The IRS has an Offer in Compromise (OIC) program, which allows eligible taxpayers to settle their tax debt for less than the full amount. But how much less than the full amount will the IRS actually accept? It depends.
When the IRS receives an offer, the IRS reviews the taxpayer’s financial information using a special formula to come up with an amount the IRS believes the taxpayer can reasonably pay. As long as the taxpayer meets the other eligibility criteria, the IRS will typically accept the offer if it equals or exceeds this amount.
Below, we take a closer look at how this formula works and why it’s important to seek help from a tax pro when applying. To learn more, contact Tax Network USA to schedule a free consultation with one of our OIC tax professionals.
Key Takeaways
- Settle tax debt for less – An Offer in Compromise allows eligible taxpayers to resolve unpaid taxes for less than the full amount.
- Acceptance based on RCP – The IRS is likely to accept an offer if it’s at least equal to your reasonable collection potential.
- Reasonable collection potential –The IRS calculates the RCP by taking the amount of equity a taxpayer can quickly obtain from selling their assets and adding it to their disposable income.
- The importance of getting help – A tax professional can confirm if the OIC is the best option, and if so, help the taxpayer increase their chances of acceptance by avoiding costly mistakes and submitting the lowest offer the IRS is willing to accept.
What Is an Offer in Compromise?
An Offer in Compromise (OIC) is an IRS program that lets eligible taxpayers resolve their outstanding tax debt for less than the full balance. Sometimes referred to as “tax forgiveness,” the IRS may agree to an OIC based on:
- Doubt as to liability: There’s a legitimate disagreement as to the amount owed or whether the taxpayer owes the IRS any money at all.
- Effective tax administration: The taxpayer agrees they owe the tax debt, but full collection would be unfair, inequitable, or create an unreasonable economic hardship for the taxpayer.
- Doubt as to collectibility: There’s uncertainty as to whether the IRS can realistically collect the full amount of the tax debt from the taxpayer. This is the most common option.
Most taxpayers apply for offers based on doubt as to collectibility. Applying for an OIC on this basis requires several IRS forms, including:
- Form 656, Offer in Compromise
- Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals
- Form 433-B (OIC), Collection Information Statement for Businesses
You use the 433 forms to show the IRS how much you own, how much you earn, and what you spend. Then, you make the actual offer on Form 656. You can make a lump sum offer (due within five months of acceptance) or a period payment offer that lets you split up the offer in payments over two years.
How Does the IRS Decide How Much to Settle For?
When deciding whether to accept an offer, the IRS primarily considers the taxpayer’s finances. This means looking at a taxpayer’s income and assets to see if the taxpayer can realistically pay off the entire tax debt before the Collection Statute Expiration Date (CSED) using an installment agreement, selling assets, borrowing money against the equity in the assets, or a combination of all three.
If this analysis indicates the taxpayer can’t pay the full tax debt, then the IRS calculates the taxpayer’s reasonable collection potential, or RCP.
How the Reasonable Collection Potential Works
The reasonable collection potential represents a taxpayer’s financial ability to pay their tax debt, and generally speaking, the IRS won’t accept an offer that’s less than the RCP.
To calculate a taxpayer’s RCP, the IRS starts by calculating the equity in the taxpayer’s assets. The agency uses the quick sale value of the asset minus the debt owed on the asset.
In other words, the IRS doesn’t look at what your home or other physical assets are worth in general. It says, “How much could you get if you needed to sell this tomorrow?” To cut out the debate, the agency uses 80% of the asset’s fair market value.
Then, the IRS considers the taxpayer’s disposable income. This looks at their current income and future earning potential, minus necessary and reasonable living expenses. But keep in mind that the IRS’s view of “reasonable living expenses” is probably not the same as yours – the IRS’s numbers are pretty modest. If the agency thinks you’re spending too much on housing, transportation, etc., it will apply a lower number in its OIC calculations than what you actually spend.
Offer Calculation Example
Let’s assume that Form 433-A and other OIC application documents you submit to the IRS indicate that you:
- Own a home worth $400,000
- Owe $300,000 on your home mortgage
- Earn $4,000 a month
- Spend $2,500 in allowable living expenses
- Have $1,500 per month in disposable income, after subtracting expenses from income
Based on the quick sale value of your home minus the mortgage, you have $20,000 in net realizable equity. That’s based on these calculations:
- Quick sale value: $400,000 * 80% = $320,000.
- Equity left after paying loan: $320,000 – $300,000 = $20,000.
The IRS will expect this $20,000 in the offer, plus they’ll also want your monthly disposable income. Periodic offers require 24 months of disposable income, while lump sum offers require 12 months of disposable income.
Here’s how that works out:
- $1,500 x 24 = $36,000
- $1,500 x 12 = $18,000
Add this to the $20,000 quick-sale equity in your home, and you get the following two offers:
- Lump sum offer due in five months: $38,000
- Periodic offer with up to 24-monthly installments: $56,000
Keep in mind, this is an oversimplified example of the actual IRS RCP calculation process. The more assets you have, the more complicated it gets. Also, there’s a bit of nuance. With the right arguments, you can sometimes convince the IRS not to consider certain assets – for example, if selling your home would make you destitute or if you use an asset for work.
Can I Realistically Qualify for an Offer in Compromise?
The chances of qualifying for an OIC depend on how the math works out when calculating your RCP and how effectively you present arguments about extenuating circumstances.
