Will the IRS really keep my tax refunds if I get an Offer in Compromise?

Dear Tax Guide, My wife and I recently applied for an Offer in Compromise, and we just received a letter from the IRS requesting additional supporting documentation. We plan to make monthly payments if our OIC is accepted. We have been told that the IRS will keep our future tax refunds (which are usually between $3,000 and $5,000), and that the IRS will not apply this money to the OIC offer amount but rather applied to the pre-offer tax liability.

Do you know if this is true? If my Offer in Compromise was accepted in 2005, and the IRS already took my 2005 tax refund, does that mean I will get my 2006 tax refund? Or will the IRS keep that as well?

Dear Reader, The IRS will in fact keep any tax refunds while your offer in compromise is being processed, and will keep any tax refunds in the year your offer is approved. David Bauman, an enrolled agent, explains:

"The IRS will keep the refund for the year the offer is accepted. In this case, the offer was accepted in tax year 2005. Therefore, the 2005 refund that would come in April of 2006 would be kept by the IRS as part of the offer agreement. The taxpayer should try to figure out how much tax he owes and attempt to break even or owe slightly so he can pay the amount due when he files. He has not defaulted the offer until he gets sent to collections on a new balance due amount after the offer is accepted.

Future refunds, for tax years 2006 and beyond, will not be affected. The taxpayer will get those refunds."

This is part of the OIC contractual agreement.

  • You agree to let the IRS keep any tax refunds, payments, and credits applied to your tax debts prior to submitting your Offer in Compromise.
  • You agree to let the IRS keep any tax refunds that would have been payable to you during the calendar year that your Offer in Compromise is approved.

    What does this mean? It means that before your Offer in Compromise is approved, that the IRS will keep any tax refunds and apply the refunds to your outstanding tax debts. Also, after your Offer in Compromise is approved, that the IRS will keep any tax refunds in the same calendar year.

    These refunds may not be counted as part of your total offer in compromise payment amount. Also, you may not apply any tax refunds towards next year's estimated taxes. This makes tax planning a little trickier. But here's what I suggest.

    Use your tax refunds to pre-pay certain taxes. For example, can you sell some profitable investments and generate some capital gains? Or perhaps you can convert some of your traditional IRA into a Roth IRA? Or perhaps you can pay more self-employment taxes by having fewer business expenses? I know it sounds weird, but try to reduce your refund by increasing your tax liability. You want your refund as close to zero as possible, because after all, you aren't going to see that money anyway.

    Adjust your paycheck withholding or estimated tax payments. Try to estimate your taxes using the recently published 2006 tax rates. Try to keep your withholding and/or estimated payments on target to be as close to your tax liability as possible.

    Again, you are going to lose your refund anyway, so try to achieve a refund amount as close to zero as possible.

    I used these strategies for a recent client of mine whose Offer in Compromise was approved. She paid fewer business expenses in order to increase her self-employment taxes. This not only reduced her tax refund, it actually will help her out in retirement by boosting her Social Security amount. I have another client who isn't self-employed. We are going to convert part of her traditional IRA to a Roth IRA, and pay the tax on the conversion. Not only does this eliminate her tax refund, it will provide tax-free withdrawals from her Roth in retirement. You may want to seek the advice of an experienced tax professional for other tips on how to handle your tax situation.

    Additional Information:
    Offer in Compromise Essentials
    Preparing IRS Form 656, Offer in Compromise
    Preparing IRS Form 433-A, Collection Information Statement
    Interview with David Bauman of JK Harris providing inside tips on filing an offer in compromise