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Seeking an offer in compromise to settle tax debt: How does it work?

An offer in compromise (OIC) is an agreement with the IRS that can enable you to settle your tax debt for less than the full amount you owe.

If you have tax debt, such an agreement would of course be a good thing. But it's important to be aware of the procedures that are required and to be realistic about prospects for using an OIC effectively.

In this post, we'll use a Q & A format to inform you about several key points.

What are the eligibility requirements for an OIC?

There are a number of specific requirements for an OIC, such as filing all of your tax forms for previous years and not being in an open bankruptcy proceeding.

In many ways, however, eligibility for an OIC comes down to your financial situation. It involves not being able to pay all of the taxes you owe while still having enough left for reasonable living expenses - and convincing the IRS of that fact . This will require providing extensive documentation of your financial situation.

Before you consider applying for an OIC, it therefore makes sense to explore other payment options, such as a payment plan or installment agreement. You can also get a sense of whether you qualify by using the IRS's online pre-qualifier tool.

How often does the IRS approve an OIC?

Acceptance rates for OICs have been trending up in recent years, but getting the IRS to approve your OIC can still be challenging.

It's true that OIC approval is much more common than it was a decade ago, when rates were down around 25 percent. But the Internal Revenue Code still gives the IRS wide discretion to accept or deny an offer.

Using this discretion, the IRS rejects many OICs. That is why assistance from a skilled tax attorney in negotiating with the IRS can be so valuable, to help find a compelling reason for the IRS to approve the offer.

In most cases, the IRS's decision is based on its assessment of what it may be able to collect over a reasonable period of time (doubt as to collectability). But the Service can also grant an OIC based on doubt as to liability (whether the tax in question is genuinely owed) and based on effective tax administration (such as allowing an OIC based on financial hardship).

How do you apply for an OIC?

There is a required application form, Form 656, and a required financial statement, Form 433-A OIC (for individuals) or 433-B OIC (for businesses.).

There is also a non-refundable application fee of $186 and a nonrefundable initial payment on the OIC amount. You will also have to choose, for your initial payment, whether to pay a lump sum in cash (at least 20 percent of the total offer amount) or to pay in monthly installments while the offer is under consideration.

The forms alone, however, are not necessarily all you need to make your case to the IRS for an OIC. For example, if there is a particularly compelling reason why you can't pay all you owe, such as serious illness that affects your ability to earn income, that should be documented and included in your application.

Can you appeal if your OIC is rejected?

Yes, you can. We will address that procedure in an upcoming post.

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