Your Options for an Income Tax Settlement

An income tax settlement is a formal agreement with a tax authority, like the Internal Revenue Service (IRS), to resolve an outstanding tax debt. These arrangements are for individuals who cannot pay their full tax liability due to financial difficulties. Federal and state agencies provide structured programs to manage or reduce the amount owed, offering a pathway to compliance that can prevent more severe collection actions. The purpose is to create a manageable solution for both the taxpayer and the government, acknowledging that collecting the full debt might not be feasible or could impose an excessive burden.

Types of Tax Settlement Options

An Offer in Compromise (OIC) is an agreement that allows certain taxpayers to resolve their tax liability with the IRS for a lower amount than what they originally owed. This option is reserved for situations of significant financial hardship. The IRS will consider a taxpayer’s income, expenses, asset equity, and overall ability to pay before approving an OIC.

For those who can pay their full tax debt but need more time, an Installment Agreement (IA) is a common solution. An IA is a monthly payment plan that allows taxpayers to pay their liability over an extended period, often up to 72 months. This arrangement provides a predictable way to manage the debt and helps avoid more aggressive collection actions as long as payments are made on time.

In cases of extreme financial difficulty, a taxpayer may be placed in Currently Not Collectible (CNC) status. This is a temporary suspension of collection efforts by the IRS. If the IRS determines that a taxpayer cannot afford basic living expenses while also making tax payments, it may grant CNC status. This does not forgive the debt, and interest and penalties continue to accrue, but it provides immediate relief from actions like levies or garnishments.

Determining Eligibility for an Offer in Compromise

To be eligible for an Offer in Compromise, a taxpayer must meet several preliminary requirements. All required tax returns must be filed, all current estimated tax payments must be made, and the individual cannot be in an open bankruptcy proceeding. For business owners, all required federal tax deposits for the current and preceding two quarters must be up to date.

The IRS evaluates OIC applications based on three specific grounds.

Doubt as to Collectibility

This is the most common basis and applies when a taxpayer’s income and assets are insufficient to cover their entire tax liability. The IRS calculates the taxpayer’s Reasonable Collection Potential (RCP), a formula used to assess what it can realistically expect to collect. This considers the value of a taxpayer’s assets and future income potential minus allowable living expenses.

Doubt as to Liability

This ground is used when there is a genuine dispute over whether the tax debt is accurate or legally owed. A taxpayer must provide evidence demonstrating that the assessed tax is incorrect due to a legal or factual error. For these cases, Form 656-L must be submitted to explain the basis of the dispute.

Effective Tax Administration

An Effective Tax Administration (ETA) offer may be accepted when the taxpayer has the financial means to pay the full debt, but doing so would create a significant economic hardship. This refers to a situation where collection would leave the taxpayer unable to meet basic living expenses. An ETA claim can also be based on exceptional circumstances where collection would be unfair or inequitable.

Information and Documentation for an OIC Application

Applying for an Offer in Compromise requires a comprehensive presentation of your financial situation to verify you are unable to pay your full tax liability. You must compile figures for your gross monthly income from every source and provide a detailed breakdown of your monthly living expenses. The IRS has established national and local standards for many costs, and it will compare your reported expenses to these figures.

A complete inventory of your assets is also required. You must report the fair market value of:

• Cash on hand and funds in bank accounts
• Investments like stocks and bonds
• Retirement accounts
• Physical assets such as vehicles, real estate, and other valuable personal property

For each asset, you will need to provide details about any associated loans or liens, as the IRS is focused on the equity you hold. This financial data must be supported by documentation like recent pay stubs and bank statements for the last three to six months. Other necessary documents include vehicle titles, property deeds, and loan statements.

The core of the OIC application package consists of two primary IRS forms. Form 656, Offer in Compromise, is the official offer document. This is accompanied by either Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses, which are used to enter your detailed financial information.

The OIC Submission and Review Process

The application package must include the completed Form 656, the appropriate Collection Information Statement, and all supporting financial documents. You must also include a $205 application fee, unless you qualify for a low-income exemption. Taxpayers meeting low-income guidelines are not required to send the fee or the initial payment.

The application requires an initial payment with the submission. For a lump-sum offer, this is 20% of the total offer amount; for a periodic payment offer, it is the first month’s proposed payment. These payments are non-refundable and will be applied to your tax debt even if the offer is rejected.

After the IRS receives your application, the case is assigned to an OIC examiner for review. The examiner may contact you with follow-up questions, and the process can take six to twelve months, or longer for complex cases. If your offer is accepted, you will receive a letter detailing the terms. If rejected, the IRS will explain the denial, and you have 30 days to file an appeal with the IRS Office of Appeals.

Alternatives to an Offer in Compromise

For taxpayers who do not qualify for an OIC, other programs can resolve tax debt. An Installment Agreement is a widely used alternative, and the IRS provides an Online Payment Agreement (OPA) tool for many taxpayers. This online system can be used to set up long-term payment plans for debts under $50,000 and short-term plans for debts under $100,000.

If you do not qualify for the online tool or prefer to apply by mail, you can file Form 9465, Installment Agreement Request. This form allows you to propose a monthly payment amount based on what you can afford. An approved agreement prevents the IRS from taking more severe collection actions.

Another alternative for severe financial hardship is Currently Not Collectible (CNC) status. To request CNC status, you will need to provide detailed financial information to the IRS, often by completing Form 433-F, Collection Information Statement. This provides temporary relief from collection pressures.