How to Prepare IRS Form 656, the Offer in Compromise Application
How to Submit an Offer in Compromise Application
IRS Form 656, the Offer in Compromise, is a proposed contract offering the IRS a certain amount of money, typically just a portion of the entire tax debt you owe. You might owe $10,000, and you propose paying the IRS $4,000 instead. Of course, you'll need an acceptable reason, and the IRS will only consider a few. It won't accept, "I just don't want to part with the money."
The IRS will agree to cancel the balance of your outstanding tax debt if it accepts your offer. But it might be rejected—there's no guarantee—or it might be returned you as "unprocessable."
The Basis of an Offer in Compromise
You can request an offer in compromise (OIC) for one of three reasons, and you'll have to make your case for each:
- There's doubt as to the collectibility of your tax debt
- There's doubt of your liability for the debt
- It's "effective tax administration" because of an exceptional circumstance
Doubt As to Collectibility
Doubt as to collectibility means that the taxpayer isn't likely to ever be able to pay the full amount of taxes owed to the IRS. It doesn't mean the taxpayer doubts that he actually owes the outstanding balance of tax debts—that's a separate reason. You're telling the IRS that it can pursue you for the debt all it wants, but it won't be able to get all the money because you just don't have it. You don't have assets you can liquidate or refinance to raise the money, and you're unlikely to be approved for an unsecured loan.
Doubt as to collectibility is the primary reason why the vast majority of taxpayers request an OIC.
Doubt As to Liability
This means that the taxpayer doubts that she's is responsible for the outstanding balance of her tax debt. You must submit a statement explaining why you believe this to be so.
It might be easier, faster, and less costly to find a way to resolve the underlying tax liability than to seek an OIC based on doubt as to liability. Alternatives include filing an amended tax return to correct any perceived errors, requesting innocent spouse or injured spouse relief, requesting penalty abatement, or asking for an audit reconsideration.
Effective Tax Administration
Effective tax administration means you're claiming that some exceptional circumstance would pose a serious economic hardship to you if you were to pay the tax. It would be unfair and inequitable to collect the entire balance due from you. You don't doubt that you're responsible for the outstanding tax debt, or that the IRS could probably collect the full amount due if it tried.
Significant economic hardship cases would include very serious health problems. Enrolled agent David Bauman, an offer in compromise specialist with JK Harris, advises:
"In submitting an offer based on effective tax administration, the taxpayer needs to provide extensive narrative of the special and extraordinary circumstances, along with the rest of the offer in compromise documentation. Right now, extraordinary circumstances would mean some sort of life or death situation, such as a serious medical condition."
Effective tax administration is the least understood of all three reasons. The IRS rarely approves an offer based on effective tax administration.
Alternatives include seeking a long-term installment agreement, requesting a partial-pay installment agreement, or seeking penalty abatement based on reasonable cause.
A large number of OIC applications are returned because they're missing one or more of the required forms, required backup documentation, or a payment or request for a fee waiver. An offer also can't be processed if you aren't current on your tax obligations.
Here's a checklist of all requirements for your OIC to be considered "processable" by the IRS:
- You must not have an open bankruptcy case.
- You must have filed all federal tax returns that you were required to file. This rule has been in place since March 2017.
- You must pay a $186 application fee as of 2019, or request a fee waiver.
- You must submit IRS Form 656, Form 433-A, or Form 433-B, along with support documentation. Form 433-A is for individuals and Form 433-B is for businesses. Each asks for a detailed analysis of your financial situation, including your income, assets, and budget.
- You must be current with estimated taxes and/or income tax withholding for the current year.
The collection information statement (Form 433-A) does not have to be submitted if you're requesting an OIC based solely on doubt as to liability.
The IRS offers an interactive pre-qualifying tool to help you determine if you're eligible before you go to the trouble and expense of preparing your offer.
You must also indicate the payment terms for your offer. These begin from the date the IRS accepts and approves your OIC:
- You'll make a cash payment of the portion of your debt you're proposing to pay.
- Ask for a short-term deferred payment arrangement.
- Request deferred payment
You can elect to pay the full amount of your offer in compromise within 10, 30, 60, or 90 days from the date of receiving written notice that the IRS has accepted your offer. This is the preferred payment option.
Otherwise, you can pay the full amount of the OIC within 24 months. You might specify a lump sum payment within 90 days, then monthly installment payments for up to 24 months from the date of acceptance.
Or you can pay the full amount of your OIC over the remaining life of the collection statute of limitations. You can specify a lump sum payment due within 90 days, then monthly installment payments for the remainder of the collection period, which is normally 10 years or 120 months from the date the tax liability was finalized.
Keep in mind that this 10-year period might have been extended or suspended by various actions taken by the IRS or even by you. Filing an OIC application automatically suspends the 10-year period while the IRS processes your request. You should negotiate with the IRS very carefully to make sure the collection period is fully defined in the terms of your offer agreement—or better yet, hire a qualified tax professional to do so for you.
You must also tell the IRS how you're going to pay the amount you're proposing. For example, you can say that you plan to sell your house, that you'll be getting loans or gifts from your family, or that you intend to refinance your mortgage.
What Are the Odds of Acceptance?
The majority of offer in compromise (OIC) applications are returned as unprocessable, or they're rejected. The IRS accepted and approved slightly more than 40% of OICs received in 2017, the last year for which data is available. This worked out to about 25,000 approvals among 62,000 applications received.
The IRS will generally accept an OIC if all the paperwork is in order and it believes that the offer is the most money it's likely to be able to collect through other efforts. It will probably reject your application if it believes it can collect from you if you elect one of the alternatives mentioned above.
You have 30 days to appeal if the IRS rejects your offer. Use Form 13711 to explain why you disagree with the decision.
If Your Offer Is Accepted
The offer in compromise is a contract between you and the IRS, so you should read IRS Form 656 very carefully before you sign and submit it. The OIC contract sets forth your responsibilities. The IRS can and probably will revoke your offer and re-instate the full amount of your original tax debt if you fail to comply with any of the contractual provisions.