Getting Out of Trouble—the Offer in Compromise
By Christian Reeves
“Chris, I’m in a big trouble,” started one of my clients. “I owe around US$50,000 to the IRS for the last three years and I’m now unemployed. My only asset is a car worth about US$1,000. Do I have options?”
“Yes, you do,” I assured him.
My client owed back taxes, but couldn’t afford to pay the entire bill. I advised him to opt for an Offer in Compromise, which would allow him to clear his debt by paying just part of what he owed.
Let’s start with the basics.
The Offer in Compromise is a program established by the IRS aimed at helping people who can’t pay their back taxes because they are experiencing financial hardships. Through this program, taxpayers can negotiate a reduction of their debts.
“How come,” you’d ask. “Isn’t the government running huge deficits these days?”
The government needs your money…but many hardworking Americans cannot afford to pay their bill in full. To the IRS it’s better to get back even a small percentage of that debt than nothing at all. Seen from this perspective, making a deal with you makes sense.
Note that the IRS does not grant Offers in Compromise to everyone. In fact, only one in every four Offers in Compromise filed is ever negotiated. However, when it made a deal, the IRS settled for an average of about 16% of the taxpayer’s ability (Source: United States Government Accountability Office, Report to the Committee on Finance, U.S. Senate, April 2006)
Filing an Offer is not for the faint of heart. You must prove you can’t afford to pay in full and it is in the best interest of the IRS to settle for less. This means that you have to open up all of your financial records to the IRS, including bank statements and mortgage documents. You need to provide receipts for each and every item on your expense list. To make matters even more complicated, you have to take into account the fact that the IRS has its own table of “allowed expenses” to determine what kind of lifestyle you should be permitted to keep until the tax debt is paid off. Properly analyzing your tax satiation (actual income vs. allowed standards) and fully documenting your case are the keys to getting an Offer in Compromise accepted.
You will be required to submit forms 656, 433-A, and 433-B, if applicable, as well as all the supporting documentation to substantiate your assets, liabilities, income, and “allowed living expenses.”
The amount you can afford to pay the IRS each month is determined by subtracting from your average monthly income the “allowed living expenses.” In determining these living expenses, the IRS uses what it calls the “national standards” of what it will allow for food, clothing, and other items; the “local standards” are used to determine the maximum allowed expenses for housing, utilities, and transportation. These calculations are applied regardless of your actual expenses documented on form 433-A.
The amount you can afford to pay the IRS in the Offer in Compromise program is the value of this stream of income plus the value of your assets, such as retirement accounts, automobiles, real estate, etc. The value of your monthly payments (income stream) is calculated by multiplying the monthly figure by 48 or 60 months, depending on the type of Offer you submit. More on this in a minute…
Remember: The IRS will only consider an Offer in Compromise after all other payment options have been exhausted. In fact, the Service encourages you to explore all the available ways to pay the liability such as cash advances on credit cards, borrowing against 401(k) funds or life insurance policies, etc. You may even be given an extension of time to pay, ranging from 30 to 120 days.
Finally, before an Offer in Compromised is considered, the IRS evaluates the possibility of you qualifying for an Installment Agreement. For this purpose, if you owe less than US$25,000 in taxes, Form 9645 also needs to be filed. If you can’t afford to pay the tax debt in full in an Installment Agreement, only then will you be considered for an Offer in Compromise.
When applying for an Offer in Compromise you must generally include a US$150 application fee and a deposit of 20% of the amount you offer (for example, if you owe US$50,000 and offer to pay US$2,000, then you have to include one check for US$150 and another one for 20% of US$2,000, or US$400) in the case of a “lump sum” payment option. You can also choose other payment options, but this typically results in your Offer being delayed for up to 12 months.
There are additional requirements for applying for an Offer in Compromise. For a start, all your federal tax returns must be filed…the IRS absolutely will not consider an Offer in Compromise if your returns are unfiled. Also, you can’t be in bankruptcy. You must wait to exit bankruptcy to file an Offer in Compromise, if your tax debt will not be discharged.
