If a taxpayer has a tax obligation that he does not believe he will be able to pay in full, he can propose what is known as an Offer in Compromise (OIC). An OIC allows the taxpayer to make a lump sum or installment payments that total less than the full amount of the tax obligation. The requirements for an acceptable OIC are very stringent, and once an OIC is accepted, the taxpayer must live up to the terms of the agreement or risk having the agreement canceled.

Offer In Compromise Defined

There are three circumstances in which a taxpayer is eligible to file an application for an OIC: if there is reasonable doubt that the taxpayer could ever pay the entire amount, if there is reasonable doubt that the taxpayer is liable for the disputed amount or the taxpayer can demonstrate exceptional circumstances, such as extremely high medical bills. Low-income taxpayers and taxpayers with extraordinary expenses stand the best chance of having an OIC approved by the IRS. The IRS website in December 2009 cited an example of a couple who was responsible for the custodial care of a child with a serious long-term illness as qualifying under the extraordinary circumstances standard.

Application Process for the OIC

The taxpayer must calculate what he believes he can reasonably pay toward the tax obligation. Once the calculations have been made, the taxpayer must file the proper paperwork, contained in the package or Form 656-B. In most cases, the taxpayer must include a payment for processing the form (150 in 2009) as well as either 20 percent of a proposed lump sum payment or the first installment of an installment payment proposal. The fee and the payment are nonrefundable whether the IRS accepts the OIC or not. Low-income taxpayers can file a request for exemption from the filing fee and from the requirement to post a payment along with the application for the OIC. Taxpayers who file an offer in compromise because of doubt of liability are exempt from filing fees with the OIC.

Consideration and Acceptance of the OIC

While the OIC is being considered, the taxpayer is not liable for installment payments which are applicable to the outstanding balance covered in the OIC. However, tax liens are not released by an OIC; release only occurs once the lien is paid or the terms of the OIC are completely satisfied, whichever comes first. The taxpayer should make full payment for any taxes that become due during the period the OIC is under consideration and if it is ultimately accepted. If the OIC is accepted, the taxpayer must remain current on tax payments for five years after the date of the agreement, or until the terms of the agreement are fulfilled, whichever is later. If an OIC is not withdrawn, returned or rejected within 24 months of the IRS receipt date, it will be ruled as "accepted."

Source:

IRSgov: What You Must Know Before You File an Offer in Compromise

IRS.gov: What is an Offer in Compromise?

IRS.gov: Do You Qualify for an Offer in Compromise?

Resource:

IRS.gov: How to File an Offer in Compromise

IRS.gov: IRS Issues New Form 656 Booklet and Revised Offer in Compromise Form