If you have a tax debt you cannot afford to pay, you may have heard that it’s possible to reduce your total tax liability with the IRS by submitting an Offer in Compromise.
If so, you’ll probably be wondering exactly how low the IRS might be prepared to go, how the whole process works, and how much you should offer to the IRS?
The short answer is that the amount you should offer in compromise is clearly dictated by a specific calculation, which we’ll go into below.
It’s also important to know that while this tax relief option can be a game-changer for many taxpayers with federal debt, it’s also a highly complex one with a lot of nuances that are important to understand before you start the application process.
In this article we’ll explain everything you need to know about submitting an Offer in Compromise, including how much to offer, the terms you’d need to adhere to, common mistakes people make in their applications, and how to increase your chances of getting an Offer in Compromise approved.
What is an Offer in Compromise and who is it for?
An Offer in Compromise (OIC) is a tax relief option that allows you to settle your tax debt with the IRS for less than the full amount that you owe.
It has strict eligibility criteria, which is mostly centered around you legitimately not being able to pay your tax debt, or if doing so will put you into financial hardship.
Other eligibility requirements are that you:
- Have filed all required tax returns and made all required estimated payments
- Aren’t in an open bankruptcy proceeding
- Have a valid extension for a current year return (if applying for the current year)
While reducing your tax debt to something more affordable may sound like the perfect option, it’s important to know that it’s one of the harder tax relief options to get approved, and over 50% of all applications are usually denied.
Working with a tax professional is therefore the best way to approach applying for an Offer in Compromise, as they will be able to help you identify whether or not you are a candidate and if an OIC is definitely your best option. There are other alternatives, such as Installment Agreement payment plans, which are often more suitable and might even save you more money in the long run.
How much should I offer for my Offer in Compromise?
Although the name may make it sound like it’s an open negotiation, it’s not really.
The amount you should offer in your OIC application is based on a very specific calculation that has clearly defined guidelines.
The result of the calculation is known as your “reasonable collection potential” (RCP), which is basically what you can afford to pay once subtracting your living expenses from the combined value of your income and asset equity, and what the IRS can reasonably collect from you before the collection statute expires.
The exact offer you make must be equal to or greater than your RCP, and if approved it must be paid in full within either 5 months or 2 years – depending on the offer terms you choose.
Offer in Compromise examples: How to calculate your offer amount
To calculate your OIC offer amount and submit your application, you’ll need to complete two IRS forms:
- Form 656, Offer in Compromise
- Form 433-A (OIC) for individuals, or Form 433-B (OIC) for businesses
Form 656 is for the official application of your OIC, but Forms 433-A or -B are the ones you need to work out your offer amount.
These forms require you to declare all information regarding your household or business, income, assets, expenses, etc.
Specific calculations are then applied in order to define:
- the realizable (or available) equity of your assets
- your official disposable monthly income
It’s important to note that the disposable income calculation is based on your income less necessary living expenses – most of which have a pre-defined cap based on national standards, rather than being your own actual expenses. The available equity of your assets is also calculated using specific formulas, and it’s highly recommended to consult a professional to ensure you get all these numbers correct.
Once you have these figures, you can calculate the appropriate offer the IRS will accept.
There are two options when submitting an OIC offer, reflecting different payment terms, and each offer has its own calculation:
Option 1: Lump-sum cash offer
This option will give you the biggest reduction in your total tax liability, but you will need to pay the entire amount within 5 months of the offer being accepted.
You must also pay 20% of the offer amount when submitting the application. This down payment is non-refundable, so if your offer is denied it will be kept by the IRS and applied against your tax liability.
Lump-sum offer calculation (to be paid within 5 months):
Option 2: Periodic payment offer
This option will give you a smaller reduction in your total tax liability than the lump-sum option, but it allows you to pay it off monthly for up to 24 months.
Again, you must pay the first proposed installment at the time of applying, and all subsequent monthly payments while the offer is under consideration. These payments are also non-refundable in the instance that the offer is eventually denied, but will be applied against your outstanding debt.
Periodic payment offer calculation (to be paid within 24 months):
Offer in Compromise examples with numbers
Say you’re an individual taxpayer with no dependents and a tax debt of $50,000.
