Offer in Compromise: A Detailed Guide

1 in 12 small businesses in the US gets shut down every year on average.

From our experience of being around business owners all the time, we truly know how heart-wrenching it feels when small businesses close their doors; everyone starts worrying about what’s next while uneasy feelings of helplessness and frustration consume everything.

A big tax debt on top of such hardship feels like a heavy rock on the chest.

If you find yourself in such a condition, first, let us give you a hug. Then let’s talk about a way that can actually get rid of that massive tax debt: Offer in compromise.

A Primer on Offer in Compromise

Here is one thing about the IRS: It would collect the money one way or another. And that doesn’t mean it will take everything you have. The IRS can meet you midway and find a solution, such as installment payments.

However, when you are really incapable of paying your debt, the IRS might begrudgingly settle for an amount less than your actual liability. This agreement between you and the IRS is called an Offer in Compromise. Once your offer is accepted, any tax ability over the agreed amount is not to be paid ever.

We used the word “begrudgingly” here for a reason. An Offer in Compromise acceptance means the IRS gets less money from you. Therefore, when IRS examiners receive an offer, they comb through every little detail of the taxpayer’s financial situation. And more often than not, they reject the offer. Some experts estimate the IRS rejects 3 out of 4 offers.

Nonetheless, there are strategies to improve your chances and we cover them in a later section.

Who Qualifies for An Offer in Compromise (OIC)?

Offer in Compromise is an option for both individual taxpayers and businesses. By “individual taxpayer,” we meant anyone who is self-employed / wage earner / sole proprietor. You can send an Offer on behalf of a business that is registered as a corporation, LLC, or partnership too.

The basic “foot in the door” criteria for Offer in Compromise are straightforward:

• All your tax payments, including estimated taxes or withheld taxes, must be cleared.
• You have filed all the tax returns before the deadline.
• You haven’t declared bankruptcy.

The IRS has a pre-qualifier tool available on its website. Anyone can use it to check their eligibility for an Offer in Compromise. There are two caveats, though: first, it’s only available for individual taxpayers. Second, it merely offers a suggestion. You can qualify for an offer even if this tool shows you are not, provided you can make a strong case.

However, the IRS is legally allowed to consider an offer only if your case falls into one of these three categories:

Doubt as liability

Doubt as liability covers the cases where you don’t agree with what the IRS told you to pay. In other words, there is a legitimate dispute about the amount or existence of a tax liability. By filing for an OIC, you essentially communicate, “Since I don’t agree with what you say my tax debt is, let’s settle the matter at a lower price.”

There is no guarantee the IRS will automatically take your offer. As mentioned before, it depends on the case. With that said, you will be rejected automatically if any of these are true for you:

• A final court decision has been rendered about your tax liability
• You owe the IRS restitution
• You have filed a Doubt as to Collectibility Offer in Compromise for the same tax year
• You have an S-corp and made an election under IRS Code 965(i)

Doubt as collectibility

Doubt as collectibility applies to cases where the taxpayer accepts that tax doubt but doesn’t have any means to pay for it fully. In other words, if you file your offer as Doubt as collectibility, you communicate, “Even if I exhaust all of my resources, I can’t pay my tax debt off. Hence, I would like to negotiate.”

The IRS accepts your offer only if it deems your case is truly uncollectable otherwise. To determine the eligibility, it considers the reasonable collectibility potential (RCP) of the taxpayer. RCP is basically the liquidation value of your assets plus disposable income.

If your total assets and disposable income (the IRS put aside part of your income as a living expense) turn out to be less than what you owe, your offer will be accepted.

Effective tax administration

Consider this situation:  your self-employment income has taken a nosedive, and you are left only with a fund for some major operation. You know you can pay off your tax debt from that fund, but you would not have any money left for your treatment.

That could be a valid reason for not clearing tax debt and filing for an OIC.

According to the IRS regulations, such cases (where the taxpayers have compelling reasons for non-payment) go to the effective tax administration bracket.

Unlike the previous two categories, here, your chances of getting an offer really depend on how you argue for your case and persuade the IRS to say “yes” to the offer.

Application Process of Offer in Compromise

Here is the step-by-step breakdown of an OIC application:

To kick off the process,  gather information about your assets (both business and personal), monthly income, and expenses. You need these numbers to calculate your minimum offer amount. Also, keep proofs of transactions, invoices, and other documents in your reach.

If you are a wage earner / self-employed individual / sole proprietor, file Form 433A (OIC). This tax form contains all of your financial details, including your income, expenses, and assets. You get to calculate your minimum offer amount in Sec 8.

If you are filling out an offer on behalf of a business (registered as a corporation/LLC/partnership), you file form 433 B (OIC) instead. The IRS has a detailed guide on how to fill it.

Attach your supporting documents with your Form 433 A (OIC)/ 433 B (OIC). Just make sure not to send original copies, though.

Fill out the Form 656. This is the document that carries all the details about your offer, your preferred payment option, and your offer amount. Your offer amount must be either equal to or more than the minimum offer amount (found in Form 433-A/433-B).

Include a personal check or money order for your initial payment (20% of the offer if you choose the lump sum option or the first installment of your periodic payment) and a $205 application fee. However, if you are a low-income individual (check Form 433-A), you don’t pay any initial payment.

Mail your entire package to designated addresses.

5 Tips for Improving the Odds of Your Offer Acceptance

Since no one feels happy about receiving less money, expect IRS employees not to be very kind. They will try to find the tiniest loophole and dismiss your offer on the basis of that.

