The Internal Revenue System, or IRS, operates a debt forgiveness program called the Offer in Compromise. With this program, taxpayers can settle for less than what they owe, according to their financial capacity. In this article, we explain how it works.
People who are unemployed or underemployed can request uncollectible status, which allows them to freeze collections until they can make tax payments. When a person is given uncollectible status, the IRS stops any activities intended to enforce the collection of taxes. This way, families can recover financially.
This process, also known as a life jacket, helps families by halting levies on wages, bank accounts, and properties. Families who are given uncollectible status do not have to worry about losing equity on their homes, receiving reduced paychecks or losing their savings. However, the IRS may resume enforcement if families fail to improve their financial position after a certain amount of time.
To request uncollectible status, individuals must file a financial statement using Form 433A. This form will provide the IRS information needed to determine if the applicant qualifies for uncollectible status. In general, the IRS approves such requests for families whose income is only sufficient to cover basic expenses. Families who need longer tax relief can also use uncollectible status to gather the required paperwork to apply for a permanent forgiveness program.
Offer in Compromise
The IRS operates a program called Offer in Compromise, or OIC, which allows taxpayers to settle their debt for a lower amount than what they owe. Through this program, the IRS and taxpayers reach an agreement to reduce tax debt to an amount that can be paid.
For example, the Offer in Compromise program would allow someone owing $50,000 to pay only $10,000. The final amount is determined according to how much the person can afford to pay without falling into financial distress. If their position allows them to pay more, the IRS will most likely ask for a higher sum of money before settling.
Offer in Compromise is used by a significant number of taxpayers each year, who have saved thousands of dollars in the process. Unlike the life jacket initiative, Offer in Compromise is a permanent solution to tax debt, freeing families of potential IRS enforcement.
The Offer in Compromise program has different options to determine how much money individuals can pay. The first option is known as an “offer based on collectivity.” This option allows taxpayers to reach an agreement in which they pay as much as they can, instead of what they owe. This offer is often given to people whose income has been drastically reduced, making it difficult for them to pay back taxes on previous income.
The second option is designed for people who believe their tax debt amount to be incorrect. Through this method, individuals can challenge the amount being collected, and ask for new tax calculations to be performed. This option, known as “offer based on liability,” is useful for people who believe the results of their tax audits to be incorrect.
The third option is known as a compromise based on “effective tax administration.” With this option, taxpayers can reach an agreement with the IRS to pay less than what they owe if paying the full amount would put them in financial hardship. For example, a family that owes $40,000 may be able to pay the full amount by taking a home equity loan. However, doing so could increase the risk of foreclosure or make it hard for the family to cover basic expenses. In such a case, the IRS might accept an offer in compromise due to effective tax administration.
How To Qualify for OIC
To qualify for an offer in compromise, taxpayers must be in filing compliance. This means that they have filed all previous tax returns. In general, the IRS requires taxpayers to have filed tax returns for at least the previous six years. Individuals who have a significant number of past debt or unfiled tax returns should provide all relevant paperwork to the IRS once they apply for an offer in compromise. Otherwise, their application will be denied because of non-compliance with tax rules.
Before applying for an offer in compromise, taxpayers should analyze their previous tax returns to verify any discrepancies. In many cases, their actual debt is less than what the IRS says they owe. A tax professional is often necessary to accurately verify previous tax returns in search of potential debt reductions. It is common for taxpayers to find out they do not need an offer in compromise after analyzing previous tax returns.
To determine if a taxpayer is eligible for an offer in compromise, the IRS relies on what is called reasonable collection potential, or RCP. This metric is calculated using taxpayers’ net equity in assets (such as homes and vehicles) and future disposable income. The IRS will decline an OIC if taxpayers can cover any outstanding tax debt with their assets and income without falling into financial hardship or exceeding the collection statute of limitations. For IRS collections, the statute of limitations is ten years, compared to only four years for other types of debt.
For example, a taxpayer reports in January 2019 that they still owe $30,000 on a tax return filed in 2015. He then submits an OIC application to request their debt be forgiven. Their current assets amount to $2,000 in equity and $200 in monthly disposable income. The collection statute of limitations for that tax return is April 2025, which means the IRS can only collect 75 monthly payments of $200, for a total of $15,000. Adding up their equity, the final RCP value for the taxpayer would be $17,000. In this case, the taxpayer would have their OIC application approved.
The formula used to calculate the reasonable collection potential is straightforward. However, complications may arise when determining which assets will be included, and how to value them. The IRS has also established limits on what taxpayers can claim as living expenses. If necessary, the agency will scrutinize and set spending limits on basic expenses before approving an OIC application. This means that a taxpayer that originally reported only $200 in disposable monthly income may actually have to put $300 instead if the IRS determines some additional expenses as disposable.
How To Apply for OIC
To take advantage of this program, taxpayers must file forms 656-B and 433-A, informing the IRS that they cannot pay their back taxes. Taxpayers must also remit the application fee, as well as an initial payment required by the IRS. After that, the agency will analyze the information provided in both forms, and perform a study of taxpayers’ assets, income, mandatory expenses and other financial data required to determine their repayment ability. The IRS has no more than two years to analyze an OIC application and make a decision. If after two years the agency has not processed an application, it is then automatically accepted.
The IRS usually handles offers in compromise in two ways. The first method requires that taxpayers pay 20 percent of the total offer amount right away, with the remainder being paid in no more than five payments. Using the example above, the taxpayer would have to provide $3,400 in advance and make five more payments of $2,720.
Using the second method, taxpayers pay a portion of the offer amount in advance and make monthly payments while the IRS considers the proposal. In this scenario, the initial payment does not have to equal 20 percent of the offer amount. If the IRS approves the application, taxpayers continue making monthly payments until they pay off the offer amount. The monthly payment amount will be determined by the collection statute of limitations.
Before the IRS approves an offer in compromise, taxpayers must agree to certain terms and conditions. This includes filing all tax returns and making all required monthly payments. The IRS often also asks applicants to apply any current tax refunds to their debt. In return, individuals get released from any federal tax liens on their properties. Once the process is complete, taxpayers see their previous tax debt forgiven and replaced with the amount agreed to in the offer in compromise.