An offer in compromise (OIC) is an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liabilities for less than the full amount owed. To qualify for an OIC, the taxpayer must have filed all tax returns, made all required estimated tax payments for the current year, and made all required federal tax deposits for the current quarter if the taxpayer is a business owner with employees. Taxpayers who can fully pay their tax liabilities through an installment agreement or any other payment option will usually not qualify for an OIC.
In most cases, an OIC will not be accepted by the IRS unless the amount offered by a taxpayer is equal to or greater than the “reasonable collection potential” or RCP. The RCP is how the IRS measures the taxpayer’s ability to pay. The RCP includes the value that can be realized from the taxpayer’s assets, such as real property, automobiles, bank accounts, and other property. In addition to property, the RCP also includes anticipated future income less certain amounts allowed for basic living expenses.
To be accepted, an OIC must meet certain conditions: First, if there is doubt as to liability as when there is a genuine dispute as to the existence or amount of the correct tax debt under the law; Second, if there is doubt as to collectibility as when the taxpayer’s assets and income are less than the full amount of the tax liability; and third, when there is no doubt that the tax is legally owed and that the full amount owed can be collected, but requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances.
Those who wish to apply for relief under the OIC program can submit to the IRS an accomplished Form 656 (Offer in Compromise), along with the $186 application fee and the required supporting statements relevant to the justification stated, plus the initial tax payment. The taxpayer may choose to pay the offer amount in a lump sum or in installment payments. A “lump sum cash offer” is defined as an offer payable in 5 or fewer installments within 5 or fewer months after the offer is accepted. If a taxpayer submits a lump sum cash offer, the taxpayer must include with the Form 656 a nonrefundable payment equal to 20 percent of the offered amount.
While the offer is being evaluated, the non-refundable payments and fees will be applied to the tax liability. Pending approval or rejection of the OIC application, the legal assessment and collection period is extended but the taxpayer is expected to make all required payments associated with his or her compromise offer. If within two years of the receipt date, the IRS does not make a determination, the OIC application will automatically be deemed approved.
On acceptance of the OIC, the IRS expects that the taxpayer will have no further delinquencies and will fully comply with the tax laws. If the taxpayer does not abide by all the terms and conditions of the OIC, the IRS may determine that the OIC is in default. If on the other hand, the IRS rejects an OIC, the taxpayer will be notified by mail. The letter will explain the reason for the rejection of the offer and will provide detailed instructions on how the taxpayer may appeal the decision. The appeal must be made within 30 days from the date of the rejection letter.