An Offer-in-Compromise is a contract between the IRS and a taxpayer to settle a tax debt for less than what is owed. I get lots of calls from folks excited at the prospect of being able to negotiate down what they owe IRS. And then I burst their bubble with the bad news: it is very hard to get an Offer in Compromise (OIC) from the IRS. Last year, only 24 percent of OICs submitted were approved. And, the OICs the IRS accepts are overwhelming for taxpayers who are disabled, retired, or otherwise unlikely to earn money in the future.
Can You Trust Ads From Tax Resolution Firms Promising a Fresh Start?
There are shady “Tax Resolution Firms,” advertising they eliminate tax debt through an Offer in Compromise or the “Fresh Start Program” — a name for OICs the IRS stopped using almost a decade ago, though these bottom-feeding Tax Resolution firms haven’t noticed. These ads are highly misleading because the IRS rarely forgives any debt. In fact, many people calling me have been swindled by one of these firms before coming to me (read here for the main elements of the scam). Places like Optima and Leading Tax Group (the two firms my clients have most often mentioned), take $5,000-$15,000 to submit an OIC that they know will NEVER granted. But they don’t tell clients this. Instead, the scam is to look surprised when the OIC is denied and tell the client there was nothing they could have done. Nothing they could have done? Here’s an idea: how about not filing OICs for people who still have significant future earning power, and charging exorbitant rates to do so? The IRS has only ever approved a small fraction of the OICs submitted (click here for a study by the Taxpayer’s Advocate). Even the IRS warns taxpayers about these “mills”!
Why Are So Few Offers in Compromise Accepted by the IRS?
To understand why the IRS accepts so few OICs, one needs to know that the IRS sees itself primarily as a law enforcement agency, not as a collection agency. Implication? The IRS’ main priority isn’t to collect whatever money it can get. Rather, its main priority is to enforce US tax laws consistently and fairly. If the IRS determines you owe $10,000, and you may earn $10,000 in the future, then the IRS will hold out to get all that it’s owed in the future, rather than what you can afford to pay in the present. After all, if the IRS negotiates away some of what you owe, then maybe your neighbor will want a special deal (like you got), and then your Uncle Vinny will want a special deal, and then his pal Saul, …. and soon the entire country is hounding the IRS for special deals.
This kind of haggling undermines the institutional legitimacy of the IRS, something it avoids at all costs. If the IRS determines you owe $10,000, then it wouldn’t be fair to every other taxpayer if you were allowed to pay less. How would you feel if your neighbor got away with not paying what s/he owes, just because s/he was able to butter-up an IRS agent or hire a good attorney, while you did your civic duty and paid what you owe? Avoiding unequal application of the law is why the IRS only approves an OIC when the taxpayer can prove they will never be able to earn what they owe. In these cases, the IRS — if challenged — can honestly say, “There was no way we’d ever collect what was owed, so we took what we could get.”
Moreover, the IRS doesn’t hide its decision criteria: it offers an on-line calculator to determine if taxpayers should even bother applying! So, if the IRS is so clearly signaling whom it will approve OICs for, then why does it reject so many? Last year’s 76% of OICs that were rejected were almost certainly submitted by the sleazy tax debt relief firms on behalf of clients who thought they had a chance of qualifying when they have none.
OIC acceptance by the IRS is an exception, not the rule. But the scummy, scammy tax resolution firms won’t tell you this (because then no one would pay their outrageous fees).
Alternative #1 to Offer in Compromise: Bankruptcy
So what are the alternatives to dealing with tax debt, when an OIC won’t work? One alternative is to file chapter 7 bankruptcy. Most federal and state tax debt can be discharged (wiped out) in bankruptcy, if certain conditions are met. The tax debt (1) must be three years or older, (2) for years in which tax returns were filed (if you didn’t file a return, then that tax isn’t eligible for discharge in bankruptcy, and (3) cannot be payroll tax debt. But, if these and some other technical requirements are met, then many taxes can be eliminated through bankruptcy.
Alternative #2 to Offer in Compromise: Installment Agreement
An Installment Agreement is the best alternative to an OIC for taxpayers who do not qualify for bankruptcy (usually because they earn too much or have lots of assets other than equity in a primary home or retirement accounts – both of which are allowed to come through bankruptcy). The vast majority of taxpayers who cannot fully pay their federal taxes set up an Installment Agreement with the IRS, whereby they make agreed-to monthly payments to the IRS, over a period of up to six years, to pay off their back taxes. Here’s details.
Alternative #3 to Offer in Compromise: Uncollectible Status
Finally, there are cases where the IRS accepts Installment Agreements that repay nothing ($0/month) called Uncollectible Status. To qualify, a taxpayer’s basic living expenses must be greater than your take-home pay (and the IRS uses sets very low acceptable amounts for monthly spending on rent, utilities, food, etc). With this option, the IRS isn’t letting the taxpayer off the hook on paying everything that’s owed, it’s just agreeing that the taxpayer cannot afford to pay anything right now, and promising it won’t take aggressive collection action, like levying on your bank account or wages.
Uncollectible Status is a temporary designation. If the IRS determines a taxpayer is uncollectible, then it will demand the taxpayer resubmit their financial information in 18 months to two years, to ensure they still cannot afford to make payments on their tax debt. The IRS really wants taxpayers to repay them as soon as they are able to. Read more about Uncollectible Status here.
Offer in Compromise: Bad Way to Get Rid of Tax Debt
I don’t like OICs as a way to get rid of tax debt. The process is cumbersome, expensive, and arbitrary. First, it often takes one to two years to get an OIC approved. The IRS moves slowly on most things, but it tends to move particularly slowly on OICs. Second, it is an invasive process because you must prove that you cannot afford to pay what you owe. This means turning over all of your financial information, on Forms 433 and 656, to be considered for an OIC. You’ll also be asked to provide documentation such as bank statements, credit reports, car lease or loan papers, and other substantiation of your debts and assets. Trouble is, some IRS agents want more information than others, so it’s hard to predict both what they’ll ask for, and how many times they’ll ask for additional information (which drives up the cost if you’re using an attorney to submit the OIC). Third, I have seen OICs rejected that I thought would be approved, and vice versa – so it can be an arbitrary process.
If you’re dealing with tax debt, I am likely to recommend any of the alternatives to an Offer in Compromise – Bankruptcy, Uncollectible Status or an Installment Agreement. While I do file OICs occasionally, I only do so when I’m highly confident of success for the client, which is how I think it should be – unlike so many tax debt resolution companies.
Call me and we’ll explore the best way for you deal with tax debt.
June 24, 2023