The Offer in Compromise (OIC) program is the well-known program advertised on the radio by national firms who claim to be able to settle your tax debt for pennies on the dollar. But what they fail to mention is that you must meet specific criteria to qualify for the program. Unscrupulous big firms make promises that they can eliminate your tax debt, then charge you a large fee to fill out some paperwork, without first evaluating whether you qualify for the program. Once your case is rejected by IRS, they drop you, claiming that the engagement you hired them for is over. The cases of the victims would never have qualified to be presented to the IRS. Be aware of how the Offer in Compromise program works so you don’t fall prey to a scam.
That being said, I have seen taxpayers get out of thousands of dollars of tax liabilities with this program, so it is a viable option to settle your tax debt. The OIC is a written agreement between the IRS and a taxpayer, which allows the taxpayer to fully satisfy an unpaid tax liability including interest and penalties for less than the full amount owed. For the taxpayer who qualifies, this program is an escape from an otherwise devastating financial situation.
The Internal Revenue Code gives the IRS the authority to compromise taxes when there is a legitimate dispute of the tax owed (Doubt as to Liability), when it is unlikely that the tax can be collected in full (Doubt as to Collectability), or to promote effective tax administration. This chapter will discuss the most common of the three, the Doubt as to Collectability offer.
The goal of the Doubt as to Collectability (DATC) program is to reach a compromise that is in the best interest of both the taxpayer and the IRS. The IRS gets to collect an amount which it otherwise may not be able to collect, and the taxpayer has an opportunity to settle a dispute and move forward with a fresh start towards voluntary compliance.
You can find an OIC pre-qualifier tool at www.irs.gov to use for a preliminary determination of whether you qualify for the program. The pre-qualifier tool is just for obtaining a preliminary determination of whether you may qualify. It does not give an official decision. The final determination is ultimately made after the IRS reviews a properly submitted application.
The obvious benefit of the Doubt as to Collectability program is that you can completely and permanently settle your tax debt for less than the full amount of the liability. There are some other benefits to the program as well. Unlike a bankruptcy, the OIC does not damage your credit. And once the OIC is accepted and the settlement is paid, the IRS will release the lien filed against you. Afterwards, you can apply for a withdrawal of the federal tax lien, which removes the lien from your public record completely, so it’s like the lien was never there. If protecting your ability to obtain credit is a concern, then the OIC is a beneficial resolution option.
There are also a number of disadvantages to the program. For starters, you must agree to suspend the statute of limitations on assessment for the tax periods covered by the OIC. This allows the IRS more time to assess additional tax for the time that the offer is pending, plus an additional year if the offer is rejected, returned, or terminated. While you do have the right to waive this extension of time, if you do so the IRS may not consider the offer.
In addition to the extended assessment statute of limitations, you also must agree to extend the collection statute of limitations for the time that the offer is pending plus an additional 30 days. The collection statute is also extended by the time an offer is being considered under an appeal. The offer is also contingent upon the taxpayer remaining compliant with filing and paying taxes when due for the next five years. This may seem inconsequential since this is a legal requirement anyway, but it is sometimes difficult for taxpayers who have been continually delinquent, to suddenly fully comply with legal requirements. Having a qualified tax professional’s guidance is often imperative to remain compliant. Finally if the offer requires periodic payments over 24 months, the IRS can reinstate the full balance for default of a required payment.
To qualify for a Doubt as to Collectability case, the taxpayer must be unable to pay the full amount due through equity in assets and income by the collection statute expiration date. The taxpayer must also be current with all return filing requirements and payments for the most recent year. The offer must be at least what the IRS can otherwise reasonably collect through administrative means. This figure is referred to as the taxpayer’s Reasonable Collection Potential (RCP). Determining the validity of this qualification requires a detailed examination of the taxpayer’s assets, income, and expenses by an IRS offer examiner. Furthermore, if an offer is submitted for less than the RCP calculation, there must be special circumstances to justify the lower offer, which must be explained in detail to the offer examiner.
The RCP Components: Equity and Income
Without going into full detail of the calculation, let’s go over its two main components: the equity component, and the income component. The equity component is calculated by estimating what the proceeds would be if all of the taxpayer’s assets were sold, and then all of the loans secured by those assets were paid off. The income component is determined by what the taxpayer’s take home pay is, minus allowable expenses. Allowable expenses are what the government deems to be appropriate to support the health and welfare of the taxpayer’s family. It is not necessarily what the taxpayer actually spends per month. Basically, if an expense is necessary for the production of income, or the health and welfare of the family, then it is allowed.
