Offer In Compromise
The offer in compromise is a vehicle used by a taxpayer that, technically, owes more money to the Internal Revenue Service than has the financial ability to pay. It is sort of a "let's make a deal" plan that allows the taxpayer to go on with their financial life without the burden of Uncle Sam on their backs. The offer in compromise is basically, a settlement of a delinquent tax account for less than the full amount due. The IRS Code Section 7122 states that the IRS may compromise any civil or criminal case arising under the IRS laws prior to any collection case going to criminal prosecution.
The offer in compromise, although extremely time-consuming for the tax attorney or the CPA preparing the documents, if presented correctly, can successfully discount a tax liability by as much as 75% of the total amount owed. The whole concept is based on the ability to pay premise. If the taxpayer does not have the means to repay the Internal Revenue Service, it makes sense to the taxpayer, as well as to the collection agents, to get the liability "off the books" and settle the outstanding taxes for the more reasonable, collectible amount.
As with any settlement process, the offer and compromise can be a very tedious and time-consuming process. Certain requirements should be met, and one of three specific reasons should be addressed before applying. These reasons should be one of the following:
Inability to Pay
The taxpayer, based on his or her financial net worth or income, does not have the ability to pay the total outstanding tax balance owed. This reason should be based on the taxpayer's net worth, where the total liabilities owed are more than the assets owned, and it would be impossible for the taxpayer to pay, even on a payment plan over a period of time. A collection agent, in proving that the taxpayer does not have the ability to pay the full amount, uses various measurement tables. These tables are allowances given to the taxpayer to allow for mortgage payments and debt service, food and grocery allowances, utility allowances and so on. These tables, unfortunately, are very unrealistic.
For example, the tables in an offer and compromise stipulate a living allowance, including mortgage payments, food and groceries, utilities and so forth, to be $1,100 per two-member family. Any income earned in excess of this allowance could technically be used as money toward the tax liability according to the IRS tax tables.
Doubt as to Actual Liability
The actual tax liability, after tax audit and verification, may not be believed to be the correct amount by the taxpayer. An example of this would be if a taxpayer were audited, and the IRS agent estimated income and taxes due to poor record keeping, unavailability of the records, an excess amount of cash sales and transactions and so forth. Since the IRS estimates these tax liabilities, there is doubt as to the correctness of the tax assessment. Rather than drag the case through the tax courts, the taxpayer is willing to shortcut the process and "make a deal" with the IRS.
Promote Effective Tax Administration
This is the newest and latest reason being used by many tax attorneys for their clients. This is the "IRS, please have a heart" reason for the offer and compromise. The taxpayer, knowing that it does not have the ability to pay the taxes owed, but cannot prove it based on the IRS collection tables, and has a net worth substantiating ability to make reasonable payments, asserts that making these payments will cause "undue hardship" on the taxpayer. The IRS takes into consideration that, even thought the taxpayer could make payments on the total taxes, penalties and interest owed on paper, that making such payments would cause certain financial distress, and possibly, bankruptcy to the taxpayer. This reason sort of falls under the "kinder and gentler" IRS image they have been trying to promote to the public in recent years. Unfortunately, this reason is not an easy one to sell to the IRS in an offer and compromise.
The Internal Revenue Service has created a streamlined offer and compromise program to compromise liabilities of less than $50,000. In order to qualify for this program, the offer must meet the following criteria:
- The tax liability must be for personal income taxes, penalty assessments, or employment (payroll) taxes owed by an out-of-business sole proprietorship.
- The aggregate liability must be $50,000 or less, including accrued penalties and interest.
- The taxpayer must be a wage earner or self-employed with no employees.
- Any real property owned must be limited to his/her personal residence only.
If the taxpayer falls within the above perimeters, he will be sent a document request letter allowing a 14 day deadline to provide requested documents, where appraisals, pictures of assets, comparable sales and so forth may be requested to prove the value of assets.
There are other strategies that can be used in reducing an IRS liability. But the offer and compromise is one of the most effective because it stops the collection process and prohibits the IRS from attaching a levy or a tax lien on any assets during any period that a taxpayer's offer in compromise is being processed. The IRS, during the application process, 30 days after rejection of the offer, and any period in which an appeal of the rejection is being considered, cannot attach or levy assets. Although only 35% of all offers in compromise are accepted by the IRS, if for no other reason, the offer and compromise can buy valuable time to the taxpayer looking to raise funds to pay the tax liabilities before getting assets attached, levied or seized.