Offer in Compromise
An offer in compromise - An Offer In Compromise (“OIC”) allows a taxpayer to settle their tax debt for less than the full amount owed. It may be a legitimate option if a taxpayer cannot pay their full liability or doing so would create a financial hardship.
You have probably heard of people who claim to be able to settle IRS debts for “pennies on the dollar”. The Offer In Compromise is generally what these people are referring to and unfortunately, many times these claims prove to be false. The IRS occasionally makes deals – however, there is no “tax debt fire sale” going on with the IRS.
Submitting an Offer In Compromise is a very formal process. The IRS requires extensive information concerning the taxpayer’s assets, income, and expenditures as well as documentation. The IRS looks at the taxpayer’s income and assets to make a determination of the taxpayer’s reasonable collection potential.
We can assist you in navigating this complicated process and in determining how much to offer in your unique situation.
To be eligible to file an OIC, the taxpayer must be current with all filing and payment requirements. Also, the taxpayer cannot be in an open bankruptcy proceeding.
In determining the amount of an offer that will be acceptable when there is doubt as to collectability, the IRS will require the total amount to be equal to (a) the net realizable value of the taxpayer’s assets that the IRS could seize, plus (b) the value of the total sum that the IRS could collect over a specified period under a monthly payment plan (taking into account the taxpayer’s future income less what the IRS considers “Allowable Living Expenses”).
For purposes of an Offer In Compromise, a taxpayer’s assets include most items one would normally think of including bank accounts, real estate (including a primary residence), vehicles, and so forth. Amounts in individual retirement accounts, vested balances in 401(k) plans, and similar retirement assets must be included in the asset calculations although they can be discounted for income taxes and penalties that would be incurred if you cashed them out. IRS Publication 594, titled The IRS Collection Process lists the types of property that cannot be seized. (There aren’t many.)
In general terms, the net realizable value of a taxpayer’s assets is the value the IRS believes it could get if it seized the taxpayer’s assets and sold them, after paying off any debts associated with the assets. Generally the IRS allows a “quick sale value” in determining the net realizable value of a taxpayer’s assets which is 20% less than fair market value. For example, if a taxpayer owns their personal residence which has a fair market value of $150,000, the quick sale value would be $120,000. If the taxpayer owed a mortgage balance of $110,000 on the residence, then the IRS would require the amount of your offer to include this $10,000 net equity in the residence. Obviously, assets like a bank account would be valued at the actual balance since such assets are already stated in cash.
With an Offer In Compromise, the taxpayer may select to base their offer with either a “Lump Sum Cash” offer or a “Periodic Payment” offer. The choice of either making a Lump Sum Cash offer or alternatively a Periodic Payment offer will determine the amount of future income (net of Allowable Living Expenses) a taxpayer will be required to include in their Offer In Compromise.
Under a recently announced IRS Fresh Start Initiative, with a Lump Sum Cash offer, the Taxpayer must include one year of future income (net of Allowable Living Expenses) in their offer. With a Periodic Payment offer, the Taxpayer must include two years of future income (net of Allowable Living Expenses) in their offer.
With a Lump Sum Cash offer, the taxpayer is required to make a payment equal to 20% of their offer at the time they submit their OIC. Note that this payment is non-refundable to the taxpayer if the IRS subsequently rejects the OIC.
With a Period Payment offer, the taxpayer is required to start making periodic payments under the plan they propose at the time they submit their Offer In Compromise. These monthly payments continue even while you are waiting on the IRS to accept or reject your offer. If the IRS subsequently rejects your offer, these payments are non-refundable.
Disadvantages of Filing An Offer In Compromise
Although not intended as an all-inclusive listing, some of the potential disadvantages of filing an Offer In Compromise are:
- After the Offer In Compromise is accepted, the taxpayer must timely file all future tax returns and make all tax payments in full for the next five years. This includes payroll taxes for your business and estimated tax payments if needed. If you fail to satisfy this condition, the IRS may reinstate the original amount owed, plus penalties and interest accruing after the original amount was determined even after you have paid the amount offered in compromise.
- Submitting an Offer In Compromise extends the statute of limitations for the IRS to collect taxes from you during the time the offer is being considered, plus any appeal, plus 30 days. This is true regardless of whether the IRS accepts the offer.
- After submitting an Offer In Compromise, the taxpayer gives up the right to later contest, either in court or with the IRS, any taxes that were subject to the offer, even if your offer is rejected.
- As part of the process of making an offer in compromise, the taxpayer makes a full disclosure of all their assets. If the IRS subsequently finds out you omitted anything, it may revoke the offer even after payments have been made. If the IRS rejects the offer, they now know about all of your assets.
- Payments are required when an offer is made without any assurances that the offer will be accepted. In a lump sum offer, a payment of 20% of the amount of the offer is made with the offer. When a periodic payments offer is made, the taxpayer must begin making the periodic payments even while the IRS is still considering the offer.
- After an offer in compromise is accepted, the taxpayer gives up the right to any income tax refunds for any period prior to the offer being accepted and for the year in which the offer is accepted.