When to File an Offer in Compromise with the IRS

"Pennies on the dollar." "Clear your taxes for less than you owe." "One time settlement offer."

You've no doubt heard these phrases, or similar ones, pitched to you on television and radio ads. Tax preparers and legal firms are eager to net clients that are in a heap of tax debt by promoting the idea that they can resolve liabilities, for less, way less, than what is actually owed. Do these companies know some undisclosed secret to tax resolution? Is the ability to negotiate these types of agreements specific to tax lawyers and CPAs only?

As much as they would like you to buy into that perception, the answer is a resounding NO. There is one primary way that the IRS agrees to accept an amount less than full payment. As you already know, this proposal is called an Offer in Compromise (OIC).

To be sure, a tax firm or attorney has the experience to arrange an OIC with minimal difficulty in the preparation of the required forms. They will advise you of the fees the IRS charges, request that you submit a detailed financial analysis, and categorize everything into an orderly package ready to submit. But let me be clear, the Service's OIC program is designed to be done by taxpayer's themselves, and there are NO options under this program or any other that are available to any lawyer or CPA that are not available to the taxpayer directly.

An OIC is an agreement between the taxpayer and the government to settle a tax liability for payment of less than the full amount owed. Any type of catch phrase that presents the idea of paying less than the total balance is referring to this program. Because the IRS realizes that some individuals are not in a position to pay their taxes in full, the OIC program allows for a compromise when it is in the best interests of both the taxpayer and the government.

When should an Offer be filed? Who is eligible for this program? How much does it cost? All good questions. For detailed information, visit the IRS web site. Or go directly to the IRS Offer in Compromise Tax Center. You can also read through the informational package that the IRS uses for the Offer program, Form 656. But we'll go over a few things.

Some individuals consume themselves with trying to determine when the Service's 10-year expiration date is about to toll. By law, the IRS only has so long to collect an unpaid debt. Some may advocate that if a balance is close to expiring, no agreement should be entered into, as this will prolong the clearance of the debt under statute. This date is called the Collection Statute Expiration Date, and is generally ten years from the date a balance is assessed, not ten years from the return filing date. For example, if a 2005 timely filed return showed a refund, but then an audit completed in 2008 created a balance owing, the clock starts as of 2008, not 2005. In addition, there are many factors that extend the expiration date, including any type of appeal or litigation, bankruptcy, military deferments, disaster area declarations, and other actions, including the filing of an OIC.

For this reason, the advice given may be to do nothing, and let the balance expire. Quite frankly, this is an unlikely scenario. By the time the ten year period is close to conclusion, the IRS has no doubt filed a Notice of Federal Tax Lien, attempted to garnish any wages or bank accounts that have reported earnings to the Service, and if the balance is egregious enough, referred the account to the field for Revenue Officer assignment. In other words, if you haven't already tried to negotiate a resolution with the IRS within the past nine years to prevent or stop the above actions, then you're certainly not going to make an eleventh hour settlement.

Additionally, it is a fallacy that an accepted Offer in Compromise extends the collection expiration for the entire duration of the terms of the Offer. The collection statute is ONLY extended by the time an Offer is pending, as well as for 30 days after the rejection of an Offer plus any time during which a timely appeal is pending. So if an Offer is processable, meaning that all forms have been submitted, signed, and any application fees have been paid, then the expiration is extended during that period. If the terms of an Offer call for a deferred payment to be made on a compromised balance, say for the next five years, then the collection expiration is NOT lengthened for those five years. In fact, the IRS would not even accept an Offer under that scenario, because the balance would not be protected under the current Collection Statute Expiration Date.

There are three provisions that an OIC is filed under. One such provision is called "Doubt as to Collectibility." Most Offers are filed under this condition. This means that a taxpayer has demonstrated, through the submission of detailed financial information, that there is no likelihood that they can make a full payment over a reasonable amount of time. Factors that are reviewed include an individual's future earning potential, any assets or investments that one has, or if there is an ability to make significant monthly payments over the remaining amount of time left on the statute. The IRS now accepts installment agreements that will not full pay the entire balance over the remaining time on the ten-year statute. This is not an OIC, and if one has the ability to do this, it's unlikely that an OIC would be accepted.

The second way an OIC is filed is under the provision of "Doubt as to Liability." This means that an individual has legitimate doubts that the balance is correct, and they can substantiate that only part of the assessed debt is owed, or in some cases, that the entire tax debt should be abated. Some of the required pre-payments, discussed below, are waived under this provision.

The third and most recent addition is "Effective Tax Administration." If a taxpayer does not have any doubt that the tax is correct and there is potential to collect the full amount of the tax owed, but an exceptional circumstance exists that would allow the IRS to consider an offer, then one may file an offer under this basis. To be eligible, a taxpayer must demonstrate that the collection of the tax would also create an economic hardship or would be unfair and inequitable.

Prior to any Offer being accepted, a taxpayer MUST be in filing compliance. Any outstanding individual and or business tax returns have to be filed before the Service will consider an Offer. Additionally, the IRS will not process an Offer if they determine that estimated tax payments for the current year's income tax liability are not paid up. Something else to keep in mind: If any tax debt has been turned over to the IRS's collection division, no hold on collection action will be granted until a determination has been made that a taxpayer qualifies for the Offer program. If a required financial analysis reveals an ability to full pay, borrow to full pay, or pay via installments, the Service will expect a taxpayer to resolve their balances in this manner, and will not "hold" collection actions for the preparation of an OIC that is unlikely to be accepted. A taxpayer has the right to submit an OIC at any time; abeyance of enforcement action may not coincide with that however. If the Offer is deemed processable by the Offer Unit, at that point collection will cease. Furthermore, liens are not lifted under an OIC. A lien can only be released when the entire tax debt, either the current full payment or full payment of the compromised debt, has been paid up.

The actual OIC package, Form 656, is about 40 pages long and has detailed worksheets to assist one in determining how much they should offer, as well as information as to the different types of repayment plans the Service has available for an accepted OIC.

New provisions went into effect in 2006. Prior to that, an overwhelming majority of the Offers submitted had no realistic ability to be accepted. Taxpayers filed them as a means to delay collection, and firms prepared them left and right and charged hefty sums to do so. Under current provisions, taxpayers submitting a request to pay on their offer amount by means of a lump sum (payments made in full or within five installments) must include a non-refundable payment equal to twenty percent of the offer amount. Any periodic payment OIC (six installment payments or more) must include the first proposed installment payment. A taxpayer is also required to make additional, non-refundable installments each month while the IRS reviews the offer. In addition, a $150 application fee must be paid, unless one qualifies to have the fee waived because of economic hardship.

Unfortunately, unscrupulous companies charge excessive fees to people who have no real chance of having their debts reduced under the government's OIC program. The Law Offices of Roni Lynn Deutch, American Tax Relief, and JK Harris & Co., all well-known tax relief "specialists," have had class action lawsuits filed against them by disgruntled clients. Even well-intentioned firms will encourage taxpayers to allow them to prepare and file an OIC, even though the percentage of offers accepted remains relatively low. Be prepared to drop upwards of $1,000 or more to have someone prepare an Offer for you. For this reason alone, it is worth reviewing the program along with the assistance of an IRS representative. The IRS will be able to give you some general information as to this process as well as to aid you in the preparation of your Offer.