Offer in Compromise Vs. Installment Agreement: Which Tax Debt Solution Will Save You the Most?

An Offer in Compromise (OIC) is a program from the IRS that allows qualified individuals to settle their tax debts for less than the full amount owed. This option is intended for taxpayers who will likely never be able to pay off the full amount of their tax debt due to their financial circumstances.

The concept behind an OIC is to reach an agreement that benefits both the taxpayer and the IRS, ensuring that the maximum amount of tax revenue is collected within a reasonable period.

Types of Offers in Compromise

• Doubt as to Collectibility: This type applies when there’s doubt that the taxpayer could ever pay the full tax liability. It’s the most common type of OIC and considers the taxpayer’s income, expenses, asset equity, and future earning potential.

• Doubt as to Liability: This type is suitable for situations where there is a genuine dispute about the existence or amount of the correct tax debt under the law. It does not require the IRS to evaluate the taxpayer’s financial situation.

• Effective Tax Administration: This offer is for taxpayers who may be able to pay the full amount but doing so would create an economic hardship or would be inequitable because of exceptional circumstances. This type of OIC considers the taxpayer’s age, health, income potential, and other factors that might affect their financial future.

Eligibility and Evaluation

To qualify for an Offer in Compromise (OIC), the IRS conducts a thorough financial review of the taxpayer. This process involves assessing the taxpayer’s realizable equity, which reflects the cash value of their assets after deducting secured debts. The review also considers any financial hardships that impact the taxpayer’s ability to cover basic living expenses. Special circumstances, such as health problems or other personal factors, are also evaluated.

The key part of this evaluation is the calculation of the Reasonable Collection Potential (RCP). The RCP is an estimate of the maximum amount the IRS expects to collect from the taxpayer. It includes projections of future income, adjusted for necessary living costs, and the value of any assets that could be sold for cash, minus outstanding debts.

Application Process for an Offer in Compromise

To apply for an Offer in Compromise (OIC), taxpayers must follow a structured process, outlined here in step-by-step detail:

1. Gather Documentation: Collect all necessary financial documents that provide a clear picture of your financial situation. This includes bank statements, pay stubs, property valuations, and records of expenses.

2. Complete the Required Forms:

3. Form 656-B, Offer in Compromise Booklet: This form outlines the proposal for how much the taxpayer can pay and why the offer should be considered.

• Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals: This form provides detailed information about the taxpayer’s income, debts, living expenses, and assets.

4. Submit Initial Payment: Along with the application, taxpayers must submit an initial payment. The type of payment depends on the chosen payment option outlined in Form 656-B:

5. Lump Sum Cash Offer: Pay 20% of the total offer amount with your application. If accepted, pay the remaining balance within a five-year period.

• Periodic Payment Offer: Start with the first installment of the proposed payment plan.

6. Pay Application Fee: A non-refundable application fee is usually required unless the taxpayer qualifies as a low-income taxpayer or is submitting a Doubt as to Liability OIC. The fee must be paid with the application to process the OIC.

7. IRS Review: The IRS will review the application, assessing the Reasonable Collection Potential and confirming compliance with tax laws. This review determines whether the OIC is in the best interest of both the taxpayer and the IRS.

8. Response from the IRS: If the IRS accepts the offer, the taxpayer must meet the terms outlined in the acceptance letter, including keeping up with all tax obligations and payments. If the offer is rejected, the taxpayer has the right to appeal the decision.

Advantages and Limitations of an Offer in Compromise

Advantages

• Significant Reduction in Tax Debt: An Offer in Compromise can lower the total amount owed, often to a fraction of the original debt, providing financial relief.

• Final Resolution: Once an OIC is accepted and the agreed amount is paid, the remaining tax debt is forgiven, offering a clean slate to taxpayers.

Limitations

• Strict Eligibility: Qualifying for an OIC is challenging as it requires proving severe financial hardship or other special circumstances, making it inaccessible for many taxpayers.

• Requires ongoing Compliance: Settling tax debt for less than the amount owed requires future compliance and not owing for the next 5 years otherwise it could default the Offer in Compromise and that tax debt comes back.

Choosing Between IA and OIC

Installment Agreements are best suited for taxpayers who can handle a steady payment plan but may not be able to settle their full tax liability immediately. This option is ideal for those with a consistent monthly income and can meet the IRS’s criteria for regular payments without compromising their basic living expenses.

On the other hand, an Offer in Compromise is a preferable choice for taxpayers facing extreme financial difficulties that make paying the full amount of tax liability unrealistic. This option is suited for individuals who can prove that paying the total tax debt would create significant economic hardship. The OIC is beneficial for those with minimal disposable income and assets, as it can reduce the amount owed and provide a fresh financial start.