The U.S. tax code provides an option known as an Offer in Compromise to taxpayers who owe more to the IRS than they can possibly pay. You can enter into an agreement with the IRS to pay less than your full tax debt, often over time.
Of course, the IRS won't simply take your word for it that you don't have the resources to pay your entire tax debt. You'll have to prove it by submitting various forms of documentation, and the IRS will keep your tax refunds for a period of time if your offer is approved.
What Is an Offer of Compromise?
An offer of compromise is a proposal to the IRS to pay less than the full amount of your tax debt because you simply don't have the available funds or because paying the full amount would present a financial hardship.
The IRS will assess your application and approve or deny your offer, or it might send your offer application back to you because you left out some important documentation or information. This doesn't necessarily mean that your offer has been rejected. You can amend your application and submit it again.
- Acronym: OIC
How Does an Offer of Compromise Work?
The OIC process begins when you submit Form 433-A to the IRS, along with copies of all documentation that the form requires. You must also submit Form 656(s), providing details of your tax debt and how much you owe.
The application fee is $205 as of 2020, and you should also submit whatever payment you've proposed when you send in your forms. The fee is waived if you can prove that there's doubt that you owe the full amount of the tax—and if the IRS can't prove that you're wrong. There's also a low-income exemption if your income for your family size is 250% or less of the federal poverty guidelines.
You would submit a payment of $100 with your OIC application if you're proposing paying off a portion of your balance at the rate of $100 a month. But if you're offering $2,500 instead of a $5,000 tax liability and if you've indicated that you'll pay this in a lump sum, you should remit $2,500 with your application.
It can take some time for the IRS to make a decision regarding your offer after you submit it. Collection efforts will be suspended during this time, but the IRS might still file a Notice of Federal Tax Lien against you to try to collect from you later if your offer is rejected or if you don't abide by its terms.
Your offer is automatically accepted if you don't hear back from the IRS within two years of the date of receipt of your application.
Debt.org reports that the IRS accepted approximately 25,000 of 62,000 OIC offers in 2017, which works out to a little better than 40% approval rate.
Pros and Cons of an Offer in Compromise
The IRS will keep any tax refunds you're entitled to during the period of time while your offer in compromise is being considered and processed. It will also keep any tax refunds due to you in the year in which your offer is approved.
For example, you might make your offer in 2020, and it's also accepted in 2020. The IRS will keep any refund you might be entitled to in 2021 for the income you earned and taxes withheld and paid during the tax year 2020. Future refunds for income earned during tax years 2021 and beyond wouldn't be affected, but you won't receive any that are still due to you from the tax year 2020 or earlier.
The IRS says in its Form 656 Booklet, "The IRS will keep any refund, including interest, for tax periods extending through the calendar year that the IRS accepts the offer. For example, if your offer is accepted in 2020 and you file your 2020 Form 1040 on April 15, 2021 showing a refund, the IRS will apply your refund to your tax debt. The refund is not considered as a payment toward your offer."
These refunds won't be counted as part of your total offer in compromise payment amount. They won't reduce the OIC balance you've agreed to pay, and you can't apply them toward next year's estimated tax.
Requirements for an Offer in Compromise
The IRS can approve an Offer in Compromise for one of three reasons:
- The total of your assets and income are less than what you owe the IRS. There's "doubt as to collectability."
- You've reached a stalemate with the IRS regarding the legitimacy of your tax debt. You can't prove you don't owe it but the IRS can't prove that you do, either. The IRS refers to this as "doubt as to liability."
- Paying the tax debt would create an economic hardship for you based on exceptional circumstances. This is referred to as "effective tax administration."
The IRS provides an Offer in Compromise Pre-Qualifier on its website if you're unsure that you meet the necessary criteria for your offer to be accepted. It can give you an idea where you stand.
You can't be approved if you've failed to file any required tax returns or to make any required estimated tax payments in previous years.
- An Offer in Compromise is a proposal to pay the IRS less than the full amount of your total tax debt.
- You can commit to paying a lesser amount in one lump sum, or you can make periodic payments over time.
- The IRS approves Offers in Compromise about 40% of the time.
- The IRS will keep any tax refunds you were due during the year in which you make your offer or earlier.
NOTE: Tax laws change periodically. You should always consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and it's not a substitute for tax advice.