The stress of owing the IRS money is a lot. And the stress only multiplies the more you owe. That said, there are legal ways to settle your tax debt for less than what you owe. The IRS offers options such as the Offer in Compromise (OIC) program, which allows qualified taxpayers to reduce their tax liabilities substantially.
This program, often touted as a way to “pay pennies on the dollar,” can be a lifeline for those struggling with tax debt.
In this article, we explore how this process works, the eligibility requirements, and the steps you can take to apply.
What Is an Offer in Compromise (OIC)?
An Offer in Compromise is a program offered by the IRS that allows taxpayers to settle their debt for less than the full amount owed. The IRS considers your ability to pay, income, expenses, and asset equity when evaluating whether to accept an offer.
This program is not guaranteed for everyone who applies. It’s designed to help taxpayers in financial hardship by allowing them to make a settlement that the IRS deems reasonable given their financial situation.
Last year, the IRS accepted around 37% of the Offer in Compromise applications, according to the IRS Data Book 2023. This acceptance rate shows that while it’s not easy to qualify, it’s possible for those who genuinely cannot afford in full. The IRS calculates whether to accept an offer based on what they call the “reasonable collection potential” (RCP), which determines how much they can realistically expect to collect from you based on your financial situation.
Eligibility requirements for an Offer in Compromise
To be eligible for an Offer in Compromise, you must meet several stringent requirements. The IRS will only accept an offer if they believe that the amount you propose is the most they can collect within a reasonable time frame. To assess this, they look at various factors such as:
- Your income and ability to pay
- Your expenses, including necessary living costs
- The equity in your assets
- Your current and expected future financial circumstances
For OIC eligibility, you must be current with all filing requirements. This means all past tax returns must be filed, even if you cannot currently pay the balance due. The IRS confirms that failure to file required returns is the primary reason why OIC applications are rejected. Those who are in bankruptcy or undergoing an audit are not eligible to apply for the program.
The IRS has also made recent changes to the OIC pre-qualifier tool, which helps taxpayers determine if they are eligible before submitting an application. This tool has been updated to reflect the latest economic factors and costs of living, providing more accurate assessments for taxpayers.
How the offer amount is determined
The amount you offer to the IRS must be based on your RCP, which is calculated by evaluating your income and assets. The IRS uses a formula to estimate how much you can afford to pay. They assess your disposable income—what’s left after expenses such as housing, utilities, and food—and the value of your assets, including bank accounts and property.
The IRS typically expects the offer amount to be paid in either a lump sum or over a short period of time. Recent data shows that the average OIC settlement is around $10,234. This is substantially lower than many taxpayers’ original tax debts, making it a viable option for those facing large liabilities and lack the financial means to pay them off entirely.
It’s important to be realistic when determining how much you can offer. If the IRS believes you can afford to pay more than you offer, they’ll reject your application. For this reason, it’s often recommended to work with a tax professional like David’s Family CPA who can help you calculate the most appropriate and reasonable offer.
The application process
The application process for an Offer in Compromise can be complex, and it’s essential to provide accurate and thorough documentation. The application requires you to submit Form 656 (Offer in Compromise) and Form 433-A (Collection Information Statement for Individuals) or Form 433-B (for businesses), along with a non-refundable application fee of $205.
In recent years, the IRS has streamlined the OIC application process to make it easier for taxpayers to apply online. Many OIC applications are submitted electronically now. This move toward digital applications has sped up the processing times, allowing for quicker resolution of outstanding tax debts.
Once your application is submitted, the IRS will evaluate your financial situation and decide whether to accept or reject your offer. The process itself can take several months, depending on the complexity of your case and the accuracy of the documentation provided. In the meantime, you must continue to make any required tax payments and stay current with your filings.
Common pitfalls and mistakes to avoid
While an Offer in Compromise can be an excellent way to resolve tax debt, there are several common pitfalls that applicants should be aware of. First, many taxpayers make the mistake of submitting an unrealistic offer, only to have it rejected. As mentioned earlier, the IRS will only accept an offer that they deem reasonable based on your RCP.
Another common error is failing to stay current with tax filings during the OIC process. If you miss a filing deadline or fail to pay your current taxes, the IRS can revoke the agreement, leaving you back at square one.
It’s also essential to consider the long-term consequences of an OIC. While it may provide immediate relief, the IRS will continue to monitor your financial situation for several years after acceptance. If your financial situation improves dramatically, the IRS may revisit your case and demand a higher payment, as stipulated in the terms of the agreement.
Preparing a strong OIC application
Settling your IRS debt through an Offer in Compromise is a legitimate and effective option for many taxpayers. While the process is rigorous, with careful planning and a realistic offer, it’s possible to reduce your tax liabilities and get back on track financially.
Understanding the eligibility requirements, staying compliant with tax filings, and avoiding common mistakes will improve your chances of success in this process. David’s Family CPA can help you present a well-substantiated case to the IRS.