Don't Bet the Business

When you owe the IRS or a state taxing authority back taxes, but you have limited means to pay them, it’s always good to have options.

In an earlier two-part blog series, we covered the Installment Agreement (IA) and the Offer-in-Compromise (OIC). The series outlined these two programs and their suitability for taxpayers with different circumstances. It also discussed the different variations of both programs that can be used by taxpayers to begin paying back their taxes.

Many taxpayers have very little discretionary monthly income or available assets to begin repayment. When this is the case, the IRS allows taxpayers to make partial monthly payments, or settle the balance completely, for an agreed upon sum that is often far less than the total balance due.   

These two options are the Partial Payment Installment Agreement (PPIA) and the OIC. Both options accomplish different objectives for very specific taxpayers.  But which option is best for you?

When considering these two options, it is easiest to think of the PPIA as requiring the taxpayer to give part of what they earn to the IRS and an OIC as the option that requires the taxpayer to give part of what they own. In this way, a PPIA or OIC is tailored to the specific needs and circumstances of each taxpayer.

The following is an overview of these two programs and the circumstances where they are best leveraged to settle tax balances with the IRS.

Option 1: The Partial Payment Installment Agreement

A PPIA is an installment agreement that allows the taxpayer to make monthly payments for less than would be required to fully pay the tax balances within the 10-year collection statute period. Since the payment generally will not pay back the full balance over time, the taxpayer must apply for acceptance with the IRS to establish a PPIA.

The IRS will generally accept a PPIA when there are insufficient assets available to liquidate for an OIC agreement, and insufficient remaining monthly income after expenses for a full IA. The IRS will require a full disclosure of the taxpayer’s assets, income and expenses to determine if a PPIA would be acceptable to begin paying back the tax balance.

In addition to this disclosure, the taxpayer must meet the following criteria:

• Owe more than $10,000 in total balances for all tax years;
• Make their current tax payments and file any outstanding tax returns;
• Not be in active bankruptcy; and
• Have limited assets that can be liquidated to pay any balances.

The IRS will evaluate the financial disclosures provided by the taxpayer to determine eligibility for a PPIA. If accepted, the monthly payment will be the remining discretionary income that the taxpayer can afford to pay after expenses. This payment will be less than the normal payment that is common for the other IA types.

While the IRS may accept a PPIA to settle tax balances, it is only a temporary option. The IRS will review the financial profile of a taxpayer every two years. If the PPIA, as previously established, is still necessary or appropriate based on an updated picture of the taxpayer’s finances, the IRS will extend the PPIA for an additional two years. This two-year financial review cycle will continue until the taxpayer’s finances have improved to make the PPIA no longer necessary or the collection statute runs out and the tax balances are no longer collectible.  

In other words, the IRS will accept a lower payment now with the goal of increasing the payment later. If the financial health of the taxpayer has improved, the IRS may raise the monthly payment of the PPIA or convert it to a full payment installment agreement. The relevant penalties and interest will also continue to accrue during the term of a PPIA.

If the taxpayer continues to make payments as scheduled, any balance remaining at the end of the collection statute will be released.

Lastly, because the PPIA is subject to review for the duration of the collection statute, it is generally easier to establish with the IRS and requires far less paperwork than an OIC. The IRS agent evaluating the proposed PPIA has increased discretion to accept it as proposed because the two-year review allows the IRS to modify the payment on a regular basis.

Option 2: The Offer-in-Compromise

An OIC is a settlement alternative where a taxpayer offers to settle all outstanding tax balances for a sum based on their available monthly income and the liquidation value of any assets. This settlement amount is often far less than the total tax balance owed. 

The biggest advantage of an OIC is that once approved by the IRS, it is final. Provided that the taxpayer pays the compromised amount on time and remains compliant for the next several years, the IRS will permanently eliminate the balances for the compromised tax years. The finality of the settlement and the ability to settle large balances for a relatively small lump sum payment makes an OIC a very attractive option for many taxpayers.

Unlike the PPIA, the OIC requires a large amount of supporting documentation. A taxpayer must provide three months of financial statements and supporting documentation for any assets to determine eligibility for an OIC. Because the acceptance of an OIC is final, the documentation and offer amount is highly scrutinized. If the reasonable collection potential of a taxpayer is greater than the total offer to settle, the IRS will reject the OIC. If the supporting documentation is insufficient to substantiate the numbers claimed in the OIC, it will also be rejected. It is possible to appeal a rejected OIC to provide additional documentation or to increase the total offer amount to a level that is acceptable to the IRS, but this will add additional time to the process.

Unlike a PPIA, it also can take a significant amount of time for the IRS to evaluate and determine whether to accept a proposed OIC. A properly submitted OIC can take up to a year or more to be fully evaluated by the IRS.

There are several important drawbacks to an OIC when compared to a PPIA. While the OIC is pending, the collection statute is paused. If the OIC is rejected, the collection statute will not resume for six months following the date of rejection. This pause will expand the time that the IRS can collect the tax debt beyond the normal 10-year period. While the OIC is under consideration, penalties and interest will continue to accrue. As part of an application for an OIC, a lump sum payment must be made at the time of submission. This lump sum is not retuned if the OIC is rejected for any reason.

For these reasons, it is generally not in a taxpayer’s best interest to submit an OIC that has a low possibility of acceptance. Taxpayers should carefully evaluate whether an OIC is the correct option based on the overall probability of acceptance.

So, Which Option is Right for You?

For many taxpayers, the answer to this question will depend largely on their current financial health as well as what they expect their finances to be in the future. A PPIA can be a great option for taxpayers with an ability to make a monthly payment but who have few assets available for liquidation to make a lump sum payment. An OIC can be a great option for taxpayers who have little disposable income after accounting for monthly expenses but who have assets available that can be liquidated for a lump sum payment.

As with any collection alternative, it is best to consult with a tax attorney to walk through both options to determine which is right for you.