How to Settle IRS Debt

An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles a taxpayer’s tax liabilities for less than the full amount owed.

However, few taxpayers are good candidates for offer in compromise. To learn why, read on.

Step 1: Determine if you are Current on your Tax Obligations

You must be currently be in full compliance, which means:

  • You’ve filed all your tax returns that you are legally required to file
  • You’re having the correct amount of taxes withheld based on your Form W-4 or paying your estimated tax payments for the current year if you’re self-employed
  • Businesses must be making their current quarter’s payroll tax deposits
  • Continue to remain compliant through the rest of the process

To see if you meet the pre-qualifications, you can use the IRS’ OIC Pre-Qualifier tool. Note: just because you meet the pre-qualifications does not mean that your offer will be accepted.

Step 2: Obtain a copy of your Tax Account Transcripts

Get a copy of your account transcripts from the IRS for the tax year(s) for which you currently owe taxes. Determine the amount that you owe, including penalties and interest.

Step 3: Complete a Financial Analysis

Complete a financial analysis by calculating your reasonable collections potential (RCP). This is an important calculation as it determines whether your offer will be ultimately accepted or rejected.

There are two parts to the RCP:

  1. The RCP includes the value that can be realized from the taxpayer’s assets, such as real property, automobiles, bank accounts, and other property.
  2. The RCP also includes anticipated future income less certain amounts allowed for basic living expenses.

The IRS will determine the quick sale value of your assets, as well as your anticipated future earnings. If your offer meets or exceeds this reasonable collection potential, then your offer should be accepted.

However, if the taxpayer has remaining monthly income and the IRS can receive more through a payment plan before the collections statute expires, the offer may be rejected as “not in the government’s interest”, provided that no special circumstances exist.

Most taxpayers are not good candidates for an offer in compromise because their ability to pay or reasonable collections potential is too high.

Step 4: Submit your Paperwork and First Payment

If you’ve determined that you have an offer that is acceptable (and also taking into consideration collections statutes), then you’ll submit the following to the IRS:

  • Completed and signed Form 656
  • Completed and signed Form 433-A (individuals) or 433-B (businesses)
  • Photocopies of all required supporting documentation
  • A check or money order payable to the “United States Treasury” for the initial payment
    • If making a lump sum offer, you must make a payment of at least 20% of the total offer amount, and the remaining balance to be paid in 5 months. *
    • If making a periodic payment, the first payment must be paid with the offer and the rest within 6 to 24 months per the terms of the offer.*
  • A separate check or money order payable to the “United States Treasury” for the $186 application fee.*

*There are exceptions for taxpayers that qualify as low income.

Mail the above documents to the appropriate IRS processing office in your state.

Step 5: Continue to Make Payments and Remain in Compliance

While your offer is being reviewed (anywhere between 6-12 months or longer), you must continue making payments per the offer terms as if the offer has been accepted. Additionally, you must remain in full compliance with the tax code for 5 years after the acceptance of the Offer. If a tax return is late or a new tax debt is incurred during this 5 year period, your offer is revoked and the complete amount of the existing debt with interest becomes collectible.

If an Offer is Rejected

If the IRS rejects the offer, it will NOT return the application fee or any other payments made with the offer.

If you received a letter notifying you that the IRS rejected your offer, you have 30 days from the date of the OIC rejection letter to request an appeal of the decision. If it’s been more than 30 days from the date of the rejection letter, your appeal won’t be accepted. Remember to mail your appeal to the office that sent you the rejection letter.

You should always consult with a tax professional before making any decisions about how to best resolve your particular matter.

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