If you’re facing a significant tax debt and aggressive collection efforts from the internal revenue service (IRS), an offer in compromise (OIC) might be able to provide a lifeline. An OIC can reduce your tax debt and then let you pay the remaining amount with monthly payments.
Sound too good to be true? The program is real and can be very valuable for a qualifying individual with an unresolved tax liability. Some people save thousands or even tens of thousands of dollars through the IRC program.
But as with most things tax-related, the OIC process can be complex and intimidating. Many people find the OIC system much easier to navigate with help from an experienced tax attorney.
Read on to learn more.
When Can I Make an Offer in Compromise?
An OIC is an agreement you make with the IRS to settle your tax debt for less than the full amount you owe. You can qualify for an OIC if you meet the following three criteria:
- You’ve filed all your tax returns.
- You received a bill for at least one tax debt that you will include on the offer.
- You’ve made all required estimated tax payments for the current year. If you’re a business owner with employees, you’re also required to have made all required federal tax deposits for the current quarter and the two preceding quarters.
Some states also have offer in compromise programs (including Michigan, where our firm is located). However, the rules for these programs differ from state to state, so we’ll stay focused on the federal IRS-operated OIC program in this article.
Reasons the IRS Will Accept an OIC
If you qualify for an OIC, it means that you can send the IRS an offer, and they will consider it—but it doesn’t guarantee they’ll accept the offer. The IRS accepts offers in compromise not out of generosity, but because they would rather get something from you than nothing.
So, the IRS will only accept your OIC if you can convince them that paying your total tax debts in a timely fashion would be impossible or create serious financial hardship. And to make that case, you’ll have to document your entire financial situation, including your monthly income and all your assets—bank account balances, properties, cars, and anything else of value that you own.
In short, if you owe the IRS $10,000 but you have $20,000 in an investment or retirement account, you probably won’t qualify for an OIC. The IRS will look at every opportunity to collect the full tax bill before they consider settling your debt for less.
The IRS accepts offers in compromise based on three possible reasons:
- Doubt as to liability: You don’t actually owe the tax debt, or the amount of tax liability that the IRS calculated is wrong.
- Doubt as to collectability: Your assets and your income are less than the total amount of the tax debt, so there is no way the IRS could hope to collect the full amount.
- Effective tax administration: The IRS might be able to collect the full amount of tax debt, but paying the full amount would either create serious economic hardship for you or would be unfair based on some exceptional circumstances that you can demonstrate to the IRS.
If you meet the application criteria for an OIC listed above and you believe one of the three reasons for OIC acceptance applies to your situation, then you might be a good candidate for the OIC program.
How Do I Get an OIC?
To submit an offer in compromise, you’ll need to fill out and submit IRS Form 656, Offer in Compromise, as well as IRS Form 433A or Form 433(B), preferably with help from a tax professional.
If you review the instructions on this form, you’ll see that the IRS doesn’t give you a lot of guidance as to how much you should offer. In fact, all the form says is your offer should be more than $1 and should be based on what you believe you owe.
The tricky part of an OIC is that it falls on you, the taxpayer, to make the first move. However, the OIC process is not a negotiation. If your offer is too low, you’ll receive a denial letter. You could apply again, but the process carries a $205 application fee (which can be waived for low-income applicants), and you also need to submit an initial payment with your offer—which is non-refundable, even if the IRS rejects your offer.
So, it’s important to get your offer right the first time. Otherwise, you’ll end up wasting time and money without getting any relief from your total IRS tax debt.
How Much Should I Offer in Compromise to the IRS?
When the IRS decides whether to accept an OIC, they look to a calculation called reasonable collection potential (RCP). For the IRS to accept your OIC, your offer must be equal to or greater than the RCP.
The short way to explain your RCP calculation is:
- The liquidation value of your assets (meaning the money you’d get if you sold them quickly, typically around 80% of their true value), plus
- Your disposable future income (the money you have left each month after taxes and allowable living expenses like housing, transportation, food, clothing, and medicine).