With that said, if you avoid the most common errors and use some common sense, you can improve your chances. Here are a few tips to get you started.

Don’t disqualify yourself

The IRS screens all those offers in compromise applications hard. You don’t want to make their job easier by not complying with any of these conditions:

• All the tax payments (estimate tax or withheld income tax, for example) must be cleared before you submit the offer.
• You must have no previous tax returns file pending.
• You must not file for bankruptcy
• You stop paying your taxes while waiting for your offer’s acceptance.
• You should not leave the box empty where you are supposed to write your offer amount.

These steps will not increase your chances per se. But if you ensure you check off these boxes, then it’s guaranteed that your application will not go to the bin, and someone at the IRS office will at least review your offer.

Don’t save up your money for your offer

You may want to save some cash and feel a little confident while approaching the IRS with your offer.

But don’t do it.

You must be thinking, “What?”. But consider this: The IRS will look through all of your accounts anyway. If they find you have the “luxury” of saving some cash after your expenses, they might insist on installment payments.

Also, if you are in a financially dire situation, you should be spending on more pressing matters. There is no point in giving a lot of money to the IRS (and lowering your chances of an agreement, ironically)

Now, you might be tempted to give your saved cash to a friend. However, the IRS will track it anyway and consider it as a dissipation of assets. You don’t want to give the wrong impression of you trying to “hide” your assets, especially when you are looking at an offer of acceptance.

Long story short, file for an offer in compromise only when you are really in bad financial shape, and don’t overcomplicate it.

Get a job, any job

Pay close attention here: go for an offer in the compromise route when you are in bad financial shape but not when you are at your worst. That means it’s far better to file for an offer when you are underemployed than unemployed.

Sounds counterintuitive? Allow us to explain.

If you are relatively healthy and young, the IRS expects you will not be unemployed for long. Therefore, if you put zero income (in case of recent unemployment) in section 7 of Form 433 A (OIC), the IRS will not take it for face value.

They might just take your expected income if you were fully employed.) and work with that number. As a result, your chances of getting an offer get lower (because of your high earning potential).

However, if you get a low-paying job, you can use your new wage amount in section 7 of Form 433 A. In that case, the IRS can’t use some weird income averaging. Therefore, they get a closer look at your actual financial situation, and your chances go up.

Please note you have to convince the IRS that your under-employment is a long-term term, which brings us to the next tip

Tip: Read section 5.8.5.20 of the Internal Revenue Manual to understand how the IRS estimates a taxpayer’s ability to pay in different situations.

Keep your financial situation stable

When you submit your offer using Form 656, you disclose almost everything about your financial situation.

However, IRS teams don’t pick up your offer earlier than at least some months (a year in most of the cases). And during the review process, they might ask for updated information.

If your current financial situation is significantly better than before, the IRS would consider your period of underemployment as temporary. In that case, they can either reject the offer or insist you to increase your offer amount.

Therefore, you want to keep your financial situation somewhat in the ballpark of what it was when you filled for an offer in compromise. Sometimes that could mean you have to remain underemployed for quite some time. That compromise might be necessary for  getting rid of a massive tax burden.

Set up a payment plan with your state

When you are in a dire financial situation, chances are, you owe taxes to your state authority too. And unlike the IRS, state revenue departments are not willing to compromise easily.  One big reason is they have 20 years to collect taxes from you.

Nonetheless, you want to set up an installment payment with the state. It helps your offer in compromise with the IRS in two ways:

• Any payment plan would bring down your available disposable income. And the lesser cash flow you have, the greater chances of offer acceptance.
• It makes complete sense that you are trying to negotiate with state authority too as you are financially struggling.

Therefore, it’s smart to come to an installment payment agreement with the state before you knock on the IRS door with an offer in your hand.

What To Do If Your Offer Is Accepted

Smile ear to ear. Hug your kids. You should always celebrate when your tax burden is no longer there. However, you can’t slack off just because you got what you wanted.

First of all, you must not miss any payment installment if you opted for Periodic OIC payment. And in case you picked the Lump sum OIC payment option, do pay it off before the deadline. Keep in mind, IRS folks can blow up the whole arrangement if they feel you are not 100% serious about it. In that case, you will be liable to pay off the original owed amount.

Also, it’s important you keep a pristine tax record for the next five years. That means, you have to pay your estimated taxes and withhold taxes in time, file accurate tax returns and respect the extension deadline (if you appeal for it).

Think of it this way: The IRS is taking a financial loss to help you deal with financial hardship. If you don’t play by the IRS’s rules, it has the power to take everything away from you.

What To Do If Your Offer Is Rejected

No matter what you do, there is always a chance you might get rejected. In many cases, the offer examiners at the IRS office think the quoted offer amount isn’t high enough and reject on the basis of that.

If you don’t get a counter offer (which is always more than your offer) and get outright rejected, you have 30 days to request an appeal. And it can be a good idea too. This time your offer can reach some other examiner who might find the offer reasonable and accept it.

However, if you don’t want to appeal, keep in mind, whatever you paid (20% of lump sum or installments of periodic payment) will not come back to you. The IRS will use the money to offset your current tax liability.

Conclusion

When you are neck-deep in tax debt (and you have no way to pay it) OIC can help you to start fresh. However, not every offer gets accepted. You still have to walk on the eggshell even when your offer has been accepted.

With that said, if you really think OIC is your last resort, plan well and make a reasonable offer. This article covers a few aspects of how to prepare for an OIC. However, if you need more solid advice, always contact a professional.