Taxpayers have several options for resolving federal tax debts. They can request a monthly payment plan, for example, or submit an offer in compromise, or seek bankruptcy protection. How do you know which is right for you if you find yourself in this position?
We spoke with David A. Bauman, an Internal Revenue Service (IRS) enrolled agent with tax representation firm JK Harris, about the advantages and disadvantages of filing an offer in compromise. Here's what he had to say.
What Are the Options For Dealing With Tax Debts?
To this, Bauman said: "Taxpayers have five alternatives for resolving IRS collections activity: setting up an installment agreement, setting up a partial payment installment agreement, submitting an offer in compromise, filing for bankruptcy, or being declared not currently collectible by the IRS."
How Do You Know Which Debt Strategy Is Right for a Client?
Concerning debt strategies, Bauman said: "We'll generally prepare a financial statement for clients based on their unique financial situation to determine which tax debt strategies are best for each. Everything depends on the client’s personal financial situation. We examine the client’s ability to pay. The offer in compromise program might be a good option if a client can't afford to pay his tax debt in full."
"In particular, we examine the client’s monthly disposable income," Bauman added. "If there’s sufficient disposable income, we generally recommend that the client set up an installment agreement or a partial-pay installment agreement. If the client is making enough income to cover expenses and is more or less breaking even, then we might recommend an offer in compromise."
"But if the client spends a lot of money on expenses that the IRS won't allow," Bauman said, "we might recommend that the client consider bankruptcy as an alternative."
What Are the Biggest Factors in Determining a Successful Offer in Compromise?
"The taxpayer must have the ability to pay something and to borrow," said Bauman. "Additionally, the IRS won't approve an offer in compromise if the taxpayer isn't in compliance with the tax laws. For example, the taxpayer must be current on estimated tax payments or federal income tax withholding, they must be making payroll tax deposits on time, and they must have filed all tax returns. The ability to pay and to borrow is measured by the reasonable collection potential."
Which Tax Debt Strategy Do You Prefer?
"Generally, we prefer that a client set up an installment agreement or an offer in compromise," stated Bauman. "Installment agreements and offers in compromise are contracts between the taxpayer and the IRS. As long as the terms of the contracts are being fulfilled, the IRS won’t bother the taxpayer."
What About Partial Payment Installment Agreements?
To this, Bauman stated: "These involve a taxpayer making monthly payments but she ends up paying less than the full amount owed. Partial payment installment agreements can be easier to get than offers in compromise but unlike an offer or a full-pay installment agreement, the IRS can re-evaluate the terms of a partial payment installment agreement every two years."
"For example, if the IRS thinks the taxpayer can afford to make bigger payments," Bauman added, "the partial payment installment agreement might have to be renegotiated. The taxpayer can request reevaluation at any time should his circumstances change to such a degree that the agreed-upon payment can no longer be made."
How Does a Taxpayer Request a Partial Payment Installment Agreement?
In response to this question, Bauman said: "Taxpayers should submit a written request for a partial payment installment agreement to the IRS revenue officer assigned to their cases or to the Automated Collection System unit handling their accounts. A written request can be submitted to the Service Center where the taxpayer files his tax return if he wants to set up a partial payment installment agreement before either of these two IRS interactions has occurred."
"Forms 433A and/or Form 433B must also be submitted," Bauman added, "which represent the Collection Information Statement and shows the taxpayer's ability to pay. The taxpayer will have to submit documentation to support the information on these forms."
What About Taxpayers Who Have Little or No Documentation?
"The IRS expects documentation to accompany the Collection Information Statement," Bauman said, "but some clients don't keep their bank statements and paystubs. We do the best we can, based on the documentation they can provide."
"The IRS typically wants the backup documentation," Bauman added, "or they'll disallow the expenses being claimed. In some cases, however, the IRS will accept written projections of a client’s income when there’s little documentation to go on. For example, a taxpayer starting a new business might have to estimate his future income and expenses. Such income projections have to be reasonable."
Can Payroll Taxes and Penalties Be Settled?
To this question, Bauman stated: "A business owner can try to settle payroll taxes and penalties through an offer in compromise. If neither the business nor the business owners have the ability to pay the taxes in full, the IRS might accept an offer in compromise."
Can a Taxpayer Request an Offer in Compromise Based on Doubt as to Collectability or Liability?
