So, you want to settle your tax debts with the IRS? Does the IRS really settle tax debts? Yes, they do. Tax debts can be settled through the IRS’s offer in compromise program. There are three types of offers in compromise, but the most common is “doubt as to collectibility.” This means the IRS has doubt that it will be able to collect the tax due within the statutory period it is allowed collect. When filing an offer in compromise based on doubt as to collectability, it is critical to understand both the substantive and procedural requirements. The IRS will not hesitate to reject or return an offer in compromise. Having your ducks in a row will help improve the likelihood of success.
Step 1: Compliance
Compliance is a critical element to resolving tax delinquencies. Compliance has two components. The first is filing compliance. The IRS will require taxpayers to file all missing tax returns for at least the last six years before it will even consider accepting an offer in compromise. In some cases, the IRS may require missing returns be filed going back even further in time.
The second component of compliance is staying current with all deposit requirements such as estimated tax payments or payroll deposits. The IRS wants to know that a taxpayer is not going to continue to accrue new tax debts if an offer in compromise is accepted. They do this in two ways. First, they require deposits to be current. Second, they can default an accepted offer if a taxpayer fails to meet tax obligations at any time for five years following acceptance.
Step 2: Evaluating Reasonable Collection Potential
Offers in compromise are evaluated in large part based on “reasonable collection potential.” Reasonable collection potential is the amount the IRS expects it can collect from a taxpayer. The IRS evaluates reasonable collection potential by analyzing income, allowable expenses, equity in assets, retired debt and dissipated assets. These items are used to not only evaluate whether or not to accept an offer in compromise, but to also determine an acceptable amount of an offer in compromise. Many taxpayers (even some tax professionals) try to file an offer in compromise without giving any consideration to the IRS’s criteria.
Step 3: Preparing and Filing an Offer in Compromise
The taxpayer will need to complete a collection information statement and Form 656. Taxpayers with a business may need to complete multiple collection information statements. The collection information statement contains the financial information the IRS needs to evaluate a taxpayer’s reasonable collection potential. The Form 656 contains the taxpayer’s settlement proposal and terms of the offer in compromise.
The IRS requires current documentation to support the information contained in the collection information statement. Income statements, bank statements are the minimum. Additional documents may also be required such as proof of doctor bills, life insurance statements, investment account statements, retirement account statements, etc.
These forms are usually submitted to a centralized offer in compromise unit for consideration along with a deposit on the amount offered to compromise the tax debt and a processing fee. Some low income taxpayers may qualify for a waiver of the filing fee and deposit requirement.
Step 4: IRS Evaluation
Once the IRS receives the offer in compromise, it will begin the process of evaluating whether or not to accept a taxpayer’s settlement proposal. This process can be lengthy. The IRS often requests additional and updated documentation. IRS deadlines can be short and the IRS will not hesitate to return an offer in compromise without substantive review if their demands for documents and information are not satisfied timely. Maintaining good financial records is helpful in providing a quick response to any IRS demand. Once the IRS has all the information they require, it will make a determination to accept or reject an offer in compromise.
There are many variables to consider when submitting an offer in compromise to the IRS. The IRS will not just accept an arbitrary settlement proposal. Most offers submitted to the IRS are returned or rejected. This is primarily because those submitting offers in compromise do not understand the applicable rules. Staying compliant with tax regulations, properly evaluating, preparing, and filing an offer in compromise, and responding to IRS demands while an offer is pending is critical to the success of an offer in compromise.