Your available equity in assets is $10,000 and you have a disposable income of $400 a month.
If going for the lump-sum option, the calculation for your Offer in Compromise offer would be:
If accepted, this means your tax debt would be reduced from $50,000 to $14,800.
You would be required to pay $2,960 (20%) at the time of application, and the remaining $11,840 in full within the following 5 months.
If going for the periodic payment option, the calculation and offer amount would be:
If accepted, your tax debt would be reduced from $50,000 to $19,600.
You would be required to pay $817 (first monthly payment of 24 total payments) at the time of application, and a further $817 every month while the application is being reviewed, and for the full 24 months if it is accepted.
While the lump-sum option may look preferable in terms of it being a lower overall amount, it’s important not to forget the 20% down payment and that you would need to pay off the full amount within 5 months. For many people, this means it is not a viable option, and the periodic payment option is more suitable.
How much does an Offer in Compromise cost?
In addition to the above-mentioned down payment, you have to pay an application fee of $205 when submitting your Offer in Compromise.
There are no other “costs” of an OIC. However, you should consider the cost of your application being denied…
Given that the upfront payment can often be a significant amount, and is not refunded in cash if the offer is denied, you will want to ensure your application is likely to be accepted before parting with this amount of money – or you may find yourself in a worse financial position than before.
It’s also important to note that penalties and interest continue to accrue while the offer is being considered, which will also negatively impact your total tax liability if your OIC is denied.
The only exception to paying the $205 fee and down payments is if you are a low-income taxpayer. To qualify for low-income certification, your individual or household’s gross income must fall at or below 250% of the official published poverty level guidelines. If this is the case, you don’t have to pay the OIC fee or down payment. However, you will still need to pay the full offer amount over the agreed period if your offer is accepted.
How to get an Offer in Compromise approved
To be successful in your OIC application, you need to do all of the following:
- Prove that you cannot afford to pay your tax debt within the remaining collection statute, or that doing so will cause you serious economic hardship. (Generally this means that you will need to be on a low monthly income and have next to no assets).
- Meet all other eligibility criteria.
- Make an offer that is equal to or greater than your calculated RCP.
- Submit all required documents and information without error.
While it is possible to complete an OIC application yourself, the exact calculations and eligibility criteria are incredibly complex, and making just one mistake may cost you the approval of the offer.
The best way to get an Offer in Compromise approved is by enlisting the help of a professional tax relief firm like Tax Relief Helpers. We will only submit an OIC offer if it is your best option, we are confident it will be accepted, and we will ensure everything in your offer application is 100% accurate, taking all the stress and uncertainty off your plate.
Common mistakes when applying for an Offer in Compromise
There are several common mistakes that result in people’s Offer in Compromise applications being rejected. These include:
- Not submitting all the required documents and information. It’s a complex process and a lot of information is needed. Failing to submit something, even by accident, can cause the IRS to question the accuracy of your offer and reject it.
- Miscalculating (and underestimating) the value of your assets.
- Miscalculating disposable income by reporting higher than allowed expenses.
- Not accounting for future income potential. If there’s a potential for increased earnings in the coming years, this also needs to be accounted for.
- Overlooking alternative tax relief options that may be better suited. Installment Agreements or Currently Not Collectable are just two of the other options available that may be more suitable to your situation and save you more money in the long run.
- Not seeking professional help. All of the above mistakes can be avoided by seeking help from experienced tax professionals from the outset. Tax Relief Helpers know exactly what you need to include, how to calculate everything accurately, and if an OIC is the best option in your situation.
Get professional help for your Offer in Compromise
An Offer in Compromise can be a saving grace for many people staring into the void of unmanageable tax debt.
However, it is also one of the most complex tax relief applications, and one of the hardest to get approved. Given this complexity, there is a lot of room for error and misunderstanding, which will only increase the likelihood of your offer being denied.
For something this important, it is well worth getting help from a professional.
Our team of experts at Tax Relief Helpers know the system inside and out, so we can walk you through it from start to finish, check you meet all requirements, handle all the calculations and forms for you, and make sure you are opting for the best tax relief option for your specific situation.
If you have tax debt that you cannot afford to pay, contact us today to find out how we can help, and if an Offer in Compromise is a viable option for you.