Legal Definitions - offer in compromise

An offer in compromise is a formal proposal made by a taxpayer to the Internal Revenue Service (IRS) to settle their tax debt for a lower amount than what they originally owe. This program allows certain taxpayers facing significant financial hardship to resolve their tax obligations when they cannot pay the full amount due, or when there is a legitimate dispute about the amount owed.

It's important to understand that the IRS has the discretion to accept or reject an offer in compromise; it is not an automatic right. The IRS typically evaluates an offer based on the taxpayer's "reasonable collection potential," which considers their ability to pay based on their assets (like bank accounts, real estate, vehicles) and future income. An offer in compromise is generally considered in situations where:

• Doubt as to Liability: There is a genuine dispute about whether the taxpayer actually owes the tax debt, or the amount of the debt is incorrect.
• Doubt as to Collectibility: The taxpayer's assets and income are insufficient to pay the full amount of the tax debt. This is the most common reason for an offer.
• Effective Tax Administration: Requiring full payment would create an economic hardship for the taxpayer or would be unfair and inequitable due to exceptional circumstances, even if they technically have the ability to pay.

Here are some examples illustrating how an offer in compromise might apply:

• Example 1 (Doubt as to Collectibility): Sarah owned a small retail shop that unfortunately went out of business during an economic downturn. She accumulated a substantial amount of unpaid business taxes, including payroll taxes, before closing. Now unemployed and with very limited savings and no significant assets, Sarah realizes she cannot possibly pay the full tax debt. She submits an offer in compromise to the IRS, proposing to pay a reduced amount that reflects her current inability to meet the full obligation, demonstrating "doubt as to collectibility."

• Example 2 (Doubt as to Liability): Mark received a notice from the IRS stating he owes a significant amount of tax for income from a freelance project he claims he never undertook. He has documentation proving he was not involved in the project and that the income was mistakenly attributed to him by a third party. Mark files an offer in compromise, arguing that he should not be held responsible for the debt because there is "doubt as to liability" regarding the income in question.

• Example 3 (Effective Tax Administration): Eleanor is a retired widow living on a fixed social security income. She incurred a large tax debt several years ago due to an unexpected medical emergency that depleted her savings, causing her to fall behind on her taxes. While she technically owns her modest home, selling it would leave her homeless and unable to afford alternative housing, given her age and health. Paying the full tax debt would force her into severe economic hardship. Eleanor submits an offer in compromise based on "effective tax administration," arguing that requiring full payment would be inequitable and create an undue burden.