Offers in Compromise and Installment Agreements

If a federal tax balance cannot be paid in full, there are two formal answers. An installment agreement stretches the payment over time and keeps the liability intact. An offer in compromise settles it for less than the full amount, but only where the IRS accepts that it will not do better by collecting. The choice between them is largely arithmetic: the agency compares what it could realistically extract from your assets and future income against what you are proposing, and an offer below that figure is rejected almost automatically. Both routes are conditioned on being current with filing and with the present year's payments.

1.What must be true before either is possible

• Every required return for prior years has been filed. An unfiled year stops the process regardless of the merits.
• Current-year obligations are being met — withholding adjusted, or estimated installments paid as described in estimated tax payments and the underpayment penalty.
• A business with employees is current on its federal tax deposits for the recent period.
• The taxpayer is not in an open bankruptcy case, which routes the liability through a different system entirely.

These are not formalities. Compliance is what the agency is buying with a settlement or a payment plan: an arrangement that leaves the taxpayer accruing new liability solves nothing, and the agreement will contain a term terminating it if new balances arise.

2.The three grounds for an offer

Doubt as to collectibility

The most common ground. The liability is not disputed, but the taxpayer's assets and income will not produce the full amount within the remaining collection period.

Doubt as to liability

A genuine dispute about whether the tax is owed at all, raised where the ordinary channels for contesting it have closed. It requires a reasoned legal or factual argument, not merely a preference.

Effective tax administration

The tax is owed and could be collected, but collection would create economic hardship, or would be unfair and inequitable given exceptional circumstances. The narrowest ground and the hardest to establish.

The grounds are pleaded on the form itself, and the supporting package differs sharply between them: a collectibility offer is an accounting exercise, a liability offer is an argument. The current forms and instructions are on the IRS page for Form 656.

3.How reasonable collection potential is built

Reasonable collection potential is the number an offer must beat. It has two components. The first is the net realizable equity in assets — real property, vehicles, bank accounts, retirement accounts, business equipment, and receivables — generally valued at a discount from fair market value to reflect a forced sale, less any encumbrance that outranks the government. The second is future income: monthly income less allowed living expenses, multiplied by a number of months that depends on how quickly the offer will be paid.

Two consequences follow. First, a taxpayer with substantial home equity or a funded retirement account will struggle on a collectibility ground even with modest income, because the equity is counted whether or not it is accessible without hardship. Second, an offer proposing a lump sum paid quickly uses a shorter multiplier for future income than one paid over a longer term, so the faster structure can produce a lower total. The standards and multipliers are updated by the agency, so the current figures should be read from the IRS payment and collection pages rather than assumed.

Caution: A submitted offer suspends the collection period while it is pending and for a period after rejection. A rejected offer therefore leaves the government with more time to collect than it had before, which is a real cost of an application made without a realistic prospect of acceptance.

4.The installment ladder

A fifth status is not an agreement at all. Where a taxpayer's income barely covers allowed living expenses, the account can be reported as currently not collectible, which pauses active collection without settling anything. Interest continues, the balance grows, and the file is revisited when income data suggests a change.

Entering an agreement generally suspends levy action, and it does so while a request is pending, while it is in effect, and for a period after a rejection or termination. It does not automatically remove a filed notice of federal tax lien, though the agency will withdraw or release one in defined circumstances. A rejected agreement, like a rejected offer, may be taken to the Independent Office of Appeals.

5.State balances follow their own rules

A federal settlement resolves federal tax only. State revenue departments operate independent collection systems, and their willingness to compromise varies enormously. Some states run a formal offer program resembling the federal one; others will grant payment plans but almost never reduce principal; a few require legislative or board approval for any compromise. Nothing in an accepted federal offer binds a state, and the reverse is equally true.

Two practical points. A state may hold a lien on the same property the IRS is valuing, and its priority relative to the federal lien depends on filing order and state law. And a state agreement's monthly payment is an expense the IRS will consider in its own computation only to the extent its standards allow, so simultaneous negotiations should be sequenced rather than run in parallel without thought.

6.Questions this raises

Are the advertised programs that promise to settle tax debt for a fraction of what is owed real?

The offer in compromise is a real statutory program, but the advertising misrepresents it. Acceptance turns on an arithmetic comparison between the offer and what the agency believes it can collect, not on negotiation skill. A taxpayer with equity or steady income will not qualify on a collectibility ground no matter who prepares the paperwork. Read the eligibility material the IRS publishes before paying anyone a fee.

What happens to the balance that is not collected under a partial-pay agreement?

It expires. The government has a limited period to collect an assessed tax, and when that period ends the remaining balance ceases to be enforceable and the lien releases. That is why the agency reviews partial-pay agreements periodically and raises payments if income improves. The period can be suspended by events such as a pending offer, a bankruptcy, or time spent outside the country.

Can I choose which years an offer covers?

No. An offer submitted on a collectibility ground must cover all periods for which liability exists at the time it is submitted; the agency will not settle one year and continue collecting another where the same financial picture governs both. A liability-based offer is different, since it disputes a specific assessment, but even then the collection picture for other years is not partitioned.

Does an accepted offer affect future refunds?

Historically the agency applied a refund for the year the offer was accepted to the liability rather than sending it to the taxpayer, and the offer terms have been revised on this point more than once. Because the term is written into the agreement itself, read the version of the form you are signing rather than relying on how it worked for someone else. Acceptance also requires filing and paying on time for a period afterward.

7.Choosing between them

1. Fix the compliance gaps first. File missing returns and correct current-year withholding or installments. Nothing proceeds until this is done.
2. Build the financial statement honestly. List assets, encumbrances, income, and expenses as they are. The agency verifies against third-party data, and an understated asset ends the process rather than improving it.
3. Compute the collection potential yourself. If it exceeds the balance, an offer on collectibility grounds is not available and the question is only which installment structure fits.
4. Ask how much collection time remains. A balance nearing the end of its collection period may be better served by a partial-pay agreement than by an offer that suspends the clock.
5. Check for a liability defense. Where the assessment itself is questionable — a substitute return, an unnoticed adjustment from an IRS examination, or a payroll assessment of the kind covered in the trust fund recovery penalty — a doubt-as-to-liability route may be stronger than any payment plan.
6. Keep the agreement alive. Most agreements fail on a later unfiled return or a new balance, not on a missed payment.

Where a request has stalled, where hardship is immediate, or where the agency's standard channels have not produced a response, the independent Taxpayer Advocate Service can take the case up within the agency.