The full calculation to figure out your RCP can get a bit more complicated.
Two Repayment Options for Your OIC
The IRS offers two repayment schedule options for an accepted offer in compromise:
- Five-month repayment period (often called a lump sum payment): You must submit an initial payment that equals 20 percent of your total offer at the time of the application
- 24-month repayment period: You must submit an initial monthly payment and continue to make payments in monthly installments while the IRS considers your offer
For reference, 24-month OICs often take the IRS 6-12 months to review and finalize—and for either type of OIC, the payments you make are non-refundable. So, you could end up sending the IRS a half-dozen or more hefty payments only to receive a denial, at which point you can’t get back any of the money you paid.
This situation might sound harsh and maybe even unfair, but since you owe the IRS money, they have no obligation to return your payments. Getting your OIC denied hurts, so it’s critical to work with an experienced tax professional and submit the right offer the first time around.
Getting Ready to Calculate Your Offer Amount
There are two key elements in the formula for calculating your reasonable collection potential (RCP), which is the minimum amount the IRS will accept in an offer in compromise. Those elements are:
- Net realizable equity (NRE): The money the IRS could get if you sold assets right now. To figure out your NRE, the IRS will take the total market value of your assets (home, cars, jewelry, and anything else that can be sold quickly) in which you have positive equity (meaning you don’t owe more on them than they’re worth). Then, the IRS will subtract 20 percent to account for the fast sale and subtract the amount of any debts against the asset. Note that IRS doesn’t subtract 20 percent of the value of cash and cash equivalents (like cashier’s checks, traveler’s checks, and money orders).
- Monthly disposable income (MDI): The amount of money the IRS believes you could put toward paying your tax debt every month over the next 12–24 months. This amount equals your after-tax monthly income minus living expenses that the IRS considers allowable. Allowable living expenses include:
- Housing and utilities
- Out-of-pocket health care expenses
- Food, clothing, and other items
Note that IRS rules set maximum allowances for these expenses. Allowable living expenses can set aside money for you to live, but it might not be at the standard you’re used to. The IRS won’t let you chalk up expensive sports cars, fine dining, or expensive boutique clothing as necessary living expenses.
The Formula for Calculating Your OIC
Once you’ve calculated your NRE and MDI, you can use the full formula to figure out your RCP. The formula to calculate the minimum offer amount the IRS will accept for an OIC is:
- 5-month repayment plan: NRE + 12 months of MDI
- 24-month repayment plan: NRE + 24 months of MDI
If all this sounds complicated, it is. A person trying to use this formula can easily miss assets or otherwise make mistakes that can lead to a rejection. Rather than trying to figure out an offer amount by yourself, it’s almost always better to work with a tax attorney who can help you through the process.
Even if you have to pay some fees for professional help, an OIC that’s properly put together can save you thousands, possibly tens of thousands of dollars. And there’s no substitute for the peace of mind, time savings, and confidence you get from working with a tax attorney who knows the rules and processes for the OIC program inside and out.
Let West Michigan’s Tax Experts Guide You Through an Offer in Compromise
When you’ve got problems with tax debt, you need compassionate guidance, understanding, and support. Our team at CBH Attorneys & Counselors is experienced in tax law at all levels: federal, state, and local. We work with people in Grand Rapids, Kalamazoo, West Michigan, and throughout the state to not only to navigate current tax issues but also to build strategies focused on future success.
If you’ve got an unresolved tax issue, don’t wait to get in touch. Your tax problems won’t go away on their own, but it’s never too late to start on the path to resolution. Get in touch today so we can listen to your story and talk about your rights and options.
If you or a loved one needs legal tax help, fill out our quick contact form today or call us at our Grand Rapids, Michigan office directly at (616) 608-3061.
The content provided here is for informational purposes only and should not be construed as legal advice on any subject.