Offer in Compromise Based on Effective Tax Administration
Help for People Who Can Afford to Pay Their Tax Debts, but Paying Would Create Economic Hardship or Be Inequitable
Internal Revenue Code (IRC) 7122 allows the IRS to settle some tax debts for less than owed, but generally, to get approved, you must prove that you cannot pay the tax debt in full. However, what about situations where you technically could pay in full but forcing you to do so would create an economic hardship or be unfair? This is where an offer in compromise based on effective tax administration comes into play.
This program is designed for taxpayers who can afford to pay the tax bill in full, but the IRS allows them to settle because it’s the fairest thing to do. Qualifying for effective tax administration can be complicated, and for the best results, you should work with a tax professional. To learn more and figure out if this is the right option for you, contact us today. In the meantime, here is an overview of this program.
What Is an Effective Tax Administration Offer in Compromise?
An offer in compromise based on effective tax administration is when the IRS agrees to let you settle your tax bill for less than you owe even though you could afford to pay the bill in full or make monthly payments. This IRS offers these settlements in the interest of fair tax administration.
To give you an example, imagine that you can afford to pay your tax bill in full if you sell your home. However, if you sold your home, you wouldn’t be able to afford rent prices in your area, and you would suffer due to the sale. In this type of situation, the IRS may let you settle for less than you owe because forcing you to pay would create economic hardship.
This program isn’t just for people who can afford to pay in full right away. It’s also for people who could afford to make payments on the tax debt, but doing so would create economic distress. For instance, this might apply in a case where you could afford to make monthly payments but you need the funds for medical care or other essentials.
How to Apply for OIC Effective Tax Administration
To apply, you should complete IRS Form 656-B (Offer in Compromise) booklet. This packet has all of the application materials including Form 433-A OIC (Collection Information Statement for Wage Earners and Self-Employed Individuals) and Form 433-B OIC (Collection Information Statement for Businesses).
You must note that you’re applying based on effective tax administration. If you apply based on doubt as to collectability, you will need to amend your application.
When you apply, you provide the IRS with detailed information about your income, expenses, debts, and assets. The IRS uses this information to assess your reasonable collection potential (RCP). The RCP is the amount that the IRS would be able to collect if it enforced collection actions against you. It includes a portion of the equity in your assets and all of your disposable income.
To qualify for a settlement based on effective tax administration, your reasonable collection potential must be enough to pay the tax bill in full. But forcing you to pay the bill in full would be unfair or inequitable.
You also must include a written explanation of your exceptional circumstances. This should explain why paying in full would cause economic hardship or be inequitable. Note this in section three of Form 656 or attach a document with your explanation.
Most Common Reasons for ETA Settlements
The IRS reviews all applications for offers based on effective tax administration on a case-by-case basis. However, these tend to be the most popular reasons that people use this program:
- You have a long-term illness and you need to preserve income and assets for healthcare costs.
- If you borrowed against your assets, you would be unable to make the payments and afford basic living expenses.
- Liquidating your assets would create economic hardship.
- Fraudulent acts by a payroll service provider — If your business has been compliant with all other tax obligations, but forcing you to pay a liability created by a payroll service provider would strain your business, you may qualify.
The agency doesn’t just look at the numbers on your application. Instead, it takes into account your written responses and any supporting documents (such as doctor’s notes) that you provide. The IRS takes age, health, and other personal circumstances into consideration when deciding if you qualify for this program. To ensure you are providing the IRS with the most effective information and the most compelling, you should work with a tax professional.
At the W Tax Group, our seasoned tax debt resolution specialists know what the IRS wants to hear, and we shape your written responses to achieve the lowest settlement possible.
Public Policy Vs. Economic Hardship
Economic hardship is not the only reason that the IRS accepts ETA offers. The IRS also accepts these offers in the interest of promoting equity in tax administration.
Basically, this means that the IRS believes that taxpayers are more likely to be compliant if they believe the tax system is fair, and they are more likely to cheat the system if they believe that it is unfair.
