Considering an Offer in Compromise?
Potential Risks & Drawbacks
What Are the Drawbacks to an IRS Offer in Compromise?
If you have unpaid taxes with the IRS, and can’t pay in full, resolving the taxes you owe for less may sound like a great idea. The most commonly mentioned way to do this is the IRS offer in compromise. Requesting an offer in compromise also pauses the IRS’ tax collection efforts (like liens and levies) while the IRS decides whether to accept your application.
Yet like many other financial decisions, an offer in compromise has its pros and cons. Even if you can get the IRS to agree to an OIC (which can be challenging), it may not always be the best path to resolving your tax problem. The goal of this article is to focus on the cons of the OIC, but before we get into those, let’s first examine how the offer in compromise works.
Overview of an Offer in Compromise
You can apply for an offer in compromise based on doubt as to liability when it can be proven that you don’t actually owe the taxes. However, most offers are based on an inability to pay, and in these cases, the IRS determines your eligibility by looking at your assets, income, potential future income, and other factors.
The IRS then compares that information to the amount of your tax debt to decide if you can pay the full amount. And if you can, the IRS will then decide if it would create a financial hardship for you to do so. All of this to say, the IRS is more likely to accept your OIC request if you can show the amount you’re willing to pay to settle the tax debt is the most money the IRS can reasonably expect to collect from you.
The IRS may also accept your OIC application if there are exceptional circumstances that make it unfair for you to pay the entire tax debt or would put you in an economic hardship even if you have the income and assets to pay off your entire tax debt (this is also known as “effective tax administration”).
In addition to the financial eligibility requirements, there are also other conditions for OIC approval, such as:
- Filing all required tax returns and making any estimated payments;
- Having a tax return deadline extension (if applying for the current year);
- Not being in an open bankruptcy proceeding; and
- Having made all tax deposits for the current and most recent two quarters (this last requirement only applies to employers).
To submit an OIC to the IRS, you usually begin by completing IRS Form 656. This is also known as 656-B, as it’s such a long and detailed form that it comes as a booklet. This booklet will contain other forms you will probably need, such as Form 433-A (OIC) or Form 433-B (OIC).
IRS Offer in Compromise Risks
Now that you have a rough idea of what an OIC is and who can apply for one, let’s examine the risks and problems that you should consider before starting the application process. Some of these relate to the application process itself, but there can still be disadvantages to using an OIC to resolve your tax debts.
The Financial Cost of the OIC
There are two types of financial burdens to consider with an OIC. The first one relates to the application itself, as you’ll need to pay a $205 application. The second one is the initial payment that you must include with your offer. This initial payment can come in one of two forms:
- Lump sum: You must provide 20% of the total offer amount, with the remaining balance paid in five or fewer payments within five months of the date the IRS accepts your OIC request.
- Periodic payment: You must make the first payment of a series of monthly payments. These monthly payments must be made over the next six to 24 months, as required by the terms of your OIC request.
Keep in mind that you don’t have to send any money with your OIC request (application fee or initial payment) if you meet the Low-Income Certification guidelines (these are outlined in Form 656).
Besides these initial financial costs incurred during the OIC process, you’ll need to remember that you must have the money to continue making the necessary payments if the IRS accepts your OIC. Depending on the terms of your OIC and the size of your tax balance, these could place a notable financial burden on you.
If the IRS doesn’t accept your OIC, the agency will keep the payment and apply it to your tax debt.
Complexities & Time Requirements to Obtain
Besides the financial costs, the time and effort involved in completing an OIC application can be the most significant drawback to the OIC. There are a lot of pages to complete and information you must provide for the necessary IRS forms. Therefore, it’s easy to miss a small detail and have the IRS reject your OIC application.
Remember, the IRS is ultimately trying to decide if you have the financial resources to pay off the entirety of your tax bill. This means the IRS will take a deep dive into your sources of income, the property that you own, and your financial obligations. You can expect to provide documentation relating to things like your home, cars, bank accounts, where you work, and monthly bills.
