- 1 Step 1: Determine if you are Current on your Tax Obligations
- 2 Step 2: Calculate your Discretionary Monthly Income
- 3 Step 3: Obtain a copy of your Tax Account Transcripts
- 4 Step 4: Complete a Financial Analysis
- 5 Step 5: Submit your Paperwork and First Payment
- 6 Step 6: Continue to Make Payments and Remain in Compliance
- 7 The Risks of Submitting an Offer that is Rejected
Step 1: Determine if you are Current on your Tax Obligations
You must be currently be in full compliance (1), which means:
- You’ve filed all your tax returns that you are legally required to file
- You’re having the correct amount of taxes withheld based on your Form W-4 or paying your estimated tax payments for the current year if you’re self-employed
- Businesses must be making their current quarter’s payroll tax deposits
- Continue to remain compliant through the rest of the process
Step 2: Calculate your Discretionary Monthly Income
Next, you should calculate your discretionary or remaining monthly income, which is basically your monthly income minus necessary living expenses. See IRS Form 656B for a worksheet. For a lump sum offer, your remaining monthly income over the course of 12 months would have to be more than what the IRS could collect before the expiration of the statute on an installment agreement (more in step 3). If your remaining monthly income over the course of 12 months exceeds your tax debt, then obviously there’s no point in submitting an offer in compromise, unless you’d like to pay the IRS more than you have to.
Step 3: Obtain a copy of your Tax Account Transcripts
Before you can resolve any problem, you need to understand the problem. Simple right? Get a copy of your account transcripts from the IRS for the tax year(s) for which you currently owe taxes. Determine the amount that you owe, including penalties and interest. Then determine the collections statute of limitations (CSED). If your CSED is about to expire, you might want to hold off on submitting an OIC as this will “freeze” the statute.
Step 4: Complete a Financial Analysis
Complete a financial analysis by calculating your reasonable collections potential (RCP). This is a very critical calculation as it determines whether your offer will be ultimately accepted or rejected. The RCP is basically a calculation of your ability to pay which is a combination of your future monthly discretionary income (over a course of 12 or 24) months and what the IRS could potentially collect from seizure of your assets. (2) The IRS will calculate an 80% quick sale value on the fair market value of your assets for purposes of calculating the RCP, minus the loan balance, if any. (3) Your Offer must equal or exceed the RCP to be accepted. (4)
RCP as expressed in a formula:
RCP = (DMI x #MO) + (FMV x 80% – LB)
DMI = Discretionary Monthly Income (Gross monthly income – IRS allowed personal living expenses)
MO = 12 or 24 months (depends on whether you’re applying for a lump sum or periodic payment offer).
FMV x 80% – LB = total equity in assets, or total fair market value x 80% – loan balance
When the calculations show that you are eligible for an Offer in Compromise based on Doubt as to Collectibility, in addition to the financial analysis you should carefully consider the impact of the CSED (Collection Statute Expiration Date). In accordance with IRM 188.8.131.52 Offers should not be accepted where the tax can be paid in full as a lump sum or can be paid under current installment agreement (IA) guidelines, unless special circumstances are identified that warrant consideration of a lesser amount. The offer should be recommended for rejection based on the taxpayer’s ability to full pay under current IA guidelines. In other words if taxpayer has a remaining monthly income and can pay the entire amount of liability before the CSED expires or under a PPIA (Partial Pay Installment Agreement) the IRS could potentially receive a substantially higher amount than the proposed offer, the offer will most likely be rejected as “not in the government’s interest”, provided that no special circumstances exist.
Step 5: Submit your Paperwork and First Payment
If you’ve determined that you have an offer that is acceptable (and also taking into consideration the CSED), then you’ll submit the following to the IRS:
- Completed and signed Form 656
- Completed and signed Form 433-A (individuals) or 433-B (businesses)
- Photocopies of all required supporting documentation
- A check or money order payable to the “United States Treasury” for the initial payment
- If making a lump sum offer, you must make a payment of at least 20% of the total offer amount, and the remaining balance to be paid in 5 months. (5) *
- If making a periodic payment, the first payment must be paid with the offer and the rest within 6 to 24 months per the terms of the offer.*
- A separate check or money order payable to the “United States Treasury” for the $186 application fee.*
*There are exceptions for taxpayers that qualify as low income.
Mail the above documents to the appropriate IRS processing office in your state.
Step 6: Continue to Make Payments and Remain in Compliance
While your offer is being reviewed (anywhere between 6-12 months or longer), you must continue making payments per the offer terms as if the offer has been accepted. Additionally, you must remain in full compliance with the tax code for 5 years after the acceptance of the Offer. If a tax return is late or a new tax debt is incurred during this 5 year period, your offer is revoked and the complete amount of the existing debt with interest becomes collectible. (6)
The Risks of Submitting an Offer that is Rejected
- Applying for an offer in compromise requires you to send complete financial information to the IRS that they would not have had otherwise, including your bank account information, assets, and household expenses. If your OIC is rejected, you’ve just given the IRS all the tools they need to accelerate collections against you.
- If the IRS rejects the offer, it will NOT return the application fee or any other payments made with the offer. (7)
- Filling a Offer in Compromise freezes the statute of limitations. If you or your practitioner didn’t consider an imminent collections statute expiration, you’ve probably cost yourself a lot of money that could have been wiped out by the statute expiration. In fact you’ve given the IRS more time to collect since the statute will be “frozen” during the 6-12 month or longer process.
It is rare that a taxpayer will be able to submit a successful offer-in-compromise on their own. You should consider hiring an attorney that handles federal tax debt collections matters.