Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Offer in Compromise

What it is:

An offer in compromise is an arrangement between a taxpayer and a taxing authority, whereby the taxing authority agrees to let a taxpayer settle a tax debt for less than the full amount.

How it works (Example):

For example, let's say John owes the IRS $40,000 in back taxes. He can't pay it. To make an offer in compromise, he files IRS Form 656-B and Form 433-A, and he remits the application fee and initial payment to the IRS. The IRS evaluates the forms, as well as John's income, assets, expenses, and ability to pay. Then it either accepts or rejects John's offer in compromise.

Generally, offers in compromise take one of two forms:

1. The taxpayer pays 20% of the total offer amount with his application, then, if the IRS accepts the offer, the taxpayer pays the rest in five or fewer payments.

2. The taxpayer makes an initial payment and then makes monthly payments while the IRS considers the offer. If the IRS accepts the offer, the taxpayer continues making monthly payments until the agreed-upon balance is paid in full.

If the IRS accepts the offer in compromise, John must agree to other terms, including filing all required tax returns and making all payments, applying any current tax refunds to his tax debt, and obtaining the release of any federal tax liens after doing so. John must also promise to comply with tax laws for at least five years. If the IRS does not accept John's offer in compromise, he can appeal the rejection within 30 days.

The IRS has two years to accept or reject John's offer. If it takes longer than that, the offer is automatically accepted.

Why it Matters:

An offer in compromise is an attempt to settle a tax debt, though the term is also used in cases where a borrower is attempting to settle a loan balance.

Generally, the government accepts an offer in compromise when it doubts that it can collect the full amount of a tax liability from a taxpayer in a reasonable time. One measure it uses, called reasonable collection potential (RCP), equals the value of the taxpayer's assets plus four or more years of future income less reasonable living expenses.

According to the Taxpayer Advocate Service 2010 Annual Report to Congress, the IRS accepts roughly one offer for every 290 taxpayers with delinquent accounts. While the IRS is considering an offer in compromise, it suspends collection activities and extends the legal assessment and collection period.

It is important to note that certain information about offers in compromise is public record, meaning that the general public can access some information about any individual's offer in compromise activities with the IRS. Taxpayers who are in open bankruptcy proceedings are not eligible to make offers in compromise, and the IRS will not accept an offer in compromise unless it is clear that the taxpayer has complied with all current filing requirements.