While the Offer in Compromise program is the least commonly used tax debt resolution tool, it can be a very powerful tool when your client is eligible.
Whenever you hear the phrase “pennies on the dollar” in relation to federal tax liabilities, you are hearing a reference to the Offer in Compromise (OIC) program.
The OIC program is intended to give taxpayers without the financial means to pay their tax debt a way to pay whatever they have, and then start over. In many ways, an OIC is similar to a bankruptcy filing on taxes only. The major difference, however, is that an OIC is an administrative proceeding, rather than a court proceeding.
There are some unlicensed sales representatives at some national tax resolution firms that will promise everybody they talk to that they qualify for this program. Unfortunately, not only is this obviously unethical, but it’s also incredibly incorrect.
According to data from Table 16 of the IRS Data Book, the IRS closed out over 7.1 million collections cases in fiscal year 2015. The IRS accepted 27,000 Offers in Compromise out of the 67,000 applications submitted. So, not only were nearly 60% of OIC applications rejected, but only 0.38% of closed Collections cases were closed out through the OIC program.
In other words, the Offer in Compromise program is the least frequently applicable resolution strategy for a federal tax debt. This is contrary to what many people believe, including within the professional tax community.
Among the hundreds of taxpayers I’ve represented in front of SB/SE Collections, the vast majority of them are ultimately resolved through a payment plan. Another 10 to 15% are resolved through the Currently Not Collectible (CNC) program, also commonly referred to by its IRS computer code, Status 53. If you choose to specialize only in Collections representation, you’ll quickly discover that very few cases are closed out through the OIC program.
With that said, it’s still important to have a firm grasp on how this program works. In addition, I’m a firm believer in using the offer calculation formula as a tool for helping you determine the best resolution strategy for your client. By calculating the Reasonable Collection Potential (RCP), you will then know what the IRS expects to be able to collect from the taxpayer. If the taxpayer owes more than the RCP, s/he might be a good OIC candidate. If s/he owes less than RCP, s/he is most likely going to end up in an Installment Agreement. If RCP is less than zero, then s/he is a good CNC candidate.
An Offer in Compromise application will require complete financial disclosure. In other words, a full and accurate Form 433-A or Form 433-B will be required, along with complete supporting documentation. Because the government is going to accept less money for the tax debt than what the taxpayer owes, they are going to go to great lengths to make sure the taxpayer actually qualifies. If you submit full and proper documentation, and offer the full amount of the calculated RCP, you’re all but guaranteed to have your OIC accepted.
Some taxpayers will file an OIC simply to “buy time” to figure something else out, since the process normally takes around 12 months for an Offer application to be processed. While this may sound like a worthwhile strategy, it should be noted that the 10-year statute of limitations on the government’s ability to collect the tax debt is extended day-for-day while an offer is in processing, plus 30 days after it is ultimately denied. Extending statute of limitations is, in most cases, detrimental to the taxpayer in the long run.
It’s also important to mention that the OIC program is not just a tool for Enrolled Agents, CPAs, and tax attorneys. While you must have one of these licenses to represent a taxpayer during the Collections process, any unenrolled preparer with a PTIN can prepare the OIC application for any taxpayer. In other words, while an unenrolled preparer cannot represent the taxpayer through the Offer process, you can most definitely prepare the Form 656—and charge a handsome fee for doing so.
A taxpayer’s eligibility to settle for less than what is owed is directly related to the RCP. As previously mentioned, if the offer amount is equal to or greater than the minimum amount calculated using the IRS formula, then the taxpayer may be eligible to file an Offer in Compromise.
In addition, the taxpayer must:
- Have filed all past due tax returns
- Not currently be generating new tax liabilities
- Agree to properly file and pay on all tax returns, on time, for the next 5 years
- Agree to let the IRS keep any tax refunds otherwise coming through the year in which the OIC is accepted.
Failure to abide by these rules will result in rejection of the offer, or default the offer agreement and result in full reinstatement of all tax liabilities that were eliminated – plus full penalties and interest that would have accumulated in the meantime.
In addition to a $186 application fee, a taxpayer is required to make payments on the Offer in Compromise, unless s/he meets low income qualification guidelines for an exception to this rule.
The first payment option is used when the taxpayer will pay the entire amount of the settlement offer within five months of acceptance or less. With this option, the entire offer amount may be paid with the application, of course, but a minimum non-refundable deposit of 20% of the offer amount must be submitted with the application unless the taxpayer meets low income qualifications. Using this lump sum payment option provides the benefit of not being required to make regular payments on the offer while it is being processed. Using this option also results in paying the smallest possible offer amount, because the taxpayer’s remaining income under the RCP calculation formula is only multiplied by 12 months.
The second payment option, periodic payment, requires the taxpayer to make regular payments on the OIC while the IRS is considering it. These payments are non-refundable, and the first payment must be included with the Offer application on your Offer in Compromise while the IRS is considering it, unless the taxpayer meets low income guidelines. Under the periodic payment option, the taxpayer must pay the full offer amount within 24 months.
Keep in mind that penalties and interest continue to accrue on the tax liability while OIC payments are being made, even though ultimately those penalties and interest go away when the Offer is paid off and settled. If the taxpayer defaults on the OIC terms, however, those accrued penalties and interest are added back on to the balance due, and the taxpayer will be held liable for the full amount.
