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.
See Reg. §301.7122-1(c)(3)(iii).
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.
Is an Offer in Compromise the Right Solution?
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.