If you are a senior citizen living on a fixed income or suffering from a serious illness, then you may expect special consideration from the IRS. Be prepared to show medical records, doctor’s statements, and other supportive documents, even write a letter detailing your special circumstances. As a colleague of mine used to say, ”paint it black” and you’ll stand a better chance of reducing your debt through an Offer in Compromise.
In the event your Offer in Compromise is accepted, you will be required to file and pay all your taxes on time for a period of five years. Also, you’ll agree that the IRS may keep any tax refunds that would have been payable to you during the calendar year when your Offer in Compromise was approved and for the years prior to the Offer.
Pros and Cons of Making an Offer in Compromise
Having an Offer in Compromise approved is not taking a free ride. The government runs vigorous enforcement programs and, if not careful, your original debt may be reinstated in full, together with all penalties and interest accumulated.
But let’s first talk about the advantages (some of them are…well, obvious):
- You save money…a lot of money, actually. If accepted, the amount you’ll pay under the agreement may be just pennies on the dollar of the original debt.
- After you’ve paid the amount agreed to, any tax lien is released within 30 days and your credit rating will improve.
- Your stress level is reduced while the Offer is pending because all collection actions are suspended during this time.
Are there disadvantages? Sure, I’ve just mentioned one at the beginning of this section…having to adhere religiously to the IRS rules. Here are others:
- Filing an Offer gives the IRS extra time to collect from you. Normally, the IRS has 10 years to collect your debt; after the 10 years are up your debt is canceled. When you file an Offer in Compromise, the collection period is extended by the time the Offer is under consideration, plus 30 days.
- You’ve now provided the IRS with everything about your financial situation, and thus with a roadmap for the Service to take better collection action in case your Offer is rejected.
- And now a biggie…In most cases when the taxpayer has a large debt for which an Offer in Compromise is desired, he/she also owes state income taxes, credit card debt and/or other financial obligations. The Offer in Compromise will not do anything for solving these issues. Therefore, the Offer in Compromise is not a complete solution for all the debt you owe. The only solution to eliminate the federal tax debts as well as other financial problems you may have is bankruptcy. Read hereLINK about dumping your tax debt in bankruptcy.
- Note than many states have Offer in Compromise programs very similar to the federal program. It is possible to eliminate state and federal tax debts by filing Offers in Compromise with both agencies simultaneously.
What if My Offer Is Rejected?
This happens very often. It may be that the IRS thinks you can pay off all your debt or it deems the amount you offered to pay too low. I’ve even had Offers rejected on the nebulous grounds of “against public policy,” whatever that means.
Also, a very large number of Offers are returned each year because the forms are completed incorrectly, or the Offered amount, and thus the 20% deposit, is unreasonable. The reason may even be as simple as forgetting to sign the form (it happens more often than you’d think) or not listing your Social Security number. Analyzing, documenting, and submitting an Offer in Compromise is a very mechanical and detailed process, which takes years of experience to master.
In the case when the Offer amount is too low then you can submit another form, with a higher amount. If the rejection is due to a different reason, you will find it explained in your rejection letter. You have the right to appeal the IRS decision within 30 days from the date of the rejection.
When You Need a Tax Professional…
Always choose a reputable tax professional who has experience preparing Offers in Compromise. Many unscrupulous promoters claiming they can slash your debt to just pennies on the dollar advertise on billboards, late-night TV, and the Internet. These so-called “offer mills,” often with slick advertisements, can take away your money and not live up to the promises they made in the first place. For reviews of some of these promoters, check out the FAQs section LINK of this website.
At Premier Tax & Corporate, Inc. you will find a group of well-trained professionals who will work together with you in order to achieve the best available result for your particular situation. Our enrolled agents and tax attorneys add the most value in planning, preparing, and documenting your Offer in Compromise. Also, just as important, our professionals can determine if you qualify for an Offer in Compromise prior to its being filed, saving you thousands of dollars and months of time. Contact us by phone at (800) 581-6716 or by e-mail at firstname.lastname@example.org. We are here to help.