If you are in debt up to your eyeballs with the IRS with no end in sight, then you might want to consider an Offer in Compromise (OIC). An OIC is a repayment plan with the IRS where the taxpayer can propose paying a lesser amount and the IRS will forgive the remainder.
This all sounds great in theory and like a sterling silver lining, but step back for a moment. There are very stringent requirements for applying for an OIC. For starters, you have to have exhausted all other means of repaying the debt and you cannot have filed bankruptcy.
The IRS will agree to an Offer in Compromise when:
- There is a doubt that the IRS can collect the entire amount (doubt as to collectibility offers)
- There is a genuine doubt as to the accuracy of the amount owed (doubt as to liability offers)
- It fosters effective tax administration
The objective of the Offer in Compromise is to reach a settlement that is in the best interest of both the government and the taxpayer. The taxpayer is given a fresh start, and an opportunity to voluntarily comply with any future obligations. For the IRS, compromise presents an alternative to declaring the amount uncollectible or to otherwise engage in a lengthy installment agreement. (See Reg. §301.7122-1(b).).
In this chapter, I go into depth about what conditions need to be met in order to be eligible for an OIC. I will also caution you at the onset that this is not an easy process and the percentage of OICs that actually get accepted by the IRS is pretty low.
If after reading this chapter, you believe that you are a good candidate for an OIC, I encourage you to give me a call. I have been highly successful in getting OIC approved by the IRS for taxpayers and I would be happy to help you assess your odds.
Offer in Compromise Objectives
Here are the goals that the IRS seeks to accomplish when they accept an offer in Compromise:
- Collect what can be practicably collected at the earliest possible time and at the least cost to the government
- Reach a settlement in the best interest of both the government and the individual taxpayer
- Afford the taxpayer a fresh start so that they may voluntarily comply with all future tax requirements
- Attain revenue that may not be collected by any other means
Extent and Finality of an Offer-in-Compromise
An accepted offer applies to all tax, penalties, and interest for the years or periods which are included in the offer. Once the IRS accepts your offer, it is settled for good. Unless there was falsification of information or documents; concealment of assets or your ability to pay; or some other important factual misunderstanding, the case cannot be reopened. See Reg. §301.7122-1(e)(5); IRM 220.127.116.11.1 (12-26-19).
As indicated above, the IRS is only authorized to agree to an offer only if at least one of the following bases for compromise exists: doubt as to collectibility, doubt as to liability, or the compromise fosters effective tax administration. The latter of which is only considered under exceptional circumstances, or if the taxpayer would otherwise become exposed to economic hardship. Lastly, the offer can only be accepted if the IRS has assessed the tax liability, although this does not preclude the IRS from considering an offer in compromise prior to assessment. See Reg. §301.7122-1(a).
Doubt as to Liability
A doubt as to liability refers to a case where there is a legitimate dispute about the amount or existence of a tax liability under the law. Consequently, a doubt as to liability would not exist if the liability has been affirmed by a final judgement. Otherwise, there must be sufficient evidence provided to the IRS which supports a determination that the amount assessed warrants doubt as to liability. The minimum offer the IRS will accept varies under the circumstances; depending on the level of doubt raised.
Doubt as to Collectibility
This category deals with an inability to pay. Naturally, an inability to pay the assessed tax liability raises doubt as to collectibility. In these cases, the IRS will accept an offer which reflects reasonable collection potential (RCP). The IRS determines RCP by assessing whether the taxpayer’s assets and income (present and future) will amount to less than the amount owed. In this calculation, the IRS will also set aside the amount needed by the taxpayer to pay basic living expenses.
In their review of the taxpayer’s assets, the IRS considers whether there are assets available to the taxpayer by transfer; but are out of the government’s reach or otherwise insulated from collection due to state laws on marital property. In considering the adequacy of an offer, the IRS generally only considers the assets and income of a non-liable spouse under circumstances where that property is vulnerable to IRS collection anyway.
These circumstances include:
- Property which was conveyed to defraud creditors
- Property which is governed by state laws that allow collection of the taxpayer’s liability from the assets and income of the non-liable spouse (e.g., states with community property laws)
Under these circumstances, the assets and income of both the taxpayer and the non-liable spouse will be factored into the offer decision. The assets and income will be considered up to the extent that the taxpayer and non-liable spouse can demonstrate that any further amount would have a material and adverse effect on the standard living on them and their dependents.
The IRS allows for a certain amount that the taxpayer must retain for basic living expenses. This amount is based on two things:
- the National and Local Living expense standards
- an evaluation of the specific facts and circumstances of the taxpayer
See Reg. §301.7122-1(c)(2)(ii).
