There are many ways to resolve tax debt, depending on your situation. The best way to settle with the IRS may change with your circumstances. For example, this success story of an offer in compromise did not start with an offer in compromise at all! What began as an installment agreement later evolved into an offer in compromise—thanks to the threat of bankruptcy.
Getting an Offer in Compromise Approved
The taxpayer in this success story first realized she needed tax resolution help at 62. When she filed her tax returns for the first time in five years, she owed the IRS $300,000 in back taxes. At that time, she earned a six-figure income and could afford to pay her tax debt over six years using an installment agreement.
Because this taxpayer could afford to pay her balance in full before the 10-year collections statute of limitations expired, she did not qualify for an offer in compromise (OIC) at the time. The OIC program allows taxpayers to settle with the IRS for less than they owe. The amount a taxpayer offers to the IRS is determined by the equity in their assets, excess monthly income (after allowable expenses), and the time period over which payments are to be made.
Installment agreements break debt into manageable monthly payments rather than a lump-sum payment that many taxpayers simply cannot afford. With $300,000 in tax debt, this particular taxpayer had to submit her financial statements in order to have her installment agreement approved. Since she was able to pay her tax debt within six years, the IRS allowed her to use her actual living expenses to determine the monthly payment instead of their Collection Financial Standards, which are typically lower.
Our taxpayer continued making payments toward her tax debt for several years. When COVID-19 affected her job, her income decreased by 30%, and based on her living expenses, she could no longer afford the monthly payment specified in her installment agreement.
If the taxpayer had attempted to revise her payment plan, she would have needed to provide updated financial statements showing she was capable of paying her tax debt within the remaining collection period based on the IRS expense standards. However, since her actual expenses were higher, she would have needed to adjust her lifestyle. Instead, she used the threat of bankruptcy to negotiate an offer in compromise.
The Threat of Bankruptcy
To discharge back taxes in Chapter 7 bankruptcy, a delinquent taxpayer must satisfy several requirements:
- The debt is from income taxes, not payroll taxes.
- They have not committed any tax evasion or fraud.
- The tax debt is at least three years old.
- The tax return was filed at least two years ago (in most jurisdictions).
- The IRS assessed the tax debt at least 240 days before bankruptcy declaration.
After analyzing her tax debt year by year, we determined she now met the requirements for her tax debt to be discharged in bankruptcy for all but one year.
The Internal Revenue Manual (IRM) states in Part 5 that “consideration should be given to a potential bankruptcy filing” during an OIC investigation. The IRS must determine how much it is likely to recover with an OIC compared to bankruptcy based on the specific circumstances. When taxpayer are considering bankruptcy, their reasonable collection potential (the amount the IRS believes it can recover, often abbreviated as RCP) may decrease because some tax debt can be discharged through bankruptcy. The IRS acknowledges this fact and adds, “acceptance of an offer for less than reasonable collection potential may be appropriate based on the facts of the case.”
An Offer in Compromise Success Story
Under normal circumstances, the IRS would have expected our taxpayer to pay her debt in full because her RCP was sufficient to cover her remaining balance. Through an OIC, she offered $40,000 to be paid over 24 months, which was $5,000 more than what would be paid to the IRS in bankruptcy.
In many situations, the IRS does not believe that the taxpayer will file for bankruptcy and will not accept such a low offer. However, we argued that this taxpayer’s age, declining income, and need to save for impending retirement left her with no option but to file for bankruptcy, which would result in all but $35,000 of her tax debt being discharged.
The IRS accepted this offer for $40,000, and our taxpayer has finished paying off her IRS debt!