Sometimes unforeseen circumstances can create financial hardships that make it difficult for individuals and businesses to meet their tax obligations. To alleviate some of the financial strain, the IRS offers a Tax Forgiveness Program, officially known as an Offer in Compromise, to allow eligible taxpayers to settle their debts and find a fresh start. Let’s consider seven things before and after submitting your Offer.
You Must be in Tax Compliance, but What Is That?
To be eligible for an (OIC), taxpayers must comply with their tax filing and payment obligations. This means they must have filed all necessary tax returns for previous years and are making their current tax payments.
Current tax payments are:
- For W-2 Employees: Withholding is sufficient so that taxes won’t be due at the end of the year
- For the Self-Employed: Current year’s estimated tax payments
- For a Business: Current quarter and two preceding quarters’ payroll tax deposits
File all required tax returns and make current tax payments to avoid the IRS returning your OIC application.
Reasonable Collection Potential-Consider All Allowable Expenses
Offers in Compromise are evaluated based on your reasonable collection potential (RCP). The two components of RCP are equity in your assets (after considering IRS adjustments) plus your future remaining income (FRI). Your FRI is your monthly disposable income (MDI) multiplied by a factor of 12 or 24, depending on whether you select a lump sum or periodic payment option. MDI is your monthly income less allowable living expenses, including housing and utilities, food and clothing, vehicle ownership and operating costs, health insurance, and out-of-pocket health care costs. The IRS adjusts the amount of living expense standards on an annual basis.
It’s important to consider what allowable expenses you’re not incurring. For instance, you may not have medical insurance for yourself or your family, or maybe you have no life insurance to leave your family if something happens to you. Spending on these items will reduce your RCP and improve your family’s future health and financial security.
The IRS will only allow expenses that taxpayers have a history of paying. Therefore, it’s essential that you begin paying these expenses before filing your Offer in compromise.
Will the IRS Consider a Potential Bankruptcy Filing When Determining to Accept Your Offer-in-Compromise?
If some or all of your tax debt is dischargeable in bankruptcy, you may be able to use this to your advantage when filing an OIC. When an offer is submitted, the IRS is supposed to consider a potential bankruptcy filing if the taxpayer raises it as a possibility. This is because the IRS must decide how much it is likely to recover with an OIC versus bankruptcy. They will compare your RCP to the amount of your Offer, which should be at least what they would receive if you filed for bankruptcy. The IRS will consider whether the taxpayer has previously filed for bankruptcy, what other debts the taxpayer may have, and what tax liabilities may be dischargeable.
The IRS recognizes that tax debts can be discharged in bankruptcy and, therefore, may accept an offer for less than RCP based on the facts of the case. We have successfully used a potential bankruptcy filing to reduce the RCP calculation by the IRS.
Don’t Forget to Consider the Time the IRS Has Left to Collect the Tax
The IRS generally has ten years to collect a tax liability. Once the ten years have passed, they can no longer collect the debt. If you filed your tax return late, the ten years will begin running once you filed the return. The date that your tax debt expires is known as the Collection Statute Expiration Date (CSED).
Some events may temporarily stop the ten years from running. This causes the ten years to be extended. Submitting an offer in compromise suspends the collection period for the time it is pending plus 30 days.
Knowing the CSED to determine whether to submit an offer or consider another tax relief option, such as currently not collectible (CNC) status, is important. If the IRS believes you cannot pay your outstanding taxes and basic living expenses, it can place you in CNC status. This means they won’t try to collect back taxes unless your financial situation improves before the CSED is reached.
Let’s look at the case of Mary and Mike. They owed $80,000 in back taxes with a remaining CSED of 24 months and want to settle their back taxes by making an offer with the IRS tax forgiveness program. Their RCP is $40,000, which consists solely of the equity in their home. However, no bank will lend them money. Unfortunately, in most submitted offers, the IRS still expects this equity to be included in RCP and paid as part of the Offer. If not, the Offer will be rejected.
So what are Mary and Mike to do in this situation? Since their RCP is comprised solely of the equity in their home, they can request to be placed in CNC status. Unlike an offer in compromise, your inability to borrow against an asset does not disqualify you from CNC status.
Since the remaining two-year collection period continues to run while in CNC status and Mary and Mike’s finances are not expected to improve over that time, the CSED will be reached, and they will be relieved from their back tax debt.
The IRS Rejected My Offer in Compromise, Now What?
If the IRS rejects your Offer, don’t panic, you have appeal rights. You’ll need to file Form 13711, Request for Appeal of Offer in Compromise, within 30 days of the rejection. If you’re truly a good offer candidate and properly document your case, it is not unusual for a rejected offer to be subsequently approved by the IRS Office of Independent Appeals.
If you submitted an offer and chose the periodic payment option, you don’t need to continue making payments on your Offer once it’s rejected and waiting for your appeal.
I Can Afford to Pay in Full, but I Don’t Owe What the IRS Claims I Owe
When you disagree with the IRS’s determination of your back tax liability, you may submit an OIC based on doubt as to liability (DATL). By filing this Offer, you assert that you have a legitimate reason to dispute the amount of tax owed rather than your inability to pay the full amount.
Illustration: Nicholas sold some property several years ago and failed to report it on his tax return. The IRS calculated a gain on the sale based solely on the proceeds without considering his cost basis. They sent him a notice regarding the adjustment and a demand for $25,000 payment, but he never received it. Since Nicholas hasn’t paid the tax they claim he owes, he can file a DATL showing the correct gain and tax owed and offer to pay that amount. The IRS will typically accept the Offer as long as he provides sufficient documentation of his cost basis.
Can you Default and Void an Offer-in-Compromise?
Yes, a taxpayer can default on an accepted Offer in several ways:
- Failure to pay the balance of the Offer per the payment provisions of the accepted agreement
- Failure to return a mistakenly issued refund paid to the taxpayer through the date the Offer is accepted
- Failure to remain in tax compliance for the five years following the acceptance of the Offer
- Failure to fulfill the terms of a related future income collateral agreement
If you default on your Offer, it will be voided, and the balance of the liability will be reinstated. The IRS will begin collection activities against you to the extent that time remains on the CSED.
Get Help with the IRS Tax Forgiveness Program
The IRS Tax Forgiveness Program, known as an Offer in Compromise, provides a lifeline to taxpayers struggling with overwhelming tax debts. By providing a pathway to settle for less than the total amount owed, this program opens the door to financial recovery and a fresh start. If you are burdened with unpaid taxes and facing financial hardship, explore the options available through the IRS Tax Forgiveness Program. The tax resolution specialists at East Coast Tax Consulting Group can assess your eligibility and ease the application process. Tax relief is possible, and we’re ready to help you with the IRS Tax Forgiveness Program.