Offers in Compromise for Veterans and Military Families: How the IRS Does the Math

You have seen the commercials. "Settle your IRS debt for pennies on the dollar." Here is the truth: an offer in compromise is a real IRS program, and it does work for the right taxpayer. But the result is driven by math the IRS publishes, not by who calls the IRS on your behalf. If you understand the math, you can tell in an afternoon whether an offer makes sense for you.

What an offer is

IRC 7122 authorizes the IRS to compromise tax liabilities. The IRS offer in compromise page describes it this way: an offer may allow you to settle your tax debt for less than the full amount if you cannot pay in full or doing so would cause financial hardship. The IRS considers income, expenses and asset equity. The same page adds a sentence everybody should read twice: generally, the IRS will not accept an offer if you can pay the debt in full through a payment plan and/or equity in assets.

Eligibility basics

According to the IRS, to be eligible you must:

• File all required tax returns.
• Make required estimated tax payments.
• Not be in an open bankruptcy.
• If you are an employer, make required federal tax deposits for the current and last two quarters.

The IRS offers a Pre-Qualifier Tool on its website. Use it as a reality check.

The fee and the payments

The IRS page states that every OIC application requires a $205 application fee and a first payment unless you meet the low-income qualifications. There are two payment options:

• Lump sum. Pay 20% of the offer with the application. If accepted, pay the rest in five or fewer payments.
• Periodic payment. Make an initial payment with the application and keep making payments while the IRS considers the offer, then continue until paid.

If you qualify as low income, you do not pay the fee, the initial payment or periodic payments during review. Only individuals qualify for that consideration. If the offer is rejected, the fee is not returned and payments are applied to the balance.

The math: reasonable collection potential

The IRS's offer financial analysis is in IRM 5.8.5. Two pieces drive the number.

Net realizable equity in assets

IRM 5.8.5 defines it as quick sale value less amounts owed to secured creditors with priority over the federal tax lien, and applicable exemptions. The manual says quick sale value is normally 80% of fair market value, with room to use a different percentage depending on the asset and the market.

Future income

IRM 5.8.5.25 defines future income as gross monthly income less allowable living expenses, multiplied by a number of months that depends on the offer terms:

• Offer paid in 5 months or less, in 5 or fewer payments: 12 months.
• Offer paid in 6 to 24 months: 24 months.

If less time than that remains on the collection statute for all the periods, the IRS uses the months remaining.

Assets at quick sale value, plus monthly surplus times 12 or 24. That is the number to beat.

How VA disability fits

Veterans are often surprised here. VA service-connected disability compensation is exempt from IRS levy under IRC 6334(a)(10), so the IRS cannot seize it. But IRM 5.15.1 says the IRS generally counts all household income, including tax-exempt income, in determining ability to pay. In offer cases, that means VA compensation goes into the income side of the future income calculation. A veteran with modest retired pay and substantial VA compensation may have more "future income" on paper than expected. See VA disability on IRS financial statements.

The flip side: veterans with service-connected conditions often have necessary medical and housing expenses above the standards. IRM 5.8.5 gives an example of a taxpayer with a physical disability who needs housing not covered by the local standard and is allowed the higher cost with verification. Document those expenses.

Special circumstances

Not every offer is about collectibility alone. IRM 5.8.5 references Effective Tax Administration offers and offers based on doubt as to collectibility with special circumstances. The manual's examples include a family whose move would cost a disabled child a needed school program. If paying in full would be unfair or create hardship because of circumstances like these, say so and document it.

While the offer is pending

The IRS page lists what happens once your application is processed: you get notified, the IRS may request more information, it suspends most collection activity, it extends the collection period, and it may file a Notice of Federal Tax Lien. IRC 6331(k)(1) bars levy while an offer is pending and for 30 days after a rejection (longer if you appeal). You must keep making required offer payments. You do not need to keep paying an existing payment plan on the same balance.

One more rule worth knowing: the IRS page says an application is automatically accepted if the IRS does not accept or reject it within two years of receipt, not counting time on appeal.

If the offer is accepted

You must meet all the terms in Section 7 of Form 656, including staying compliant with filing and payment requirements after acceptance. The IRS will not release federal tax liens until the offer is paid in full, and some offer information becomes part of a public inspection file.

Is an offer right for you?

• If your reasonable collection potential is close to what you owe, a payment plan is probably the answer. See installment agreements.
• If you have no ability to pay now and little time left on the collection statute, CNC may cost less. See CNC for veterans.
• If the balance dwarfs anything you could pay before the statute expires, an offer deserves a hard look.

Be wary of anyone who quotes you a settlement amount before seeing your numbers. The IRS formula decides. Nobody can promise you a result.