Can You Really Settle Your Tax Debt with the IRS for Pennies on the Dollar?
Here's the inside scoop on Offers in Compromise (OICs) and settling a debt with the IRS.
You've probably seen the commercials on television: A pitchman says that you can settle your tax bill for "pennies on the dollar." All you have to do is hire the law firm in the commercial and they will use their special negotiating skills and inside knowledge to get you off the hook with the IRS.
In real life, however, it's not so easy to get the IRS to settle a tax debt for pennies on the dollar. It does happen, but only in cases where a taxpayer clearly does not have the assets and/or income to pay off the tax debt in a reasonable time. If you have the money to pay the IRS--or will likely have it in the future--no amount of negotiating will convince the IRS to settle for less than you owe. This is so whether you represent yourself or hire a high-priced law firm.
What these commercials are talking about is getting the IRS to accept an offer in compromise. An offer in compromise--"OIC"--is an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liabilities for less than the full amount owed. The IRS will accept your OIC only if you convince it that:
- you aren't able to pay the full amount in a reasonable time, either as a lump sum or over time through a payment agreement
- there is doubt as to the amount of your tax liability (unusual), or
- due to exceptional circumstances, payment in full would cause an "economic hardship" or be "unfair" or "inequitable”-- for example, you can’t work due to health problems, or you’d be left with no money to pay your basic living expenses if you sold your assets to pay your tax bill in full.
To make this determination, the IRS looks at your income and assets to determine your "reasonable collection potential (RCP)." You must provide detailed information about your financial situation on IRS Form 433-A (individuals) or Form 433-B (businesses), Collection Information Statement. This includes verifiable information about your cash, investments, available credit, assets, income, and debt. In addition to property, the RCP also includes your anticipated future income, less amounts allowed for basic living expenses. You can use the Offer in Compromise Pre-Qualifier on the IRS website to determine whether you are eligible and prepare a preliminary proposal.
You will need to come up with a minimum offer amount as part of your OIC. This is the minimum amount the IRS will accept and is based on the financial disclosures you make in your Form 433. Basically, your offer must equal the net realizable value of your assets plus your excess monthly income after subtracting your monthly expenses. You then multiply this number by 12 or 24, depending on which payment period you choose (either five months or two years). You can follow the instructions in Form 433 for calculating your minimum offer.
Before you submit your offer, you must (1) file all tax returns you are legally required to file, (2) make all required estimated tax payments for the current year, and (3) make all required federal tax deposits for the current quarter if you are a business owner with employees. If you or your business is currently in an open bankruptcy proceeding, you are not eligible to apply for an offer. Your debts need to be resolved in your bankruptcy proceeding--that's what bankruptcy is for.
The Offer in Compromise Booklet, Form 656-B (PDF) has step-by-step instructions for preparing and submitting all the necessary forms for an OIC. You don't have to hire a law firm or other tax professional to make an OIC. If your offer is rejected, you can appeal within 30 days using Request for Appeal of Offer in Compromise, Form 13711 (PDF).