IRS back taxes — what is an offer in compromise?
An offer in compromise is where you ask the IRS to settle for less than 100% on the amount of back taxes (interest and penalties also) that you owe. Keep in mind that this is normally only when you do not have the ability to pay back the full amount.
We understand that owing any debt is stressful but owing debt to the IRS is incredibly scary. The IRS has massive power and resources available to find you and take your money. (Here is a good introduction to the collection process with the IRS).
But understand there are options.
In this article we will talk about the basics of an offer in compromise and then in future articles we will drill down into more detail.
There are three basic varieties of an offer in compromise
1. Effective tax administration (where you could pay it back but it would be unfair to ask you to do this — very rare this is granted)
2. Doubt as to liability (where you have a legitimate argument that you don’t owe the amount as both sides settle to avoid the risk)
3. Doubt as to collectibility — this is the most common one.
Effective tax administration
This is very rare. You owe the money and have the ability to pay. But because of age or medical issues, etc. you have a compelling argument why the government should not require you to pay all that you owe.
An example is you owe $250,000 and have a paid for house of $300,000 and $200,000 in the bank.
But your house is handicapped accessible and it would be hard to find a similar one. You also due to medical bills spend more in medical costs than your social security.
The IRS might say based on your life expectancy, etc. that they will accept $100,000 even though they could have made you pay the whole amount.
Again remember this is an option but very rarely approved by the IRS.
Doubt as to liability
This is where there is a legitimate doubt as to whether you owe the amount claimed by the IRS. It can be a disputed area of tax law.
This is similar to debt buyer lawsuits where there is a problem with the person (collector or IRS) being able to prove that you owe them money.
So you explain that doubt and propose a comprise settlement.
More common than “effective tax administration” but the most common by far is the doubt as to collectibility discussed next.
Doubt as to collectibility
Here, there is no doubt as to the amount that you owe. We are not fighting on “liability” but instead the “collectibility” of the debt. So the IRS is to collect all that is owed but they are to recognize when it is not feasible to collect it all.
Stated differently, you and I have an obligation to pay every dollar we owe and can pay.
So if we owe it, but can’t fully pay it, then we propose an offer in compromise due to the doubt as to collectibility.
There are particular financial disclosure documents we must provide as it makes sense the IRS wants to see our assets, income and expenses, in order to evaluate our offer.
Do keep in mind part of the art of this is knowing the rules and what the IRS considers which allows you to structure your finances in a way to maximize the possibility of your offer in compromise being accepted.
What are the requirements to even make an offer in compromise?
Before we can make even the best offer in compromise offer, we need to get things in place.
First, we have to be current on our taxes. No unfiled tax returns. No missing payroll tax deposits etc. To get the benefit of an offer in compromise, we have to show good faith by being in compliance now.
Second, a “lump sum” is to be paid off in five months or less. So if you make a lump sum offer, make sure you can pay it.
Third, a monthly payment plan (different than an installment agreement), must be paid in 24 months or less.
Fourth, you need to do all the proper planning that is possible to increase your chances of being accepted.
Where do you start if you are dealing with significant IRS debt?
Here are a few ideas.
You need to know the exact amount that is owed — for example, open all of your mail.
We will need to have your tax transcripts to see what exactly is owed.
Gather your financial information so you have a good idea of your income and expenses.
Get with either a lawyer, a CPA or an enrolled agent to get advice on what you can do now and what you can change in the near future to give you the best possible outcome.
You can reach us at 205-879-2447 or contact us through our website.