What You Need to Know About Offer in Compromise Regulation

Alexandra Tapp

Expert Contributor
Last Updated: December 9, 2021

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The IRS has stringent rules and requirements for qualifying for an offer in compromise, which allows taxpayers to pay less taxes than they owe.
In determining whether you are eligible for an offer in compromise, the IRS will calculate your reasonable collection potential or the amount it can legitimately expect you to pay in taxes.
You must adhere to offer in compromise regulations and make the agreed-upon payments properly so as not to default on your offer.

Individuals who owe more in taxes than they can realistically afford to pay have several back tax assistance options available to them. One of those is an offer in compromise, in which the Internal Revenue Service (IRS) agrees to allow the taxpayer to settle his or her amount for a lesser amount. To qualify, however, you must send in a detailed application and adhere to IRS rules and offer in compromise regulation. Here’s what you need to know about this process.

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1 How to Qualify for an Offer in Compromise

2 The Application Process

3 How the IRS Accepts Offers

4 Payment Plan Options

How to Qualify for an Offer in Compromise

Offer in compromise regulation requires you to have filed all your tax returns and paid the current year’s estimated taxes. The IRS only accepts offer in compromise applications if you fall within one of three categories:

Doubt as to Liability. If you believe your amount of back taxes is incorrect and can prove it.
Doubt as to Collectibility. If you don’t make enough money or have enough assets to pay off your entire back taxes. This is the most common type of offer in compromise.
Effective Tax Administration. If you do have enough assets to pay your back taxes but doing so would cause you significant financial hardship to the extent that you can’t afford basic living expenses. This could be due to circumstances such as unforeseen health issues, a disability, caring for dependents, or retirement without any other income.

If you believe you are eligible based on one of these scenarios, you can fill out and submit the appropriate forms and documents to the IRS.

The Application Process

If you are submitting an offer based on doubt as to liability, you must fill out Form 656-L. For doubt as to collectibility and effective tax administration, you must complete Form 656 as well as 433-A (if you’re an individual and not a business). With the latter two — assuming you don’t qualify for a low-income exception — you must also pay an application fee. The IRS then has two years to either accept or reject your offer.

How the IRS Accepts Offers

Let’s look specifically at the most common type of offer in compromise — doubt as to collectibility. In deciding whether to accept your offer, the IRS will calculate your reasonable collection potential (RCP), or the amount it can realistically expect you to pay in taxes. It does so by taking into account your income, assets, expenses, and more. Under offer in compromise regulation, you must provide documentation and evidence of all this with your application.

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The IRS will first look at your total income, from wages to investments. Then it will calculate your monthly expenses, including living costs such as housing and utilities, transportation costs such as car payments and maintenance, child care, alimony, and more. It uses national standards to estimate average expenses for food, clothing, supplies, etc. while it calculates transportation and living expenses according to your region, family size, and other circumstances. Offer in compromise regulation does differ by state, with New York and California being the least lenient.

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Lastly, in determining RCP the IRS will evaluate your assets and their quick sale value (QSV), or what they would sell for quickly (within 90 days) in their current state. This is typically 80% of the asset’s fair market value.

While the IRS is looking over your application, it must suspend collection activities against you. The IRS might return your application and request more documentation if you:

Didn’t include enough information
Are filing for bankruptcy
Didn’t include the requires fees or payments
Aren’t up-to-date on your current taxes

If the IRS rejects your offer outright, you can appeal it in the Court of Appeals within 30 days.

Fortunately, since instituting the Fresh Start program in 2012, the IRS has accepted increasingly more offers in compromise. This is because it has:

Updated taxpayers’ future income calculations
Allowed student loans and owed taxes to be part of the taxpayer’s budget
Broadened what qualifies as living expenses
Reduced the amount of car equity and bank account contents that contribute to one’s assets
Cut income-producing property from one’s assets

These changes and more have reduced the average amount needed to settle back taxes by 75%.

Payment Plan Options

If the IRS determines, based on your RCP, that you cannot pay your taxes in full, it will accept your offer. You can pay the agreed-upon amount in one of two ways:

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Lump Sum Cash Offer. You must pay 20% of your offer upfront, followed by the rest of the amount in no more than five installments over no more than five months from the IRS accepting your application.
Periodic Payment Offer. Here you pay off your back taxes in at least six monthly payments within two years.

You must continue to file your tax returns and pay taxes on time for the next five years. If you don’t adhere to offer in compromise regulations, the IRS will consider your offer to be in default and demand you pay back your original back taxes in full, plus any interest or penalties.

Tax laws and offer in compromise regulations can be complicated to understand and can vary by state. For this reason, you might want to contact a tax attorney or back tax assistance company to help you fill out your application, gather all the appropriate paperwork, and communicate effectively with the IRS. If you need help lowering your back taxes, we can guide you through the offer in compromise process to give you the best chance of it being accepted by the IRS. Contact one of our qualified professionals to learn more.

Alexandra Tapp

Expert Contributor
Last Updated: December 9, 2021

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