Preparing IRS Form 656
Offer in Compromise Application
IRS Form 656 is a proposed contract. In Form 656, the taxpayer is agreeing to offer the IRS a certain amount of money. In exchange for the money, the IRS agrees to cancel the taxpayer's outstanding tax debts. This proposal may be accepted or rejected by the IRS, or returned to the taxpayer as "unprocessable." (Download a copy of IRS Form 656 in the PDF file format.)
The vast majority of Offer in Compromise applications either are returned as unprocessable or are rejected.
Approximately 16% of Offers are accepted and approved by the IRS. Because the Offer in Compromise is a contract between you and the IRS, you must read IRS Form 656 carefully several times. The Offer contract sets forth your responsibilities. If you fail to comply with any of the contractual provisions, the IRS can and probably will revoke your Offer in Compromise and re-instate the full amount of your original tax debt.
The basis of the Offer in Compromise
You must request an Offer in Compromise under one of three reasons:
- Doubt as to Collectibility,
- Doubt as to Liability, or
- Effective Tax Administration.
Doubt as to Collectibility
Doubt as to Collectibility means that the taxpayer could not ever pay the full amount of taxes owed to the IRS. The taxpayer does not doubt that he or she actually owes the outstanding balance of tax debts. Doubt as to Collectibility is the primary reason the vast majority of taxpayers request an Offer in Compromise.
Alternatives to an Offer in Compromise based on Doubt as to Collectibility would be a long-term installment agreement, a partial-pay installment agreement, or being declared not currently collectible by the IRS.
Doubt as to Liability
Doubt as to Liability means that the taxpayer doubts that he or she is actually responsible for the outstanding balance of tax debts.
The taxpayer must submit a statement explaining why the tax liability is doubtful. A collection information statement (Form 433-A) does not need to be submitted if you are requesting an Offer in Compromise based solely on Doubt as to Liability.
Alternatives to an Offer based on Doubt as to Liability would be to file an amended tax return, to request innocent spouse or injured spouse relief, to request penalty abatement, or to request an audit reconsideration (PDF). Basically, it may be easier, faster, and less costly to find a way to resolve the underlying tax liabilities than to seek an Offer in Compromise based on Doubt as to Liability.
Effective Tax Administration
Effective Tax Administration means that the taxpayer is claiming that some exceptional circumstance such that paying the tax would pose a serious economic hardship, would be unfair, and would be inequitable. The taxpayer does not doubt that he or she is responsible for the outstanding tax debts, and does not doubt that the IRS could probably collect the full amount of taxes. 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 and death situation, such as a serious medical condition."
Effective Tax Administration is the least understood of all three reasons, and so the IRS rarely approves an Offer in Compromise based on Effective Tax Administration.
Alternatives to an Offer based on Effective Tax Administration would be to file an Offer based on Doubt as to Collectibility, to seek a long-term installment agreement, requesting a partial-pay installment agreement, being declared not currently collectible by the IRS, or seeking penalty abatement based on reasonable cause.
A large number of Offer in Compromise applications are returned as being unable to process by IRS staff. An Offer cannot be processed if it is missing any of the required forms, is missing any required backup documentation, or if you have not enclosed payment or a request for a fee waiver. An Offer also cannot be processed if you are not current on your tax obligations.
Here's a checklist of all requirements in order for your Offer in Compromise to be considered "processable" by the IRS:
- Must not have an open bankruptcy case,
- Must have filed all federal tax returns that you are required to file,
- Must have filed payroll tax returns and made on-time deposits of payroll taxes for the prior two quarters (for business taxpayers),
- Must pay $150 Offer in Compromise application fee, or request a fee waiver,
- Must submit IRS Forms 656, 433-A, and/or 433-B, along with support documentation, and
- Must be current with estimated taxes and/or income tax withholding for the current year.
You must indicate the payment terms for your Offer in Compromise. The payment terms begin from the date that the IRS accepts and approves your Offer in Compromise.
Payment Terms Available
- Cash Payment
- Short-Term Deferred Payment
- Deferred Payment
Pay the full amount of your Offer in Compromise within 10, 30, 60, or 90 days from the date of the written notice that the IRS accepted your Offer. This is the preferred payment option. I strongly encourage taxpayers to choose the 90-day payment option, as this generally gives them enough time to come up with money to pay off the IRS.
Short-Term Deferred Payment
Pay the full amount of the Offer in Compromise within 24 months from the date of the written notice that the IRS accepted your Offer. You may specify a lump sum payment within 90 days, and then monthly installment payments of up to 24 months from the date of acceptance.
Deferred Payment Offer
Pay the full amount of the Offer in Compromise over the remaining life on the collection statute of limitations. You may specify a lump sum payment due within 90 days, and then monthly installment payments for the remainder of the collection period. The normal collection statute of limitations is 10 years (or 120 months), from the date that a tax liability was finalized.
This 10-year period may have been extended or suspended by various actions taken by the IRS or by the taxpayer. Filing an Offer in Compromise suspends the 10-year period while the IRS processes the Offer in Compromise. You should negotiate with the IRS very carefully to make sure the collection period is fully defined in the terms of your Offer agreement.
Source of Funds
The taxpayer must indicate where the money will come from to pay the IRS. Let the IRS know exactly how you plan to raise enough cash to pay your Offer. For example, you can say that you plan to sell your house, or that you will be getting loans or gifts from your family, or that you intend to refinance your mortgage.