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What Is an Offer in Compromise?
By Ashley Donohoe MONEY RESEARCH COLLECTIVE
Paying taxes is an inevitable responsibility that can be stressful for even the most financially stable individuals. If you’re experiencing economic hardship, it can feel overwhelming. Fortunately, the Internal Revenue Service has a program in place for taxpayers who, for various reasons, are unable to pay their tax debt in full.
If you’re behind on your taxes, you can try making an offer in compromise — also known as an OIC — with the IRS. But what is an offer in compromise, and how can it help you pay your taxes?
IRS offer in compromise as a tax debt relief solution
The IRS offer in compromise program lets qualified taxpayers settle their tax debt for less than the full amount. For this agreement to work, you must show the IRS that you can’t pay your tax liability under other options, such as an installment agreement. In other cases, it allows you to prove that your tax liability isn’t accurate.
Filing for an offer in compromise stops collection activities while the IRS looks over your documentation and makes a decision. If you’re approved, you won’t have to deal with further tax penalties and interest on top of the agreed amount. Therefore, you save money and receive tax debt relief.
What it is and how it works
So, what is tax relief like under an offer in compromise plan? You start by estimating how much of your tax liability you can repay based on your current assets, expenses and income. The IRS requires that the compromise is reasonable and that your income and assets keep you from being able to pay your balance in full. You provide the IRS with your current financial information and the proposed amount you’re offering to pay on your application.
During the process, you’ll specify whether you prefer to make monthly payments or pay back the balance in a lump sum. The first option means making ongoing payments for up to two years. In contrast, the lump sum option gives you five months to repay the balance in a maximum of five installments. In either case, the IRS requires an initial payment sent with your application unless you meet the low-income exemption.
After you’ve submitted your application and initial payment, the IRS evaluates your documentation to determine whether to approve your proposal.
If the IRS accepts your offer, you’ll proceed with the chosen payment agreement and now owe less in taxes. You also won’t incur further penalties or interest on the balance. The downside is that the IRS can put a tax lien on your property if you default.
The IRS could also return or reject your offer. You might have your application returned if you don’t provide all the requested information and down payment or if you haven’t yet filed your tax return. If this happens, you can resolve the issue and apply again. If the IRS rejects your offer, you’ll receive a letter explaining why, and you can appeal within 30 days.
Taxpayers that qualify
Of course, not everyone qualifies for this program, and the IRS sets strict criteria for getting an offer in compromise approved. It first requires that you’ve exhausted alternatives like IRS installment plans. It also needs evidence that the agency likely can’t get the full amount from you, that repayment would harm you significantly financially or that your tax liability has an error.
If you’re not up-to-date with your filing, you’ll need to look into how to file back taxes first. You must also show that you’ve filed a tax extension and met estimated tax payment requirements. Plus, you can’t be in the process of declaring bankruptcy or undergoing an IRS audit.
Unless you’re merely disputing an inaccurate tax liability, the IRS also requires that your income, expenses and assets qualify for the program. The calculations can get complex, so the IRS has an offer in compromise pre-qualifier tool to help you assess your eligibility. Along with answering questions about your tax compliance and bankruptcy status, you’ll provide the following information:
- Your location
- Household information
- IRS debt owed
- Tax year
- Values of assets such as bank and retirement accounts, properties and vehicles
- Monthly income sources and amounts
- Monthly expenses such as housing, transportation, utilities, insurance, taxes and dependent care
If you use this pre-qualifier tool, it will recommend potential agreements and show an OIC example you may wish to propose. The IRS will also assess whether you can afford to repay the total tax balance based on the financial data provided. If you’re ineligible, you’ll be guided on which steps to take next.
How to apply for an offer in compromise with the IRS
Before starting the application, make sure to have key financial information and documentation ready. These will include:
- Statements showing asset values and loan balances
- Paystubs, W-2s and 1099 forms showing your income
- Bills and other records of your monthly expenses
You should have paper copies handy since the IRS will need you to submit these with your application. Once you’re ready, you’ll go through the following steps:
1. Completing the appropriate forms
The IRS provides instructions and the necessary tax forms in the Form 656 booklet on its website. These typically include Form 656 (Offer in Compromise) and Form 433-A (Collection Information Statement for Wage Earners and Self-Employed Individuals). Even if you use the best tax software for filing tax returns electronically, you’ll still need to complete these forms by hand and mail them to the listed IRS address.
You’ll start with Form 433-A, which documents information about your finances and includes calculations to determine the offer amount. The first three sections request information about your household, employment and personal assets, while the fourth through sixth sections deal with any self-employment income and assets. The seventh section documents your household income and expenses, and section eight involves calculating your offer. You’ll provide further personal details in section nine and sign the application in the last section.
Next, you’ll fill out Form 656, which is the actual offer in compromise form. The first section asks for personal details and tax information, while the second section relates only to business filers. You’ll choose an offer reason and provide an explanation in the third section and specify the payment terms in the fourth section. Sections five and six relate to how and from where you’ll get the funds and important payment requirements. After reviewing the seventh section’s terms, you’ll sign in section eight.
