The IRS can also accept an OIC if there is doubt as to liability or based on effective tax administration when paying the liability in full would create an economic hardship or there are exceptional circumstances that would make paying in full unfair and inequitable. The OIC program gets a lot of hype in the press and media, but it is rarely used. In 2019, of 20 million taxpayers who owed the IRS $539 billion in back taxes, only 54,225 OICs were received and only 17,890 were successful in “settling” their tax debt.
Why do so few get an OIC?
First, most applicants may not qualify. They may have equity in assets or future income that can pay their tax liability before the IRS collection statute expires (generally 10 years from the date the tax is assessed). For example, a taxpayer can pay their liability if they owe the IRS $20,000 in tax debt and have a retirement account with a balance of $50,000. The IRS will not settle with this solvent taxpayer unless the taxpayer has special circumstances.
Second, it may be “cost-prohibitive” to settle. This means the taxpayer may not be able to fund the OIC settlement.
On March 12, 2020, final regulations were released that increased the OIC user fee from $186 to $205 (effective for OIC applications submitted after 4/27/2020). While a 10% increase may seem like a lot, it’s only a small part of the potential cost of an OIC. The user fee usually does not prohibit many from applying for an OIC. The real cost is how much is needed to settle the tax bill. This amount is called the “offer amount” and represents a calculation of how much the IRS will accept to settle a tax bill.
Third, taxpayers will not qualify for an OIC unless they have filed all tax returns and made all required estimated tax payments for the current year, if applicable. To qualify, business owners with employees must have made all required federal tax deposits for the current quarter. In addition, taxpayers with an open bankruptcy cannot apply for an OIC.
The real cost: the offer amount
Most people believe that the IRS haggles with the taxpayer about how much it will take to settle the tax bill. Some believe that the IRS will just take a percentage of the bill or waive penalties and interest in a settlement. These are all myths.
If a taxpayer qualifies for an OIC, they will then determine how much to offer the IRS. The “offer amount” in an OIC is the amount the IRS will reasonably collect from the taxpayer before the statute to collect expires. This is their “Reasonable Collection Potential” (RCP). RCP is a formula of how much the IRS will accept to settle a tax lability. RCP is equal to the taxpayer’s “net realizable equity” (NRE) in their assets, plus a component of their future monthly disposable income (usually 12 or 24 months) depending on the type of OIC payment method.
An illustration of the OIC settlement amount
Let’s use a simple example to illustrate offer amount calculation. First, assume that a taxpayer owes $50,000 for 2016 (also assume that the IRS has 100 months left on the statute of limitations to collect), and has a NRE in assets and future income as follows:
NRE in assets (only asset is the home): $10,000
- Home that is owned with a mortgage:
- Fair market value of $150,000
- Value of home at “quick sale value” (QSV) of 80% = $120,000 (IRS rule that values asset sales at (QSV))
- Loan of $110,000
- NRE: $120,000 (QSV) less $110,000 (loan) = $10,000
Future monthly disposable income (MDI): $200 a month
- Two earners, with allowable IRS living expenses (subject to limits placed on a taxpayer by the IRS Collection Financial Standards):
- Monthly average gross income: $6,000
- Monthly average necessary living expenses and expenses to produce income, limited by IRS Collection Financial Standards: $5,800 (for categories such as: food/clothing/misc.; housing/utilities; transportation expenses; medical expenses; and other, such as taxes paid, health insurance, term life insurance, child care costs, court-ordered payments, etc.)
- MDI: $6,000 (average gross income per month) less $5,800 (average necessary living expenses per month) = $200
First–does the taxpayer qualify for an OIC? In this case, the taxpayer qualifies for an OIC. The taxpayer has $10,000 in NRE and $200 in MDI–both of which will not pay the IRS in full before the collection statute expires.
Here is the computation that shows that they qualify: the taxpayer’s total “ability to pay” the IRS before the collection statute expires is equal to $10,000 (equity) plus the amount it could collect from the taxpayer in monthly payments ($200 a month in MDI for 100 months or $20,000), before the collection statute expires or $30,000 in total. The $30,000 is less than the $50,000 total amount owed, so the IRS will not collect the tax liability owed in full before the collection statute expires. Essentially, $50,000 owed less $30,000 ability to pay leaves the IRS to write-off $20,000 at the end of the statute.
