The Internal Revenue Code (IRC) Section 7122 allows taxpayers to settle tax debt for less than they owe, a process known as an Offer in Compromise (OIC). This provision affects individual taxpayers and businesses with unpaid tax liabilities.
The effective date of the OIC program is tied to the Taxpayer Bill of Rights, which became law in 1996, with a $10,000 threshold for expedited processing.
Legal Standard for Tax Debt Settlement
The IRC Section 7122 standard for settling tax debt for less than owed is based on doubt as to liability or doubt as to collectibility, with a $25,000 minimum offer requirement. The court considers factors such as the taxpayer’s income, expenses, and asset equity when evaluating an OIC. In practice, this means that taxpayers with significant assets or high income may not qualify for an OIC.
In plain terms, the legal standard requires that the taxpayer demonstrate a legitimate reason for the IRS to accept less than the full amount owed, such as a $50,000 debt with only $10,000 in assets. The taxpayer must also file all required tax returns and make all required estimated tax payments within the 6-month period preceding the submission of the OIC.
The IRS uses a formula to calculate the taxpayer’s reasonable collection potential (RCP), which is the amount the IRS could collect from the taxpayer’s assets, income, and other sources within a 60-month period. If the RCP is less than the total tax liability, the taxpayer may be eligible for an OIC, with a 20% payment due with the application and the remaining 80% due within 5 months.
Conditions for Settling Tax Debt
Taxpayers who meet the conditions outlined in IRC Section 7122 may be able to settle their tax debt for less than they owe, with a $5,000 minimum payment required for a lump-sum OIC. The taxpayer must also agree to comply with all tax laws and regulations for a period of 5 years, with a $2,000 penalty for non-compliance.
This is where the law gets teeth: if the taxpayer fails to comply with the terms of the OIC, the IRS may revoke the agreement and collect the original tax debt, plus interest and penalties, which can total up to 25% of the original debt within 24 months.
Prohibitions and Limits
The IRS prohibits taxpayers from submitting an OIC if they are in bankruptcy or have an open audit, with a 12-month waiting period after the audit is closed. Taxpayers who have been convicted of a tax-related crime within the past 10 years are also ineligible, with a $100,000 fine and up to 5 years in prison for tax evasion.
In addition, the IRS may reject an OIC if the taxpayer has not filed all required tax returns or made all required estimated tax payments within the past 6 months, with a $195 penalty for each unfiled return and a $135 penalty for each late payment.
The OIC Process
To settle tax debt for less than owed, taxpayers must submit Form 656, Offer in Compromise, to the IRS, with a $205 application fee and a $7,500 minimum offer for a periodic payment OIC. The taxpayer must also provide detailed financial information, including income statements, expense reports, and asset valuations, within 30 days of submitting the application.
The IRS will review the OIC application and may request additional information or documentation, such as 3 years of tax returns and 6 months of bank statements, within 45 days of receiving the application. If the OIC is accepted, the taxpayer must comply with the terms of the agreement, including making all required payments within 24 months.
The taxpayer may also request a hearing with the IRS Office of Appeals if the OIC is rejected, with a 30-day deadline for filing the appeal and a $500 filing fee.
State-by-State Variation
Some states, such as California, New York, and Texas, have their own tax debt settlement programs, with a $10,000 threshold for eligibility in California and a 20% payment plan in New York. Other states, such as Florida and Illinois, do not have a state-level OIC program, but taxpayers may still be eligible for the federal OIC program.
For example, in California, taxpayers may be eligible for a state OIC if they have a total tax liability of $25,000 or less and have not been convicted of a tax-related crime within the past 5 years, with a $1,000 penalty for non-compliance and a 12-month payment plan.
Special Situations or Exceptions
Currently Not Collectible
Taxpayers who are currently not collectible (CNC) may be eligible for an OIC, with a $10,000 minimum offer requirement and a 24-month review period. The IRS considers a taxpayer CNC if they have no income, assets, or other means to pay the tax debt, with a $500 penalty for non-compliance.
Innocent Spouse Relief
Taxpayers who are eligible for innocent spouse relief may also be eligible for an OIC, with a $5,000 minimum payment required and a 12-month waiting period after the relief is granted. The taxpayer must demonstrate that they were unaware of the tax debt and had no reason to know about it, with a $1,000 penalty for non-compliance.
Enforcement and Consequences
The IRS has increased enforcement of tax debt settlement programs in recent years, with a 25% increase in OIC applications in 2022 and a $10 million budget for OIC processing. Taxpayers who fail to comply with the terms of an OIC may face penalties and interest, which can total up to 50% of the original debt within 36 months.
In addition, the IRS may also impose criminal penalties, including fines and imprisonment, for tax evasion or other tax-related crimes, with a $100,000 fine and up to 5 years in prison for each count of tax evasion and a 10-year statute of limitations for tax crimes.
- Federal Trade Commission. debt collection rules and consumer rights
- Consumer Financial Protection Bureau. relevant consumer protection guidance
- Office of the Law Revision Counsel. Fair Debt Collection Practices Act