"Yes," said Bauman said. "I've seen the IRS approve an offer in compromise based on effective tax administration. These cases are rare, however. Basically, the taxpayer needs to demonstrate that he or she is suffering an extraordinary hardship so collecting the tax would be inequitable and unfair. I can think of a case where the taxpayer was suffering a significant medical hardship and it was uncertain whether he would even live long enough to pay off his tax debts."
"In submitting an offer based on effective tax administration," Bauman continued, "the taxpayer needs to provide an extensive narrative of the special and extraordinary circumstances along with the rest of the offer in compromise documentation. Extraordinary circumstances would generally mean some sort of life and death situation such as a serious medical condition."
Which Is Better, Making a Lump Sum Payment or Making Monthly Payments?
Here, Bauman stated: "We generally recommend that taxpayers make a cash offer to pay within 90 days of notice that the IRS has accepted their offer in compromise. Cash offers get the attention of the IRS so these applications are sometimes processed faster. Also, the IRS thinks there's less of a chance that the taxpayer might default on the payment arrangement."
"The offer amount is based on the reasonable collection potential," Bauman added, "which includes a calculation of monthly disposable income over the next 48 or 60 months. With a cash offer, the IRS multiplies disposable income over 48 months. With a 24-month payment offer, the IRS multiplies disposable income over 60 months. So taxpayers are usually better off with the cash offer if they can pay within the shorter time period. Otherwise, the taxpayer is better with the higher 24-month offer because there would still be a contract that can be counted on as long as the terms are honored."
Can the Taxpayer Change Their Mind?
"The taxpayer can switch payment plans at any time prior to acceptance or rejection by the IRS," stated Bauman. "However, the change isn't typically made until the IRS comes back with a counteroffer."
"Switching payment plans will change the monthly income factor by the multiplier of 48 or 60," Bauman continued. "Taxpayers should be working closely with their tax professional to make sure they choose whichever payment plan is right for them."
Should You Do It Yourself or Hire a Tax Professional?
"Generally," Bauman said, "taxpayers should seek the advice of an experienced tax professional when they're trying to resolve tax debt problems. An offer in compromise might or might not be the best solution to the problem."
"But if a taxpayer owes less than $10,000 in taxes," Bauman said, "he can probably handle the problem himself by calling the IRS and requesting a payment plan. If he owes between $10,000 and $25,000, however, he should consult with a tax professional about the options available to him. And if he owes more than $25,000, the taxpayer should definitely be working with an experienced tax professional."
What Should a Taxpayer Look for in a Professional?
Bauman answered this question by stating: "Taxpayers should look for someone with significant experience in IRS collection matters, especially experience in dealing with revenue officers, the Automated Collection Systems division, and appeals."
"They should find out how many years a tax professional has been working with collection matters," Bauman added. "Additionally, taxpayers should be looking for a professional with extensive tax knowledge, especially concerning the laws for the collection of tax debts. The professional should be admitted to practice before the IRS such as an enrolled agent, a certified public accountant, or a tax attorney."
"Many times a client will first seek the help of their attorney," Bauman went on to say, "but not all attorneys specialize in IRS collections. An attorney can help you evaluate potential tax professionals, however, and can make a recommendation about which tax professional seems best qualified to help."
What's the Process and How Much Does It Cost?
"Everything depends on the taxpayer’s unique financial situation," Bauman said. "How long an offer in compromise takes depends on how fast the IRS processes the offer. I tell clients it can take anywhere from six months to two years. The fastest I’ve seen the IRS process an offer is four months. The longest was two and a half years."
"The price for an offer in compromise and other IRS representation services will vary," continued Bauman. "The more complex the case, the higher the fee for professional help. An offer in compromise, just by itself, will cost a minimum of $2,500 in most cases and possibly more depending on how complicated the case is."
"And sometimes clients need more than just an offer in compromise," Bauman went on to say. "They might also need to prepare back taxes. So the total cost always depends on the complexity of the case and how much help the client needs."
Are There Any Disadvantages in Filing an Offer in Compromise?
"The offer in compromise is just one tool for handling tax debts," stated Bauman. "Taxpayers should consult with a tax professional to find out if any other tax debt strategy, such as an installment agreement or bankruptcy, is right for them."
"The biggest disadvantage to an offer in compromise is that filing an offer delays the 10-year statute of limitations on collecting tax debts," Bauman added. "The IRS has 10 years to collect tax debts but the 10-year period is suspended while the IRS is processing an offer in compromise. This means the IRS can have extra time to collect on tax debts if the offer in compromise is rejected."