Effective Tax Administration
Under circumstances where grounds do not exist to justify compromise based on doubt as to liability or doubt as to collectibility, the IRS may accept an offer to compromise in order to support effective tax administration when:
- The entire liability can be collected, but would create an economic hardship
- Exceptional circumstances exist which cause a detriment to the taxpayer’s ability to voluntarily comply, and compromise would not allow taxpayers to undermine compliance with tax laws
See Reg. §301.7122-1(b)(3).
When contemplating an offer in compromise with a basis in effective tax administration, please note that the IRS will consider all of the facts and circumstances of the case; this includes the taxpayer’s complete record of compliance with tax laws.
The agency considers the following factors when evaluating economic hardship:
- The taxpayer is incapable of earning a living because of a long-term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer's financial resources will be exhausted providing for care and support during the course of the condition
- Although the taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support
- Although the taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses
See Reg. §301.7122-1(c)(3)(i).
Examples. Here are a few hypotheticals to help illustrate what circumstances would constitute an economic hardship:
The taxpayer has assets sufficient to satisfy the tax liability. The taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the taxpayer will need to use the equity in his assets to provide for adequate basic living expenses and medical care for his child. The taxpayer's overall compliance history does not weigh against compromise.
Liquidation of Assets
The taxpayer is retired and his only income is from a pension. The taxpayer's only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses. The taxpayer's overall compliance history does not weigh against compromise.
Disability and Fixed Income
The taxpayer is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate his disability. The taxpayer's equity in the house is sufficient to permit payment of the liability he owes.
However, because of his disability and limited earning potential, the taxpayer is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because the taxpayer's home has been specially equipped to accommodate his disability, forced sale of the taxpayer's residence would create severe adverse consequences for the taxpayer. The taxpayer's overall compliance history does not weigh against compromise.
The IRS considers the following factors to decide whether a compromise would undermine taxpayer compliance with tax laws:
- The taxpayer’s history of compliance with filing and payment obligations required by the tax code
- Taxpayer’s deliberate tax avoidance efforts
- Whether the taxpayer has encouraged others to refuse compliance with the tax laws
See Reg. §301.7122-1(c)(3(ii).
Examples. For a clearer understanding of how taxpayer compliance factors into exceptional circumstances, take a look at these two examples:
In October of 1986, the taxpayer developed a serious illness that resulted in almost continuous hospitalizations for a number of years. The taxpayer's medical condition was such that during this period the taxpayer was unable to manage any of his financial affairs. The taxpayer has not filed tax returns since that time.
The taxpayer's health has now improved and they have promptly begun to attend to their tax affairs. They discover that the IRS prepared a substitute for return for the 1986 tax year on the basis of information returns it had received and had assessed a tax deficiency. When the taxpayer discovered the liability, with penalties and interest, the tax bill is more than three times the original tax liability. The taxpayer's overall compliance history does not weigh against compromise.
The taxpayer is a salaried sales manager at a department store who has been able to place $2,000 in a tax-deductible IRA account for each of the last two years. The taxpayer learns that they can earn a higher rate of interest on their IRA savings by moving those savings from a money management account to a certificate of deposit at a different financial institution.
Prior to transferring their savings, the taxpayer submits an email inquiry to the IRS at its webpage, requesting information about the steps they must take to preserve the tax benefits they have enjoyed and to avoid penalties. The IRS responds in an answering email that the taxpayer may withdraw his IRA savings from their neighborhood bank, but they must redeposit those savings in a new IRA account within 90 days. The taxpayer withdraws the funds and redeposits them in a new IRA account 63 days later.
Upon audit, the taxpayer learns that they have been misinformed about the required rollover period and that they are liable for additional taxes, penalties and additions to tax for not having redeposited the amount within 60 days. Had it not been for the erroneous advice that is reflected in the taxpayer's retained copy of the IRS email response to their inquiry, the taxpayer would have redeposited the amount within the required 60-day period. The taxpayer's overall compliance history does not weigh against compromise.
An offer in compromise is a sound solution if you are in debt to the IRS and have no way to pay it in full. However, in order to apply, there are specific conditions that you must meet, as outlined in this chapter.
The main argument that taxpayers make is that paying their tax debt will create a financial hardship. Well, the IRS has heard that excuse forever, so you need to make a very convincing case and I have presented what conditions constitute financial hardship.
But, the IRS would rather receive something instead of nothing, so they will assess the potential collectibility of your tax debt. If it looks like the probability is high, then they might be more willing to work with you.
Just keep in mind that the majority of OICs get either rejected or returned. If you want to increase the odds that your offer will be approved the first time you submit it, I urge you to call me. I have successfully drafted OICs for other clients and would welcome the opportunity to help you with yours.