If you’ve found yourself in debt to Uncle Sam, there are many ways to pay what you owe, including working out an installment payment plan with the IRS.
What you might not know is that you could also potentially qualify for what is known as an IRS offer in compromise — a program that allows you to settle your debt for less than the amount you owe.
[READ : Do You Owe the IRS? How to Find Out]
Qualifying for an IRS offer in compromises is difficult. Not only do you have to prove you’re unable to pay back what you owe, the application process can take quite a long time. Still, these offers can be a huge help if you’re struggling to get out from under a debt load.
Read on to learn more about IRS offers in compromise and how to apply — then decide if this is the right debt-payoff solution for you.
What Is an IRS Offer in Compromise?
An offer in compromise refers to an agreement with the government to settle your tax debt for less than you owe, and there are a few different kinds of these offers.
Logan Allec, CPA and founder of Choice Tax Relief, explains the difference:
“The most common is ‘doubt as to collectibility;’ a situation in which you’re arguing to the government that you cannot afford to pay the entire amount you owe, so you are offering a certain amount that represents the amount you can afford to pay,” he says.
With “doubt as to liability,” he says, you’re arguing to the government that you do not actually owe the tax they think you do — or at least not all of it.
The least common offer is effective tax administration, Allec says. In this case, you’re arguing to the government that while you do owe the tax and you can pay it, it would be unfair based on principles of undue hardship or public policy to force you to pay the tax.
“These offers in compromise are rarely submitted and even more rarely accepted — you basically have to have a really good story, often involving a debilitating or terminal illness or some other extreme life circumstance,” he adds.
Most people who think of an OIC are actually thinking of doubt as to collectibility, which is when an individual reaches a settlement with the IRS for less than the full amount of tax debt they owe because they can’t not afford to pay the entire bill.
State Income Tax Offer in Compromise
The most common offer in compromise is for federal tax debt but some states offer programs for state tax debt as well.
According to Allec, most states that charge income tax have some kind of OIC program, but they are typically much more difficult to qualify for than a federal program.
“Part of this is that states are simply more stingy overall than the federal government and do not have the immense borrowing capacity that the federal government does. And with the exception of Vermont, they have to balance their budgets,” Allec says.
Additionally, states have more time to collect tax debt, and therefore are more likely to be able to collect from the taxpayer, he says.
Who Qualifies for an IRS Offer in Compromise?
Paul Koullick, founder and CEO of Keeper tax software, warns those hoping for an offer in compromise that the road will be a tough one. Eligibility requirements are strict.
“The bar here is pretty high. You can’t be in bankruptcy and you have to be caught up on your back taxes. If you’re self-employed, like a freelancer or gig worker, you also have to be up to date on all your quarterly tax payments. And it’s incredibly common for people to miss those,” Koullick says.
[How to File Taxes When You Are Self-Employed]
In addition, Koullick explains, the IRS won’t approve your offer if your assets demonstrate that you can afford to pay back your debt. So, if you have funds stashed in a 401(k), for instance, before getting an OIC you’d be expected to withdraw them and pay the penalty to pay your tax debt.
“There are possible exceptions, like having a serious illness, or maybe caring for a loved one who has a serious illness and can’t work. But the IRS wants you to dig deep, sell your assets and pay everything you can, not just pay with whatever liquid cash you have on hand,” Koullick says.
Jon Morgan, CEO and editor in chief at Venture Smarter, a business consultancy firm, adds that the IRS will want to see that applicants have made significant efforts to pay off their debts before turning to an OIC.
“The IRS considers several factors when determining eligibility, including a taxpayer’s financial situation, ability to pay and the amount of tax owed. The IRS will also consider whether the taxpayer has made a good faith effort to pay their tax debt, such as setting up a payment plan or making partial payments,” Morgan says.
Allec offers a formula that will help predict if you will qualify, based on the application forms:
1. Determine your monthly gross income.
2. Subtract tax withholdings and necessary living expenses, per IRS guidelines, to get your net disposable income.
3. Multiply your net disposable income by the number of months remaining until your IRS debt drops off.
4. If the result of this calculation is greater than your IRS debt, you don’t qualify for an offer in compromise; if the result is lesser than or equal to your IRS debt, keep going.
5. Multiply your net disposable income by 12.
6. Add your net equity in assets.
“If the result is less than your amount of tax debt, then you just might qualify for an offer in compromise,” Allec says.
[Read: How to File Taxes for Free.]
How to Apply for an IRS Offer in Compromise
Before you apply for an offer in compromise, consider consulting a tax professional or tax attorney. Like most government paperwork, the OIC process can be confusing and tedious, so having an expert to guide you can help you avoid mistakes and maximize your chances of approval.
To apply for an offer in compromise, you’ll need to complete the following, per the IRS:
— Form 433-A (OIC) (individuals) or 433-B (OIC) (businesses) and all required documentation as specified on the forms.
— Form 656(s) — you must submit individual and business tax debt (Corporation/ LLC/ Partnership) on separate Forms 656.
— $205 application fee (nonrefundable).
— Initial payment (nonrefundable) for each Form 656.
Documentation for Form 433-A (OIC) will include things like bank statements and pay stubs, Allec says. This is what the IRS will use to do the math and check your assets as well as calculate your offer in compromise amount.
The initial payment will be 20% of your offer in compromise amount for lump sum cash offers in compromise. The payment amount varies for periodic payment OICs,, and you’ll have to continue making monthly installment payments while you await approval.
Low-income applicants might qualify for exemption from the application fee and initial payment. The IRS Form 656-B booklet offers more information on who qualifies for this option. Note, the IRS released a new version of this form in April 2023, so make sure you are using the latest option.
IRS Offer in Compromise Acceptance and Payment Plan
After you submit your application, the IRS will review your offer and assets to decide if your OIC is accepted or rejected.
“It could take a good year before you hear from the IRS about your offer in compromise,” Allec says.
If your offer is accepted, payments vary depending on the type of offer you’re approved for. If you applied for periodic payments, you should have made installment payments while you awaited approval. After approval, you’ll continue to make monthly payments until the balance is paid in full.
With a lump sum cash OIC, you will have submitted a 20% initial payment with your application. After you’re accepted, you must pay the remaining balance in five or fewer payments.
Alternatives to an IRS Offer in Compromise
If you don’t qualify for an IRS offer in compromise, don’t fret. There are a couple of other options for managing your tax debt, including setting up an installment payment plan with the IRS or making partial payments to minimize penalties. Consider consulting a tax professional about which option is best for you.
[READ: What Happens if You Don’t Pay Your Taxes?]
Is an IRS Offer in Compromise Worth it for You?
“An offer in compromise is a way to get out of an unaffordable tax burden by getting the IRS to accept your best offer. The remainder of your debt is settled completely — you don’t have to pay it back at any point in the future,” Koullick says.
That said, an OIC might not be achievable for everyone seeking one, and you will have to come up with your application fee and initial payment. Consider all possible solutions before deciding if an offer in compromise is right for you.
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IRS Offer in Compromise: Everything You Need to Know originally appeared on usnews.com
Update 02/20/24: This story was published at an earlier date and has been updated with new information.
