Nobody enjoys paying taxes, but there are situations where you may need assistance on options for paying your taxes. You might consider whether bankruptcy is an option for resolving your taxes, but not all taxes can be discharged in bankruptcy and sometimes there are other factors that make bankruptcy not a viable option and bankruptcy may not be the best alternative for taxes.
In some situations, you may be able to resolve your taxes for less than the amount that you owe by submitting an Offer in Compromise. Unlike other creditors, though, the IRS is not authorized to simply negotiate a tax debt the way a bank might negotiate a credit card bill. The IRS is required by law to administer the tax laws in a way that is fair to all taxpayers – that means that the IRS cannot require one taxpayer to pay a tax bill in full, while arbitrarily allowing another taxpayer to get a discount.
There are situations where it makes sense for the government to agree to accept less than the amount owed. The Offer in Compromise process is more structured than simply sliding offers back and forth across a table as if you were buying a car, or picking up the phone and negotiating a lower interest rate on your credit card. In order to make sure that all taxpayers get equal treatment, the IRS must follow strict guidelines that are set out in hundreds of pages of regulations, published IRS policies and Court precedent.
An Offer in Compromise (an “OIC”) may allow you to resolve your IRS debt for less than you owe. To qualify for an OIC, you must show the IRS that there is some doubt as to whether the IRS will ever be able to collect the tax bill from you now or in the foreseeable future. This is an offer based on “doubt as to collectibility.” The IRS can also consider whether, due to exceptional circumstances, payment of your full tax bill would cause an economic hardship or would be unfair or inequitable. This is an offer based on “effective tax administration.” Less frequently, the IRS can also agree to reduce your tax bill based on “doubt as to liability.”
Offers in Compromise Based on Doubt as to Collectibility
An offer based on doubt as to collectibility begins with a math exercise. The IRS takes into consideration your income and your assets to determine the “reasonable collection potential” on the account. “Reasonable collection potential” means how much the IRS could take from your income while still leaving you with enough left over to meet basic living expenses, plus what the IRS could recover if it began seizing and selling your assets. Not surprisingly, the amount that the IRS thinks that it could collect from you is usually higher than the amount that most people think that they can pay.
If you are considering an offer in compromise based on doubt as to collectibility, you may want to first consult the free online pre-qualifier tool provided by the IRS.
Remember that just because the pre-qualifier says that you qualify for an offer does not mean that your offer will be approved, and just because the pre-qualifier says that you do NOT qualify for an offer does not mean that your offer will be rejected.
The tool, however, only takes a few minutes and will help set your expectations in the process. If the pre-qualifier suggests that you do not qualify for an offer based on doubt as to collectibility, we can help you present your unique situation to the IRS in a way that will consider factors that the online pre-qualifier does not take into account. If the pre-qualifier suggests that you will qualify for an offer, we can help you put an offer together that increases the chance that the IRS will accept your offer and can help you navigate the complex process.
There is an opportunity for creative advocacy in presenting your financial information to the IRS. The IRS only considers certain expenditures in computing your ability to pay. Sometimes, your actual expenses may be more than what the IRS considers to be reasonable. From the IRS’s perspective, that means you have money going towards housing that could be used to pay taxes. In order for the IRS to “allow” those expenses, you must fully document and explain why your expenses exceed the “allowable” amount, and then convince the IRS to accept it. Some of the factors discussed below for an offer in compromise based on economic hardship may also be considered in an offer based on doubt as to collectibility.
If you are interested in pursuing an offer based on doubt as to collectibility, we recommend that you begin immediately tracking your income and all of your expenses very closely. Consider using a program or app to track and categorize your monthly expenses. Alternatively, track your expenses on a spreadsheet or some other method that will help us show the IRS where you money goes each month. Keep documentation to back up those expenses. Knowing the rules and the extent of the IRS’s flexibility on these issues is crucial to obtaining the best possible result.
Offers in Compromise Based on Doubt as to Liability
The tax assessment process is a long and arduous process, but there comes a point where the amount of tax is final and neither the taxpayer nor the IRS can revisit whether the tax has been correctly calculated and assessed. An offer based on Doubt as to Liability is not an opportunity re-litigate the underlying dispute. Generally, you need to show that there remains a legitimate reason to question whether you should owe the taxes, and there is not another avenue available to challenge the assessment.
Suppose the IRS sent you a notice of an audit. You had moved and did not get the notice and missed the meeting with the auditor. The IRS disallowed all expenses and now you have a tax debt. You discover the problem when you try to borrow some money and find that there is a federal tax lien filed. The time limits for challenging the audit have all expired but you are able to provide an explanation that supports reasonable doubt justifying a reduction to a portion or all of your tax debt. The IRS will not simply adjust your account and erase your tax debt, but may agree to compromise the debt because there is a doubt as to whether you really should have been found liable for the tax.
Offers in Compromise Based on Effective Tax Administration
The IRS can only consider an offer based on effective tax administration (“ETA”) after it has first evaluated whether the offer should be considered under the Doubt as to Collectibility or Doubt as to Liability criteria. Effective Tax Administration is essentially the “backstop” that ensures that taxes are being administered fairly across all taxpayers. An ETA offer may be appropriate where the math shows that the taxpayer can pay the tax debt in full over time, but there is some extraordinary reason why the IRS should accept less than full payment. There are two types: economic hardship and public policy or equitable grounds.
