Believe it or not, if you owe the IRS less than $50,000, they consider this a “Small Tax Debt”.
I know. That’s freaking crazy! I don’t know about you, but $50k is a lot of money. This is where the IRS Fresh Start program, and specifically their Offer In Compromise option come into play.
When faced with any tax debt, most individuals and businesses become overwhelmed (who wouldn’t?) and find themselves in financial dire straits (They Rock).
Back to the IRS Fresh Start Offer in Compromise. Uncle Sam understands (the IRS) that not everyone can pay their taxes on time and in full. This is why they created the Fresh Start programs, with the Offer in Compromise (OIC) available for those with serious financial issues.
The IRS Fresh Start OIC aims to provide an easier (relative to tax debts over $50k) methodology for resolving tax debts, giving taxpayers an opportunity to regain their financial footing.
Explaining the IRS Fresh Start Offer in Compromise
Defined
The Offer in Compromise is a program option that allows taxpayers to settle their tax debt for less than the amount due. The amount to be paid is a statutory calculation (i.e., not something that is truly “negotiated”)
Do I Qualify?
To qualify you must first owe less than $50,000. This will allow you to apply using the Fresh Start initiative. You must also be able to demonstrate financial distress that currently does not allow you to pay towards your taxes. The duration of this distress also has no foreseeable end point.
What Kind of Taxes Qualifies?
Most taxes charged by the IRS are eligible. This includes Income Taxes, Payroll Taxes and Self-Employment Taxes.
Why Apply for an OIC?
Obviously, the biggest benefit of an Offer in Compromise is the reduced tax debt. The next biggest benefit has to be resolving the tax issue. This is the kind of thing that can keep you up a lot of nights. Putting a plan into motion will do a lot for your emotional well being.
What Else?
An Offer in Compromise has three options. Doubt as to Collectibility, Doubt as to Liability and Effective Tax Management. For purposes of this paper, we will focus on Doubt as to Collectibility.
What is The IRS Fresh Start Tax Relief Program?
Introduction
The IRS Fresh Start Tax Relief Program is designed to help individuals and businesses who are struggling with tax debt. The Fresh Start program has different options available to you depending on your current tax situation.
The beauty of the Fresh Start program is the simplicity of applying and collecting supporting documentation. If you owe more than $50k the application process asks for a lot more information.
These are the four payment options available:
- IRS Fresh Start Installment Agreement – This option allows you to pay back all or most of your tax debt over time. The maximum term is 72 months.
- IRS Fresh Start Offer in Compromise – An Offer in Compromise is the one those Tax Debt companies advertise. Pay Pennies on the Dollar!! Yeah. Maybe.
- Currently Not Collectible (CNC) – While technically not a payback option, if your financial hardship is truly overwhelming, you can ask the IRS to leave you alone. This status lasts between 6-12 months. This is a great tools for a tax pro’s quiver.
- Penalty Abatement – Also not a payback option but a way to reduce penalty and interest charges.
How Can You Qualify for an IRS Fresh Start?
This parts easy. There are very specific criteria that must be met. Qualifications are:
- Your tax debt must be LESS than $50k. If it’s over $50k you can pay it down so it’s less than $50k. I know. Easier said than done.
- You must be current with all tax filings. All required tax returns must be filed. This includes any payroll or excise tax returns.
- If you’re self employed, you must make all required estimated tax payments. If you are a W2 employee, your withholding must be sufficient.
- You agree to pay your tax debt within the next six years in monthly installments, or within the determined period of your OIC.
There are a few other items:
- If you’re self employed and had an income drop of at least 25%
- You file Single and have income of less than $100,000
- You file married and have income of less than $200,000
Why You Should Strive for the IRS Fresh Start Program
The simplicity.
Look. This whole process sucks. You owe the government a lot of money that you don’t have. You’re feeling overwhelmed and lost. Asking for help is hard enough, but when you see everything the IRS needs, your head will explode.
That’s where the Fresh Start program comes into play. The Fresh Start program was design with small tax debts in mind. The Fresh Start process is a lot less invasive and has a lot of ways to help. As long as you owe less than $50k.
Applying for an IRS Offer in Compromise
I’m not going to go into the step by step. I will go over the process and point out items of importance
- Get your documents ready. For your situation it would be all bank statements, credit card statements, paystubs, leases, notes…anything to prove your situation.
- PrepareIRS form 656. Self employed individuals will need to fill out forms 433A and 433B.
