It is often possible when struggling with debt to work out an arrangement with one’s creditors where they agree to settle for something less than the full balance plus interest plus fees to which they would otherwise be entitled. What many taxpayers don’t realize is that the Internal Revenue Service (IRS) is also sometimes willing to accept such arrangements.
Known as an “offer in compromise” (OIC), this potentially allows a taxpayer some leeway on their tax debt. The relevant IRS form to consult is Form 656.
An OIC must meet at least one of three conditions:
1. There is some doubt as to whether the assessed tax liability is correct.
This is not a requirement that the assessed tax liability be shown to be incorrect. Instead it allows the IRS to show some flexibility in gray area cases.
2. There is some doubt as to whether the full amount of the tax debt would be collectible by the IRS if they did stick to their guns.
In deciding if a tax debt is collectible, the IRS looks at a formula of (48 x monthly disposable income) + total assets. The IRS expects to be able to collect this much, so it will normally only consider a settlement offer at least this high.
3. There is reason to believe collection of the full tax debt, even if possible, would result in unacceptable economic hardship or would be unfair and inequitable.
This allows the IRS to go easier on taxpayers who are disabled, elderly, or have extenuating circumstances making payment especially painful.
A taxpayer applies for an OIC in one of two ways. In order to propose a lump sum settlement, he or she must include a $150 application fee plus 20% of the proposed lump sum. In order to propose payment over time in monthly installments, he or she must include the $150 fee plus the first month’s installment, and then continue to submit at least the amount of a monthly installment every month while the settlement offer is being considered. (A low income taxpayer in some circumstances may be partly or wholly exempt from these fees and down payments. Also, the $150 application fee is not required if relief is being sought solely on the basis of doubt that the assessed tax liability is correct.)
If the proposed settlement is accepted by the IRS, then the rest of the lump sum or the remainder of the monthly installments must be paid as proposed, or the agreement can be voided. If the proposed settlement is rejected by the IRS, then the tax debt remains in place, though it is reduced by the amount the taxpayer paid off in submitting the proposed settlement. If the IRS fails to accept or reject the proposed settlement for two years, it is treated as accepted.
For more information on these and other tax matters, consult www.irs.gov.