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Could An Offer In Compromise Help You Settle Your Tax Debts?

by Ian Wallace

Tax debt is a common problem in the United States. In 2009, the Internal Revenue Service (IRS) estimated that 8.2 million Americans each owed an average of $10,000 in unpaid taxes, penalties or interest. Unpaid tax can lead to serious penalties, so it's unsurprising that so many people take out loans to cover these debts. Nonetheless, before you take out a loan to pay off a tax debt, consider other ways to relieve yourself of this financial burden. Find out how an offer in compromise could work for you.

IRS policy on debt

To make sure people pay their taxes, the IRS generally takes a strict stance on unpaid debts. The IRS has more legal power than other debtors. If you don't pay your taxes voluntarily, the IRS can quickly take enforcement action, which can ultimately lead to the seizure and loss of your property.

Nonetheless, the IRS is also a relatively pragmatic debtor. In nearly all cases, it's better for the IRS if taxpayers settle their debts voluntarily. As such, if there's a good reason you cannot pay the taxes you owe, the IRS will sometimes accept an offer in compromise.

How an offer in compromise works

An offer in compromise (OIC) is a legal agreement between you and the IRS, which allows you to pay off your debt at a heavily discounted rate. The terms of an OIC can vary considerably between debtors, but some people have arranged a discount of as much as 99 per cent of the original debt. The IRS must consider every OIC submitted, but many debtors fail to meet the criteria for these arrangements.

To arrange an OIC, you must fill out IRS Form 656, which also includes an application fee. Within the application, you must answer questions about your ability to pay, your income and other expenses you have to pay. The IRS will also want to know about any assets or property you own. As part of the application, you must also decide if you want to pay the discounted amount in installments or as a lump sum.

Situations when the IRS will accept your application

The IRS doesn't accept every application, but the strength of your application normally relies on two criteria. These are:

  • The net realizable equity of your assets (NRE)
  • The reasonable collection potential of your debt (RCP)

In simple terms, these criteria help the IRS decide if it's likely they will get their money if they take enforcement action against you. If you can show 'doubt as to collectibility', the IRS may accept your application. Similarly, if you can prove that repayment would cause your family serious economic hardship, the IRS may also accept your OIC offer.

You can use the IRS online pre-qualifier to quickly find out if you are eligible to apply for an OIC. By answering a few questions, you may immediately realize that you won't meet the requirements. For example, you cannot apply for an OIC if you are in an open bankruptcy proceeding.

Things to consider before you apply for an OIC

If the repayment of your tax debts would cause serious problems, the OIC process could offer a valuable lifeline. An OIC offer must equal the realizable value of your assets plus any money the IRS could make from your future income. As such, if you don't own property and you don't have a job, an OIC could drastically cut your debts.

However, one thing you should remember is that the IRS will often wait a long time to collect taxes. As such, even if you don't have a job at this time, the IRS may decide to decline the OIC if there is evidence that you stand a good chance of receiving a reasonable income in the near future.

As such, it's always sensible to get financial advice before you submit an OIC application. The application process is normally time-consuming and relies on a lot of paperwork and form filling. Once you hand over the information, if the IRS declines your application, it's likely to become much harder for you to fight enforcement action.

While your application is under review, the IRS will suspend collection services, but interest and penalty charges can still add to your debt. You may still also receive a Notice of Federal Tax Lien, which means enforcement action can start immediately if the IRS declines your offer.

An offer in compromise could help you settle unpaid tax debts, but it's seldom easy to get the IRS to agree to these arrangements. Nonetheless, before you take out a loan to pay off a tax debt, seek professional financial advice from a tax service like Capital Accounting And Tax Service Inc, and find out if an offer in compromise could help you.