What is an IRS Offer in Compromise (OIC)?
Failure to timely pay one’s IRS tax liabilities can result in IRS penalties, asset seizure, wage garnishment, revocation or denial of passport privileges, and in extreme cases criminal prosecution. Indeed, Al Capone, Wesley Snipes, Willie Nelson, and Nicolas Cage have all faced IRS criminal enforcement over unpaid tax liabilities.
Fortunately, the IRS provides several options for potential resolution of one’s tax liabilities and tends to view favorably those taxpayers who proactively work to address outstanding tax liabilities prior to the IRS taking enforced collection action. One resolution option is an installment agreement, where taxpayers enter into an agreement with the IRS to make monthly payments that will pay their tax liability in full. A second resolution option is a collection hold, where the IRS agrees to temporarily delay enforced collection, typically after taxpayers demonstrate personal or financial hardship.
A third resolution option is the IRS Offer in Compromise (OIC). The OIC program, which derives its authority from IRC §7122, is an agreement between taxpayers and the IRS that allows taxpayers to settle their federal tax debt for less than the full amount owed. In broad terms, in an OIC, taxpayers submit an application to the IRS and propose an Offer Amount based on certain criteria and computations established by the IRS. The IRS evaluates the application and Offer Amount, often with some negotiation with the taxpayers, and determines whether it will agree to an OIC and at what Offer Amount. If the Offer Amount is calculated to be lower than the federal tax liability, an OIC generally can be accepted. The remaining federal tax liability is permanently eliminated, assuming the taxpayers pay the Offer Amount and maintain tax compliance going forward. In this way, the OIC program has sometimes been referred to as a “fresh start” program for taxpayers struggling to pay their tax liability, and who demonstrate an intent and ability to maintain tax compliance going forward.
While the IRS Offer in Compromise (OIC) can be a financial lifeline for many taxpayers, evaluating taxpayer eligibility for an OIC, completing the application, and addressing IRS scrutiny of that application requires careful preparation, attention to detail of the rules and requirements, and skilled negotiation with the IRS. This article outlines how to evaluate eligibility for an OIC, use the OIC pre-qualifier tool, complete the OIC application, and appeal a rejected OIC application. It addresses why certain OIC applications fail, with a view to avoiding such pitfalls, and considers certain special circumstances.
IRS Offer in Compromise (OIC) Eligibility
The first step in the IRS Offer in Compromise (OIC) process is determining whether the taxpayers meet the basic eligibility criteria. The OIC is not available to all taxpayers; in fact, the OIC rules are designed to ensure that only those taxpayers who truly cannot afford full payment qualify. To meet the initial eligibility criteria (evaluated at the time of filing and while the OIC is under IRS review), the taxpayers must meet all three of the following requirements:
1. The taxpayers must be current on filing all required tax returns. The IRS will not consider an Offer in Compromise (OIC) application if the taxpayers have not met their basic legal obligation to file tax returns.
2. The taxpayers must be current on estimated tax payments and tax deposits. This is particularly important for self-employed individuals or business owners who make quarterly estimated payments.
3. The taxpayers’ current financial situation—based on current income, current expenses, and equity in assets—must be such that the IRS determines that the taxpayers do not have the ability to pay their tax liabilities within a reasonable timeframe.
A common misconception is that having financial difficulty automatically qualifies the taxpayers for an IRS Offer in Compromise (OIC). Instead, the taxpayers must demonstrate that their financial condition makes it impossible for them to pay the full tax debt. If full payment of the tax liability is possible—as determined by the IRS and informed by the OIC application—then the IRS is unlikely to approve the Offer Amount. Understanding these eligibility criteria, in addition to calculating an Offer Amount based on IRS guidelines, saves time and maximizes the chances that the IRS accepts the OIC at an Offer Amount that is acceptable to the taxpayers.
Confirming Initial IRS Offer in Compromise (OIC) Eligibility Using the Pre-Qualifier Tool
Before submitting an IRS Offer in Compromise application, taxpayers should use the pre-qualifier tool, available for free on the IRS website for use on a completely anonymous basis. This online resource serves as a guide to assess potential eligibility by reviewing basic financial details and determining whether it is worth pursuing an OIC rather than, say, an installment agreement.
The IRS Offer in Compromise (OIC) pre-qualifier tool asks the taxpayers to input details about income, expenses, and assets. Based on that information, the OIC pre-qualifier will provide an estimate of an acceptable Offer Amount. This allows taxpayers to gauge whether that Offer Amount might be acceptable based on their total tax liability and perceived ability to pay. For example, if the Offer Amount exceeds the taxpayers’ total tax liability, the taxpayers would not be eligible for OIC. Also, if the Offer Amount is so high that the taxpayers would be required to compromise their existing assets (for example, borrowing against their primary residence or liquidating retirement savings), the taxpayers may decide that the OIC is not worth the cost and turn to another collection alternative such as an installment agreement.
