An Offer in Compromise (OIC) is a type of agreement between both the taxpayer and the IRS outlining and settling the taxpayer’s tax liabilities for less than the current balance due. If the taxpayer’s liabilities can be fully paid through the utilization of an installment agreement or any other related means, then the taxpayer would not ordinarily be eligible for an OIC.
To be eligible for the OIC program, the taxpayer must have already filed all tax returns, made the required estimated tax payments for the current year and also made all required federal tax deposits for the current quarter (IRS.gov, “Topic 204 – Offers in Compromise,” 8/21/2013). Federal tax deposits are specific to business owners with employees.
The IRS provides all of the tools necessary for taxpayers to pursue multiple options with regard to settling taxpayer liability. However, at times, taxpayers will seek the advice of supposed knowledgeable professionals only to discover that they could have negotiated the process themselves.
There are two cases that provide insight into some of the abuses taxpayers have experienced as a result of trusting tax professionals. These two cases also provide insight concerning the need for taxpayers to become more knowledgeable about the process of paying taxes.
The Offer in Compromise Process
Taxpayers currently in an open bankruptcy proceeding will not be eligible for an offer in compromise. Tax liabilities and other financial debts are resolved through the process of bankruptcy only. If you do not fall under this category, then the IRS will accept an OIC on three grounds. First, if you have genuine doubt with regard to your tax liability, then you will need to complete Form 656-L, Offer in Compromise (Doubt as to Liability).
Second, acceptance of an offer in compromise will be permitted if it is determined that the amount you owe is fully collectible. Lastly, “an offer may be accepted based on effective tax administration when there is no doubt that the tax is legally owed and that the full amount owed can be collected, but requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances” (“Topic 204”). In addition to submitting Form 656-L, taxpayers must also complete and submit Form 433-B (OIC), Collection Information Statement for Businesses.
It is important to note that penalties and interest will continue to accrue during the evaluation process. You must only submit an offer for tax years that have been assessed by the IRS. The taxpayer must submit all required forms and fees as part of the application process. The IRS offers guidance that provides insight into the process as well as application materials.
Net Realizable Equity in Assets
The net realizable equity in assets is defined as a calculation of the fair market value of the property multiplied by the quick sale discount factor, or 80 percent, subtracted by the balance of any loans secured by the property. The net realizable value of your assets is specific to cars, real estate, and personal property.
The Asset/Equity Table
The asset/equity table (AET) is defined as a table that lists all of the taxpayer’s assets, encumbrances, and exemptions. The table calculates “the equity which is included in the reasonable collection potential (RCP) calculation” (IRS.gov, “Part 5. Collecting Process, Chapter 8. Offer in Compromise, Section 4. Investigation,” 8/24/2013).
The major headings of the asset/equity table include the following: assets, fair market value, quick sale reduction percentage, quick sale value, encumbrances or exemptions, and net realizable equity.
Under each major category, the taxpayer lists information concerning different types of assets. References to assets include cash/bank accounts, offer deposit, loan value life insurance, pensions/IRA/401k, real estate, furniture/personal effects, vehicles, accounts receivables and tools/equipment.
On the table, the taxpayer calculates the amounts and lists the future income value. The IRS allows exemptions based upon the total dollar amount of the assets. With regard to cash/bank accounts, net equity should not be less than zero.
How Much Should I Offer? Minimum Offer Amount and Reasonable Collection Potential
Determining the minimum or maximum amount you should offer is predicated on your understanding of the types of offers and payment options the IRS will accept.
Lump Sum Cash Offer
A taxpayer may choose the lump sum offer, which is defined as an offer where the taxpayer makes five or fewer installment payments within 24 months after the offer is accepted. “If a taxpayer submits a lump sum offer, the taxpayer must include with the Form 656, Offer in Compromise a nonrefundable payment equal to 20 percent of the amount. This payment is required in addition to the $150 application fee” (IRS.gov, “Topic 204 – Offers in Compromise,” 8/22/2013). Under the offer in compromise requirements, the nonrefundable amount cannot be returned to the taxpayer if the offer is either rejected or accepted. Instead, it will be applied to the taxpayer’s liability.
