Offers In Compromise  

What is an Offer in Compromise?

Basically, an offer in compromise (often called an “OIC”) is a proposal made to the IRS on Form 656 wherein a taxpayer seeks to pay an amount less than what is owed to settle a liability.  If accepted, the taxpayer has an obligation to be 100% compliant with Federal tax laws for the next 5 years, or the OIC will be revoked and the original liability will be reinstated.

What types of OICs are there?

 There are three types of OICs.  The most common is the Doubt as to Collectibility (DOC OIC).  This is where the taxpayer lacks the financial ability to pay in full the Federal tax liability before the 10-year collection statute of expiration date (referred to as the “CSED) expires.  I will focus on this type of OIC in this paper.

The second type is the Doubt as to Liability.  This typically applies to taxpayers who were audited and did not have the opportunity to present all of their evidence and as a consequent, the IRS assessed a liability that they believe is greater than they owe.

The third and final type is called Effective Tax Administration.  This is basically a hardship OIC.  The taxpayer has the ability to pay off what they owe in full, but to do so would create a serious undue hardship.  For example, a taxpayer may have equity in a residence sufficient to pay off the IRS, but that equity is needed to cover future medical expenses due to a terminal or serious medical issue.

What is required to qualify for the DOC OIC?

The taxpayer must complete form 433A-OIC which is a financial statement.  In this document, all assets are listed.  Cash, bank deposits and liquid assets are valued at their face value.  Other assets like cars and real property are generally valued at 80% of their current fair market value (FMV).  For example, a house with a fair market value of $500,000 and a mortgage of $200,000 would be listed at 80% of $500,000 (which equals $400,000), less the $200,000 mortgage. The “net realizable value” of the residence would be $200,000 ($400,000 less $200,000).  The sum of all net assets is referred to as the net realizable value of assets.

In addition, the IRS will take into consideration the most the taxpayer can pay in monthly installment payments over the life of the CSED (the 10-year statute).  In determining how much the taxpayer can pay monthly, the IRS will apply the “Collection Financial Standards.”  These represent the maximum the IRS will allow for certain expenses to offset their monthly income. For example, in Los Angeles County, the maximum rent expense allowed for a couple with one child would be $2,890.  This cover rent, utilities, homeowner’s insurance and any other costs associated with renting an apartment or house.  If the taxpayer’s actual costs are, say, $4,000, then the IRS will only consider $2,890 in determining the net monthly payment the taxpayer can make toward their liability.

Once the IRS has calculated the net realizable value in the taxpayer’s assets, and the total they would receive in net monthly payments over the life of the CSED, that total must be less than what is owed to the IRS (considering the future accrual of interest and late payment penalty).  If it is more, then the taxpayer will not qualify for the OIC DOC.

How much must be offered to compromise the liability?

Assuming that the amount of assets plus monthly payments is less than the liability, then the minimum cash offer amount would be the sum of the net realizable value in assets PLUS 12 months of payments – plus $1.  This amount has to be paid within 5 months of the notice of acceptance of the offer.  Generally, this type of offer requires the taxpayer to have an outside source for the offer amount – typically a gift, loan or a combination from family member.

There is another payment option that allows for the offer amount to be paid over 24 months.  However, the offer amount is calculated differently – the 12 months of payments is increased to 24 months of payments which make the offer in some cases out of reach for taxpayers. The vast majority of offers are cash offers for that reason.

Are there other factors considered in determining if an OIC will be accepted?

The IRS will consider the following in determining if it will accept an OIC:

a. Taxpayer’s age – generally, the older a taxpayer, the less likely they will be in a position to earn enough income over their remaining working life to pay off the liability.  Age is definitely a factor they will consider.

b. Taxpayer’s health – if a taxpayer has a serious illness that can impact future earnings, then that can have a significant impact on whether or not the OIC is accepted.  A taxpayer with a terminal illness would be an example of where the IRS would be remiss in not seriously considering an OIC when the likelihood of the taxpayer being around to pay off the liability with future income is remote.

c.  Past income levels – a taxpayer who at one time made a significant annual salary, but now is earning significantly less due to general economic conditions or a temporary medical challenge, would be less likely to have an OIC accepted.  The IRS would factor in the taxpayer’s ability to return to a high level of income in the future.  If they seriously considered such an offer, then the IRS could require a “future collateral income agreement” – which basically says that for the next 5 years, if their income returns to a higher level, the IRS will be entitled to a portion of the increased income.  The income thresholds and the percentage of additional income to be paid are generally negotiable during the consideration of the OIC.

What does it cost in fees to go through an OIC?

Most professionals will represent a client pursuing an OIC on an hourly fee basis. The reason is that at the outset, it is impossible to be able to predict just how invasive the IRS will be in validating the financial condition of the taxpayer.  Further, if the front-line function of the IRS (called ‘Compliance”) does not accept the proposed OIC, then there is an opportunity to appeal the denial to the IRS Office of Appeals.  That requires more time and effort to go through that process.  In my experience, a typical OIC without having to go through an appeal would take about 10 hours on the average.  If there is a need for an appeal, then the additional time could be somewhere between another 5-10 hours.  The time is dependent on a number of factors such as how much the taxpayer is able and capable of doing in the way of document presentation, indexing, etc, and the level of inquiry the IRS employee pursues in evaluating the offer.

What is the approval process for an OIC?

If the total for all taxes, penalties and interest is less than $50,000, then the IRS employee makes the recommendation for acceptance to his or her manager who has the authority to accept OICs.  If the amount  of taxes, penalties and interest is $50,000 or more, then in addition to the managerial approval, the IRS Area Counsel (the IRS attorney group) must also review and approve the OIC for “legal sufficiency.”