The IRS Offer in Compromise (OIC) pre-qualifier tool is not the official or final determination on OIC eligibility. Nonetheless, it allows taxpayers to gauge their chances of an OIC application being accepted by the IRS, potentially saving time, legal cost, frustration, and OIC application fees.
How Much Should I Offer in Compromise (OIC) to the IRS?
An important aspect of the IRS Offer in Compromise (OIC) is calculating the Offer Amount. The Offer Amount or reasonable collection potential (RCP) is calculated using the standard OIC forms included with the IRS application. Thereby, generally, the amount offered in an OIC must equal or exceed the applicants’ RCP to be acceptable by the IRS.
In broad terms, the Offer Amount or RCP is calculated using Form 433-A and/or Form 433-B to determine the applicants’ net monthly income and equity in assets. Net monthly income is determined by taking the aggregate monthly income from all sources and reducing that by the allowable monthly expenses. Equity in assets is determined by taking the fair market value of an asset, applying an 80% discount to illiquid assets (e.g., retirement accounts, real property, vehicles), and reducing that adjusted fair market value by any loan balance or other debt. It is essential to correctly calculate the Offer Amount or RCP, guided by experienced legal counsel, as offering less than the Offer Amount or RCP can result in automatic return of the IRS Offer in Compromise (OIC).
Completing the IRS Offer in Compromise (OIC) Application
The IRS Offer in Compromise (OIC) application consists of (i) IRS Form 656 (Offer in Compromise), (ii) IRS Form 433-A (OIC Collection Information Statement for Wage Earners and Self-Employed Individuals) and/or IRS Form 433-B (OIC Collection Information Statement for Businesses), (iii) a non-refundable application fee (currently $205), and (iv) a non-refundable initial payment.
IRS Form 433-A, signed by the individual applicants under penalty of perjury, is used for individual income tax liabilities (i.e., Form 1040) and employment tax liabilities (i.e., Form 941 and Form 940). Generally, married spouses would jointly complete Form 433-A to resolve joint tax liabilities. Form 433-A requires basic information about the applicants and their employers, bank accounts, brokerage accounts, retirement accounts, cash value life insurance policies, real property, vehicles, self-employment income (e.g., Schedule C) and assets, household income, and household expenses. Household expenses are subject to certain IRS collection financial standards that set a ceiling on the amount of expenses that applicants can claim. Some of these IRS collection financial standards vary based on living areas; nonetheless, applicants in higher living cost areas may find that housing that they believe reasonable for the area exceeds the amounts allowed by the IRS collection financial standards. Form 433-A then aggregates this information to generate an Offer Amount. Finally, but not to be overlooked, Form 433-A requires that applicants include copies of supporting documentation for the financial reporting, which may include employer pay stubs, bank and financial account statements, mortgage and other borrower statements, statements of state tax liability and any installment agreements, list of accounts receivable and notes receivable, court orders for child support and/or alimony, trust documents, and documentation to support any special circumstances.
IRS Form 433-B, signed under penalty of perjury on behalf of the business, is used for corporate tax liabilities (i.e., Form 1120) and employment tax liabilities (i.e., Form 941 and Form 940). Form 433-B requires basic information about the corporate applicant and its officers, major shareholders, bank accounts, brokerage accounts, notes receivable, accounts receivable, real property, vehicles, equipment, business income, and business expenses. Form 433-B then aggregates this information to generate an Offer Amount. Finally (and similar to Form 433-A), Form 433-B requires that the applicant include copies of supporting documentation, which may include profit and loss statements, bank and financial account statements, list of accounts receivable and notes receivable, mortgage and other asset statements, and documentation to support any special circumstances.
IRS Form 656 constitutes the formal agreement between applicants and the IRS, and sets forth basic information about the applicants, the taxes being included in the IRS Offer in Compromise (OIC), low-income certification, reasons for the offer, payment terms, source of funds, and offer terms. Applicants must choose one of three reasons for requesting an OIC. Most proposals fall under “Doubt as to Collectability” where applicants argue they do not have sufficient equity or income to pay their tax liability in full. The other two categories are “Effective Tax Administration – Economic Hardship” and “Effective Tax Administration – Economic Hardship,” both of which are less common, as they imply that the applicants could pay their tax liability in full but special circumstances exist that justify the IRS agreeing to set aside some or all of the tax liability.
