OFFER-IN-COMPROMISE

     An offer in compromise (OIC) allows taxpayers to settle their tax liabilities for less than the full amount.

     If taxpayers are unable to pay a tax debt in full and an installment agreement is not an option, they may be able to take advantage of an OIC. Generally, an OIC should be viewed as a last resort after taxpayers have explored all other available payment options. The IRS resolves less than one percent of all balance due accounts through the OIC program. An OIC is not available if the taxpayer is a debtor in an open bankruptcy proceeding.

     An offer in compromise is an agreement between a taxpayer and the IRS that resolves the taxpayer's tax debt. The IRS has the authority to settle, or "compromise," federal tax liabilities by accepting less than full payment under certain circumstances. A tax debt can be legally compromised for one of the following reasons:
          Doubt as to liability - Doubt exists that the assessed tax is correct.
          Doubt as to collectibility - Doubt exists that the taxpayer could ever pay the full amount of tax owed.
          Effective Tax Administration - There is no doubt the tax is correct and could be collected but an exceptional circumstance exists that allows the IRS to consider a taxpayer's OIC. To be eligible for a compromise on this basis, the taxpayer must demonstrate that collection of the tax would create an economic hardship or would be unfair and inequitable.

     The objective of the OIC program is to accept a compromise when it is in the best interests of both the taxpayer and the government and promotes voluntary compliance with all future payment and filing requirements.

     All taxpayers who submit a Form 656, "Offer in Compromise" must pay a $150 application fee except in two instances:
    1.     The OIC is submitted based solely on "doubt as to liability;" or
    2.    The taxpayer's total monthly income falls at or below 250% of the Department of Health and Human Services poverty income levels.

     In addition to the Form 656, the IRS requires extensive information about the assets, liabilities, income and expenses of the taxpayer, and also requires information about the taxpayer’s spouse and other members of the household. The IRS applies the community property law of the state in which the taxpayer lives to determine the taxpayer’s financial position. Therefore, if a taxpayer is contemplating marriage, he or she should consider a pre-nuptial agreement specifying that the future spouse's wages are his or her separate property.

     Except in the case of “special circumstances” described in the next paragraph, the OIC amount must equal or exceed the IRS’s evaluation of the taxpayer’s reasonable collection potential (“RCP”) amount. The information provided on the collection information statements assists the IRS in determining the RCP. The RCP equals the net equity of the taxpayer’s assets plus the amount the IRS could collect from the taxpayer’s future income. Assets are valued at their "quick sale" value, usually 80% of their fair market value. If the IRS’s financial analysis indicates that the taxpayer has the ability to fully pay the tax liability, either immediately or through an installment agreement, the OIC will be rejected. The taxpayer must offer an amount greater than or equal to the RCP amount. All offer amounts must exceed zero. Since taxpayers cannot offer an amount that the IRS can otherwise collect, an OIC is usually made by borrowing funds from a third party (almost always a friend, relative or significant other) and making a lump-sum cash offer from the borrowed funds.

     If there are special circumstances, the IRS may waive the RCP amount. If special circumstances cause the taxpayer to offer an amount less than the RCP, the taxpayer must explain the circumstances on Form 656, and the taxpayer must also attach to Form 656 any supporting documents to help support the taxpayer’s special circumstances. Special circumstances may include factors such as advanced age, serious illness from which recovery is unlikely, or any other factors that have an impact upon the taxpayer’s ability to pay the total RCP and continue to provide for the necessary living expenses for the taxpayer and the taxpayer’s family.

     The IRS usually cannot levy or sell leased property, so taxpayers contemplating an OIC should lease their automobiles and furniture, rent an apartment and avoid acquiring assets in his or her name. However, a taxpayer should not transfer assets to another, as this could run afoul of the fraudulent transfer prohibitions. Owned assets should be valued at the lowest supportable price. Used furniture, equipment, and clothing are usually worth a small fraction of their original price. Low blue book should be used for automobiles and then reduced further for needed repairs, excess mileage or other reasonable damage. The value of an owned home should be reduced by accrued taxes and repair costs. A contractor should provide an independent valuation of the home’s condition and estimated repair costs.

