How to Get an Offer in Compromise Approved for Tax Debt Settlement

Dealing with tax debt can be a significant challenge for individuals and businesses. One potential solution is an Offer in Compromise (OIC), which allows taxpayers to settle tax liabilities for less than the full amount owed. While this option can provide relief, navigating IRS requirements and procedures is essential.

Filing Compliance

Securing an Offer in Compromise starts with meeting filing compliance, a core requirement set by the IRS. All tax returns for the current and prior years must be submitted. For instance, outstanding returns from 2022 or earlier must be filed before the IRS will consider an offer. Accurate and timely records are critical, as discrepancies can delay or jeopardize the process.

Taxpayers must also stay current with estimated tax payments and federal tax deposits. Individuals expecting to owe taxes must make timely estimated payments. Similarly, businesses must stay current with federal tax deposits, including payroll taxes. The IRS scrutinizes these obligations as indicators of a taxpayer’s commitment to fulfilling tax responsibilities. Failure to comply can lead to rejection of the OIC, regardless of financial circumstances.

Criteria for Approval

The IRS evaluates an applicant’s ability to pay, income, expenses, and asset equity to decide if the offer is reasonable. This process requires detailed documentation of the taxpayer’s financial situation. Individuals use Form 433-A (OIC), while businesses use Form 433-B (OIC) to disclose income, expenses, and asset values.

Future earning potential also plays a role in the IRS’s decision. If a taxpayer is likely to see an increase in income, the IRS may require a higher offer. Conversely, demonstrating a long-term decrease in income can support a lower settlement.

Reasonable Collection Potential

Reasonable Collection Potential (RCP) is a key factor in determining eligibility for an Offer in Compromise. The IRS calculates RCP by combining the equity in assets with projected future income, minus necessary living expenses as defined by IRS guidelines.

Factors considered in RCP include cash, investments, real estate, and other assets. For example, home equity is calculated by subtracting the mortgage balance from the property’s market value. Future income is assessed based on current earnings and other revenue sources, with allowable deductions for living expenses.

Applicants can improve their chances of approval by carefully analyzing their finances, identifying allowable expenses, and accurately documenting asset values and income projections. Transparency is crucial, as discrepancies can lead to higher RCP calculations, potentially disqualifying the applicant. Using tools like the IRS’s OIC Pre-Qualifier tool can help assess eligibility and estimate RCP before applying.

Preparing and Submitting Forms

Submitting an Offer in Compromise requires precision and adherence to IRS guidelines. Taxpayers must complete Form 656, Offer in Compromise, along with Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses. Accurate and complete information is essential, as errors can delay or derail the application.

Form 656 requires taxpayers to outline their offer amount and the reason for the compromise request, such as doubt as to collectibility, doubt as to liability, or effective tax administration. The submission includes a non-refundable application fee and an initial payment unless the applicant qualifies for a low-income certification, which waives these fees. Supporting documents like bank statements, pay stubs, and appraisals must be well-organized and submitted with the forms.

Payment Arrangements

After submitting an Offer in Compromise, taxpayers must choose a payment arrangement that fits their financial situation. The IRS offers two options: lump sum cash and periodic payments.

The lump sum cash option requires 20% of the offer amount upfront, with the remaining balance due within five months if the offer is accepted. This option suits taxpayers with access to liquid assets but requires careful planning to avoid financial strain. For instance, selling investments to fund the payment may trigger capital gains taxes, which should be considered.

The periodic payment option allows taxpayers to make monthly payments during the review process and continue until the full amount is paid if the offer is accepted. While this option provides more flexibility, it requires a long-term commitment. Payments made during the review are non-refundable, even if the offer is rejected, making it critical to propose an amount that aligns with financial capacity.

Reasons for Denial

Many Offers in Compromise are denied due to common mistakes or shortcomings. One frequent issue is proposing an offer too low relative to the taxpayer’s Reasonable Collection Potential. For example, undervaluing assets or overstating expenses can result in rejection.

Non-compliance with filing or payment obligations during the application process is another major reason for denial. Falling behind on estimated tax payments or federal tax deposits while the OIC is under review can disqualify an applicant. Additionally, incomplete or inaccurate documentation, such as missing forms or discrepancies in financial disclosures, can lead to rejection.

In some cases, the IRS rejects offers due to public policy concerns, such as a history of egregious noncompliance or fraudulent behavior. While less common, these denials emphasize the importance of demonstrating good faith and a genuine effort to resolve tax liabilities. Taxpayers who are denied can appeal the decision, but addressing potential issues upfront is critical to avoid delays and additional effort.