Federal taxes are unavoidable. You pay taxes on your income, your bank account interest, investment account earnings, some types of forgiven student loans, and loads of other assets and wealth.
Some borrowers cannot afford the taxes they owe, so they end up with unpaid federal tax debt. If you’re facing a tax debt you can’t pay back, you might qualify for a program that lets you pay back only part of what you owe. It’s called Offer in Compromise.
Below, we’ll explain more about Offer in Compromise, who qualifies, and why student loan borrowers should know about it.
What is an Offer in Compromise?
The Offer in Compromise (OIC) program is run by the Internal Revenue Service (IRS). It permits an approved taxpayer to negotiate a settlement for unpaid tax debt. In other words, it lets qualified individuals pay less than what they owe in taxes, and in return, the IRS considers it paid-in-full.
This debt forgiveness program offers borrowers reprieve from tax debts that are often far out of proportion with their income.
What is Unpaid Tax Debt?
Tax debt is taxes you owe the IRS after the filing deadline has passed. You might make a partial payment when you file, but if you don’t pay the full amount before the deadline passes, the amount left over is your tax debt.
Sometimes you have tax debt accidentally because you forgot to send in your final payment. In other cases, you might have tax debt because you knowingly did not or could not pay what you owe.
A few circumstances that can leave people with an unexpected tax bill they cannot afford include:
- You had federal student loans forgiven and owe taxes on the amount forgiven t
- Your employer wasn’t withholding the correct amount of your paycheck
- You’re self-employed and forgot to withhold taxes or didn’t do it correctly
- You took credits, exemptions, or deductions that you weren’t qualified to claim
How to Reduce Your IRS Tax Bill with an Offer in Compromise
Anyone with unpaid tax debt can apply for an Offer in Compromise, but for your best shot at success, you should follow these steps:
1. File Your Past Tax Returns
The IRS only approves offer in compromise requests from individuals who have filed all of their previous tax returns. Filing your past tax returns doesn’t guarantee you’ll be approved, but it’s a necessary step for a shot at success.
You’re able to go back and file past returns whenever you want, so make sure you do that before applying.
2. Check Your Financial Eligibility
The OIC program is a type of debt forgiveness program designed for individuals in difficult financial circumstances. It’s on you to prove that repaying your taxes in full is a) not possible based on your current financial situation or b) doing so would create a financial hardship. Paperwork you might need to submit includes copies of bills, proof of income, bank account statements, and an overview of your assets.
Taxpayers in the middle of an IRS audit or in bankruptcy will not qualify for the OIC program.
3. Check Estimated Tax Liability if You’re Self-Employed
Self-employed taxpayers like babysitters, freelancers, small business owners, or anyone else who makes estimated tax payments need to make sure they’re caught up on those payments. The IRS will not settle with someone who’s behind on the current year’s estimated tax payments.
Fortunately, you can catch up on those quarterly estimated payments at any time. You just might need to pay a late fee.
4. Complete the Offer In Compromise Pre-Qualifier Assessment
The IRS’ website hosts an OIC pre-qualifier tool that helps you determine your eligibility. It’s only a guide, so the results are not guaranteed. When evaluating your application, the IRS considers your completed OIC application and their own investigation into your situation.
If the tool states that you can afford to pay the total tax liability in full, you’re still able to apply for an OIC. You’ll have the chance to discuss your situation with the IRS to help inform the investigation side of their application review process.
The tool also prepares a preliminary proposal, suggesting how much the IRS thinks you can afford to repay. This is usually a good number to use in your offer in compromise application, but you do not have to use this number. However, the number you submit should be in line with your ability to pay and has to be more than $0.
5. Submit the Application Yourself or with a Tax Professional
Now it’s time to submit your official Offer in Compromise application. You can file the application on your own, or you can enlist a qualified tax professional to assist you. That’s entirely up to you and your comfort level and confidence with tax-related paperwork.
The official Offer in Compromise application is in IRS Form 656 Booklet. You will need to fill out the application in its entirety and follow all directions to avoid having your application automatically rejected by the IRS.
Your finalized application should include:
- Form 433-A (OIC) (individuals) or 433-B (OIC) (businesses) plus all required documents
- Form 656(s) – individual and business tax debt
- $205 non-refundable application fee
- Initial payment for each Form 656
When you fill out the offer in compromise application, you will choose between two different payment options. The initial payment is based on the option you select.
Lump-Sum Cash: Send in 20% of the total offer as an initial payment with your application. If the IRS accepts your offer, you’ll receive a letter in the mail. Then, you will need to pay the remaining balance from your approved offer in 5 or fewer payments.
Periodic Payment: Send in the initial payment with your application. Keep making monthly installment payments while the IRS evaluates your offer. If the IRS accepts your offer, you will make monthly payments until you’ve paid off the settlement amount in full.
Payment Exceptions for Low-Income Individuals
If you meet low-income certification guidelines, you do not have to pay the application fee or send in any initial payments or pay any monthly installments while your offer is being evaluated.
One of the forms in the Form 656 Booklet outlines the criteria for low-income certification. It’s based on your income, your family size, and your location.
What Happens After I Submit My Offer in Compromise?
The IRS will review your application and complete an investigation.
While the IRS is reviewing your offer, the following actions happen:
- Any payments and the application fee are applied to your tax liability
- The IRS might file a Notice of Federal Tax Lien
- Other collection efforts are suspended
- Legal assessment and collection period is extended
During this time, you should:
- Make all required payments relating to your offer in compromise
- Continue paying any required quarterly estimated tax payments for the current tax year
- Stop making payments on an existing installment plan
When I Will I Know if My Offer in Compromise is Accepted?
On average, the IRS takes six months to either accept or reject your offer in compromise. If your situation is complicated, it could take a lot longer. However, if you do not hear back within two years of the IRS receiving your offer, it is automatically accepted.
If your offer is accepted, you will then follow the Offer Terms and continue to make payments until you’ve paid off the settlement amount in full.
What if My Offer in Compromise Gets Rejected?
Unfortunately, most offer in compromise applications get rejected by the IRS. In 2015, the IRS only accepted 27,000 offers out of 67,000 offers.
When your offer gets rejected, it’s because you didn’t follow the steps above and/or the IRS deemed that you’re financially able to pay back the full amount of taxes you owe.
You are allowed to appeal the decision within 30 days using the Request for Appeal of Offer in Compromise, Form 13711. Get help with repealing your rejected offer from the IRS Independent Office of Appeals.
A Word of Caution Regarding Offer in Compromise
When you submit an offer in compromise, you must provide the IRS with detailed information about your income, expenses, assets, bank account balances, and other financials. The IRS keeps that info on file indefinitely and can use that information to inform future collections activity against you. It’s a risk worth considering, especially if the pre-qualifier tool estimated that your offer in compromise will not be accepted.
What Does an Offer in Compromise Have to Do With Student Loans?
After 20 to 25 years on an income-based repayment plan, federal student loan borrowers are eligible to have their qualifying federal student loans forgiven.
Unfortunately, that doesn’t mean you’re free and clear. Under current rules, the forgiven amount is seen as taxable income by the IRS. The borrower must pay income taxes on the forgiven amount the same way they pay taxes on money earned at work.
For many borrowers, the tax bill is just as burdensome as having student loans. They cannot afford the tax bill, so it becomes an unpaid tax debt. An Offer in Compromise may be able to provide much-needed relief to those individuals by letting them settle the tax debt for far less than what they owe.