An Offer in Compromise (OIC) is a government program administered by the IRS that enables taxpayers to resolve their tax debts for less than the total amount owed. This tool is designed to promote effective tax administration by balancing the IRS’s need to collect revenue against the taxpayer’s actual financial ability to pay.
Background and Purpose
The OIC program began in 1951 to provide a structured method for taxpayers facing financial hardship to settle tax liabilities without the IRS engaging in prolonged collection efforts or forcing bankruptcy. The IRS evaluates whether the offered amount represents the “reasonable collection potential,” meaning the maximum the IRS expects to collect through all available means, such as wage garnishments, liens, or asset seizures.
How Does the Offer in Compromise Work?
Taxpayers submit an application using IRS Form 656: Offer in Compromise, accompanied by a financial statement such as Form 433-A (for individuals) or 433-B (for businesses). The application requires full disclosure of income, expenses, assets, and liabilities. Along with the application, the taxpayer pays an application fee (currently $205) and either an initial payment or the full offer amount if paying in lump sum.
Once submitted, the IRS reviews the application, financial details, and the taxpayer’s compliance status — including whether all tax returns have been filed and if any bankruptcy proceedings are pending.
Eligibility Criteria
To qualify for an OIC:
- All required tax returns must be filed.
- The taxpayer cannot be currently involved in an open bankruptcy case.
- The offer must be realistic, reflecting the taxpayer’s ability to pay as determined by IRS guidelines.
Real-World Example
Consider Sarah, who owes $20,000 in back taxes. Due to limited income and necessary living expenses, she can only afford to pay $8,000. After compiling a detailed financial statement, she submits an Offer in Compromise for $8,000. The IRS reviews her case and accepts the offer, settling her tax debt and stopping further collection actions.
Who Benefits Most?
The Offer in Compromise is especially valuable for:
- Taxpayers experiencing financial hardship.
- Individuals and businesses with limited assets or cash flow.
- Those who cannot realistically pay their full tax debts without severe economic hardship or liquidation of essential assets.
Important Tips for Applying
- Accurately complete all required forms to avoid delays.
- Update the IRS promptly if your financial circumstances change during the application process.
- Consult with a tax professional or enrolled agent familiar with OICs to improve your chances of acceptance.
- Understand the IRS strictly evaluates each offer to ensure it represents the most the government can recover.
Common Misconceptions
- It does not erase tax debt without payment. The IRS requires a reasonable offer, not a free debt forgiveness.
- Approval isn’t guaranteed. The IRS carefully assesses financial capacity and will reject insufficient offers.
- You must be current on tax filings. Applications are only considered if the taxpayer has filed all required returns.
- It doesn’t usually affect credit scores. IRS settlements typically don’t impact credit reports directly like loans or credit cards.
Frequently Asked Questions
Q: Can I appeal if my Offer in Compromise is rejected?
A: Yes, taxpayers can request a reconsideration or appeal the decision. Alternatively, other payment options such as installment agreements are available.
Q: Does submitting an OIC stop IRS collection actions?
A: Generally, pending a valid offer, the IRS will suspend collection activities while it evaluates the offer.
Q: How long does the OIC process take?
A: Processing times vary but often range from several months up to a year depending on case complexity.
Q: Can I withdraw my offer once submitted?
A: Yes, but withdrawing may prompt immediate resumption of collection efforts.
Additional Resources
For more detailed guidance, consult FinHelp’s comprehensive explanation of IRS Form 656: Offer in Compromise and visit the official IRS page on Offer in Compromise.
This approach to tax debt resolution exemplifies effective tax administration by allowing the IRS to collect revenue responsibly while easing the financial burden on struggling taxpayers.