Periodic Payment Offer
The periodic payment offer is defined as an offer where the taxpayer makes six or more monthly payments within 24 months after the offer is accepted. When the taxpayer submits the offer, he or she must also submit the proposed installment payment along with Form 656. This payment is required in addition to the $150 application fee. Similar to the lump sum cash offer, the 20 percent first installment payment is nonrefundable.
“Also, while the IRS is evaluating a periodic payment offer, the taxpayer must continue to make the installment payments provided for under the terms of the offer. These amounts are also nonrefundable” (“Topic 204”). The first and successive installment payments are all applied to the tax liabilities. The “taxpayer has a right to specify the particular tax liabilities to which the periodic payments will be applied” (“Topic 204”).
A collateral agreement is specific to offers in compromise. A collateral agreement is defined as the ability of the government to “collect funds in addition to the amount actually secured by the offer, or to add additional terms not included in the standard Form 656 agreement, thereby recouping part or all of the difference between the amount of the offer or additional terms of the offer and the liability compromised” (IRS.gov, “Part 5. Collecting Process, Chapter 8. Offer in Compromise, Section 6. Collateral Agreements,” 8/24/2013).
If the taxpayer refuses to enter into a collateral agreement, this refusal may serve as a basis for rejecting the taxpayer’s offer.
Keep in mind that collateral agreements are not used to accept an offer where the amount is less than the taxpayer’s current financial condition. Instead, a collateral agreement is specifically appropriate where “significant recovery is anticipated or securing a collateral agreement will facilitate resolution” (“Section 6. Collateral Agreements”).
 More information about Offer in Compromise (OIC) is available in Form 656 Booklet, Offer in Compromise. You may access the PDF here: http://www.irs.gov/pub/irs-pdf/f656b.pdf.
Pros and Cons of an Offer in Compromise
You must weigh the pros and cons of offer in compromise in light of the other options available to you. When considering whether to choose this option, you must also consider the advantages and disadvantages. The OIC allows you the opportunity to reduce your tax liability relative to your current financial situation.
However, settling with the IRS by way of offer in compromise might be the second-best option. For example, the requirements for accepting an OIC are stringent. Taxpayers are required to have low monthly income and practically no assets. “Thus you may end up wasting time and money on trying to [settle] with the IRS when that effort could have been applied toward a better method of resolving your tax liability” (IRSSolution.com, “Pros and Cons of An Offer in Compromise,” 8/24/2013).
In addition, keep in mind that the IRS cannot collect on your federal tax liability forever. “The Collection Statute Expiration Date (CSED) prevents the IRS from collecting taxes after 10 years” (“Pros and Cons of Offer in Compromise”). When the IRS considers an offer in compromise, it tolls it, or basically freezes it while your submission is under review. “In other words, if you have an older liability, it might be a bad idea [to] pursue an Offer in Compromise because the CSED is about to expire” (“Pros and Cons of Offer in Compromise”).
On the upside of the pros and cons of an OIC, choosing to pursue this option may be worthwhile in terms of reducing your tax liability to a level that is consistent with your current ability to repay. The OIC will put the activities of collectors on hold, therefore, ongoing collection activities such as wage garnishments begin before you file the offer in compromise. They may also continue after the filing.
Although choosing OIC, which is essentially requesting non-collectible status and allowing you to be taken out of collections without the fear of levy or garnishment, sounds good and may be an optimal choice in terms of reducing your tax liability, you still have to remember that the IRS can file a federal tax lien against you at any time.
If the IRS determines that you have an ability to pay, then the status of non-collectible may be removed and you will undoubtedly be required to begin paying at your current or assumed income level.