For the payment terms, applicants must choose between a lump sum offer and periodic payment. In a lump sum offer, the applicants take the Offer Amount calculated on Form 433-A and/or Form 433-B. The initial non-refundable payment made with the IRS Offer in Compromise (OIC) is calculated as 20% of the Offer Amount, with the remaining 80% paid within five months after the IRS accepts the OIC. In contrast, in the case of a periodic payment offer, monthly non-refundable payments extending not more than 24 months must continue to be paid using IRS Form 656-PPV (Offer in Compromise – Periodic Payment Voucher) while the OIC is pending IRS evaluation, including any appeal of the OIC. In other words, the applicants must continue making monthly payments even before knowing whether the IRS will agree to accept the OIC. If the applicants miss any monthly payments, then the IRS will return the OIC without any appeal rights, keeping any payments and applying them to the outstanding tax liability. While there may be some circumstances where the periodic payment offer makes sense, in most cases, the lump sum offer is the preferred option.
It is critical that the IRS Offer in Compromise (OIC) form be completed honestly and completely, and experienced legal counsel can play a crucial role. Failure to do so may result in the IRS returning the OIC application without appeal rights, with the IRS keeping any initial payment and applying it to the outstanding tax liability. Further, in some circumstances, the IRS could consider the returned OIC to have been completed in bad faith and with the primary purpose of delaying IRS collection efforts. Such a determination can result in increased IRS collection efforts, and limit alternative collection resolution options with the IRS. More egregious misstatements may be determined to be fraud and subject to civil or criminal penalties.
IRS Offer in Compromise (OIC) Application Tips
There are several other common considerations that arise when preparing the IRS Offer in Compromise (OIC) application. One is that the IRS generally does not allow unsecured debts to be considered as valid liabilities, such as credit cards, personal loans, and medical bills. The rationale is that applicants should prioritize the federal tax liability and can walk away from such unsecured liabilities.
Also, IRS generally does not allow applicants to claim expenditures other than those specified in Form 433-A and Form 433-B, and in amounts not to exceed IRS collection financial standards. This includes private secondary school tuition, college tuition, or charitable expenditures—none of which the IRS considers to be valid expenses. Notwithstanding this general rule, the IRS may exercise some discretion and exceed the IRS collection financial standards where special circumstances warrant, for example, necessary out-of-pocket medical expenses. The IRS generally sets a high bar for these exceptions, requiring clear explanation with supporting documentation.
The IRS generally will allow applicants to claim payments of state tax liabilities as a necessary monthly expense, subject to some limitations on reasonableness and proportionality with the federal tax liability. Again, the IRS Offer Specialist will require a copy of the state installment agreement and proof of payment history to the state.
In most cases, it helps to include a detailed IRS Offer in Compromise (OIC) cover letter with the OIC application. This cover letter should summarize the relevant details from Form 433-A and/or Form 433-B. It should also detail any special or unique circumstances important for the IRS Offer Specialist to consider. For example, it might explain how the applicants fell behind on their tax liabilities, such as personal or family medical issues, property destruction, or personal tragedy. It may also help explain why the applicants cannot access certain equity in assets that otherwise would need to be included in the Offer Amount. Again, the OIC cover letter should clearly articulate these circumstances and reference supporting documentation included with the OIC.
IRS Evaluation of the Offer in Compromise (OIC) Application
If the IRS deems an Offer in Compromise (OIC) application to be incomplete or deficient, typically it will return it to the applicants within one or two months without appeal rights. If the applicants believe the IRS acted in error, applicants can request reconsideration within 30 days of the date of the IRS letter accompanying the returned application.
If the IRS deems the Offer in Compromise (OIC) application to be complete, it will assign it to an IRS Offer Specialist or IRS Offer Examiner for review and scrutiny. The IRS generally suspends all enforced collection actions during its consideration of the OIC application. If the applicants were in an IRS installment agreement, generally the IRS will suspend such payments automatically.
In most cases, the IRS Offer Specialist will request updated supporting documentation. It is important to note that the IRS Offer Specialist has certain investigatory tools stated under IRC §7602(c) and elsewhere to confirm whether information has been omitted from the IRS Offer in Compromise (OIC) application (for example, a failure to list a bank account). It is important to reply promptly to any information requests. The IRS Offer Specialist will use that updated financial documentation to update the Offer Amount. In most cases, even with a complete OIC application, the revised Offer Amount will exceed the original Offer Amount.
