The Internal Revenue Code provides that a tax liability can be resolved for less than the full amount of the total debt. Sometimes, the tax debt can be resolved for a fraction of the total. This procedure is known as an Offer in Compromise. In the right circumstances, an Offer in Compromise can be used to get a person out of tight spot.
An Offer in Compromise is generally available to taxpayer in three circumstances:
1) when the person or business cannot afford to pay (Doubt as to Collectability),
2) when the person or business may not be liable for the tax asserted (Doubt as to Liability), or
3) other special circumstances (Effective Tax Administration).
When a person cannot afford to pay a tax liability, they may be eligible to settle their debt on the basis of Doubt as to Collectability. Resolving the debt this way does not afford the taxpayer any substantial amount of privacy concerning their financial status, but is often well worth it. The taxpayer must prepare a Form 656 and related financial statements outlining all income, expenses, assets and debts. This will form the basis of any acceptable compromise amount.
The compromise financial statement is intended to help you find the right number for a compromise. The IRS also has a “pre-qualifier” tool on its website that can help decide whether a compromise is an option. However, depending on your specific facts and circumstances, these calculations might not get you to the right number. This is particularly so in more complication situations. If you use these tools and don’t think that you can afford to pay the resulting number, a reputable tax professional can help determine for how much the IRS may settle the debt.
A person might also be able to settle their debt for less than the full amount of the debt if there is a doubt as to their liability for the tax due. This is generally used to challenge whether the IRS’ calculation of the tax liability was correct. This form of a compromise, however, is less rarely used because there are many opportunities to determine the correct tax debt before getting to the position where a compromise is an option.
A liability may also be resolved for less than the full amount of the tax if there are special circumstances that warrant a resolution of the debt. For the IRS to settle the debt on this basis, the IRS must be convinced that, in spite of an ability to pay the tax owed, other special circumstances exist that suggest a compromise is appropriate.
When faced with a large tax liability, an Offer in Compromise should be considered. While not available in all circumstances, when available, this procedure can lift a heavy weight from a person’s shoulders.
Most states also have compromise procedures as well.
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