Knowing you owe tax debts that you can't pay can be a heavy burden. Although the Internal Revenue Service (IRS) offers payment plans and installment agreements, in some situations, this isn’t enough. Fortunately, another IRS payment option available to you is making an offer in compromise (OIC).
What is an offer in compromise?
An offer in compromise is an agreement that, if accepted by the IRS, permits you to pay them less than you owe and will settle the tax debt that you included in the offer. You may apply for an OIC when you cannot pay your tax liability in full or if it will create a significant financial hardship.
This article covers who qualifies to apply for an OIC and how to calculate your offer.
Meet the eligibility criteria
Before applying for an offer in compromise, make sure that you meet these eligibility criteria.
You must have:
- Filed all tax returns, along with making required estimated payments
- Not in the process of an open bankruptcy
- Have a valid extension for the current tax year, if applicable
- If you are an employer, you must have made all required tax deposits for the current and past two quarters
While these are the initial criteria, you must carefully follow these requirements when submitting an offer in compromise. Some are simple—such as signing the application—while others will take more time, such as submitting specific documentation and calculating your offer. You can find specifics about which forms the IRS requires based on your situation on the IRS website.
If the IRS hasn't previously done so, you can expect the IRS to levy your assets when you submit an offer in compromise. This means that if you own a home, for example, the IRS will likely place a lien on it, meaning they would receive the funds owed if you were to sell it. Once the IRS accepts your offer and you pay the agreed-upon amount, you can apply to have the lien removed if it isn't done automatically.
Understand the exclusions
Most people will qualify to apply for an OIC. However, applying doesn't guarantee acceptance. Remember to always explore other options or resolve open claims first.
Additionally, you must not have:
- A currently open bankruptcy proceeding
- An open audit
- An open innocent spouse claim
Also, you must not be able to pay in full through an installment agreement or with equity in an asset.
Declare the reason for submitting an OIC
The IRS requires you to select one of the following three reasons for submitting an Offer in Compromise.
- Doubt as to liability. You dispute the existence or the amount of the tax debt.
- Doubt as to collectability. Your assets and income are less than the full amount of the tax liability.
- Effective tax administration. The payment would create an economic hardship or would be unfair and inequitable because of exceptional circumstances.
You will then be required to complete certain documentation and submit it, along with a $205 application fee (non-refundable). The forms to submit will be:
- Form 433-A (OIC) (individuals) or Form 433-B (OIC) (businesses) with all required documentation as specified in the forms
- Form 656(s), which, if you have to submit both individual and tax debt, there will need to be separate forms for each
- Each Form 656 requires an initial payment (non-refundable)
Note that the initial payment will vary based on your offer and the payment method you elect. The two payment methods are lump sum cash and periodic payment.
Calculate your offer
To calculate how much your offer should be, you need to tell the IRS about your financial situation, including money you have on hand or in bank accounts, your debts, investments, and assets. Per the IRS guidelines, you may submit exceptions with explanations.
Individuals—including self-employed individuals—will fill out Form 433-A, while businesses will complete Form 433-B. When businesses use assets to produce income, such as farm machinery, they may be allowed to exclude the equity for those assets.
Below are guidelines. Also, carefully read the information in the Form 656-B Booklet and on the application to gain a thorough understanding of what you need to do.
- An allowance of $1,000 is available to individuals for your bank balance, meaning that funds over that amount are considered an asset available to pay your tax debt.
- An allowance of $3,450 is available to individuals for the value of their car.
- For homes, the IRS has you calculate the quick-sale value, which it defines as 80% of the fair market value of your home. Next, you subtract your mortgage amount from the quick-sale value to arrive at the amount they consider could be applied toward your debt.
National standards are used to calculate the monthly food, clothing, and other expenses for each person in your household. If your actual expenses exceed the national standards amounts provided by the IRS (for example, if you have unusual dietary requirements due to a medical condition that causes high food bills), you can submit the application with your actual expenses and provide an explanation for the reason you need a higher amount.
Consider getting professional help
You can apply for an OIC directly or with the help of a tax or legal professional. Whether you go at it on your own or submit it with the help of a professional, use the Offer in Compromise Application Checklist in the IRS Form 656 Booklet. You are responsible for what you submit, so take the time to check things off, even if you are working with a professional.
Applying for an offer in compromise does not mean the IRS will accept your offer. In 2022, taxpayers proposed 36,022 offers in compromise to settle existing tax liabilities for less than the full amount owed. The IRS accepted 13,165 offers. That data isn't meant to discourage you but to set your expectations and ensure that you take the time and carefully complete the application to ensure your best chances of success.
Find out more about Business Taxes