Economic Hardship
Let’s get one thing out of the way: paying taxes is an economic hardship for pretty much everyone. Simply because full payment will be burdensome does not mean that full payment meets the IRS requirement of economic hardship.
The definition of economic hardship comes from the tax regulations and generally means that the taxpayer would be unable to pay reasonable basic living expenses if required to pay the tax in full. The determination of a reasonable amount for basic living expenses will vary according to the unique circumstances of the individual taxpayer but does not include maintaining an affluent standard of living. Because economic hardship is defined as the inability to meet reasonable basic living expenses, it applies only to individuals (including sole proprietors) but is not available to corporations, estates, or other non-individual entities.
The IRS provides an example of what it would consider to be an economic hardship:
The taxpayer is disabled and lives on a fixed income that will not permit full payment of the taxes under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate a disability. The equity in the house is more than the tax liability, however, the taxpayer has been unable to borrow against the house. Because the home has been specially equipped to accommodate the disability, the IRS should not force a sale of the home because the taxpayer needs the special equipment to accommodate the disability.
Public Policy or Equity Grounds
In addition to an economic hardship, the IRS may consider public policy or equity grounds. We were involved in a situation where the taxpayer was one of dozens of businesses that hired a payroll processing company to file payroll tax returns and pay payroll taxes as scheduled. The taxpayer saw that the payroll company was making the correct withdrawals from the business account and that the payroll returns were correct. However, unbeknownst to the business, the payroll company was a scam. It never made the payroll tax payments. Instead, the individuals behind the payroll company stole the money from all of its customers and fled the country leaving the businesses on the hook for the unpaid taxes. The IRS determined that since the business took reasonable efforts to be diligent about meeting its tax obligations and was the victim of a crime, fairness and equity demanded that the IRS agree to work out a compromise with the business and forgive most of the outstanding tax liability.
The IRS may also consider public policy or equity grounds where the taxpayer relied on bad advice from the IRS. Conceptually, ETA offers may be appropriate where the tax debt arises despite the taxpayer’s good faith efforts to stay in compliance.
Filing the Offer in Compromise
An Offer in Compromise package consists of the correct IRS forms along with supporting documentation and, typically, a narrative argument that persuasively advocates for your unique situation in the context of the applicable statutes, regulations, IRS guidelines and court decisions. The IRS currently takes about 9-12 months to evaluate and respond to an offer. Updated financial information is usually required when the Offer package is finally reviewed so it is important to continue tracking your expenses. Many offers are rejected simply because the taxpayer fails to respond properly to the IRS’s requests for additional information.
Paying the Compromise Amount
The filing fee for an Offer in Compromise is $186 which must be paid at the time that you make the Offer. Your Offer may be paid in two ways: a lump sum Offer must be paid within five months of the date that it is accepted; an installment Offer must be paid over 6 to 24 months. If you are proposing a lump sum Offer, 20% of the offered amount must be paid when the Offer is filed along with a $186 application feel. If you are proposing to pay the offered amount in installments, you must pay the application fee for the Offer and your first monthly installment payment. You must continue to make the proposed monthly payments while the Offer is pending.
Alternatives
If you do not qualify for an offer in compromise, there may be other alternatives available. The IRS may agree to reduce or waive certain penalties. There are creative ways to work with the IRS to minimize the burden of resolving your tax account. If you do not reach an acceptable arrangement with the IRS, the Service may begin much more intrusive and burdensome collection proceedings, which can include wage garnishments, or seizing your assets such as your bank accounts or even your home. One benefit of filing an Offer in Compromise is that the IRS cannot take these collections actions against you while the Offer in Compromise is pending.
Can you do it on your own?
The Offer in Compromise program can be difficult to navigate. This is an agency that puts out over 70,000 pages of regulations to interpret the Tax Code. Most people do not have the experience or the knowledge of IRS collection policies and procedures to be able to assemble and effectively negotiate an Offer in Compromise. Offers can be particularly complex for business owners and the self-employed. It is very important to do it right the first time.
Who Should you Hire?
We have seen an explosion of advertisements on television and online for companies promising to help you resolve your tax debt. These ads often give the false impression that the IRS routinely settles taxes for pennies on the dollar, and that all you have to do is ask. As you can see from this discussion, the program is heavily regulated and requires expertise to navigate. Many of these “offer mill” companies hope to earn a quick fee to fill out a few forms and submit quick and dirty offers that have little chance of success. The offers are typically poorly prepared and lack the required supporting documentation. The IRS and many State Bar regulators are aggressively clamping down on these offer mills because they take advantage of people who are desperate to resolve their tax problems.
MORE INFORMATION
We believe that the offer in compromise program is complicated enough that most people would benefit from professional advice in preparing an offer. There are a number of good online resources available that will help you better understand the process.
IRS Tax Topic 204 — “Offers in Compromise”
IRS Offer in Compromise Pre-Qualifier Online Tool