What Percentage Will the IRS Settle For?
Tax settlements with the IRS aren't based on a percentage. The amount is calculated from a detailed analysis of your assets, income, and allowable expenses.
The Internal Revenue Service (IRS) does not settle tax debts for a fixed percentage. Instead, a formal program called an Offer in Compromise (OIC) allows some taxpayers to resolve their liability for less than the full amount owed. An OIC is an agreement based on a detailed evaluation of a taxpayer’s specific financial situation. The IRS assesses income, expenses, and the value of assets to determine what it can reasonably expect to collect.
How the IRS Calculates a Settlement Amount
The IRS does not use a simple percentage to determine a settlement amount; instead, it calculates a taxpayer’s “Reasonable Collection Potential” (RCP). This figure represents what the agency believes it can collect before the legal time limit for collection expires. Your offer must be equal to or greater than this RCP amount to be accepted. The RCP formula has two primary components: the net value of your assets and your potential future income.
The first part of the formula is your Net Realizable Equity (NRE) in assets. This is the amount of cash that could be generated from selling your property, such as real estate, vehicles, and investments. To calculate the NRE for an asset, the IRS starts with its Fair Market Value (FMV) and subtracts any outstanding loans or liens. The IRS often uses a “quick sale value,” which is around 80% of the FMV, to reflect what an asset would sell for in a quick liquidation.
The second component is your future income potential. The IRS determines this by analyzing your average monthly income and subtracting your allowable monthly living expenses, which are based on national and local standards. The resulting figure is your monthly disposable income, representing what the IRS believes you can afford to pay each month.
This monthly disposable income is then multiplied by a factor that depends on your proposed payment terms. If you offer to pay in a lump sum (five or fewer installments), your monthly disposable income is multiplied by 12. For a periodic payment plan over 6 to 24 months, the multiplier is 24. The final RCP is the sum of your NRE and this calculated future income potential.
Information and Forms for an Offer in Compromise
Preparing an Offer in Compromise application requires gathering extensive financial documentation. This information supports the calculations for your Reasonable Collection Potential. You will need to assemble documents that verify the value of your assets and substantiate your income and expenses.
You will need to provide documentation for your assets, income, and expenses, including:
- Recent statements for all bank accounts, including checking, savings, and money market accounts.
- Property tax assessments or a recent appraisal, along with mortgage statements for real estate.
- Vehicle registration information and loan statements.
- Statements for any investment or retirement accounts, such as 401(k)s or IRAs.
- Pay stubs for the last several months and proof of any other income.
- Records for all monthly living expenses, such as utility bills, rent or mortgage statements, and insurance bills.
The primary forms for an individual are Form 656, Offer in Compromise, and Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals. Businesses use Form 433-B (OIC). These forms can be downloaded from the IRS website, and you must use the most current versions. The financial data you have gathered is entered into Form 433-A (OIC) to calculate the minimum offer amount you will enter on Form 656.
The Offer in Compromise Submission Process
Once you have completed the necessary forms and gathered all supporting financial documents, you can formally submit the Offer in Compromise package to the IRS. The submission involves paying an application fee and making an initial payment toward your offer.
A non-refundable application fee of $205 must be included with your submission, though this fee may be waived if you meet Low-Income Certification guidelines. You must also submit an initial, non-refundable payment. For a lump-sum offer, this payment is 20% of the total offer amount. For a periodic payment offer, you must include the first monthly payment and continue making monthly payments while the IRS reviews your case.
The complete package should include the signed forms, all supporting financial documents, and a check or money order for the fee and initial payment. The package must be mailed to the specific IRS location designated for processing OICs, which is listed in the instructions for Form 656-B, the Offer in Compromise Booklet.
After mailing the package, you should expect a letter from the IRS confirming they have received your application. This letter will indicate if your offer can be processed or if it is being returned as incomplete. The IRS will cash your check for the application fee and initial payment upon receipt, even before a decision on your offer is made.
Post-Submission and Post-Acceptance Obligations
After submitting your Offer in Compromise, the process enters a review phase that can take several months. An IRS examiner will be assigned to your case to verify the financial information you provided. The examiner may contact you to ask for additional documentation or to clarify items, and you must respond promptly to avoid delays or rejection.
If the IRS accepts your offer, you will receive a formal acceptance letter. You must then pay the agreed-upon offer amount according to the schedule you proposed. A primary obligation is the five-year compliance rule. For five years from the date your offer is accepted, you must file all required tax returns and pay all taxes in full and on time. Failure to meet these terms will cause the IRS to default your offer, reinstating your original tax debt.
Should the IRS reject your offer, you will receive a rejection letter that explains the agency’s reasoning. The letter will often include the IRS’s calculation of your reasonable collection potential. You have the right to appeal this decision within 30 days from the date on the rejection letter by filing Form 13711, Request for Appeal of Offer in Compromise.