Next–the offer amount. The taxpayer will not be asked to pay $30,000 but instead, a computation of the NRE plus a future multiplier of MDI. The future multiplier of MDI will depend on the payment option that the taxpayer chooses. A taxpayer can either choose to pay the offer amount through a lump sum cash offer, an offer payable in 5 or fewer installments within 5 months after the offer is accepted, or through a periodic payment offer, an offer payable in 6 or more monthly installments over 24 months. If the taxpayer elects to pay the IRS through the lump sum cash offer method, they will use 12 months as the future income multiplier. The future income multiplier is 24 months if the taxpayer uses the periodic payment offer method.
Using the lump sum cash offer, the “offer amount” is computed as $12,400 ($10,000 in NRE plus $2,400 or $200 MDI for 12 months). If the taxpayer can prove to the IRS that their NRE is $10,000 and their MDI is $200 a month, they can settle their $50,000 tax bill for $12,400. A tip: NRE and MDI calculations incorporate many complicated rules which must be followed to correctly compute OIC qualification and the offer amount. Taxpayers who miss these calculations may find out that they do not qualify or have a higher offer amount that they cannot pay in the future.
The real cost, as illustrated in our example, is the “offer amount.” Can the taxpayer pay $12,400 to settle their tax bill? The reality is many cannot and therefore cannot use the OIC program.
Furthermore, there are two upfront cost when submitting an OIC to the IRS for acceptance: the $205 user fee and a partial payment of the offer amount. Unless the taxpayer qualifies as a low-income taxpayer, they will need to be able to pay some of the OIC before it is approved. Any upfront payment is non-refundable.
Upfront OIC Costs
Besides the user fee of $205, the IRS will require the taxpayer to pay part of the OIC offer amount with the application. If the taxpayer selects the lump sum payment method, the IRS will request 20% of the offer amount. In our example, that would be 20% of $12,400 ($2,480).
If the taxpayer elects the periodic payment method, they will have to make monthly payments while the offer is being reviewed by the IRS. Most OICs are taking between 7-12 months, which means the taxpayer can send 7-12 months of payments to the IRS while the OIC is being considered. These payments can be considerable and there is no guaranteed assurance that the IRS will accept the OIC. In fact, in 2019, only 1 out of 3 OIC applications were approved.
OIC costs do not end there. Taxpayers must forfeit their next tax refund if their OIC is accepted. They may also have to pay fees to a tax professional. If an appeal is involved (15% of OIC applications go to IRS appeals to settle disagreements in the application), you can add more costs to the equation.
All in all, if the taxpayer is not absolutely sure that their OIC will be approved with their proposed offer amount, the OIC can be an expensive and unworkable solution.
Other viable alternatives
Low-income taxpayers do not have an OIC user fee or down payment and generally do not have a significant financial outlay when submitting an OIC.1 The IRS defines low-income taxpayers as taxpayers who are 250% or below the poverty level for their family size and income. IRS Form 656 (the OIC application) provides these income threshold amounts. Taxpayers who meet the low-income criteria still need to be able to pay the offer amount over the agreed period when the OIC is approved.
Taxpayers have other IRS collection alternatives, Currently Not Collectible (CNC) status and installment agreements, including a Partial Pay Installment Agreement (PPIA). CNC status means that the taxpayer has no monthly disposable income to pay the IRS. PPIA means that the taxpayer can pay the IRS monthly, but will not be able to pay the total tax bill before the collection statute expires.
CNC and PPIA can be better options than an OIC because these agreements do not always require that the taxpayer pay the IRS from equity in assets. Taxpayers in financial hardship will not be asked to utilize equity (i.e. equity in a home, savings) if they need the funds to pay for living expenses or are unable to access said equity (i.e. the bank will not give a home equity loan to the taxpayer). The CNC and PPIA are often more realistic options for taxpayers.
If the taxpayer qualifies, both of these agreements can be more financially beneficial than the OIC. However, both CNC and the PPIA are temporary agreements with the IRS. If the taxpayer’s financial condition improves before the collection statute expires, the IRS can ask to renegotiate these terms.
A last tip
Taxpayers should not just look to the OIC as their only collection solution. Taxpayers facing tax debt should consider all IRS collection alternatives. Taxpayers should also consider contesting any balances owed, including penalties, if they are faced with full payment as the only option.
The best approach is to evaluate your tax situation, your personal finances, and IRS collection alternatives, then develop the best approach to pay the least amount owed. Focusing only on the OIC may lead to an expensive miss and leave your tax debt problem unresolved. For assistance creating a strategy to address your tax issue, visit Jackson Hewitt’s Tax Resolution Hub to see the various ways we can help you.
1 An application fee is not required if the OIC is filed based on doubt as to liability.