The realities about the IRS offer in compromise program
OIC acceptance is rare. Here's why.
April 28, 2014
Television and radio are filled with ads claiming that taxpayers can settle their tax balances owed to the IRS. This settlement program is known as the IRS offer in compromise (OIC). Clients who can’t pay their taxes may inquire about this overhyped settlement option; however, according to IRS statistics, it is highly unlikely that most taxpayers who have outstanding balances will have an OIC accepted.
The Government Accountability Office reported that in 2010 more than 16 million taxpayers owed taxes to the IRS, and these numbers have continued to increase. In 2013, despite the millions of taxpayers with debt, the IRS approved only 31,000 OIC applications. In contrast, the IRS had almost 4 million installment agreements in effect in 2013 for taxpayers to repay their balances.
OIC acceptance is rare for two main reasons: Either the taxpayer does not qualify for an OIC or, if the taxpayer does qualify, he or she can’t pay the offer amount.
Does your client qualify for an OIC?
The reality is, OIC qualification is based on a computation of the taxpayer’s ability to pay his or her tax debt before the IRS runs out of time to collect the debt (called the collection statute expiration date). Contrary to popular perception, the IRS decision is not largely subjective and is instead based on computational formulas. That is why IRS.gov features an OIC Pre-qualifier tool.
To qualify for an OIC, your client must prove that he or she can’t pay the total balances owed before the collection statute expires, using net equity in assets plus any future income. The IRS calculates future income as the amount it can collect on a monthly basis (monthly disposable income) before the collection statute expires.
Although the qualification formula is objective, the components of the computation of net equity in assets and monthly disposable income are often the subject of much debate and confusion. However, once the ability to pay amount is determined, the computation results are clear: Either your client cannot pay the taxes owed and qualifies for an OIC, or your client can pay the taxes owed and does not qualify.
However, qualifying for an OIC does not mean your client will obtain an OIC. To obtain an OIC, your client must be able to pay the offer amount, which is the computed amount required to be paid to the IRS to settle the debt.
Can your client pay the OIC offer amount?
The formula used to compute the offer amount differs from the formula used to determine qualification. The qualification formula and offer amount formulas use the same computation for net equity in assets. However, the offer amount formula requires only 12 or 24 months of future income, rather than the full amount that the IRS could collect before the collection statute expires.
When calculating the offer amount, it is imperative to conduct complete due diligence. In taxpayers’ initial calculations, they often find that the offer amount is too high to consider an OIC as a viable option. In addition, during the IRS’s OIC investigation process, taxpayers may discover that they incorrectly computed net equity in assets and monthly disposable income, resulting in an offer amount that is much larger than expected and too much to pay to settle the taxes owed. Tax professionals should exercise great care and diligence in properly computing the OIC's financial components to avoid a potentially costly, long investigation process when there might be a better alternative, such as currently not collectible status or an installment agreement.
Qualification and offer amount illustrated
To illustrate how the OIC qualification and offer amounts are computed, let’s assume the following facts:
In this example, the taxpayer chooses the lump-sum OIC payment option, which uses a future income multiplier of 12 months. (There is also a periodic payment option that uses a future income multiplier of 24 months.) For this example, the qualification and offer amount are computed as follows:
In this example, the taxpayer qualifies for an OIC, because the amount that the taxpayer can pay before the collection statute expires ($41,000) is less than the tax owed ($50,000). The offer amount that would be required to be paid to settle all liabilities is $11,000. This example illustrates the benefits of the OIC program for taxpayers who qualify. To provide the taxpayer with a fresh start, the Treasury Department would accept $30,000 less in payments than it could otherwise receive.
2011 IRS Fresh Start Initiative
While the number of OICs accepted is small compared with the number of taxpayers who have outstanding balances, more taxpayers are qualifying for and obtaining OICs due to the 2011 IRS Fresh Start Initiative, which softened qualification criteria and allowed for lower offer amounts.
Prior to Fresh Start, the offer amount calculation generally produced a larger settlement payment because the future income multiplier was significantly larger. In our example above, the taxpayer’s offer amount was $11,000 under Fresh Start rules. Under pre-Fresh Start rules, the same taxpayer would have had an offer amount of $29,000 – $18,000 more – because the future income multiplier would have been 48 months, instead of 12 months.
IRS data show much of the impact of Fresh Start changes: In 2013, the IRS received 30% more OIC applications compared with 2010, and the acceptance rate for OICs increased to 42%, up from 25% in 2010.
Do your due diligence first
An OIC should be considered when your client clearly has a financial hardship and there is no possibility that he or she will be able to pay the taxes in full before the collection statute expires. The qualification and offer amount computations are fairly straightforward and can easily answer your client’s questions about whether he or she should pursue an OIC.
However, determining your clients’ net equity in assets and ability to pay can be complicated. Closely examine your client’s financial situation before you conclude that he or she qualifies and can obtain an OIC. Your client may be better off with a more suitable collection alternative, such as currently not collectible status or an installment agreement.
Jim Buttonow, CPA/CITP, is a software executive and instructor in the field of tax controversy. He has more than 26 years of experience in IRS practice and procedure.