Because of the work involved in completing an OIC, it’s a good idea to think about talking to an OIC tax lawyer. They can review your situation and give you an idea as to whether the IRS is likely to accept your OIC. If you’re unlikely to get accepted, they can help save you the time and effort of applying and then getting rejected. If you’re likely to get accepted, they can make sure your application isn’t missing anything that would result in a rejection.
Finally, it takes a long time to successfully use an OIC to settle a tax debt. Depending on your situation, it can take up to a year for the IRS to review your OIC application and make a decision. Then, based on the terms of your OIC, it might take another five to 24 months to make all your necessary OIC payments.
Greater Scrutiny by the IRS for Five Years
Even if you get approved for an OIC, you need to remain in compliance with the IRS for the next five years. This includes filing all necessary tax returns and making all required tax payments on time. If you are late (or miss) a tax return or payment to the IRS over the next five years, the IRS may default your OIC. If this happens, you must pay the original tax debt, less any payments you made so far. If the IRS waived any penalties and interest, those will be reinstated.
It can also get worse. The IRS may place a lien or levy on your property to collect the remaining tax debt balance. But before you let the possibility of default scare you from thinking about an OIC, note that the IRS will usually reach out to you if there’s a missed or late payment, giving you at least one more chance to resume timely payments.
Loss of Tax Refunds
In addition to your OIC payments, the IRS may also apply any tax refunds to your outstanding tax balance. As a result, any tax refunds you usually get could be reduced or eliminated.
Privacy Concerns
If you’re a very private individual or are requesting an OIC on behalf of your business, you need to consider that OICs are part of the public record. Even though the OIC itself won’t usually affect your credit score, anyone who might be interested in your financial matters can see that you used an IRS OIC to settle your tax debt. This might affect your ability to obtain credit or your professional or personal reputation.
Tolling the Statute of Limitations
The IRS can’t collect tax debts forever. Eventually, the statute of limitations will prevent the IRS from collecting a tax debt that’s too old. This is referred to as the Collection Statute Expiration Date, or CSED. The CSED is usually 10 years from the date of the IRS tax assessment. However, this 10-year clock gets paused when you apply for an OIC. The pause lasts from the point you make the offer to the date it gets accepted, rejected, or withdrawn. If the IRS rejects your offer, the CSED clock remains paused for an additional 30 days before resuming.
For most taxpayers thinking about an OIC, this isn’t a consideration. But if you have a tax debt that’s old and approaching the CSED deadline, you may wish to avoid an OIC to prevent the IRS from having additional time to collect its tax debt from you.
Alternatives to an Offer in Compromise
If these risks or concerns mean you decide not to use an OIC, there are other options available. Some of these will also allow you to settle your tax debt for less than what you owe. The more common of these alternatives include:
- Installment agreement: Sometimes referred to as a payment plan, this is an arrangement where the IRS allows you to pay off your tax debt over an extended period of time.
- Partial payment installment agreement: This is a type of payment plan that provides the possibility of settling a tax debt for less than what you owe, but only after making monthly payments until the CSED expires.
- Currently not collectible: In situations where the IRS recognizes that you don’t have the money to pay your tax debt and basic living costs, they may place your tax debt into a currently not collectible (CNC) status. During this time, the IRS will usually cease all collection activities.
An installment agreement is ideal if you can pay off your tax debt over the next few months or few years, you’re looking for a far simpler application process, and you don’t have large tax debts. The partial payment installment agreement and CNC status options might be a good fit if your tax debt is getting close to the CSED deadline.
This is because any unpaid tax balance that still exists in a partial payment installment agreement or with CNC status when the CSED passes will go away. This is due to the IRS being legally barred from collecting tax debts where the statute of limitations has run.
Not Sure If an IRS OIC Is Right for You?
The benefits of an offer in compromise make it an enticing way to deal with your unpaid taxes with the IRS. Depending on your situation, it might not be the best thing for you to consider. If you’re still interested in the OIC, but want to learn more about other possible options, it’s best to get in touch with a tax pro, such as those from the W Tax Group.
We have plenty of experience resolving tax problems with a variety of tools, including the OIC. You can contact us to set up a free consultation.
