So you've gotten your tax bill, and there's no way you can pay the IRS what's owed. What now? If your financial situation is really dire, consider an offer in compromise (OIC). You may only have to pay a portion of what you owe.
Before the IRS will take an offer an OIC, you must meet one of three grounds:
- Doubt as to collectability
- Doubt as to liability
- Effective tax administration
For doubt as to collectability, you must convince the IRS that it's doubtful it will be able to collect what you owe, either now or in the future. For example, showing that your living expenses are more than your income and you own no real estate or other assets the IRS can go after for payment of your taxes.
To claim doubt as to liability, you must show the IRS there's a legitimate doubt that your tax bill is correct. You may do this by showing, for example, the:
- Tax examiner made a mistake interpreting the law when reviewing your taxes
- The examiner didn't consider your evidence or proof during an audit
- You have new evidence showing the tax bill is incorrect
The effective tax administration comes into play when your tax bill is correct and the IRS thinks it can collect it from you, but there's a special circumstance making an OIC possible. For example, you have to convince the IRS that collecting the tax would create an economic hardship or wouldn't be fair.
A good example is if your child has a serious life-long medical condition and it's a clear you need all your income and assets - like the equity in your home - to pay for the child's long-term medical needs.
How Do You Get One?
It starts with you; you have to make an offer to the IRS. You do this by filing Form 656. Instructions, explanations and details come with the form, but basically you need to explain:
- Why you're making the offer
- Why you can't pay the full amount of taxes you owe
- How you plan to pay the amount you're offering to pay
You must include a $150 application fee and initial payment along with the Form 656.
The IRS may reject your offer if it thinks it can collect more from you than what you're offering (called your reasonable collection potential). If your offer is rejected, the IRS usually will let you know how much it's willing to take to settle your tax bill.
You're free to make another offer that's higher than your first but lower than the IRS' suggested amount, but it's likely that offer will be rejected, too. Before going through the trouble, it may be a good idea to call the IRS to see if it's flexible on how much it will take to settle your bill.
If the IRS accepts your offer, you'll be expected to make all payments and file all future returns on time. If you don't, the IRS can cancel the OIC. Then you'll have to pay what you owe, in full, plus penalties and interest.
Reasonable Collection Potential
Usually, the key to an OIC is your reasonable collection potential. The money you're offering must be at least equal to the value of all your assets plus all the money the IRS thinks it can collect from your future income.
The IRS determines the value of assets by estimating what it would end up with if it seized your property, paid off any debts on the property (such as a mortgage) and then sold it.
Quick Sale Value
To figure the value of your assets, calculate the quick sale value (QSV). Do this by subtracting 20 percent from the fair market value of each item. This can give you an idea early on if the IRS will accept or reject your OIC.
Usually, the IRS arrives at a figure called excess earnings by subtracting your necessary living expenses from your present or estimated monthly income. The IRS will:
- Multiply this number by 48 if you're offering to pay cash within 90 days
- Multiply this number by 60, if you want to spread your payments out over two years
- Use a different method if you're offering to spread your payments out over the time period left in which the IRS can legally collect the debt. The time period is called the statute of limitations. Generally, the IRS has 10 years to collect taxes owed
"No" May Not Be the End
If the IRS rejects your OIC, you can challenge or appeal that decision. The appeal must:
- Be in writing
- Be sent within 30 days of the date of the IRS rejection letter
- Include all the information and documents you gave the IRS when you made the OIC
Although it might take a little bit of work to fill out the forms, an offer in compromise is a good idea when your financial options are limited and you owe the IRS more than you'll ever be able to pay.
Question for Your Attorney
- What is my next step after I send in my appeal from an IRS rejection of my offer in compromise?
- I negotiated an offer in compromise with the IRS. However, my financial situation is worse than before and I am now unable to pay the portion of taxes that I promised. What should I do?
- Are my OIC application fee and monthly payments tax deductible?