Statistics show that there are millions of taxpayers who owe the IRS back taxes. Many hear late night TV infomercials and talk radio advertising that the IRS will settle for less than the amount owed. The commercials are referring to the IRS’ Offer in Compromise (OIC) program. Ideally, this program will allow tax debtors to settle their back taxes for less than the amount owed.
However, in reality, the data shows that many cannot or do not utilize this program. Primarily, there are 2 reasons why OICs are rejected: the taxpayer does not qualify for a settlement, or they cannot pay the amount to settle (“offer amount”). Contrary to the commercials, the qualification and offer amount are not arbitrary amounts offered by slick negotiators – they are computations based on long-standing IRS rules for the OIC program.
More people owe the IRS
There are a growing number of tax debtors in the United States. In fact, there are currently more than 24 million individual and business taxpayers who owe the IRS, which is up 28% from 2015.
Those who owe back taxes face two choices: pay the balance owed or enter into an IRS collection alternative. Choosing neither option means facing possible IRS collection enforcement. Taxpayers have options to fulfill payment- called the IRS collection alternatives. These alternatives include extensions to pay, payment plans, hardship agreements such as partial pay installment agreements (payment plans in which the IRS gets less than full payment of the tax before the collection statute of limitations expires), not collectible status, and the offer in compromise settlement. Taxpayers who enter into these agreements can avoid levies and passport restrictions. Passport restrictions apply if the taxpayer owes more than $62,000 (adjusted annually for inflation) and is not in a qualifying agreement with the IRS on their taxes (i.e., mostly, one of the collection alternatives).
Surprisingly, only 19% of tax debtors are in a collection alternative agreement with the IRS as of the end of 2023. The remaining 81% – over 19 million taxpayers – face potential collection enforcement.
The OIC Program, Qualification, and Offer Amount
The OIC program is a long-standing IRS program that allows taxpayers to settle their tax bill for less than what they owe. There are 3 types of OICs: doubt as to collectibility of tax, doubt as to the liability of tax, and compromise based on effective tax administration. The most common type of OIC deals with taxpayers who cannot pay the IRS – Offer in Compromise for Doubt as to Collectibility. This program is the most widely used by taxpayers and the subject of most of the advertisements.
The qualify for this program, the taxpayer must be in a true financial hardship and not have the ability to pay the IRS now and in the foreseeable future. The IRS computes the taxpayer’s ability to pay by looking at both their assets and future income. The IRS allows the taxpayer to have only necessary living expenses to support their household and for expenses to produce income. If the taxpayer can pay the tax bill with their equity in assets or monthly payments to the IRS before the collection statute expires (10 years from the date the tax is assessed by the IRS), the taxpayer will NOT qualify for an OIC. The IRS has special rules to determine how to compute equity in assets and what can be paid monthly.
For example, if a taxpayer owes $50,000 to the IRS, has 6 years (or 72 months) remaining on the collection statute of limitations, and can only pay $200 a month in a payment plan, and have $5,000 in net equity in their assets, they will qualify for an OIC.
If the taxpayer qualifies for an OIC, they will next compute how much they can pay the IRS. This amount is called the “offer amount” and it represents the taxpayer’s “reasonable collection potential” based on IRS rules. The IRS has special rules to compute the offer amount.
In the OIC application, the taxpayer will select how they will pay for the OIC offer amount. There are two payment options: the lump-sum payment option or the periodic payment option. If the taxpayer selects the lump-sum payment option, they must pay 20% of the OIC offer amount at the time of the application and agree to pay the OIC offer amount in full within 5 months after the OIC is accepted by the IRS. In OICs with the lump-sum option, the taxpayer will NOT have to include all future monthly payments in the offer amount. The taxpayer will only have to offer 12 months of future monthly payments plus the equity in assets. In our previous example, the taxpayer would only pay $7,400 as an offer amount.
Most taxpayers who can make monthly payments select the lump-sum payment option. However, if the taxpayer selects the periodic payment option, they must make monthly payments of the offer amount over 2 years (24 months.) In the periodic payment option, the offer amount will require 24 months of future payments and the same equity in assets. For taxpayers who have monthly disposable income, this will lead to a higher offer amount. In our previous example, the amount would increase by $2,400.
If the taxpayer qualifies and computes their offer amount, they file an application with the IRS asking the IRS to accept the OIC offer amount. The taxpayer uses the forms in IRS Booklet 656-B. The application requires a fee of $205, which can be waived if the taxpayer meets low-income criteria. Down payments and periodic payments can also be waived in an OIC if the taxpayer meets the low-income criteria (adjusted annually). These waivers help low-income taxpayers access the OIC.
If the IRS accepts the OIC offer, the taxpayer is required to complete all the terms, which include filing and paying all tax liabilities on time for the next 5 years. Taxpayers who do not complete the terms will have the taxes, penalties, and interest reinstated by the IRS. In total, this OIC application to approval process takes between 7-12 months on average. Lower debt and less complex taxpayers usually are quicker, especially if the taxpayer or representative responds to the OIC investigation requests for information timely.