In rare cases where you doubt your tax liability, you’d complete Form 656-L to propose your offer rather than fill out Form 656 and Form 433-A. This form has sections for your contact details, tax status, offer amount, explanation of the issue and your signature. You’ll also see the offer terms.
2. Paying the application fee or requesting a waiver
Unless you can get a waiver, you’ll need to pay $205 to submit your IRS offer in compromise form. To waive the fee, your household will need to not earn more than 250% of the poverty level. You’ll also need to request the waiver on your Form 656.
The IRS accepts money orders or checks for the fee. Alternatively, you can sign up for the Electronic Federal Tax Payment System (EFTPS) tool to pay online from your bank account.
3. Making an initial payment on your new balance
With most repayment options, the IRS will require that you make a down payment. The exception is if your income qualifies under the IRS low-income certification option. The IRS Form 656 booklet includes the income criteria and the option to certify yourself and avoid submitting the initial payment.
The lump sum option requires a 20% initial payment with the application. You won’t need to pay anything else until you get approved. On the other hand, the periodic payment option requires one monthly payment immediately. With this option, you’d also need to make continued monthly payments during the application review process.
The IRS only allows you to use the EFTPS tool if you make a 20% initial payment. Otherwise, you’ll need to use a money order or check. Note that the IRS requests that you don’t send a single check that combines both the application fee and the initial payment.
Alternatives to an IRS offer in compromise
If you don’t meet the offer in compromise program criteria, you have other options to pay your tax debt. These include an IRS installment agreement and various options through the Fresh Start program.
IRS installment agreement
If you can eventually pay back the debt, consider an IRS installment plan. You can request a short-term payment plan of six months for free and get approved automatically. Alternatively, you can apply for a long-term plan that usually comes with a fee but can give you several years to pay back your tax debt. The long-term plan can require IRS acceptance depending on the amount owed, and interest and penalties will continue to apply.
Fresh Start program
The Fresh Start program started in 2011 and consists of options like the offer in compromise and installment agreements. It also includes help for issues like tax penalties and tax liens. It’s not a separate relief option itself but rather a term to describe the various initiatives the IRS offers.
How to get an offer in compromise approved
To increase your chances of having your offer in compromise approved, make sure you meet the initial IRS criteria and have used the pre-qualifier tool. Choose a realistic settlement amount based on your finances, or the IRS will reject your application. In addition, respond promptly to any further requests, such as if the IRS needs you to include more information and resubmit your application.
Since the process can be challenging, it helps to seek out a professional. They can suggest specifics on how to get an offer in compromise approved based on your situation.
How much should taxpayers offer in compromise to the IRS?
Unless there’s some extenuating circumstance you can document, you should use the offer amount calculated on your Form 433-A. Before determining this amount, you’ll need to accurately complete the sections about your income, expenses and assets. The IRS form instructs you to add your remaining monthly income to your available equity in your assets to get the offer amount.
This monthly income amount is based on what’s left after accounting for your typical expenses. The IRS has you multiply this amount by 12 for the lump sum option or 24 for the periodic payment option. When determining the equity to add to this income amount, note that loan balances for things like mortgages and car loans lower your equity.
How long does an offer in compromise take to process?
Generally, you can expect to wait at least six months for the IRS to process your offer. Incomplete applications and initial denials will lengthen the time it takes to get approved. In extreme cases where the IRS doesn’t respond for two years, you can consider your offer accepted and make further payments as you proposed.
Important points to keep in mind about an IRS offer in compromise
You’ll save time if you check your eligibility beforehand, provide accurate details and give the IRS all the requested documentation. Being patient is crucial, as is understanding that the IRS rejects many offers. Therefore, you should have a backup plan in mind. If you do get approved, make your payments as agreed to avoid having your offer default and potentially experiencing legal and financial challenges.
Hiring a tax relief company to represent you
To increase your chances of becoming one of the offer in compromise success stories, consider working with a tax relief company. For a fee, the company will examine your tax situation, calculate a suitable offer amount and help you prepare a solid application. You’ll also have someone to turn to for help if your application gets rejected or sent back for more information.
The best tax relief companies guarantee your satisfaction with their services. They also usually offer a free consultation. However, check for any rules a specific company has since some require a minimum debt amount or set income limits.
Is an offer in compromise right for you?
After using the pre-qualifier tool, you’ll have an idea of whether to proceed with this tax relief option or opt for an alternative, like an installment plan. It may be worthwhile to seek assistance from a tax relief company that can advise you on qualifying and make the application process go more smoothly. In addition, keep the 2023 tax brackets in mind to prevent future problems with unpaid taxes.
Ashley Donohoe is a business and finance writer with over a decade of experience in the field. She enjoys helping others manage their money, improve their credit, make important financial decisions, and start and run small businesses. She has earned a Master of Business Administration degree from Western Governors University as well as certifications in taxation and bookkeeping from the National Association of Certified Public Bookkeepers.