When a taxpayer cannot pay the tax bill (now or in the future) with future assets and monthly income, they may qualify for the I.R.S. Offer in Compromise program—providing a "doubt as to collectibility" in an agreement allows taxpayers who are not projected to have the ability to pay the I.R.S. before the expiration of the I.R.S. billing status to settle their tax accounts for less than the full amount. This program receives a lot of publicity in the press and media but is rarely used. In fact, in 2018, for more than 19 million taxpayers who owe $511 billion in back taxes to the I.R.S., only 24,000 were able to "settle" their tax debt.
Why do few people get an Offer-In-Compromise?
First, most applicants may not be eligible. That is, they can have a share of future assets or income that can pay taxes before the I.R.S. collection statute expires. For example, a taxpayer can pay off his/her debt if he/she has an I.R.S. tax debt of $20,000 and has a pension account balance of $50,000. The I.R.S. will not rectify this solvent taxpayer unless the taxpayer has special circumstances.
Also, it may be "prohibitively expensive" to settle. In other words, the taxpayer may not be able to fund the offer in compromise settlement.
The final regulations were published on March 12, 2020, which increased the user fee for submitting an O.I.C. from $ 186 to $ 205 (effective for an offer in compromise applications submitted after April 27, 2020). While a 10% increase may sound like a lot, it's only a small portion of O.I.C.'s potential cost. User fees do not usually prevent many from applying for an O.I.C.; the actual cost is how much is needed to settle the tax bill. This amount is called an "offer amount," a calculation of the amount accepted by the I.R.S. to settle a tax account.
Actual cost: offer amount
Most people believe the I.R.S. is negotiating with the taxpayer about how long it will take for the tax bill to be paid. Some believe the I.R.S. will only charge a percentage of the bill or waive fines and interest in a settlement. These are all myths.
If a taxpayer first qualifies for an offer in compromise, they will determine the amount to provide to the I.R.S. The "offer value" in an offer in compromise is the amount the I.R.S. will reasonably charge the taxpayer before the expiration of collection status or its "reasonable collection potential (R.C.P.)." The reasonable collection potential is a formula for how much the I.R.S. will agree to pay. The R.C.P. is equal to the "net realizable value of the assets" of the taxpayer, plus a component of their disposable income for the future (normally 12 or 24 months, depending on the type of O.I.C. payment method).
An example of how the O.I.C. Works
Let's take a simple example to explain how to calculate the value of an offer. Suppose the taxpayer owes $ 50,000 for 2017 (also assume that the I.R.S. has 100 months left in the status of limitations to collect) and has realizable equity in future assets and income, as follows:
Net Realizable Capital (N.R.E.) in Assets (the only asset is the house): $10,000
A house that is owned with a mortgage:
Fair market value of $ 150,000
80% of the quick sale value = $ 120,000 (IRS rule that rates asset sales as "quick sale value")
$110,000 of loan proceeds
NRE = $ 120,000 (QSV = quick sale value) minus $ 110,000 (loan) = $ 10,000
Future monthly disposable income (MDI): $ 200 per month
Two earners, with I.R.S., authorized living expenses (subject to limits imposed on the taxpayer by I.R.S. financial collection standards):
Average gross monthly income: $ 6,000
Average living expenses and monthly expenses needed to generate income, limited by I.R.S. financial collection standard: $5,800 (for categories such as food/clothing/sundries; housing/utilities; transportation costs; medical expenses; and others such as taxes paid, health insurance, life insurance, childcare expenses, court costs, etc.)
MDI: $6,000 (average gross monthly income) minus $ 5,800 (average monthly living expenses required) = $ 200
First, is the taxpayer eligible for an O.I.C.? In this simple case, the taxpayer is eligible for an offer in compromise. The taxpayer has $ 10,000 in N.R.E. and $ 200 in MDI, which he/she will not pay in full to the I.R.S. before the expiration of the collection statement.
Here is the calculation that shows that you qualify:
The taxpayer's total "ability to pay" to the I.R.S. before the expiration of tax collection status is $ 10,000 (net amount) plus the amount he/she could collect from the tax collection taxpayer in monthly payments (calculated as $ 20,000) before collection status expires ($ 200 per month in MDI for 100 months or $ 20,000) or $ 30,000 in total. $ 30,000 is less than the total amount owed ($ 50,000), so the I.R.S. will not fully charge any fees due before collection status expires ($ 50,000 minus $ 30,000 in payment capacity leaves the I.R.S. to cancel $20,000 end of status).
