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How to Settle Tax Debt

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If you owe taxes to the IRS, you tend to receive a lot of unsolicited advice from friends, complete strangers, cold callers, mailings, and the internet. Sometimes that advice is to file an Offer in Compromise, and to settle your tax debt for “Pennies on the dollar.” But how can you know if an Offer in Compromise is even an option for you?

First, it is important to understand what an Offer in Compromise is. The IRS and most state taxing agencies have provisions for the settlement of a tax debt. Generally, the authorities will settle a tax debt when the taxpayer can demonstrate that they will experience an economic hardship if they are required to repay the entire balance, including all the penalty and interest additions. The process for a taxpayer to prove the anticipated hardship is referred to by the IRS and most states as an Offer in Compromise. In other jurisdictions, it can be called a Settlement Offer, or some other name, but the objective for the taxpayer remains the same: to prove that your financial condition prevents you from repaying the entirety of the debt.

The first step toward filing an Offer in Compromise is to determine whether you are eligible for the taxing authority to consider settling with you. There are two major threshold issues that need to be addressed before a taxpayer is eligible for consideration of an Offer in Compromise: filing compliance, and deposit compliance.

Filing compliance requires that all tax returns have been filed, up to the most recent tax period. If you have returns that are still not filed, the taxing authorities will not even consider a settlement via Offer in Compromise. Deposit compliance means that you are making all required tax deposits in full and on time. The authorities will not settle a tax debt when there is a possibility that additional debt will be assessed on the next return that is filed. Deposit compliance includes sufficient withholding from wages and required quarterly estimated tax deposits for individuals, and timely deposits toward all tax obligations for businesses. A new accrual during the Offer in Compromise process, or after an Offer in Compromise has been accepted, will result in the rejection or default of the Offer in Compromise, so the taxing authorities are very serious about stopping the non-compliance before considering a settlement.

Once a taxpayer is in filing and deposit compliance, the next step toward filing an Offer in Compromise is to determine which forms and financial statements are required. For the IRS, Form 656 must be submitted to specify the tax periods you wish to settle, along with the dollar amount being proposed for the settlement, and the manner in which the Offer in Compromise will be funded.

States have similar forms to the 656, serving the same purpose, but the naming and numbering of those forms varies. Importantly, an incomplete, or incorrectly completed Form 656, or its state equivalent, can cause the taxing authority to return the Offer in Compromise without appeal rights or any further consideration. The return of an Offer in Compromise will require that you re-file, with a new form, and updated financial information. This can be extremely inconvenient, as often the return of the Offer in Compromise will occur several months after the initial filing.

The Offer in Compromise amount is determined by the financial statement (and supporting documentation proving its accuracy). For the IRS, businesses must submit a completed 433B-OIC, and individuals use Form 433A-OIC. Again, states all have similar financial statement forms, going by other names and form numbers.

The financial statement is a complete summary of the taxpayer’s financial condition. It requires disclosure of all identifying information for the taxpayer, assets owned, liabilities owed, available credit, income, and necessary expenses. Accompanying the financial statement, you must submit documentation to verify the information relayed. For each item on the financial statement, a verification document is required.

The verification consists of bank statements for the past several months, loan statements for any claimed loan or liability, statements for credit cards or lines of credit, pay subs, dividend or officer draw summaries, profit and loss statements, statements of cash flows, invoices, bills, and any other document to verify the information claimed on the financial statement. Often, the preparation of the financial statement, and the gathering of the verification documents is the most daunting and time-consuming aspect of preparation of the Offer in Compromise. Diligence and accuracy are important though, because the taxing authorities will do independent research, and any missing or incorrect information on the financial statement can seriously diminish the chances that the settlement will be accepted.

With the completed financial statement, and all verification documents prepared, you can now calculate how much to offer to settle the debt. State rules vary, but the IRS requires that you offer your “Net Realizable Equity in Assets” plus your “Expected Future Income” in an Offer in Compromise. Net Realizable Equity for liquid assets is the value of the asset. Net Realizable Equity for non-liquid assets is “Quick Sale Value” of the assets, or eighty percent of Fair Market Value, minus any secured senior loans.

For example, if your house is worth $200,000, and you have a mortgage balance of $150,000, your Net Realizable Equity is $10,000 ($200,000 x 0.8 = $160,000 – $150,000 = $10,000.) There is no Quick Sale Value reduction for liquid assets, like funds in bank checking and savings accounts, whole life insurance policies, or retirement or investment accounts. Those liquid assets must either be used, or they will increase the amount you have to Offer to settle your tax debt. For that reason, if you have liquid assets, you should consider using them to hire a professional to assist with the filing and negotiation of the Offer in Compromise. After all, those funds are either going to the taxing authority or to hiring a tax professional, so why not use them to increase the chances of a lower amount being accepted?

Expected future income is your recent, verifiable income, minus your allowable living expenses, leading to a net available income. That net available income must then be multiplied by twelve for a “Lump Sum” payment Offer in Compromise, or by twenty-four for a “Periodic Payment” Offer in Compromise. Add the Net Realizable Equity to the Expected Future Income to arrive at the total amount to offer to settle the debt.

