It is sometimes possible to wipe your tax slate clean at an enormous discount. If you qualify for something known as the offer in compromise, referred to as an "offer" or "OIC," the IRS has been known to accept as little as 1% of the amount owed on a tax bill and call it even.
There is no legal right to have a valid tax bill reduced by the IRS -- it is entirely a matter of government discretion. In all but a few instances, however, the IRS must at least give a properly submitted OIC fair consideration. Unfortunately, in recent years, only 25% or so of the OICs submitted were accepted by the IRS, although you do have the right to take a rejected OIC to the IRS Appeals Office.
Do You Qualify for OIC Consideration?
Merely wanting to make a deal with the IRS is not enough -- everyone would like to have his tax bill reduced. To qualify for OIC consideration, you must show the IRS that one of the following conditions exists:
- There is some doubt as to whether the IRS can collect the tax bill from you -- now or in the foreseeable future. The IRS calls this "doubt as to collectibility."
- Due to exceptional circumstances, payment of your full tax bill would cause an "economic hardship" or would be "unfair" or "inequitable."
Taxpayers who want to file a "doubt as to liability" offer must file Form 656-L. This offer is based on a claim that there is doubt as to whether the tax liability assessed is correct. This is an unusual and more difficult avenue to pursue.
The IRS recommends you use its online pre-qualifer tool to determine whether you are eligible to make an offer in compromise.
Submitting an offer to the IRS is a formal process -- you can't simply call the IRS and say "Let's make a deal." You start by completing IRS Form 656, Offer in Compromise.
There is a $186 application fee for filing an OIC, which you must attach to Form 656. You might be exempt from the fee if your monthly income is below the poverty guidelines. If you claim the poverty guideline exemption, you must submit an Application Fee Worksheet from the Form 656 booklet.
If you are offering to pay in five payments or fewer within five months or less, you must send in a minimum of 20% of the offer with your application. If you're going to take longer than five months to pay, you must pay the first installment with your offer and you must continue to make all proposed payments while the offer is pending. All these payments, including the application fee, are nonrefundable but will go towards the unpaid tax liability (except the application fee).
In addition to Form 656, you must submit a Collection Information Statement, or Form 433-A. If you are married and live in a community property state, the IRS may request that your Collection Information Statement include data on your spouse -- even if you alone owe the IRS. Take particular care in filling in this form correctly if you are serious about your OIC. The IRS scrutinizes the disclosures you make in this form much more closely when considering an OIC than when you request to pay your taxes with an installment agreement.
Downside to Submitting an OIC
Completing the forms is just the beginning. After you submit the forms, the IRS will ask you for rafts of financial documentation -- pay stubs, bank records, vehicle registrations, and myriad other items. This is an exhaustive, time-consuming process. Some taxpayers wind up submitting boxloads of documents to the IRS to support their OIC request.
There's another drawback to submitting an OIC. If your OIC is rejected, the disclosures you made about your assets give the IRS all the information it needs to accelerate its collection efforts against you. For this reason, it makes sense not to submit an offer unless it is likely to be accepted.
In addition, remember that interest keeps accruing during the offer in compromise negotiation process, meaning you'll end up owing more than ever if you don't eventually make a deal.
How Much Should You Offer?
According to the IRS, the amount of an OIC must be equal to the "realizable value" of your assets plus the amount of money the IRS could take from your future income. For example, if your assets are worth $17,200 and the amount of your future income that's available to the IRS is $14,800, your minimum offer must be $32,000. The IRS will help you determine a preliminary offer amount with its online pre-qualifer tool.
For more information on calculating the realizable value of your assets and your available future income (which varies depending on whether you offer the IRS payment immediately or over two to five years), see Nolo's Stand Up to the IRS, by Frederick W. Daily.
If the IRS accepts your offer and you will make payments over two years or longer, the IRS may record a Notice of Federal Tax Lien showing your tax debt, if it hasn't already done so. The lien will stay on your records until every last penny has been paid or the statute of limitations for collection has expired, whichever occurs first.
What if you determine the offer amount required by calculating the realizable value of your assets and your available future income, and the result is well beyond your ability to pay? Consider making an offer anyway (assuming you aren't worried about the IRS grabbing any assets you didn't reveal). IRS personnel have some leeway to accept less money than is required under strict application of the rules.
The IRS gives special consideration to people with physical or psychological infirmities. In particular, the IRS has always favored offers from people with bleak financial prospects due to advanced age -- over 60 in particular. And the IRS will consider HIV or drug- or alcohol-related problems, as well as a family member's problem if it has a detrimental financial effect on you.
The best way to bring special circumstances to the IRS's attention is through a letter attached to your Collection Information Statement (Form 433-A). It doesn't have to be formal or fancy, just one or two pages telling your tale of woe. You'll also need to attach statements from doctors and medical records indicating your condition. If the medical data doesn't show how the condition prevents you from earning much of a living now or in the foreseeable future, explain this in your own words.
If Your Offer Is Rejected -- Keep Trying
The IRS must give you a written explanation if your offer is not accepted. The IRS usually rejects offers in compromise for one of two reasons:
- The offer is too low.
- You are a "notorious" character -- for example, you've been convicted of a serious crime.
If the offer is too low, the IRS letter will state what amount is acceptable. You are also entitled to a copy of the report that lists the factors that caused the rejection. Ask the IRS for a copy. If the IRS won't give it to you, make a request under the Freedom of Information Act.
After finding out why your offer was rejected, resubmit your offer. The revenue officer or special procedures officer might help you come up with a way to make your offer acceptable.
You don't need to submit a new Form 656 if you submit a new offer within a month, if your financial circumstances have not appreciably changed and if the new offer is not radically different from the old one. Instead, write a letter. State that you wish to change your offer by increasing the amount of cash.
To submit a significantly different offer, you need to complete another Form 656.
Appealing a Rejected Offer in Compromise
You can formally appeal a rejected offer in compromise, or you can call the person who signed the letter and try to get her to change her mind. Often, instead of forwarding appeals to the Appeals Office, the IRS will reconsider your offer and engage in further negotiation.
To start a formal appeal, send a letter within 30 days of the date of the rejection letter, such as:
I wish to appeal from the rejection of an offer in compromise submitted June 20, 2014, and rejected on January 7, 2015. I request a conference.
Your appeal to a rejected offer in compromise will not be seriously considered unless all of the following are true:
- You furnished all of the data requested by the IRS during your offer processing.
- You have filed all past tax returns.
- You are current on your tax payments for the present year. Self-employed people need to have made all quarterly estimated tax payments; employers must have made all payroll tax filings and deposits.
Appealing is not a legal right -- it's within the IRS's discretion. You cannot take the IRS to court for rejecting your offer or your appeal.
For more information on offers in compromise, see Stand Up to the IRS, by Frederick W. Daily (Nolo).