An Offer in Compromise (OIC) is a settlement on IRS tax debt. The OIC process involves filing an IRS Form 656 with the IRS. An OIC does not require an attorney, CPA, or Enrolled Agent, although all three of those categories of tax professionals are permitted to submit one on a taxpayer's behalf.
On the Form 656, the taxpayer lists all the periods for which he or she owes taxes; the OIC will include all the tax periods listed on that Form 656. If a taxpayer qualifies for an OIC, it is likely the best solution for resolving a delinquent tax liability. In the last published IRS statistics, the IRS reports that the average discount on accepted Offers was 88% (only 12 cents on the dollar was paid by Americans with accepted OICs), and that the average acceptance rate was 47.6%.
Why Use a Tax Professional?
OICs that are submitted by professionals have a much higher success rate than OICs submitted by individuals. This is because individuals often are confused by the paperwork required and do not submit a proper OIC. The financial disclosure form the IRS requires (the new 433-A (OIC)- viewable on pages 7-13 at http://www.irs.gov/pub/irs-pdf/f656b.pdf) can be quite confusing. For instance, just because the IRS asks for payment information for an item or area of expense does not mean that the IRS actually takes that expense into account when qualifying the taxpayer for the OIC. For example, the IRS asks taxpayers to list the monthly payment made for "other secured debts", separate from housing or vehicle payments listed elsewhere. A taxpayer would list a boat payment in this area. The expense is totaled with other IRS-recognized expenses that are included in the expense calculation the IRS uses in the qualifying process. The taxpayer may reasonably think that, because the expense was requested on the "Monthly Household Income and Expense Information" area, the IRS includes this expense when figuring out how much money the taxpayer can pay each month. Instead, the IRS will zero out the boat payment expense, figuring that taxpayer can take every dollar that is used for it can be used to pay the tax debt. A taxpayer who does not know this will be in for an unpleasant surprise. The OIC either will not be accepted or will be revised to come in at a much higher cost than the taxpayer expected.
Another reason to work with a tax professional is that individuals often view the OIC process as similar to a negotiation with a standard creditor, which is more like haggling. The IRS does not haggle; it is not a back-and-forth negotiation. To reduce a tax debt you have to show the IRS that you don't have the ability to repay the debt, based on your household income, your allowable living expenses, and the assets in your name. The IRS will accept only what it determines is the maximum amount it can expect to collect before the debt expires due to the collection statutory expiration date.
Yet another reason to hire a professional is that sometimes individuals can offer more than they should have, because they do not understand the formula the IRS applies. For instance, if a taxpayer can demonstrate that he can only afford a total of $200 towards a tax debt of $100,000, he should not offer more than $200. Some individuals can't believe that such a low dollar OIC would be accepted and offer far more than necessary, based on a misconception that a low-dollar offer will be refused.
I highly recommend contacting a professional tax resolution firm to help optimize your chances of getting an OIC accepted, and to get the best terms. If nothing else, you can hear whether or not your financial situation will qualify you for a successful OIC. Keep in mind that some reputable professionals will want to view your IRS file and have a detailed picture of your finances, before offering making a judgment that you can reduce your tax debt through an OIC. Given the savings possibilities on accepted OICs and the fact that OICs submitted by a professional succeed more often than one's submitted individually, you would be well served to meet with a reputable tax relief specialist.
Types of Offers in Compromise
The OIC is still a relatively new IRS instrument, created in 1992 by Section 7122 of the Tax Code. The three grounds under which an OIC can be successfully negotiated with the IRS are:
OIC Doubt as to Collectibility- The most common form of OIC is the OIC Doubt as to Collectibility. In order to have a successful OIC Doubt as to Collectibility, a taxpayer must demonstrate that he or she is unable to pay the full amount owed before the time expires on the collection statute and the debt is no longer collectible. Each IRS income tax assessment is collectible for 10 years from the date of assessment. To see if a taxpayer qualifies for an OIC, the IRS examines a taxpayer’s finances, reviewing two basic categories:
- The taxpayer's monthly household income and how it compares to IRS-defined allowable living expenses
The value of assets the taxpayer owns
The IRS sets strict guidelines for monthly allowable expenses (categorized as: Living, Housing and Utilities, Transportation, Food and Clothing, and Medical Insurance), and compares the allowable expenses to monthly household income. The IRS standards are not generous. In some cases, they seem downright unfair. For instance,are broken down by county and size of family. According to the allowable housing costs, a family of four in Los Angeles County, California, is allowed to spend $2,469 on its monthly housing (rent or mortgage payment, property taxes, and homeowner's insurance) and utilities. If the taxpayer spends any more than $2,469, the IRS does not recognize it. The IRS feels that any amount over the $2,469 that the taxpayer spends on housing and utilities is money the taxpayer can afford to devote to paying the taxes each and every month until the tax debt expires. Even if common sense shows that the taxpayer will default on his or her mortgage if every dollar over the IRS cap for housing is devoted to paying the taxes, the IRS does not care.
