Tax Settlements - Are They Real?

Gregory J. Cook, EA, CPA

You've seen the advertisements on TV, "settle your tax liability for pennies on the dollar".

The IRS does have a program called Offer In-Compromise (OIC) by which a taxpayer can have their tax debt settled for "pennies on the dollar". To qualify, a taxpayer must meet strict criteria.

First, you must file a Form 433 and show the IRS what your net worth is. If your assets exceed your liabilities (assets minus liabilities equals net worth), the resulting net worth number must be less than the amount you owe in taxes.

For example: If you own your home and it is worth $200,000 and you have a mortgage of $100,000, your net worth is $100,000 (the equity in your home). And let's say you owe back taxes of $50,000. The IRS will reject an OIC because you owe them less than your net worth. They will insist that you try to borrow against the home or sell it to pay them in full.

Now the above example is very simplified and leaves out a lot of minute details, but this will give you an idea of whether you should pursue an offer or not. Let's assume that you do not own your home...

Secondly, the Form 433 will show your income on a monthly basis and what your necessary living expenses are. The IRS uses this information to calculate your "future earnings potential". If your monthly income is $6,000 and your cost of living is $5,000, the IRS assumes that you have the ability to pay $1,000 per month toward your tax liability.

The IRS then multiplies the $1,000 per month times a minimum of 48 months or the remaining statute of your tax liability to derive an acceptable offer amount. $1,000 times 48 months equals $48,000. This is the minimum amount you must offer to settle your back taxes.

It is important to note that the IRS will not allow credit card payments to be considered in the calculation and they limit the amount you can claim for shelter costs (i.e., rent or mortgage payment).

The problem I see very often with this OIC program is this. There are many companies out there that go through public records to find taxpayers that have federal tax leins on file at the courthouses. They then contact these taxpayers and use "scare tactics" to get these people to retain them to prepare an OIC.

They usually ask for a retainer of $2,500 to $10,000. They sign up anyone they can (including people that will never qualify for an OIC). After a year goes by and your OIC has been rejected, you are out the retainer you paid these people and you owe the IRS more now, because of the interest and penalties that have accrued.

We carefully screen taxpayers for the appropriateness of an OIC up front. It's really a simple matter to determine whether an "acceptable offer" can be made, before going through all the paper work, time and effort involved in the Offer In-Compromise process.