The IRS’s training materials for its employees ask them to consider this question — If the public knew about the settlement, would they perceive that the taxpayer benefited from not complying with the tax laws? If the answer is yes, you generally won’t be able to get a settlement.
However, the reverse also applies. The employee who reviews your application will also consider if forcing you to pay the bill in full would cast the IRS in a bad light. If so, you are more likely to be able to get your offer approved. The IRS doesn’t want to be known as the government agency that seizes senior’s homes or forces cancer patients into the street.
That’s why this program exists — so the IRS can take exceptional circumstances into account when determining how much you should be required to pay.
What to Expect When You Apply
When you apply, an IRS employee will review your application to make sure this is the right program for you. The employee will determine if an offer in compromise based on doubt as to collectability or doubt of liability is more suited to your situation. If so, you will be steered toward those programs.
Doubt as to collectibility applies when you can’t afford to pay the tax bill. You must submit a collection information statement to prove that you can only pay part of the balance. Doubt as to liability is when you may not really owe the full liability. You don’t have to submit a financial disclosure, but you do have to explain why you don’t really owe the debt.
What If Your Reasonable Collection Potential Is Less That Your Tax Bill?
Again, effective tax administration only applies when your reasonable collection potential meets or exceeds the full balance, but requiring you to pay would be unfair or create hardship. Generally, if your reasonable collection potential is less than you owe, you qualify for a standard offer in compromise based on doubt as to collectibility. Your offer generally needs to be the same as your reasonable collection potential.
However, if your reasonable collection potential is less than your full balance and you need an even lower settlement, you may need to apply for doubt as to collectibility with special circumstances. For taxpayers, these two programs are effectively the same, but the IRS uses different names.
Here’s an example. Imagine that you owe $20,000. Your reasonable collection potential is $25,000, but it would be inequitable to require you to pay more than $10,000. In this case, the IRS may let you settle for $10,000 based on effective tax administration.
In contrast, imagine that you owe $20,000, your reasonable collection potential is $15,000, and you can only fairly afford to pay $10,000. In this case, the IRS may offer you a $10,000 settlement based on special circumstances.
As you can see, in both of the above scenarios, the final result is the same for the taxpayer. However, due to the difference in collection potential, the IRS uses different terms for the relief offered to the taxpayer. As a taxpayer, you really only need to know the distinction because you have to mark which program you’re applying for on your application. If you make the wrong selection, you will have to amend your application. This creates processing delays.
To qualify, you must meet the following criteria in addition to the elements discussed above:
- Have a history of complying with IRS filing and payment requirements — In some cases, the IRS may suspend this requirement.
- Not have deliberately tried to avoid paying the taxes — Typically, you won’t qualify if you committed tax evasion or if the IRS believes you’re only applying to delay the collection process.
- Stay current on tax requirements after the offer’s acceptance — If you fall behind on future tax obligations, the IRS may be able to retroactively rescind your offer.
- Able to pay the settlement in a lump sum or in payments over a 24-month term — If you don’t pay your offer in the specified time frame, you will lose the offer.
Your tax attorney can talk with you about any other qualifications you may need to meet. If you don’t meet the criteria, you may want to consider other options such as a partial payment installment agreement or currently not collectible status.
Get Help Today
Are you in a situation where you could afford to pay the tax liability in full but doing so would be unfair or create undue hardship? Then, you won’t be able to qualify for a traditional offer in compromise, but you may qualify based on effective tax administration. Similarly, if you can’t afford to pay in full but you also need a settlement that is less than your reasonable collection potential, you may qualify based on exceptional circumstances.
These IRS relief programs go beyond the numbers. They require skillful negotiation and knowledge of the tax code — IRC 7122 in particular. A tax attorney can be critical for helping you get accepted to one of these programs.
Don’t let the IRS force you to pay your taxes in full if you’re dealing with exceptional circumstances. Instead, contact us for a free consultation today. At the W Tax Group, we provide personalized attention to each of our clients. We look closely at your situation and help you find the best outcome possible.