- You will be asked to verify your monthly income and expenses. The IRS has limits to the amount you can claim. These National Standards limits aren’t set in stone, so if you have an expense higher than the standards allow, you may argue the necessity on your application.
- After verifying your income and allowable expenses, what’s left over (your discretionary funds) is used to calculate your offer.
- If you are self employed, there are things you may be able to do to reduce this amount. Business expenses aren’t limited as much as your personal expenses.
- Add the value of any non business assets to this number. This last part is why most folks won’t qualify for an OIC. For example, if you have $50k of equity in your house you won’t qualify.
- For this example, your available discretionary are $500 and your net asset value is $2,500.
Now we decide the method of calculation.
There are 2 methods. 12 month calc, 5 month payback and 24 month calc, 24 month payback..
12 Month Calculation – If you select this option, you must be able to pay the debt off within 5 months of acceptance.
Using the above amounts, your offer would be $8,500 (($500×12)+$2,500). You would send 20% with the initial application (plus an application fee which amount seems to change daily. Expect around $200), and upon acceptance you would have 5 months to pay the remaining $6,800.
24 Month Calculation – If you select this option, you must be able to pay the debt off within 24 months of acceptance.
If you need 24 months to pay your debt off, your offer will be $14,500. The IRS wants your application fee and the first monthly payment (in this case $614.17) with the application (no need to send the 20%). Once accepted you wold have 24 months to pay the remaining $12,885.83 balance.
Basically, the OIC process involves completing a Collection Information Statement, paying an application fee, and providing at least the initial payment.
The IRS will then review your OIC application. This usually takes 5-6 months before they get back to you. I also advis clients to keep collecting your documents proving hardship. There is a very real possibility the IRS wants to make sure you’re still having financial hardship.
What To Do If You’re Rejected?
You will have 30 days to request an appeal. The IRS will also provide you with a letter of points they disagree. This is your map to appeal. You must address each point individually and collectively.
This is why you should continue collecting your hardship info. Right around 30% of applications are accepted so it’s just basic math that you will also be rejected.
Prior to submitting the application I go over the weak points with the client. These are the areas we expect the IRS to take issue with, but we’ve prepared and have an answer waiting for them.
How To Document Financial Hardship
This is the heart of your argument. As mentioned earlier in the post, your hardship can look like many things.
Bank statements or paystubs show reduced income. Past due notices and statements show probable negative cash flow. Rejection letters from lenders show an inability to borrow.
If health is an issue, letters from your doctor and bills showing treatments must be saved.
You aren’t making the same amount of income. Why? What happened? A law change can affect your business. A natural disaster can happen. Your biggest client can evaporate.
There are a lot of reasons you finances took a hit. Dig deep and find out what really happened.
Make Sure You Have Filed all Required Tax Returns.
This is the number 1 reason for delays. In my experience, its usually a payroll tax return that slows you down. They won’t review your application if they see a return hasn’t been filed.
Should you Hire a Professional?
I’m a big DIY guy. This is not a place to be a DIY guy. Sure, you can get lucky and get an approval, but your chances go way down if you do it yourself, plus I’m confident you will be paying more than you should.
Conclusion
The biggest takeaway is that the Fresh Start program, and specifically the Offer in Compromise are valuable tools for any taxpayer who is struggling with their finances and specifically their tax debt.
While an OIC is a first step towards regaining your financial footing, it’s important to understand the circumstances in which an OIC is the best course of action.
To be able to walk away from the majority of your tax debt, your situation must be really, historically bad (from your perspective.)
For a successful OIC application, your situation must be:
- You must be in the midst of a period of financial distress.
- You must owe LESS THAN $50,000, or can pay your debt down to less than $50k.
- Your personal asset value must be low. If you have equity in your house you may not be able to qualify.
- If you do have equity, but are unable to get a loan the lending institution is required to give you a letter outlining the rejection. If you apply for 2-3 loans and are rejected, save the letters for your application. The IRS takes into consideration your inability to procur funding elsewhere.
- If you choose the 12 month calculation method, you must be ready to pay the debt off within 5 months of approval.
- If you choose the 24 month calculation method, you must be able to pay the debt off within 24 months.
If it looks like you won’t qualify, there are other options available. And using several options in concert with each other many times will render a good result.
If you have questions, post a comment and I’ll get back to you as soon as I can.
Until then, stay cool.
JKC