Tuesday, April 1, 2008

What To Do if You Can't Pay Your Taxes -- Part 1

Here is information from Wikipedia concerning the IRS Offer In Compromise Program which lets people settle their past tax debt, sometimes for even less than the amount owed. In future posts, I will discuss other strategies for dealing with the IRS when you can't pay your taxes. I hope that you find it helpful.

The Offer in Compromise (or OIC) program, is an IRS program under 26 USC 7122 which allows qualified individuals with an unpaid taxdebt to negotiate a settled amount that is less than the total owed to clear the debt. A taxpayer uses the checklist in the Form 656, Offer in Compromise, package to determine if the taxpayer is eligible for the offer in compromise program. The objective of the OIC program is to accept a compromise when acceptance is in the best interests of both the taxpayer and the government and promotes voluntary compliance with all future payment and filing requirements.

Qualifying conditions

At least one of three conditions must be met to qualify a taxpayer for consideration of an OIC settlement:
• Doubt as to Liability — Debtor can show reason for doubt that the assessed tax liability is correct
• Doubt as to Collectibility — Debtor can show that the debt is likely uncollectable in full by the IRS under any circumstances
• Effective Tax Administration — Debtor does not contest liability or collectibility but can demonstrate extenuating or special circumstances that the collection of the debt would "create an economic hardship or would be unfair and inequitable." This Offer in Compromise program is mainly for elderly or disabled Taxpayers.

Doubt as to collectibility

Doubt as to collectibility means that the taxpayer will never be able to fully pay the tax bill. The IRS will accept a settlement based on the following formula:
Settlement Amount = 60 months of disposable income + the equity in all the taxpayer's assets. (48 in the case of offers paid within five months of acceptance.)
If a taxpayer believes he or she qualifies, the taxpayer completes a financial statement on a form provided by the Internal Revenue Service. An individual not engaged in business may use Form 433-A, and Form 433-B if engaged in business. These financial statements will allow the taxpayer to outline everything owned, and to create a monthly income and expense table.
Disposable income is monthly income minus monthly expenses. For the example given, assume that disposable income is $100. That amount is multiplied by 48 or 60 months, resulting in a product of $4,800 or $6,000. That is the tentative minimum offer.
Now the taxpayer must add the taxpayer's equity in assets. Assume that the taxpayer owns a house that is worth $200,000 and owes only owe $180,000. In this case the taxpayer has $20,000 in equity. This must also be added to your Offer. (This needs correcting. It should be 80% of value less liabilities.)
The total offer in this simplified situation would be $20,000 + $6,000, or $26,000. What's that you say? You don't owe that much? Then you are not a candidate for the Offer in Compromise program. But if you owe, say, $100,000 then this is a great deal.
However, as is usually the case, things are not this simple. If you can make a cash offer, that is pay what you offer in 90 days or less, than you use a factor of 48, not 60 months as indicated above. Therefore, the minimum amount of your offer based on your income would be $100 time 48, or $4,800.
Let's say that you also convince the IRS that your house could not be sold on the market that quickly or that there are other problems with a potential market sale. Then, you could ask for a discount to "Quick Sale Value," or QSV, instead of Fair Market Value, FMV. Your house in now valued at a discount to 80% of FMV, or $160,000. In the above example. Because your QSV is less than what you owe on the house, and assuming you have no other assets, your actual potentially acceptable offer is $4,800 plus $0, or just $4,800.

Now let's say that you cannot pay the $4,800 within 90 days. You could offer to pay the original $6,000 listed above within 24 months: for example, at the rate of $250 per month for 24 months.

If you cannot even do that, there is yet a third way to pay. You can offer to pay your monthly net income after allowable expenses (as determined by the IRS) over the life of the remaining statute on collection (originally 10 years). Lets say, you can pay $100 per month and there is 7 years (84 months) remaining on the statute. Then you will pay $100 per month for 7 years or $8,400.
If you owe more than $8,400 in tax, penalty and interest, and your offer is accepted, then you have a good deal. If you owe less, its not a good deal; in fact, it will not be an offer that the IRS will accept. You would be better off asking for an installment agreement at $100 a month until your account is satisfied.

Lowest acceptable offer

The above formula may be applicable in cases where you owe a very large sum and you have a significant amount of disposable income. However, "doubt as to collectibility" implies the inability to pay. The IRS has been known to accept offers in compromise as low as 10%, 1%, and $1 (One Dollar), but this is, as you can imagine, very rare.
If your disposable income is $0, you do not expect to have disposable income for some years, you have special circumstances, you have zero assets and if paying this debt would cause a hardship, the IRS has been known to accept ONE DOLLAR to settle your tax liability through the Offer In Compromise. Said provision takes effect 60 days after the signing.

In a recently accepted "Offer in Compromise" filed in 2006, a family experienced the disability of the primary wage-earner. The tax liability was incurred in 1994, and had been accruing interest and penalties (leading to thousands of dollars in tax liability.) The OIC form filed by the family included the required Form 433 Collection Information Statement and expense information (less than the accepted standard expense allowances for OIC formulation), as well as the fee waiver form that is applicable in low-income cases (this waives the otherwise required $150 OIC processing fee.) Because the family's expenses exceeded their income, the disability of the wage-earner and the lack of saleable assets, the IRS accepted their original offer of $1.

Recent tax legislation requires a taxpayer to make a 20% good faith payment with the offer-in-compromise. If the offer is rejected, the IRS can keep the 20% deposit.

Partial payment

Effective July 15, 2006 the IRS made changes to the Offer in Compromise program requiring that an up-front twenty percent, non-refundable payment plus $150 be submitted along with the Offer of Compromise. An Offer submitted without the fees is subject to rejections without appeal. After the IRS receives the Offer, the IRS has two years to make a decision. If the decision is not reached by that time, then the Offer is automatically accepted.

Under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA 2005) if a taxpayer chooses to make payments over time, i.e. monthly, the taxpayer must include with the offer the first month's payment. The taxpayer is not required to submit the 20%, which applies only to the lump sum payment option. Then during the time that the offer is being considered by the IRS, the taxpayer must keep making the monthly payments to keep the offer current. If the taxpayer fails to make the payments, the offer will be returned to the taxpayer.

In the case of both the $150 application fee and either the 20% down payment or the monthly payments, a low income taxpayer may be exempt from both. The taxpayer should review the Form 656A to determine whether these fees and payments apply to them.
Effect of an Offer in Compromise on IRS levy or lien

An Offer in Compromise will have no effect upon a tax lien. The lien will remain in effect until the offer is accepted by the IRS and the full amount of the offer has been paid in full. Once the offered amount has been paid, the taxpayer should request that the IRS remove the lien. An offer in compromise will stop tax levies under section 301.7122(g)(1) of the US Federal Tax Regulations. That regulation states that the IRS will not levy upon a taxpayer's property while a valid offer in compromise is pending and, if rejected, for thirty days after the rejection. If the taxpayer appeals the rejection, the IRS cannot levy while the appeals process is ongoing.


The IRS issued a consumer alert for consumers to beware of promoters' claims to settle debts for "pennies on the dollar" through the OIC program. The warning addresses companies charging high fees to consumers who may not be eligible for the program; all other payment means would have to be exhausted, including installment payments. A recommendation is to check with the Better Business Bureau before contracting any firm to resolve your tax problems.

Forbes.com: Personal Finance News