You have heard TV ads about settling IRS debt for pennies on the dollars? These tax debt settlement firms are peddling help with filing an “Offer in Compromise” (OIC).  An Offer in Compromise (OIC) is a settlement in which the taxpayer offers to pay less than the amount owed. An OIC can provide substantial relief to a qualified taxpayer. Indigent and disabled taxpayers, with no assets, can settle tax debt for very small amounts. The analysis is similar to requesting CNC status, but the attorney will have to argue that the taxpayer’s inability to pay the full liability is permanent.

Tax lawyers at legal aid programs help taxpayers with OIC applications for free. Some private firms scam taxpayers by taking fees as high as $3,000 and then doing very little to get the IRS to approve the OIC. These firms often fail to provide the back-up documents and focused negotiation required for a successful OIC. Some firms also take fees from taxpayers who have no chance of getting an OIC such as taxpayers with substantial retirement accounts or real estate holdings.

An OIC may be submitted on the basis of doubt as to collectability, doubt as to liability, or effective tax administration.1 Most offers are submitted for doubt as to collectability. This generally requires a showing that the taxpayer cannot afford to pay the liability and does not have assets that can easily be liquidated to pay the liability and that this situation is permanent. Many elderly and disabled persons with limited income are eligible to receive an OIC on this basis. 

• 1I.R.C. § 7122.

An OIC is initiated by filing a Form 656, which requires information and supporting documentation of the taxpayer’s income, assets, and expenses. The filing fee is a non-refundable $186. However, the fee may be waived for a taxpayer whose income is below 250% of the poverty line.1 A taxpayer must file all required tax returns in order for an OIC to be considered. This may lead to the taxpayer incurring more liability before all of the liability can all be settled with an OIC. You may need to request CNC status for your client while the tax returns are being processed or the OIC is being prepared. Collection actions are suspended while the OIC is being processed by the IRS. 

The purpose of the Offer in Compromise program is to settle tax debts for the maximum amount that the taxpayer can pay from net current assets and future income potential. The amount of the offer is computed as the sum of net realizable assets2 and gross income minus necessary living expenses. Even if the computed “offer” amount is zero, the taxpayer must still offer at least $1. The Internal Revenue Manual has extensive rules on how the maximum collection potential is determined.3 After the filing of the Offer, an attorney will often need to advocate with the IRS for the proposed offer amount. The Internal Revenue Manual rules are useful in this advocacy since the IRS is supposed to follow them.4 IRS requests for additional information should be timely responded to.

The IRS may allow the taxpayer to pay off the debt in a lump sum payment or in installments over a period of time, usually between 6 months and 2 years.5  In the latter case, the taxpayer will be given a fixed monthly payment amount. Be sure to structure a realistic compromise that provides the taxpayer with adequate means for basic living expenses.

If an OIC is accepted, a taxpayer must file tax returns and pay taxes owed for the next 5 years. Non-compliance could result in a default and enforcement of the compromised taxes by the IRS. Be sure to advise your client of the duty to file and pay taxes per the OIC agreement. Document your advice in writing.

Levy is suspended while an OIC is pending or in effect.6 The IRS is not required to release a prior levy upon the taxpayer’s filing of an OIC. However, it will usually release the levy if the taxpayer shows economic hardship. 

A “rejection” of an OIC may be appealed to the IRS Appeals Office.7 The rejection notice should state specific reasons why the OIC was not accepted so the taxpayer can respond in an appeal. Levy is suspended pending an appeal.8 If the OIC was submitted as part of a collection due process hearing, the rejection may be appealed to Tax Court under an abuse of discretion standard.9

If an OIC is “returned”, this means that the OIC was incomplete and that the OIC agent attempted to contact the taxpayer and/or the representative but did not get a response. The IRS takes the position that a “returned” OIC cannot be appealed and that the only remedy is to submit a new OIC. Some OIC agents seem to quickly return an Offer without giving adequate time to respond or even ignore phone messages or faxes sent by the taxpayer. If this is the case, the matter should be appealed to the OIC agent’s supervisor and possibly IRS Appeals. 

• 1Use Form 656A for waiver of the fee.
• 2“Net realizable assets” equals the Quick Sale Value of an asset (generally 80% of fair market value) minus the first encumbrance, fix-up costs, broker fees, etc.
• 3I.R.M. 5.8.5; 5.15.
• 4Fairlamb v. Comm’r, T.C. Memo 2010-22.
• 5I.R.M. 5.8.1.10.4.
• 6I.R.C. § 6331(k).
• 7I.R.C. § 7122(e); see I.R.C. §§ 6320, 6330; Rev. Proc. 2003-71 (Collection Appeals Program). Returns of Offers for additional information are not “rejections.”
• 8I.R.C. § 6331(k).
• 9See, e.g., Blosser v. Comm’r, T.C. Memo 2007-323; Samuel v. Comm’r, T.C. Memo 2007-312.

Taxpayers who own their own homes may have equity. Although the IRS will generally not require a taxpayer to sell the home, the agency may require a taxpayer to obtain a bank letter denying a mortgage on the home. Thus, a client who has equity in a home but whose income is too limited to get a mortgage may still be eligible for an OIC. 

The IRS will generally allow a taxpayer to have one vehicle for personal use unless it is an especially valuable vehicle with a lot of equity. 

A taxpayer may also have whole life insurance, savings, or a pension that could satisfy the tax liability. If the attorney can show that these funds are needed to pay future living expenses, the taxpayer may be able to keep these assets and still be approved for an OIC. The attorney will have to show that the taxpayer’s income is insufficient to pay for basic expenses, that this situation is permanent, and that the asset is needed to offset the negative income for the remainder of the taxpayer’s life. Use the Social Security life expectancy charts when making this argument. These charts can be found online at the Social Security website. 

Possible disadvantages to an OIC include an extension of the 10-year statute of limitation by the pendency of the offer plus 1 year, forfeiture of certain tax refunds, filing of tax liens to protect the IRS’s interests, adverse impact on bankruptcy options, and, if the taxpayer defaults on the offer, reinstatement of the full debt plus penalties and interest.1 An OIC will also preclude a subsequent innocent spouse claim for a tax year covered by the OIC.2 Until recently, even when an OIC was accepted, the IRS could still seize the next year’s tax refund. This policy has now been changed so that no new seizures will occur after the OIC is accepted. 

• 1The IRS will not process an Offer in Compromise for a taxpayer who is in bankruptcy. See Rev. Proc. 2003-71; I.R.B. 2003-36.
• 2I.R.M. 25.15.5.15.