What if you cannot pay your taxes to the federal government? You actually have options. One is to apply for a monthly installment payment. Second is to request to assign your account as non-collectible. Third is to apply for an offer in compromise, which we will discuss in this article.

An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayer’s tax liabilities for less than the full amount owed. In short, it is a request for debt reduction.

In most cases, the IRS will not accept an OIC unless the amount offered by the taxpayer is equal to or greater than the reasonable collection potential (RCP). The RCP is calculated by adding your total net assets and your potential income for the next 4 or 5 years or the remaining years of the statute of limitation which is 10 years, whichever is greater. Statute of limitation to collect taxes starts at the date of tax assessment by the IRS. This usually happens after they process your tax return. Your potential income is your net monthly cash flow multiplied by 4 or 5 years or the remaining years of the status of limitation, whichever is greater. The IRS uses 4 years if your offer will be paid within 5 months or less. The IRS uses 5 years if the payment plan is for more the 5 months.

For example, your bank has a balance of $500. You have no other assets. You earn $4,000 every month. You monthly necessary expenses total $3,900 giving you a monthly net cash flow of $100. You had incurred taxes back in 200X for $15,000 and it is still outstanding.

The solution, let us say 8 years has passed since the IRS assessed this tax meaning you have 2 years left before the statute of limitation expires. You also plan to pay for 5 months. So your offer would be:

Total assets + (monthly net cash flow) X (remaining months of the statue of limitation or 4 years or 5 years whichever is greater)

 $100 + ($100) (4 years) (12 months)

$100 + $4,800

$4,900 - > This is your RCP or offer as full payment for $15,000.

The above calculation is appropriate for one of 3 reasons for offer in compromise.

Three Reasons for Offer in compromise:

1. Doubt as to Collectability - Doubt exists that the taxpayer could ever pay the full amount of tax liability owed within the remainder of the statutory period for collection

2. Doubt as to Liability - A legitimate doubt exists that the assessed tax liability is correct. Possible reasons to submit a doubt as to liability offer include: (1) the examiner made a mistake interpreting the law, (2) the examiner failed to consider the taxpayer’s evidence or (3) the taxpayer has new evidence.

3. Exceptional Circumstance or Effective Tax Administration - There is no doubt that the tax is correct and there is potential to collect the full amount of the tax owed, but an exceptional circumstance exists that would allow the IRS to consider an OIC. To be eligible for compromise on this basis, a taxpayer must demonstrate that the collection of the tax would create an economic hardship or would be unfair and inequitable. Good candidates for this reason are those who are sick, disabled, retired, and other similar circumstances.

- We are CPAs, tax accountants, tax preparers, business managers and consultants based in Torrance, CA near Los Angeles, serving the entire U.S. See us at Google+, Yelp, Google Brand, Yelp. Call us at (424) 278-4838 or e-mail us at This email address is being protected from spambots. You need JavaScript enabled to view it..