Many unlicensed tax resolution salespeople, either through ignorance or simply gross incompetence, will tell everybody that they talk to that they qualify for an OIC, and that the offer amount is some percentage of what they owe.
In addition to this horrifically unethical practice, some tax resolution firms will also only tout their most successful OIC applications, showing prospects that they did indeed get 1.2 cents on the dollar for one client, and 4 cents on the dollar for another client, all while failing to inform everybody that:
a). Most of their OIC applications for clients were outright rejected, and…
b). Those that were accepted were usually only for 50 or 75 cents on the dollar.
The offer amount is the single most important part of a successful OIC application. Calculating the OIC offer amount is extremely formulaic, and requires a complete and accurate Form 433 to be filled out. The IRS goes through an extensive investigation phase to verify information on the Form 433, looking for other assets the taxpayer may own or income that was not disclosed. In short, the IRS assumes the taxpayer is lying, and acts accordingly. The IRS looks at various public records sources, and may even pull a credit report to verify what has been listed on the 433.
Within the IRS booklet containing the OIC application, there are versions of the Form 433-A and Form 433-B that are modified slightly for OIC purposes. If you use the PDF version of the booklet (just Google “IRS Form 656B”), the calculations are actually carried forward for you to the lines that determine the RCP.
In its simplest form, RCP is the sum of the net worth of the taxpayer’s assets plus all of his/her disposable income for the next 12 or 24 months. In other words:
Settlement Amount = monthly remaining income x (12 or 24) + the net realizable equity in the taxpayer’s assets
Remaining income, as opposed to the more common consumer term disposable income, is the taxpayer’s monthly income minus allowable monthly expenses. It is important to recognize that the IRS will not allow all expenses that the taxpayer actually has. Common disallowed expenses are college tuition payments for a dependent, private school tuition, charitable contributions, tithing, vacation home payments, etc. This calculation is based on direct application of the IRS Collection Financial Standards.
The number of months over which disposable income must be calculated into the offer amount is based on the payment plan option selected. For the lump sum cash offer, remaining income is multiplied by 12 months. For the periodic payment offer, remaining income is multiplied by 24 months.
Net realizable equity in assets is the quick sale value of an asset, usually 80% of the Fair Market Value (FMV) minus any liabilities which are secured by said asset. As an example, if a taxpayer has a home worth $100,000 and owes $50,000 on the home, the IRS will calculate the net realizable equity in the asset as follows: ($100,000 x .80) – $50,000 = $30,000. The IRS expects, in this example, that the $30,000 will be included in the offer amount.
Based on this explanation of how RCP is determined, and understanding that RCP is your minimum offer amount, it should be apparent why the IRS rejects so many OIC applications. In reality, the best OIC candidates are taxpayers that have very little in the way of assets, and no disposable income. The best OIC candidates often tend to be underemployed or unemployed.
When you file an OIC, a process examiner will look over the paperwork to make sure that the offer is processable, meaning that all administrative eligibility requirements have been met. The process examiner will also check to make sure that forms are properly completed, the financial package is fully documented, and that all tax returns have been filed.
If an offer is deemed to be not processable, it will be returned to you with a letter from the process examiner explaining what you need to correct, and to resubmit your offer with those corrections.
If considered processable, an offer examiner will then be assigned to actually review the merits and financial aspects of the application. This is the person that verifies assets, orders credit reports, and gets very up-close-and-personal regarding every aspect of the taxpayer’s financial situation.
The offer examiner will usually afford you the opportunity to address any inconsistencies s/he discovers in hisher findings, and allow you to argue on behalf of your client for the inclusion or exclusion of certain assets or expenses. For most taxpayers, this is where having professional representation can make a significant difference in the outcome of the Offer application.
Once the offer examiner has all the information needed to either accept or reject your offer, s/he will do so, and send you a letter explaining why.
Keep in mind that for the periodic payment offer, the taxpayer must continue to make monthly payments on the OIC while the review process is going on. These payments are non-refundable, but they can be designated. Encourage your client to write in the most recent tax type and period for which s/he owes on the memo line of the check: for example “apply to Q4 2015 trust fund only.”
If an OIC is rejected, you have the right to know why, and also the right to appeal this decision. More often than not, a dispute over inclusion or exclusion of an asset or expense item will be the primary argument you take to appeals. Settlement officers have the authority to accept or reject an OIC based on their own findings, rather than the findings of the offer examiner.
While the OIC is the least commonly used tax debt resolution tool, it can be a very powerful tool when your client is eligible. For example, I have represented a number of clients with large payroll tax debts that used the OIC program to settle both their business and personal tax debts simultaneously. By accepting individual assessment of the Trust Fund Recovery Penalty, then doing an OIC for both the active business and the individual, it is possible to compromise six- and seven-figure payroll tax debts and leave the taxpayer with his/her livelihood intact.
In addition, creating the habit of always calculating RCP for all tax debt clients will help guide you in determining the resolution option that is best for the taxpayer. This not only saves time, but serves as a check-and-balance to help ensure you are providing the best representation possible.
Jassen Bowman practiced exclusively in IRS Collections representation for eight years as an Enrolled Agent. He is the author of Tax Resolution Systems, available on Amazon, and is currently co-founder and CMO at Prolaera, a Seattle tech startup transforming the way accounting firms manage and deliver staff CPE.