Tax Law Insights

Generally, there are four methods of resolving an assessed federal tax liability: (1) full payment, (2) payment through installments under a written agreement, (3) an offer in compromise, and (4) bankruptcy. The IRS also has the authority to temporarily suspend collection or payment of federal taxes through placing an account in currently uncollectible status.

An Offer in Compromise (OIC) is an agreement between the taxpayer and the IRS that settles a tax liability for payment of less than the full amount owed. The IRS will generally accept an offer in compromise when it is unlikely that the tax liability will be collected in full and the amount offered reasonably reflects collection potential. Most individual and business taxpayers who owe income taxes, payroll taxes, penalties or interest may submit an offer in compromise to settle their tax liability.

The goals of the OIC program are: (1) to collect what is potentially collectible at the earliest possible time and at the least cost to the government, (2) to achieve a resolution that is in the best interest of both the taxpayer and the government, (3) to give taxpayers a fresh start to enable compliance with tax laws, and (4) to collect funds which may not be collectible though any other means.

Section 7122 of the Internal Revenue Code permits the IRS to compromise federal taxes, interest, and penalties. The IRS will compromise tax liabilities where there exists: (1) doubt as to liability, (2) doubt as to collectability, or (3) a specific hardship where granting an offer in compromise will promote effective tax administration.

Doubt as to liability. The IRS will grant an offer in compromise for doubt as to liability when a taxpayer provides substantial evidence that the tax liability whether or not assessed is incorrect. The taxpayer must provide the factual and legal support for the position that he or she does not owe the tax liability.

Doubt as to collectability. Doubt as to collectability exists when the taxpayer's net realizable equity in assets is less than the full amount of the tax liability, and the taxpayer does not have the ability to make installment agreement payments to pay the liability in full during the life of the collection statue of limitations.

Effective tax administration. The IRS will accept an offer in compromise that promotes effective tax administration if a taxpayer is experiencing economic hardship or compelling public policy or equity considerations exist as identified by the taxpayer which provides a sufficient basis for compromising the liability.

Individual taxpayers are not eligible for offer in compromise consideration based on doubt as to collectability or effective tax administration if: (1) the taxpayer has not filed all income tax returns, or (2) the taxpayer is involved in a pending or open bankruptcy case.

For business taxpayers filing an offer in compromise for payroll taxes, the business must file and deposit all payroll taxes on time for at least two quarters preceding the offer in compromise. In addition, the business must deposit all payroll taxes on time during the quarter in which the offer in compromise is submitted.

To apply, taxpayers must submit an offer in compromise using IRS Form 656 (Offer in Compromise) and include a detailed financial statement in support of the offer using Form 433-A (Collection Information Statement for Wage Earners and Self-Employed Individuals) or Form 433-B (Collection Information Statement for Businesses). Upon making an offer, taxpayers will need to make either a lump sum cash offer or a deferred periodic/installment payment offer to satisfy the liability. If a taxpayer desires to make installment payments, he or she must continue to make monthly installment payments while the offer is being considered by the IRS.

Once the taxpayer files the offer in compromise, the IRS will not levy or pursue any collection activity during the period the offer is pending, 30 days after an offer is rejected, or the period a rejected offer is administratively appealed. Conversely, the statute of limitations on the IRS's ability to collect the tax is suspended during the period the IRS is prohibited from levying on the tax liability. After acceptance of an offer, taxpayers must remain current with all income tax filing and payment requirements for five years or until the amount of the offer is paid in full, whichever is longer.

Taxpayer Impact

The OIC program is an option for those taxpayers who are unable to pay their tax liabilities to the IRS. It is the only administrative program available where the IRS can legally accept less than what a taxpayer owes to the government. The IRS will accept an offer when it is unlikely that the tax liability can be collected in full and the amount of the offer reasonably reflects collection potential. An OIC is a viable alternative for a taxpayer instead having his or her tax account declared as currently not collectible, entering into a extended installment agreement, or filing for bankruptcy.