (OIC) allows you to settle your back taxes for an amount that is smaller than what you actually owe. 

When evaluating your application for an offer in compromise, the IRS will take into consideration a number of factors such as your:

  • Income.
  • Ability to pay.
  • Total expenses.
  • Assets.

Generally, an offer in compromise gets approved when the amount offered is close enough to the amount that the IRS can expect to collect within a sensible time period. 

Making sure that you are eligible

Before submitting an OIC application, you might want to make sure that you meet all of the eligibility requirements. Keep in mind that if you haven’t filed all of your required tax returns and/or have failed to make any required estimated payments, the IRS will return your OIC application along with any fee that you sent with it. 

If you are currently taking part of an open bankruptcy proceeding, you are automatically ineligible to apply. 

If you are unsure whether or not you are eligible to submit an OIC application, you can use the Offer in Compromise Pre-Qualifier tool to find out. 

What happens if you can’t pay your tax bill?

The short answer to this question is: If you can manage to pay off your tax bill, it will save you money for the long haul. The reason for this is simply because the IRS will charge interest and penalties on any past-due unpaid taxes until you are able to pay off the full amount—regardless of whether or not you are on a payment plan or get approved for an OIC.

If you’re having trouble paying back the taxes you owe, the most detrimental thing you can do is try to avoid it. It’s extremely important to make this a priority, as failing to do so can result in the IRS placing a federal tax lien against your property or even perhaps your wages being garnished through a federal tax levy.

This is why making moves toward a payment plan, or an OIC for more severe situations, is the best way to avoid the worst outcomes of a stressful situation. 

How to know if an offer in compromise is right for you

An OIC is a viable option for you if you have no way of paying back tax debt or if attempting to would put you in financial hardship. Due to the nature of this type of tax relief, it’s somewhat difficult to get the IRS to approve an application for an Offer in Compromise. Less than half of the applications get accepted, so it’s important to look into your other options first. 

It’s safe to say that the criteria for getting approved are pretty firm. These are the different cases in which the IRS will consider you for an OIC:

  • Effective tax administration: When there is no question as to the amount that you owe, however, paying the tax bill in full would cause you financial hardship OR there are special factors pertaining to your specific situation that would make it unfair for the IRS to garner the full balance. 
  • Doubt as to collectability: If your total assets combined with amount of income are smaller than the total amount of tax liability, then the IRS might have reason to believe that your tax debt isn’t collectable. 
  • Doubt as to liability: If there is a legitimate dispute about how much you owe, or whether or not you owe a balance at all. 

Here are some other qualification requirements that you will need to keep in mind when applying:

  • You must have filed all of your required tax returns.
  • You must have received at least one tax debt bill that you are including in your offer. 
  • All of your required estimated tax payments must be paid for the current tax year. 
  • If you own a business and have employees, you must have made all of the required federal tax deposits for the present quarter. 
  • If you are a business owner, you must not be a part of a current open bankruptcy process.
  • You cannot have an open audit with the IRS.
  • You cannot have an innocent-spouse claim with the IRS.
  • Your case must not have been referred to the Department of Justice by the IRS. 

Applying for an offer in compromise

If you’re looking at your options and feel like an Offer in Compromise might be the best choice for your financial situation, you might want to take a look at the Offer in Compromise Booklet, Form 656-B (PDF) 

If after doing all your research, you feel overwhelmed and unsure, think about hiring a tax professional to help you navigate the form and guide you through the process. Otherwise, you will find the step-by-step information you need in the booklet above. 

Your finalized offer package should consist of:

  • Form 433-A (OIC) if you’re applying as an individual OR Form 433-B (OIC) if you’re applying for your business; along with all of the required documents that the form specifies. 
  • Form 656(s): If applying for both individual and business tax debt (such as Corporation, LLC, or Partnership), they must be submitted on separate Form 656(s). 
  • A non-refundable application fee of $186.
  • An initial payment for each Form 656 that you submit. 

Payment options for the initial payment

The initial payment you will be required to make is going to depend on the offer you submitted and the payment option you decide on. Here are the different options:

  • Lump Sum Cash: With this option, you will pay 20% of the total offer amount along with your application. You will receive written confirmation if the IRS approves your offer. If your offer is accepted, you will continue to pay the remainder of your balance in five payments or less. 
  • Periodic Payment: With this option, you will submit the initial payment along with your application. Then, you would pay down the remainder in a series of monthly payments spanning over six months to two years, depending on the terms of your offer. Keep in mind that you will need to continue making payments while the IRS is reviewing your application or else it will automatically be unapproved without an option to appeal.*

While the fees and payments are nonrefundable, the amounts do get put toward your total tax liability, in the event that you are not approved.  

*NOTE: The only exception to this is if you qualify for low-income. A low-income exception can be made so that you are not responsible for an initial payment OR making monthly installments during the time that your application is being considered.

Next steps

If your Offer in Compromise gets accepted, you will have to make sure that you follow the terms of the agreement you made. 

If for whatever reason, you fail to meet the terms of the agreement, the IRS is entitled to sue you for the original balance of your tax bill with penalties and interest tacked on. 

If your Offer in Compromise is rejected by the IRS, you are granted 30 days to file an appeal. 

Final Thoughts

Tax problems shouldn’t be taken lightly. While owing money to the IRS isn’t exactly a walk in the park, it’s good to be on top of your liability so as to avoid future problems.  If you’re unable to pay your full tax bill all at once, then you should look at a payment plan first.

If you’re still unable to pay off your tax debt with a monthly payment plan, then it might be time to look into an Offer in Compromise with the IRS.

An OIC isn’t easy to come by and you will need to meet a list of qualifications in order to apply and get approved and follow the terms if you are accepted. 

Carefully read through all of the rules and requirements before applying to make sure that everything is done properly. If the process is ruled in your favor, you might be able to settle your tax debt for less than the full amount that you owe.

Getting a handle on your tax debts starts with being honest with yourself and your current financial situation. Don’t wait until it’s too late to make the right arrangements.