Individuals who owe more in taxes than they can realistically afford to pay have several tax debt relief options available to them. One of those is an offer in compromise, in which the Internal Revenue Service (IRS) agrees to allow the taxpayer to settle his or her debt for a lesser amount. To qualify, however, you must send in a detailed application and adhere to IRS rules and offer in compromise regulation. Here’s what you need to know about this process.
Offer in compromise regulation requires you to have filed all your tax returns and paid the current year’s estimated taxes. The IRS only accepts offer in compromise applications if you fall within one of three categories:
If you believe you are eligible based on one of these scenarios, you can fill out and submit the appropriate forms and documents to the IRS.
If you are submitting an offer based on doubt as to liability, you must fill out Form 656-L. For doubt as to collectibility and effective tax administration, you must complete Form 656 as well as 433-A (if you’re an individual and not a business). With the latter two — assuming you don’t qualify for a low-income exception — you must also pay an application fee. The IRS then has two years to either accept or reject your offer.
Let’s look specifically at the most common type of offer in compromise — doubt as to collectibility. In deciding whether to accept your offer, the IRS will calculate your reasonable collection potential (RCP), or the amount it can realistically expect you to pay in taxes. It does so by taking into account your income, assets, expenses, and more. Under offer in compromise regulation, you must provide documentation and evidence of all this with your application.
The IRS will first look at your total income, from wages to investments. Then it will calculate your monthly expenses, including living costs such as housing and utilities, transportation costs such as car payments and maintenance, child care, alimony, and more. It uses national standards to estimate average expenses for food, clothing, supplies, etc. while it calculates transportation and living expenses according to your region, family size, and other circumstances. Offer in compromise regulation does differ by state, with New York and California being the least lenient.
Lastly, in determining RCP the IRS will evaluate your assets and their quick sale value (QSV), or what they would sell for quickly (within 90 days) in their current state. This is typically 80% of the asset’s fair market value.
While the IRS is looking over your application, it must suspend collection activities against you. The IRS might return your application and request more documentation if you:
If the IRS rejects your offer outright, you can appeal it in the Court of Appeals within 30 days.
Fortunately, since instituting the Fresh Start program in 2012, the IRS has accepted increasingly more offers in compromise. This is because it has:
These changes and more have reduced the average amount needed to settle tax debts by 75%.
If the IRS determines, based on your RCP, that you cannot pay your taxes in full, it will accept your offer. You can pay the agreed-upon amount in one of two ways:
You must continue to file your tax returns and pay taxes on time for the next five years. If you don’t adhere to offer in compromise regulations, the IRS will consider your offer to be in default and demand you pay back your original tax debt in full, plus any interest or penalties.
Tax laws and offer in compromise regulations can be complicated to understand and can vary by state. For this reason, you might want to contact a tax attorney or debt relief company to help you fill out your application, gather all the appropriate paperwork, and communicate effectively with the IRS. If you need help lowering your tax debt, we can guide you through the offer in compromise process to give you the best chance of it being accepted by the IRS. Contact one of our qualified professionals to learn more.