Once you have determined how much to offer, you next must decide how you prefer to fund the Offer in Compromise. A Lump Sum Offer in Compromise requires a down payment of twenty percent of the offered amount at the time of submittal, with the remaining eighty percent payable within five months of the Offer in Compromise being accepted. A Periodic Payment Offer in Compromise, on the other hand, requires you to divide the total offered amount by twenty-four, and then make two years of monthly payments toward the offered amount, starting when the Offer in Compromise is submitted.

State rules about funding settlements are not the same as the IRS, with some states requiring down payments, many states not offering a periodic payment option, and some states allowing more than two years of monthly payments to fund the Offer in Compromise amount.

After cleaning up filing and deposit compliance, preparing the financial statement, gathering the required supporting documentation, calculating the amount to offer, and deciding how to fund the Offer in Compromise, you are ready to submit the Offer in Compromise to the taxing authority. For the IRS, there is an application fee, which must be included with the filing, along with the down payment or initial monthly payment. The entire packet is mailed to the taxing authority, according to instructions in the 656 or state Offer in Compromise form. Then, you wait (and obey all tax laws).

Most taxing authorities have internal rules about how soon they are required to respond to an Offer in Compromise. The IRS, for example, has a rule that, if a final determination has not been made on an Offer in Compromise within two years from the date of submission, then the Offer in Compromise is accepted by default. They rarely miss their deadline to respond. However, it will be a long wait before any further substantive negotiations happen after the Offer in Compromise is submitted. I tell my clients to be prepared to wait between six and twelve months for a response from the IRS. Most states are quicker to respond. We typically receive a letter confirming receipt of the Offer in Compromise within about two months.

Eventually, your Offer in Compromise will be assigned to a human being to review, research, and respond to your offer. Make no mistake, this individual’s main goal is to find a reason to return or reject your Offer in Compromise. Almost without exception, the first response you receive from the Offer Specialist will be a threat to reject the Offer. Do not be deterred. My theory is that the taxing authorities always threaten rejection on the first contact, because many less-knowledgeable taxpayers will give up at that point. If you persist, you will have the opportunity to request information about the Offer Specialist’s calculations, and to respond to those calculations with counterarguments. Ultimately, even if the Offer Specialist cannot be convinced to accept the Offer as submitted, you can elicit a counteroffer.

At this stage in the negotiation, the Offer Specialist should provide you with an Asset and Equity Table, and an Income and Expense Table, detailing their calculations of an acceptable Offer amount. They may not volunteer the Tables, so it is important to know to request it. Typically, the Tables will show that the Offer Specialist has overvalued assets, overstated income, disallowed legitimate expenses, and generally worked the financial numbers to either reject the Offer outright, or to allow the highest possible acceptable Offer amount.

I routinely work with my clients to shred the Offer Specialist’s Tables, and show where they miscalculated, why their assumptions and research were incorrect, and respond with a well-reasoned, verified rebuttal to the Tables. This is why it will save you money to involve a competent tax professional in your Offer in Compromise. You may not recognize the common tricks employed by Offer Specialists, but we do.

If, ultimately, the taxpayer and the Offer Specialist cannot agree to acceptable Offer in Compromise terms, then the Offer in Compromise will be rejected. The IRS grants a right to appeal the rejection of an Offer in Compromise, but most states do not. If you appeal the rejection of the Offer in Compromise, you will have the opportunity to negotiate with an Appeals Officer.

If the Offer in Compromise is accepted, the taxpayer will be required to fund the settlement according to the schedule proposed in the original submittal. Failure to fund the Offer in Compromise as agreed can lead to a default of the Offer in Compromise. Similarly, the accrual of a new liability, or the failure to follow the tax laws for five years after acceptance will lead to a default. If the Offer in Compromise defaults, the entire original debt will be reinstated, including all penalty and interest accruals that occurred subsequent to acceptance.

As you can see, there are many steps to preparing, submitting, and negotiating an Offer in Compromise. Any mistake at any step can result in the return, rejection, or default of the Offer in Compromise. The IRS will tell you that the percentage of Offers in Compromise that are accepted is about 30% for these reasons. I would speculate that many of the 70% of rejected Offers in Compromise were filed by the taxpayers themselves, without competent representation by a tax professional.

Those Offers in Compromise take just as long for the taxing authorities to process. That can lead to a taxpayer wasting months, or even years, on a single, or a series of Offers in Compromise that had no chance of being accepted. During the time that those hopeless Offers in Compromise are pending, the taxing authorities are continuing to add penalties and interest to the tax debts. In the end, that time has been wasted, and the debt has only grown.

However, I would venture to say that my colleagues and I at Fortress Tax Relief have well over double the national acceptance rate for Offers in Compromise (and a large percentage of the ones we file that are rejected are rejected due to our clients’ inability to remain compliant with the tax laws).

There are several reasons why we crush the national average. First, we do not waste time by filing OIC’s that we know have little chance of being accepted. Second, we take charge of the settlement process and typically snuff out Offer-killing problems before they surface. Third, we know how to identify government findings in terms of income, allowable expense, and net realizable equity in assets that are erroneous and/or unfavorable to our clients. And lastly, and perhaps most importantly, we know how to challenge those unfavorable findings and win.

If you would like to know whether you qualify for an Offer in Compromise (tax settlement), pick up the phone and give Fortress Tax Relief a call. We have caring and knowledgeable professionals on staff who would be happy to answer any questions you may have and to outline a solution tailored to your specific needs and circumstances. There is no charge for a telephone consultation, so give us a call today!

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