By subtracting only the expenses it recognizes from the taxpayer's household income, the IRS comes up with a dollar amount that it figures the taxpayer can afford to pay towards the debt each month. The IRS takes this dollar amount and multiplies it by the number of months remaining for the IRS to collect on the tax debt before it expires. Multiplying the monthly available income by the number of months left to collect gives the IRS a specific dollar amount it feels it can reasonably expect to collect from the taxpayer's current and future income.
After determining the amount the taxpayer can afford to pay each month, based on his her or her income, the IRS then works to determine the value of the taxpayer's assets. The IRS assigns a dollar value to equity in property or vehicles, and the taxpayer's holdings in retirement accounts, savings accounts, investments, stocks, bonds,life insurance policies, valuable artwork or collections, and business holdings. For assets like a car or a property, the IRS standardly assigns a value of 80% of the fair-market value, then subtracts any liens or amounts owing on the property. A car that is owned free and clear that has a resale value of $5,000 would have an IRS asset value of 80% of $5,000 or $4,000. A house with a market value of $150,000 and a $100,000 mortgage balance would be valued as a $20,000 asset (80% of the $150,000=$120,000; $120,000 minus the mortgage balance of $100,000 leaves the $20,000 value). Retirement accounts are assigned a value equal to what would come to the taxpayer after any penalties or taxes are paid. Stocks are valued at the amount the taxpayer would have after any commissions for selling the stocks are paid. Any positive equity is then totaled in an asset valuation, but a negative asset, such as an underwater home counts as $0; it cannot be subtracted from other assets of value.
If the total of the multiplied income plus the asset value is less than the tax debt, the IRS will accept a settlement. If it is equal to or greater than the tax debt, the IRS will reject the OIC Doubt as to Collectibility.
Here is an example for figuring out an OIC Doubt as to Liability. Let's say that a person has a household income of $5,000 per month and IRS allowable expenses of $4,800 per month. The IRS figures that the taxpayer can afford $200 per month each month until the tax debt expires. The maximum time to collect on a tax debt is 10 years from the time the tax is assessed, so the maximum multiplier is 120. Assuming that the the IRS has 9 years left to collect on the debt, it would multiply the $200 available each month by 108, the number of months in 9 years, calculating that the taxpayer can afford a total of $21,600. In this example, the IRS would not settle for less than $21,600, even if the taxpayer has $0 worth of assets. If the only asset the taxpayer had was the car worth $5,000, the IRS would add $4,000 (80% of the $5,000) to the $21,600 and would not accept an offer of less than $25,600.
- OIC Doubt as to Liability- The taxpayer can prove that he or she does not owe the tax that the IRS says is owed. Even after an audit and appeal, the OIC Doubt as to Liability is one final chance to prove that the tax assessment is not valid. To succeed with an OIC Doubt as to Liability, the taxpayer most possess substantive proof and evidence that the IRS was wrong in making the tax assessment in the first place.
- OIC Effective Tax Administration- There is a more recent, third type of OIC, an OIC Effective Tax Administration. In and OIC ETA, the IRS and the taxpayer agree that the taxpayer has the ability to pay the debt, but an exceptional circumstance exists that allows the IRS to consider an OIC. According to the IRS, "to be eligible for compromise on this basis, a taxpayer must demonstrate that the collection of the tax would create an economic hardship or would be unfair and inequitable. For instance, the IRS may accept an OIC ETA from a taxpayer whose only asset is a valuable home that is specially designed to meet the taxpayer's serious physical handicap, when the presence of a valuable home would negate an OIC Doubt as to Collectibility.
Hold On Collections During OIC
An additional benefit of submitting an OIC is that it puts a temporary hold on all IRS collection activity. Once the IRS acknowledges receipt of a submitted OIC, the IRS is prohibited from collecting on a tax liability, by levy or sending collection letters or an IRS Revenue Officer to collect. The suspension of collection activity lasts during the period in which the Offer is being processed, or 30 days following rejection of an offer, or during the appeal of an OIC. This window of non-collection is frequently a respite for taxpayers, securing additional time for taxpayers to work out a solution while preventing the IRS from seizing any assets or levying pay or a bank account in the interim. The only exception to the hold on collections is if the IRS rules that an OIC was submitted frivolously, where the taxpayer was using the OIC system to stop collections without submitting a valid OIC for consideration.