At any time, a manager conference may be requested. Also, certain disputes may qualify for Fast Track Mediation.
In addition to the generally objective figures set forth in the IRS Offer in Compromise (OIC) application, it is important to be aware of several critical issues that can arise outside of the OIC application:
1. Assets transferred for less than full value, which the IRS sometimes refers to as “dissipated assets,” such as a home that is transferred to a child shortly before filing the IRS Offer in Compromise (OIC). If the IRS determines that the applicants transferred an asset for less than full value, then the IRS will include that asset’s equity in determining the Offer Amount.
2. Recent payments made for expenses that otherwise would be excluded by the IRS under the IRS collection financial standards. Examples of this include large credit card payments or college tuition paid shortly before filing the IRS Offer in Compromise (OIC). Similarly, if the IRS determines there was such excluded or prohibited payment, it will include that payment amount in calculating the Offer Amount.
3. The IRS believes that the Offer in Compromise (OIC) is not in the government’s best interest. For this analysis, the IRS looks to the amount of time remaining on the collection statute of limitations (typically, 10 years) and whether the remaining monthly income calculated in Form 433-A and/or Form 433-B would allow for full payment of the tax liability prior to the running of the statute of limitations period. The general rationale is that the IRS believes it is in the government’s best interest to collect whatever it can before the collection statute of limitations expires.
4. The IRS requiring estimated quarterly tax payments to equal 100% (divided by four) of the total tax paid in the prior year. In the case of a sole proprietorship or other small business, such a requirement can pose a significant financial hardship and risk rejection of the IRS Offer in Compromise (OIC).
5. The IRS requests that the applicants file a tax return prior to the filing deadline, for the purpose of obtaining an additional financial data point for purposes of evaluating the IRS Offer in Compromise (OIC). This is more common in the case of a sole proprietorship or other small business.
These considerations are critical issues in the IRS Offer in Compromise (OIC) process, where experienced legal representation can play a crucial role in navigating and negotiating the OIC and Offer Amount, especially where special circumstances exist.
Rejected IRS Offer in Compromise (OIC), Appeals, and Resubmission
If the IRS Offer Specialist rejects the Offer Amount and/or proposes a revised Offer Amount that is not acceptable to the applicants, then the applicants may appeal the IRS determination by filing IRS Form 13711 within 30 days from the date of the rejection letter, enumerating each specific item in dispute and the reason for disagreement, and signing the appeal under penalty of perjury. (Note that a rejected offer is distinguishable from a returned offer, which cannot be appealed.)
The role of IRS Appeals is to determine whether the IRS Offer Specialist was correct in rejecting the Offer Amount and it will provide the applicants with an opportunity to submit clarifying information or other necessary documentation. In that case, typically, the applicants will submit updated financial records. Generally, IRS Appeals has more discretion to consider special circumstances or exceptions to general IRS guidelines, which may result in a lower Offer Amount. In effect, this gives the applicants another bite at the IRS Offer in Compromise (OIC) apple.
Accepted IRS Offer in Compromise (OIC) and Continuing Tax Compliance
If and when the IRS Offer in Compromise (OIC) is approved, the taxpayers must comply with specific terms, including making agreed-upon payments promptly. It also requires, for a period of five years after acceptance, that the taxpayers pay any required estimated taxes, file tax returns, and pay the tax liability on those returns, all on a timely basis. Failing to meet these terms can void the OIC, thereby reinstating the original tax liability (reduced by any payment received by the IRS pursuant to the OIC), plus interest and penalties.
The IRS may file a lien if one has not already been filed. Generally, the IRS will release the lien 45 days after the final payment has been received and processed.
The IRS may also keep any accrued but unpaid tax refund prior to accepting the OIC, and any retained refund amount will not be counted towards the Offer Amount.
Summary
An IRS Offer in Compromise (OIC) can offer a financial lifeline to taxpayers overwhelmed by their federal tax debt. Convincing the IRS to agree to an OIC requires more than just submitting forms and hoping for the best. It can take up to 24 months from the time of filing an OIC for the IRS to complete its evaluation and investigation. Experienced legal counsel can serve a critical role in assisting taxpayers in evaluating OIC eligibility, advising on the rules and requirements to ensure that applicants disclose all information required to withstand an initial IRS rejection, representing applicants in filing the OIC, addressing IRS scrutiny of the OIC, and advocating for the best possible terms for the applicants that will also meet IRS requirements. For taxpayers contemplating an OIC, the arduous process can be worth the effort, as it can allow taxpayers to resolve long-standing tax liabilities and avoid enforced collection actions, securing peace of mind and a return to financial freedom.