Working with a professional who is familiar with what the IRS will allow is beneficial here. The most effective resolution specialists perform pre-offer submission planning to implement strategies which position the taxpayer in the most favorable position for offer acceptance. In addition, the practitioner can advocate for a taxpayer to allow an expense by showing that it is related to the production of income or is for the support of the family’s health and welfare. Often the experienced professional can reduce this component to zero with a bit of planning.
For example, if you drive an old clunker because it is paid off, you may consider upgrading to something newer even if it means paying a note. The new note amount will reduce your offer amount considerably. The amount of the note payments reduce the offer amount, which essentially gets the taxpayer a new car without impacting monthly cash flow. A reliable vehicle is easily justified as required for the production of income.
You can also consider buying health, life, or disability insurance if you have none. Again, the payment you make to the insurance company will reduce your offer amount.
There is even a way for a taxpayer to pay for the tax resolution professional’s representation retainer and get a dollar for dollar decrease in the OIC amount, meaning that the IRS pays your professional representation. Can you sense that I’m suggesting you hire a pro to represent you?
I’m keenly aware of the fact that you will get a much better resolution of your tax problem if you hire someone who does this for a living and genuinely cares about helping you. Remember, the IRS is under no obligation to help you find the best resolution. Unless you are well-versed in the Internal Revenue Code or the IRS’s Internal Revenue Manual, consider hiring someone who is.
There are two ways to pay for your offer once it has been accepted: the cash payment (or lump sum option), and the monthly periodic payment option. There are advantages and disadvantages to both. Let’s take a look at both so you can understand the difference.
Lump Sum Offer in Compromise
An offer is considered lump sum if the amount of the offer will be paid in 5 months or less from the time it is accepted. The IRS will accept a lower dollar amount as an offer if the taxpayer is in a position to pay the offer amount in 5 months or less. The downside to the lump sum offer is that a 20% payment must accompany the offer when it is submitted. If the offer is later rejected, the IRS keeps the 20% payment and applies it to the taxpayer’s outstanding balance. If this occurs, you can still appeal the decision but the money will not be returned.
For those interested, I have a strategy to avoid sending in the 20% down payment with the lump sum offer that works like a charm. I would be glad to share it with you if you contact my office.
Periodic Payment Offer in Compromise
An offer that is to be paid in 6 to 24 months is referred to as a “periodic payment offer in compromise.” 24 months is the maximum timeframe allowed to spread the offer payments over. This type of offer requires the 1st payment to be submitted with the offer, rather than the full 20% down payment required by the lump sum offer. In addition, while the offer is under review, the taxpayer must continue to make the monthly periodic payments as shown in the offer. Again, if the offer is rejected, the money is kept and applied to the tax debt.
While this type of offer requires a higher dollar amount offered, it allows a more flexible payment arrangement.
Case Study Example
A self-employed contractor owed the IRS over $112,000 due to economic industry fluctuations. As a result, he wasn’t able to keep current on his quarterly estimated tax payments for a couple of years. The IRS was also levying his bank account and his 1099 income.
The taxpayer had minimal equity in assets and we did some “financial planning in reverse” so that the taxpayer was positioned as a very good OIC candidate. We obtained levy releases on all income sources and prepared, submitted, and negotiated the offer, and were able to settle the case in full for $11,000, thereby saving our client over $100,000 and having the federal tax liens released! The client got his life back!
Final Thoughts On OICs
Due to the fact that an Offer in Compromise can significantly reduce your tax debt, this is where the resolution industry has seen most of the unscrupulous practices. A slick-talking salesperson who has no actual knowledge of the program can easily dupe unsuspecting taxpayers out of substantial fees without first verifying if they qualify for the program. Some national firms have been shut down because of this type of abusive sales tactic.
Work with someone you know or a specialist local to your area who is licensed, like a CPA, EA, or attorney. An ethical practitioner will take the time to get to know you and collect all the facts, then fully evaluate your case and prescribe the most advantageous resolution strategy for you. When it comes to tax resolution firms, bigger is NOT better.