Next is the value of the offer. The taxpayer will not have to pay $30,000, but an N.R.E. calculation plus a future MDI multiplier. If the taxpayer chooses to pay the I.R.S. in a fixed amount (O.I.C.'s "fixed amount" payment method), they will use 12 months as a multiplier for future income (24 months if the O.I.C.'s recurring payment method is used).
The “offer amount” is estimated at $ 12,400 ($ 10,000 in NRE plus $ 2,400 (200 MDI for 12 months)). If the taxpayer can prove to the I.R.S. that his/her N.R.E. is $ 10,000 and his/her MDI is $ 200 per month, he/she can settle his/her $ 50,000 tax bill for $ 12,400. Tip: N.R.E. and MDI calculations incorporate many complicated rules that must be followed to correctly calculate O.I.C. odds and the bid amount. Taxpayers who do not have these calculations may consider themselves ineligible or have a higher offer value that they will not pay in the future.
As shown in our example, the actual cost is the "offer amount." Can the taxpayer pay $ 12,400 to settle his/her taxes? The reality is that most cannot and, therefore, cannot use the O.I.C. program.
Upfront O.I.C. costs
In addition to the user fee of $ 205, the I.R.S. will require the taxpayer to pay a portion of the value of the O.I.C.'s supply with the demand. If the taxpayer chooses the single payment method, the I.R.S. will charge 20% of the offer. In our example, that would be 20% of $ 12,400 or $ 2,480.
If the taxpayer chooses the periodic payment method, they will have to make monthly payments of the offer amount to the I.R.S. during the offer investigation period. Most O.I.C.s last for 7 to 12 months, meaning the taxpayer can send 7 to 12 months of payments to the I.R.S. while the O.I.C. is under review. These payments can be large without any assurance that the I.R.S. will accept the O.I.C.
The O.I.C. costs don't stop there. Taxpayers must lose the next exchange if their O.I.C. is accepted. They may also have to pay substantial business fees to a tax professional of more than $ 5,000 or more to complete this process from application to approval.
Other viable alternatives
Low-income taxpayers who do not have any O.I.C. user fees or prepayment usually do not have significant financial expenses when submitting an O.I.C. The I.R.S. defines low income for taxpayers who are 250% or below the poverty line for family size and income. I.R.S. Form 656 (O.I.C. Application) has these threshold values. Taxpayers who meet the low-income criteria must continue to calculate the offer's qualification and value and be able to pay the value of the offer when the O.I.C. is approved.
The taxpayer also has other options, including two other alternatives from the Internal Revenue Service, including currently not collectible (C.N.C.) and a partial pay installment agreement (PPIA). The C.N.C. status means the taxpayer has no monthly income available to pay the I.R.S. PPIA means the taxpayer can pay the I.R.S. monthly but cannot pay taxes fully before the collection period expires.
The C.N.C. and PPIA may be better options than an O.I.C., as these arrangements do not always require the taxpayer to pay the I.R.S. from the equity in assets. Taxpayers in financial difficulty will not be required to access the equity (e.g., equity, savings, etc.) if the taxpayer needs funds to pay maintenance costs or cannot access the equity. The C.N.C. and the PPIA are generally the most realistic option for taxpayers.
If the taxpayer meets the required conditions, the two agreements can be more advantageous financially than the O.I.C. However, the C.N.C. and the PPIA are temporary agreements with the I.R.S. If the taxpayer's financial condition improves before the collection status expires, the I.R.S. may request that these terms be renegotiated.
One last tip
Taxpayers should not view the O.I.C. as the only financing solution. Taxpayers facing tax debt should consider all alternatives to I.R.S. taxation. Additionally, taxpayers should also consider disputing any outstanding balances, including penalties, if they face full payment as the only option.
The best approach is to assess your tax status, personal finances, and I.R.S. billing alternatives and develop the best approach to pay the minimum due. Focusing only on the O.I.C. can lead to a costly mistake and leave the tax debt problem unresolved.
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