Settling your IRS tax debt for pennies on the dollar may seem like a pipe dream, but the reality is that it is possible. Believe it or not, the IRS offers a legitimate way to minimize your tax liability if you can't pay your full debt or if paying it will result in financial hardship. This is known as an "Offer in Compromise."
An offer in compromise is an agreement between a taxpayer and the IRS to settle a tax debt for less than what is owed. However, participants in the program need to understand the process and meet certain qualifying criteria to be successful. There are also several pros and cons to consider.
If mounting IRS debt keeps you awake at night, a compromise offer may be the solution for you. This post covers everything you need to know about the IRS's tax debt compromise program, so keep reading to see how you may benefit.
What Is The Tax Debt Compromise Program?
Few debts fill people with sheer dread as much as a tax debt. Thankfully, the little-known but remarkably effective tax debt compromise program (also referred to as an Offer in Compromise or the IRS Settlement Program) aims to help people who are in trouble with the IRS by eliminating thousands of dollars in tax debt.
As already stated, an offer in compromise is a federal program that lets you settle your debt for less than what you owe. If you come from a low-income family, that amount may be significantly less.
How does it work?
The IRS will look at several financial factors relevant to your specific situation to calculate your "reasonable collection potential." In other words, they determine the amount they believe they can get from you within a reasonable period.
What does the IRS consider as part of their calculations?
At the very least, they review your asset equity, property, vehicles, bank accounts, current income, future income, where you live, how old your car is, basic living expenses, and ability to pay. Once they calculate how much they think you can pay, they won't accept an offer unless it's equal to or greater than your reasonable collection potential.
For example, let's assume you owe $100,000 in back taxes, but you don't have that kind of money. Before the feds garnish your wages or take your house, you apply for an offer in compromise that would settle the debt for $10,000. If the IRS has calculated that they can reasonably expect to collect $8,000 from you, they'll likely agree to your offer based on their assessment of your finances. You'll then be required to settle the amount and punctually pay your taxes in the future.
But let's dive a little deeper.
What You Should Know About The IRS Settlement Program
While an offer in compromise may sound like the ideal solution, you still need to overcome some major hurdles like passing the qualifying criteria and getting the IRS to accept your offer. You should also know how to apply and whether it's the right choice for you. With that in mind, let's answer some key questions.
Who Is Eligible For An Offer In Compromise?
Although the program is open to every taxpayer, not everyone will qualify. As mentioned, the IRS will assess your unique facts and circumstances before making a decision. However, you must meet the following eligibility criteria:
- You have filed all necessary tax returns
- You have made estimated payments for the current year
- You have received a bill for at least one tax debt included in your offer
- You're not involved in an open bankruptcy proceeding
- You have been granted an extension for a current year return (if applying for the current year)
If you are an employer applying for an offer in compromise, you must also have made all required federal tax deposits for the current and past two quarters.
Typically, there are three main reasons the IRS will grant your application:
- Paying the full amount would create an economic hardship or be considered inequitable or unfair due to exceptional circumstances.
- There's a genuine legal dispute about how much you owe or whether your tax debt even exists.
- The IRS doubts it can ever get the full amount from you based on your financial standing.
Still not sure whether you qualify?
Use the IRS's Offer in Compromise Pre-Qualifier tool to determine your suitability.
If you apply and aren't eligible, the IRS simply won't process your offer application. In this case, they'll return your application and application fee. They'll also apply the payment you included in your offer to your outstanding balance.
How Do You Apply For Tax Debt Relief?
You can find the application forms along with step-by-step instructions in the Offer in Compromise Booklet. Besides filling out the form, you'll need to create a package with all required documentation. This will differ depending on whether you're applying as an individual or business.
The current application fee is $205 and is non-refundable. In addition to the application fee, you'll need to send an initial payment toward your offer when you send in your application for consideration.