     The Internal Revenue Code requires that a taxpayer filing a lump sum offer must pay 20 percent of the offer amount with the application. A lump sum offer means any offer of payments made in five or fewer installments. A taxpayer filing a periodic payment offer (i.e. any offer of payments made in six or more installments) must pay the first proposed installment payment with the application and pay additional installments while the IRS is evaluating the offer. If the taxpayer fails to make an installment payment other than the first installment, the failure may be treated as a withdrawal of the offer. The IRS considers the 20 percent payment for a lump sum offer, and the installment payment on a periodic payment offer, as "payments on tax" and are not refundable regardless of whether the offer is declared not processable or is later returned, withdrawn, rejected or terminated by the IRS. Taxpayers may designate the application of the required payments. The designation must be made in writing when the offer is submitted and must clearly specify how the partial payments are to be applied to a particular tax period(s) and to specific liabilities (e.g. income taxes, employment taxes, trust fund portions of employment, excise tax, etc.) Taxpayers may not designate how the $150 application fee is applied. Once the taxpayer specifies how a payment is to be applied, the specification cannot later be changed. In the absence of a specification, the Service will apply the payment or payments in the best interests of the government. A taxpayer who qualifies for a low-income exception waiver or is filing a doubt as to liability offer is not required to pay the 20 percent payment on a lump sum offer or the initial payments required on a short term or deferred periodic payment offer.

     The Internal Revenue Code provides that if an offer in compromise is not rejected within 24 months after submission of the offer, the offer shall be deemed to be accepted.

     The IRS expects a taxpayer requesting an OIC to file all delinquent tax returns and pay any required estimated tax payment. IRS will notify taxpayers and provide 30 days to file delinquent returns or make the required estimated tax payments. Failure to comply will cause the IRS to return the offer back to the taxpayer. The $150 application fee along with all payments previously paid will be retained by the IRS and applied to the taxpayer’s liability.

     The IRS is cautious to avoid providing financial advantages to operating businesses through the forgiveness of tax debt. This may create the appearance that the delinquent business has been able to profit from its failure to pay, giving it an advantage over other, fully compliant businesses. Businesses that have employees are expected to have paid all required federal tax deposits for the current quarter in order for their offer to be evaluated. If the IRS determines that the required deposits have not been paid, the taxpayer will be provided with a reasonable amount of time to pay the deposits before the IRS proceeds with the investigation. In addition, the business will be expected to remain current on all filing and deposit requirements while the offer is being investigated. Failure to either pay the deposits as requested, remain current with filing or pay all deposits that become due while the offer is under investigation will cause the IRS to return the offer back to the taxpayer. The $150 application fee along with all payments previously paid will be retained by the IRS and applied to the taxpayer’s liability.

     In order to avoid defaulting an OIC once accepted by the IRS, taxpayers must remain in compliance in the filing and payment of all required taxes for a period of five years or until the offered amount is paid in full, whichever is longer. Failure to comply with these conditions will result in the default of the OIC and the reinstatement of the tax liability.

     If there is a Notice of Federal Tax Lien on record prior to filing the OIC, the lien is not released until the OIC terms are satisfied, or until the liability is paid, whichever comes first. A Notice of Federal Tax Lien may be filed during the course of an OIC investigation regardless of the type of offer being considered.

     The taxpayer has the right to appeal any offer rejected to IRS Office of Appeals.

     The statute of limitations for assessment and collection of a tax debt is suspended while an OIC is "pending," or being reviewed. The OIC is pending starting with the date an authorized IRS employee determines the Offer in Compromise Application is ready for processing. The OIC remains pending until the IRS accepts, rejects, returns or acknowledges withdrawal of the offer in writing. If a taxpayer requests an Appeals hearing for a rejected OIC, the IRS will continue to treat the OIC as pending. Once the Appeals office issues a determination in writing to accept or reject the OIC then the pending status is removed.

     The IRS cannot levy (seize) a taxpayer's property while an offer is pending and during a 30-day period after an offer is rejected. If the rejected offer is appealed, the prohibition against a levy continues.