The OIC application process requires the taxpayer to understand the nuances and rules of the OIC program and how to compute qualification and the offer amount.
Why few offers are accepted? And when to consider other options
Historically, many IRS OIC applications are not approved or rejected by the IRS. In 2023, 42% of all OIC applications were approved/accepted.
The reason is that many taxpayers either do not qualify, cannot pay the offer amount, or cannot meet the terms of the OIC. Here are the common reasons that taxpayers cannot take advantage of the OIC program:
- They have too many assets: Many taxpayers have substantial equity in their assets such as their home, vehicles, retirement plans, and other assets. They may have more value in these assets than what they owe the IRS. In these circumstances, they would not qualify for the OIC. The OIC wouldn’t be an option for them. If the taxpayer did qualify and had significant asset equity, the offer would have to be the value of the equity in the OIC offer amount. This is likely prohibitive for taxpayers who are in financial hardship.
- They make too much income or have expenses over the IRS limits: A taxpayer with too much leftover income each month (called “monthly disposable income” by the IRS) will find it difficult to access the OIC program. Monthly disposable income is a computation of the taxpayer’s gross income less their “allowable” necessary living expenses. Many taxpayers are surprised to find their monthly disposable income is higher than expected. Taxpayers can be overextended with non-allowable expenses for an OIC, such as other debts or higher than average household expenses. The IRS places limits on food/clothing, housing/utilities, and transportation costs in computing a taxpayer’s monthly disposable income. In many cases, the taxpayer exceeds those expense limits or has too much income that makes the OIC unfeasible. In these cases, the taxpayer should look for another option, such as an IRS payment plan.
- They disposed of assets just before the OIC application: The IRS defines “dissipated assets” as assets that are liquidated and not used to pay the tax bill or for necessary living expenses. For example, if a taxpayer liquidates a retirement plan or takes out a home equity loan and uses the funds for non- necessary living expenses, such as a vacation or a recreational vehicle purchase, the taxpayer will have to include the value of these “dissipated assets” in the OIC. This may disqualify or make the offer amount too high for the taxpayer to utilize the OIC as an effective collection alternative.
- They have bad records to support their financial condition: An OIC requires proof of the value of your assets and the support for the computation of monthly disposable income. Too often, taxpayers cannot obtain proper receipts to verify they paid expenses allowed in an OIC. In the investigation, the IRS OIC examiner will usually give the taxpayer a short time to show proof of specific financial items before the OIC is rejected. A common taxpayer issue is estimating expenses, but not being able to show, with documentation, the amount owed and paid. Also, the IRS will only allow paid necessary living expenses. Unpaid bills are not allowed.
- They cannot stop future tax debt: After an OIC is approved, taxpayers must file and pay on time for 5 years. Many taxpayers, such as small business taxpayers who must make voluntary estimated tax payments, often continue the filing and owing trend. Even if they are approved for an OIC, future unpaid balances just undo the settlement and return the balance to the taxpayer.
- They cannot pay the offer amount: Taxpayers must be able to pay the offer amount to settle their tax bill. Coming up with the funds to pay the settlement can be a bridge too far for most who owe and are in hardship. One of the most common means to pay for the offer amount is to borrow from friends or family. In many cases, obtaining funds in this manner is not possible – and taxpayers cannot complete the payment terms to settle their debt.
- They can pay most of the amount owed, but not all of it: The IRS’ authority to settle a tax debt is discretionary. Translation: if the IRS follow the rules for OIC acceptance, it can still not allow an OIC if it is not in the best interest of the government to settle their debt. This can occur in situations where the offer amount is significantly less that what the IRS would get in likely payments before the collection statute expiration date. In these cases, the IRS can just say “no” and ask the taxpayer to enter into another collection agreement option, such as a payment plan.
Practically, many tax debtors considering the OIC do not have records to support their financial situation. As a result, they fail the OIC investigation, because they cannot provide the IRS with the evidence needed to prove their inability to pay.
Taxpayers who do qualify and have a reasonable offer amount that they can pay – and can stay in compliance for the next 5 years – can use the OIC program. If they cannot use the OIC program and settle their tax bill, the IRS does offer other options to avoid enforcement.
These options include payment plans and the other hardship status: currently not collectible (CNC). CNC status is temporary, and the IRS can reevaluate if the taxpayer’s financial status improves. Also, payment plans and CNC status do not stop penalties and interest from accruing. They also do not stop the IRS from taking future refunds.
If you have tax debt, it is important to evaluate all options. If you believe you have a hardship and cannot pay based on the value of your assets or future income, you should consider the OIC program. When you consider the OIC program, make sure you understand if you qualify and can pay the offer amount- and evaluate whether you can stay in compliance in the future. If not, use another option that better fits your circumstances.