If IRS is after you to collect a tax liability that’s beyond your capacity to pay, you should be aware of a technique that may allow you to settle your tax debt for a fraction of its face value. It’s called an offer-in-compromise (OIC).

Like any creditor, IRS prefers a partial payment to no payment at all.

Thus, IRS is sometimes willing to settle a tax liability for less than the full amount if

(a) the taxpayer is unable to pay the full amount,

(b) there is doubt as to how much the tax liability is,

(c) collection of the liability would create economic hardship for the taxpayer (such as where the taxpayer is out of work due to health problems, or where sale of assets to pay the tax would leave the taxpayer without enough money to meet basic living expenses), or

(d) compelling public policy or equity considerations exist, and due to the exceptional circumstances IRS’s collection of the full liability would undermine public confidence that the tax laws are being fairly and equitably administered. Exceptional circumstances for this purpose might include situations where a taxpayer relies on erroneous advice from IRS, or a medical condition prevents a taxpayer from managing his financial affairs.

The taxpayer starts the settlement process by making an offer-in-compromise. If the offer is grounded on any reason other than doubt as to how much the tax liability is, financial information must be submitted along with the offer. If it is grounded on doubt as to the liability, IRS is not permitted to request a financial statement.

Except where the offer is based only on doubt as to liability or where the offer is filed by a low-income taxpayer, the taxpayer is required to make partial payments to IRS while the offer is being considered by IRS. For lump-sum offers (which include single payments as well as payments made in five or fewer installments), taxpayers must make a down payment of 20% of the amount of the offer with the application. For periodic payment offers, the taxpayer must comply with the taxpayer’s own proposed payment schedule while the offer is being considered.

Except where the offer is based only on doubt as to liability, the taxpayer must agree to comply with all tax law rules on filing returns and paying taxes for five years or until the offered amount is paid, whichever period is longer. If these requirements are not met, the compromise terminates and IRS can seek collection of the original liability amount.

A streamlined offer-in-compromise program is available for taxpayers with annual incomes up to $100,000. In addition, participants must have tax liability of less than $50,000.

An offer must be submitted in writing on IRS’s Form 656. Oral offers in compromise are invalid.

A $5,000 penalty applies to any person who submits an application for a compromise (or submits any one of certain other types of specified submissions) if any portion of the submission is either based on a position which IRS has identified as frivolous, or reflects a desire to delay or impede the administration of federal tax laws. However, the penalty is clearly aimed at those who abuse the process and should not deter taxpayers with legitimate offers from using the compromise process.

The IRS is authorized to enter into an OIC agreement with a taxpayer to settle a tax debt at a lower amount than what the taxpayer generally owes. It offers eligible taxpayers a path toward paying off their debt and getting a “fresh start.” Generally, when proposing an OIC to the IRS, you must pay an application fee and provide an initial non-refundable lump sum payment. However, the IRS has the authority to waive these payments for low-income taxpayers. Additionally, you must make an appropriate offer based on what the IRS considers your true ability to pay. There is no assurance that the IRS will accept your offer. Generally, the IRS will not accept an offer if you can pay your tax debt in full via an installment agreement or a lump sum. However, given your situation, I believe there is a good chance the IRS will accept an appropriate offer in compromise.

There are several requirements that must be met in order to file an offer in compromise. First, before we submit your offer, you must file all tax returns you are legally required to file and make all estimated tax payments for the current year. [In addition, as a business owner with employees, you must make all required federal tax deposits for the current quarter.]

Also, you should be aware that penalties and interest will continue to accrue during the time the IRS is evaluating your offer.

If you do not have sufficient cash to pay for your offer, you may need to consider borrowing money from a bank, friends, and/or family. Other options may include borrowing against or selling other assets. Note that, if retirement savings from an IRA or 401k plan are cashed out, there may be future tax liabilities owed as a result.

If your offer is accepted, you must continue to timely file and pay your tax obligations. If you fail to file and pay your required tax returns, before your offer is paid in full, or for five years after your offer is accepted, whichever is longer, your offer may be defaulted. If your offer is defaulted, all compromised tax debts will be reinstated.

In order to prepare an offer in compromise that the IRS will accept, we will need to work together to calculate an appropriate offer based on your assets, income, expenses, and future earning potential. We will have to describe your financial situation in detail and provide the IRS with documentation that supports our position. Please call me when you have the necessary information and documentation. Then we can set up a meeting and prepare the offer in compromise.

YAHNIAN LAW CORPORATION has prepared and successfully achieved offers in compromise for many clients.

Please call if you would like to discuss whether submitting an offer-in-compromise would be beneficial to you.

Rejected Offer in Compromise

At times,  the IRS decides that settling the tax debt based upon your offer in compromise is not in the IRS’s best interest.

There are several options at this point in time, including resolving the tax dispute through an appeal or by submitting another offer in compromise.

You may appeal the IRS’s decision to reject your offer in compromise by the date in the IRS Decision letter . In that case, the IRS Appeals Office will review the rejection decision internally and may or may not decide that the IRS acted properly in rejecting the offer. The appeal process is a good time to submit any information that the IRS did not consider in the original application, including any special circumstances that the IRS did not learn about from the original application. The IRS is prohibited from attempting to collect the tax debt from you while the IRS reconsiders your offer.

Additionally, you may submit another offer in compromise. A second application fee is required for the second offer. Also, the amount offered to settle the tax debt must be increased from the first offer unless your financial situation has changed. Generally your financial statement must be updated with the IRS to file the second offer in compromise.

Time is of the essence in filing an appeal because the IRS only permits an appeal to be filed within 30 days from the date of the rejection letter and you may need to update your financial statement.