Unfortunately, acceptance rates aren’t high, so to protect yourself, work with a professional.
You’re more likely to qualify for an OIC if you:
- Have a lot of debt in relation to your income.
- Have little to no equity in your assets.
- Have no realistic opportunity to notably increase your future earnings.
- Are current with all necessary tax returns and tax payments (if applicable).
You’re less likely to qualify for an OIC if you:
- Have significant equity in property, such as real estate or retirement accounts.
- Have substantial income streams.
- Have a reasonable chance of significantly increasing your future earnings.
However, you must meet basic eligibility criteria for the IRS to even look at your application. If the following issues apply, the IRS will return the offer without reviewing it.
- You have unfiled returns.
- You aren’t current with estimated tax payments or payroll deposits if you have employees.
- You are in a pending bankruptcy proceeding.
When you contact a tax professional, they can give you a decent idea of whether you’ll qualify based on your financial situation. The IRS’s pre-qualifier tool can also help you start your research, but it has limitations.
What’s a Realistic OIC Settlement Amount?
The short answer is that “it depends.” You may have heard that the IRS will sometimes settle tax debts for “pennies on the dollar,” but that’s not always possible. Generally, you’re looking at dimes or quarters on the dollar, which aren’t as catchy, but still represent a lot of savings.
It really boils down to how dire your financial situation is and how much you owe. Some taxpayers save hundreds of thousands, while others save a few thousand.
Settling a Tax Debt With the IRS by Yourself
The IRS doesn’t require taxpayers to hire a tax professional to help them apply for an OIC. But most taxpayers are better off consulting with an experienced OIC tax professional before submitting an OIC to the IRS. There are multiple reasons for this:
- Wasting time: If you don’t meet the basic criteria, the IRS will return your offer without reviewing it, meaning you’ve wasted your time with no results.
- Risk of mistakes: If you meet the basic criteria, the IRS will review the application, but mistakes can easily derail the process, leading to rejections or paying a higher offer than necessary.
- High rejection rates: The IRS generally accepts fewer than half of all offers, emphasizing the need for professional guidance.
- Non-refundable fees and deposits: If the IRS returns your offer (as noted above), it will refund the application fee and deposit, but if it reviews and rejects your offer, it will keep both of these amounts and apply the deposit to your tax debt.
- Limited appeal time: If an offer is rejected, you have a limited time to appeal. You can loop in a pro at this point, but it’s always better to be proactive.
A tax pro understands how the offer process works and what information you need to provide to get the lowest settlement possible. Working with an experienced resolution company helps you avoid submitting a higher-than-necessary offer or one that’s too low and likely to get rejected.
Want to see the best offer for your situation? Then, contact us to see how much you could save with an offer in compromise.
What If the IRS Rejects Your Offer?
The IRS will send a letter if they reject your offer. You’ll have 30 days from the date of this letter to file an appeal if you disagree. If you don’t want to appeal, you can consider other tax debt resolution options available, such as:
- Installment agreement (monthly payments)
- Penalty abatement (penalty reduction)
- Currently not collectible (CNC) status (collections pause due to financial hardship)
If you don’t make payment arrangements, the IRS will pursue the unpaid taxes. You could face tax liens, wage garnishments, or other consequences if you don’t take action.
Before applying for an OIC, Tax Network USA’s experienced OIC professionals will confirm if OIC is the best path, and if not, help you navigate your way to a different solution.
IRS Offer in Compromise Settlement Amount FAQs
Do I still pay penalties and interest if the IRS accepts my OIC?
The IRS’s acceptance of your offer means you only pay the amount of your OIC. This means anything you don’t pay goes away, even if it includes penalties and interest in addition to the underlying tax debt.
Will the IRS try to collect my back taxes while reviewing my OIC application?
The IRS will not move forward with any new collection activities once you file your offer paperwork. However, if there’s an existing collection action against you (for example, the IRS is garnishing your wages), your tax pro will need to secure a “collections hold” as the application itself won’t necessarily stop in-progress collection actions.
Will the IRS really settle my tax debt for “pennies on the dollar?”
It’s possible, but it depends on how much you’re struggling financially. The more money and assets you have and the less you owe, the more the IRS will expect you to offer.
Technically, all offers are pennies on the dollar. For example, if you owe $100,000 and settle for $20,000, you are paying 20 pennies on each dollar owed.
What does it mean if the IRS returns my offer?
If the IRS returns your offer, it means they are not even reviewing your OIC application. This is often for procedural reasons, such as not meeting eligibility requirements like filing timely tax returns. You can’t appeal a returned offer, but you can reapply.
What are my chances of the IRS accepting my offer?
Your chances mostly depend on whether you meet the eligibility requirements and submit an offer that’s close enough to your reasonable collection potential. That said, the IRS has historically accepted between roughly 25% and 50% of offers submitted from businesses and individuals. The acceptance rate is slightly higher for individual taxpayers than for business taxpayers. It’s much higher when you work with a tax professional.
Learn What the IRS Will Accept Before Submitting Your OIC
Unlike other tax relief companies, Tax Network USA carefully reviews taxpayer financial information before submitting an OIC application to the IRS. This not only increases the chances of acceptance but also confirms that the Offer in Compromise makes the most sense for resolving the tax problem.
If you’d like to reach one of our OIC tax pros, you can contact us online or call (855) 225-1040.
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