OIC Payment Options
Generally, taxpayers must submit a $150 application fee along with their OIC submission. When it comes to paying the actual amount of the OIC, taxpayers have three payment options:
Lump Sum Cash Offer- There are a few different ways that a lump sum offer can be structured, according to the IRS. "Payable in non-refundable installments, the offer amount must be paid in five or fewer installments upon written notice of acceptance. A non-refundable payment of 20 percent of the offer amount along with the $150 application fee is due upon filing the Form 656.
- If the offer will be paid in 5 or fewer installments in 5 months or less, the offer amount must include the realizable value of assets plus the amount that could be collected over 48 months of payments or the time remaining on the statute, whichever is less.
- If the offer will be paid in 5 or fewer installments in more than 5 months and within 24 months, the offer amount must include the realizable value of assets plus the amount that could be collected over 60 months of payments, or the time remaining on the statute, whichever is less.
If the offer will be paid in 5 or fewer installments in more than 24 months, the offer amount must include the realizable value of assets plus the amount that could be collected over the time remaining on the statute.
- Short Term Periodic Payment Offer- Payable in non-refundable installments; the offer amount must be paid within 24 months of the date the IRS received the offer. The first payment and the $150 application fee are due upon filing the Form 656. Regular payments must be made during the offer investigation. The offer amount must include the realizable value of assets plus the total amount the IRS could collect over 60 months of payments or the remainder of the statutory period for collection, whichever is less.
- Deferred Periodic Payment Offer- Payable in non-refundable installments; the offer amount must be paid over the remaining statutory period for collecting the tax. The first payment and the $150 application fee are due upon filing the Form 656. Regular payments must be made during the investigation. The offer amount must include the realizable value of assets plus the total amount the IRS could collect through monthly payments during the remaining life of the statutory period for collection."
Despite the IRS forms stating that different multipliers are used ,depending on how quickly the offer amount is repaid, Jim Brown, VP at Freedom Tax Relief, states that Freedom's attorneys and Enrolled Agents are "still seeing the IRS multiply the net available by the remaining months on the statute of limitation; we are not seeing the 48 month multiplier used at the Offer service centers." This is another illustration of how confusing the OIC process can be and why working with a reputable tax professional will eliminate surprises and lead to a better result.
The IRS is not bound by either the offer amount or the terms proposed by the taxpayer. The OIC investigator may negotiate a different offer amount and terms, when appropriate. The investigator may determine that the proposed offer amount is too low or the payment terms are too protracted to recommend acceptance. In this situation, the OIC investigator may advise the taxpayer as to what larger amount or different terms would likely be recommended for acceptance.
If the OIC is rejected, the taxpayer is offered an opportunity to file an appeal which will be heard by the IRS Office of Appeals. There are no rights to appeal for offers that are returned, withdrawn or terminated.
An offer is considered accepted, if it is not withdrawn, returned or rejected within two years (24 months) of the date the IRS acknowledges receipt of the offer.The 24 month period is put on hold if the taxpayer disputes the tax liability in a judicial proceeding.
Bankruptcy and OIC
The IRS will not process an OIC for a taxpayer who is currently in a bankruptcy proceeding or who owns a business that is an a bankruptcy proceeding. If a taxpayer is already in process on a OIC and files for bankruptcy the OIC can be suspended and resubmitted after the bankruptcy discharges. The 24 month mandatory acceptance period is put on hold when the taxpayer files for bankruptcy.
Five Year Compliance
If the offer is accepted, the taxpayer is on a five year 'probation.' During those five years, if the taxpayer files a required tax return late or does not pay any tax obligation in full by the due date, the offer will be revoked and the forgiven tax debt is brought back to life, along with additional penalties and interest that will be tacked on.
The IRS will keep any refund that would otherwise be forthcoming to the taxpayer for the year that the offer was submitted, any year that the offer was being reviewed, and the year that the offer was accepted. A taxpayer who is in the process of an OIC should pay attention to how much is withheld from his or her paycheck, attempting to not owe any amount that can't be paid in full when due, but also not resulting in a large refund that will be forfeited. Refunds are not forfeited, if a taxpayer submits a successful OIC Doubt as to Liability, only for an OIC Doubt as to Collectibility or OIC ETA.
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