However, there's an exception if you're applying as an individual who meets the IRS's Low-Income Certification guidelines. This is when your adjusted gross income (as determined by your most recent tax return or your household's gross monthly income) is less than or equal to the amount shown in the chart under Section 1 of the Offer in Compromise form, based on where you live and the size of your family. In this case, you don't need to include any application fee or payments with your offer.
If Accepted, What Are Your Offer In Compromise Payment Options?
You can either opt for a lump-sum payment or a payment plan.
1. Lump Sum
If you choose to pay a lump sum, you need to include an initial payment of 20% of your total offer amount when applying. The IRS will send you a written confirmation if they accept your offer. You'll then need to pay the balance in five or fewer payments.
2. Payment Plan
Like the lump sum option, you'll need to include an initial payment. You'll then need to continue paying in monthly installments while your application is under consideration. If the IRS accepts your offer, you can continue with monthly payments until the offer amount is paid in full.
It's important to note that the initial payment will not be returned if your offer is rejected. Instead, the IRS will apply this amount toward your outstanding tax debt. You will have the option to increase your offer amount for reconsideration or appeal the decision.
IRS Offer In Compromise Pros And Cons
Often, the easiest way to determine whether an offer in compromise is the right path for you is to weigh up the pros and cons.
- Get out of tax debt for less than you owe
- Avoid IRS collection activities like the seizure of your assets or earnings
- Of those who qualify, the offer acceptance rate is fairly decent, with some online reports putting it at around 40%
- The application process can be lengthy (it can take anywhere up to two years)
- The rules are strict
- If you don't qualify for Low-Income Certification, you need a $205 application fee and 20% of your offer upfront
- You'll need to reveal your financial circumstances in detail
- You must stay compliant with tax reporting for the next five years
- If you miss a payment, the IRS can reverse the offer in compromise and request full payment
- Very few people and businesses actually qualify
Although there are more cons than pros, most of the cons are based on time and effort. Getting rid of a hefty tax debt you may never be able to afford might just be worth the hassle.
Tax Debt Relief Scam
While the Offer in Compromise program is legitimate tax debt relief, many taxpayers have been victimized by a phone scam. In some cases, they've been contacted by text messages, email, and direct mail, too. The reality is that if you owe the IRS money, you're a target.
What To Know About The Tax Debt Compromise Program Phone Call
Masquerading as IRS representatives, con artists will try to swindle you by tricking you into revealing sensitive financial information. Don't do it.
These scammers and dishonest companies typically find their victims by going through tax lien notices. They'll usually promise to settle tax debt for pennies and eliminate interest rates.
The most obvious red flags are when a caller says you automatically qualify for the program or requests an upfront fee for their service. Don't continue the conversation. Hang up immediately.
These types of calls make it all the more crucial to educate yourself about the Offer in Compromise program and learn to distinguish between genuine communication from the IRS and fake contact. If you're severely in debt, the IRS will send multiple letters before contacting you via other methods like the phone.
It's also rare that the IRS will contact you about the program. As a taxpayer, you need to request an offer in compromise directly from the IRS yourself. One way to test the legitimacy of a caller is to ask them for their details via mail or tell them you'll call the IRS back. Most of the time, they'll hang up before you do.
If you've already been scammed, be sure to report it to your local authorities and the IRS.
- Debt to Asset Ratio – What It Means & How to Calculate
- What Is A 1099-c Cancellation Of Debt Notice [ANSWERED]
If you lack sufficient assets or income to cover your outstanding tax bills, the likelihood is that you're an excellent candidate for the IRS's Offer in Compromise program. Although it's not the fastest or easiest solution for clearing an outstanding tax balance, it is effective. At the very least, go through the Offer in Compromise Booklet to acquaint yourself with the steps involved and the information and documentation required.
- Why Do I Owe State Taxes, And How To Avoid Them?
- How to Start a Trust Fund [COMPLETE GUIDE]
- How Much Money Can You Receive As A Gift And Avoid Gift Tax?
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.