Offer in Compromise vs. Installment Agreement

Understanding offer in compromise

An offer in compromise is an agreement with the IRS to pay your tax debt for less than you owe. The IRS may accept your offer if you are experiencing financial hardship or there’s doubt that you owe the tax debt. For example, if the IRS considers you an innocent spouse and releases you from penalties on a joint tax return.

Saidin Hernandez, a tax and estate planning attorney in Miami, said, “The IRS will only accept an OIC when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects what the IRS could expect to collect, considering the taxpayer’s assets, income, expenses and overall financial situation.”

To qualify, you must:

• Have filed all your tax returns
• Have received a bill for at least one tax debt included in the offer
• Made all required estimated tax payments for the current year
• Have made all required tax deposits for the current quarter and the two preceding quarters if you’re a business owner with employees

To request an offer in compromise, you’ll complete Form 656. If there is doubt of liability, then you’ll complete Form 656-L. The IRS won’t attempt to collect the past due amounts while the application is in process and for 30 days after a rejection. If the offer is accepted, penalties and interest stop accruing.

Form 656 will walk you through providing your income, assets, expenses and liabilities. This information determines your “remaining monthly income,” or how much income you have left over after you’ve covered your basic living expenses.

You’ll have to pay a $205 application fee. If you own a business and have both business and personal debt you would like to settle, you’ll have to submit two separate applications.

OIC payment options

You can request either a lump sum settlement or periodic payments. If you are requesting a lump sum settlement, your offer in compromise will be 12 months of your remaining monthly income, plus any assets you have. If you’re requesting payments, your offer will be 24 months of remaining monthly income plus your assets.

When requesting a lump sum, you must send at least 20% of the balance with the application, and the remaining balance must be paid in five or fewer monthly payments.

If you are requesting periodic payments for the remaining portion of the debt, you must submit your tax relief application with the first payment and continue making monthly payments while your application is under review. The balance must be paid off within six to 24 months.

Exploring installment agreements

An installment agreement is a payment plan that will pay off your entire tax debt. The IRS will more likely accept payment plans than offers in compromise. Note that penalties and interest will continue to accrue until your debt is paid in full.

You can request installment agreements online, by phone or through the mail. If you can pay the debt within six months (180 days), then you can set up an IRS installment plan for free. If it takes longer, you’ll need to pay for a setup plan. The cheapest option is $22 to set up a payment plan with direct debit.

It costs $69 to set up online payment, or $178 to set up over the phone or by mail. You can generally choose the monthly payment you wish to make, but aim to have the full balance paid within six years.

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If you owe less than $10,000 and can pay it off within three years, your payment plan will likely be automatically accepted. However, it won’t be automatically accepted if you haven’t filed all your tax returns or if you have an existing payment plan with the IRS.

But if you can’t pay the debt within six years, you’ll need to provide additional information that explains why your payment must be lower than the standard amount. Additionally, for debts more than $50,000, you must apply through the mail using Form 9465 and Form 433-A. Form 433-A provides details on your financial situation, including income and assets.

OIC vs IA: Comparing the two options

The biggest difference between an offer in compromise and an installment agreement is that you may need to sell assets if the IRS approves your offer in compromise. The amount of your offer is up to two years of your remaining income after you’ve paid your basic living expenses, plus all of your assets. After two years, you’ll be starting over financially.

For an IA, you don’t even need to show financial information for your payment plan to be accepted if you can pay your tax debt off within six years (unless you owe more than $50,000).

Another big difference is that with an OIC, penalties and interest stop accruing. With installment agreements, these charges continue until you pay off the entire debt. Therefore, it’s a good idea to make large payments — as much as you can afford — to minimize these fees.

When to choose an offer in compromise

You may want to choose an offer in compromise if:

• You don’t have many assets you could sell.
• Your balance is very large.
• Paying the balance over six years is impossible.

If the balance you owe is overwhelmingly large, it may be best to attempt to settle the debt, especially if you don’t have many assets. It will likely be a tight two years, but you’ll have a clean slate when it’s finished.

Hernandez said an offer in compromise is the best choice when, after evaluating your assets, income, and expenses, you can’t pay the full liability or “paying the full amount would create an economic hardship, such as being unable to meet basic living expenses.”

When to opt for an installment agreement

You’ll need to consider the pros and cons of an IRS payment plan. But you may want to choose an installment agreement if:

• You can manage the payments required to pay off the debt within six years.
• You have assets that would cover the balance of the debt if sold.

If you can make payments that will pay off the debt within six years, you are likely better off with an installment agreement than an offer in compromise, even if those payments are a bit uncomfortable.

Hernandez said, “IAs are also appropriate for taxpayers who need to resolve their debt quickly to avoid enforcement actions, and for those who want to avoid the more rigorous financial scrutiny required for an OIC.”

The IRS started the Fresh Start Program to expand access to the OIC option and other tax forgiveness plans. Create an online account with the IRS to see if you’re eligible.

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With an offer in compromise, the IRS expects you to pay all of your extra income to the debt for up to two years, with very little to live on during that time. It’s an invasive process and one that can be avoided if you can meet the requirements of a payment arrangement.

The main drawback to an installment agreement is that penalties and interest will continue to accrue. But collection efforts will stop as long as you make the agreed-upon payments.

Other IRS payment alternatives

Offer in compromise and installment agreements are the two IRS tax forgiveness options you can choose if you have a tax bill you are unable to pay on time. However, the IRS can place your account in a Partial Payment Installment Agreement or in Currently Not Collectable status if necessary.

Partial payment installment agreements: You fall into a partial payment installment agreement if you have an installment agreement in place but are unable to continue making those payments.

The IRS will analyze your financial situation and may require you to sell your assets to bring your installment agreement up to date.

Currently not collectible: This status can be placed on your tax debt if you have no assets and are unable to make any payments. Penalties and interest will accrue during this time.

You can request the penalties to be removed, lowering the amount you owe, if:

• It’s the first time you’ve received penalties.
• Your tax payment was late due to a reasonable cause.
• You qualify for an exception, such as living in a federal disaster area.

Lastly, you can consider bankruptcy. If you are including tax debt in your bankruptcy filing, you must be up to date on all your tax filings and pay all current taxes as they come due.