Offer in Compromise vs. Installment Agreement: Which One Actually Fits Your Situation?

Taxpayers who owe the IRS more than they can pay may hear about an “offer in compromise” or an “installment agreement” as potential solutions. Understanding the differences between these two solutions and whether you qualify is crucial for anyone who owes money to the IRS.

Key Takeaways

• An offer in compromise reduces the total amount owed, while an installment agreement requires payment of the full balance over time.
• When deciding whether to accept an offer in compromise, the IRS applies the Reasonable Collection Potential formula, which estimates the minimum amount the IRS can reasonably expect to receive from a taxpayer’s assets and future income.
• Taxpayers who owe less than $100,000 in combined taxes, penalties and interest may qualify for a short-term payment plan.
• A Partial Payment Installment Agreement is a third option that allows a taxpayer to pay less than the full balance over time and can avoid the period of uncertainty that accompanies an offer in compromise.

What Is an IRS Offer in Compromise?

An offer in compromise is a formal agreement under IRC §7122 that settles tax liability for less than the full amount owed. An offer in compromise is submitted using Form 656, along with a $205 application fee. A full financial disclosure must be submitted using Form 433-A for individuals, and Form 433-B for businesses. If the IRS accepts the offer in compromise, the taxpayer must remain compliant with filing and payment obligations for five years after acceptance; otherwise, the IRS can revoke the agreement.

An offer in compromise is a math-based program, not a negotiation. It is best suited to taxpayers who will never be able to repay the full amount, not to individuals seeking to pay less.

How Does the IRS Decide Whether to Accept an Offer in Compromise?

An offer in compromise can be made on one of three grounds:

• Doubt as to liability: the existence or amount of the tax debt is in dispute;
• Doubt as to collectability: the taxpayer’s assets and income are less than the full amount of tax liability; or
• Effective tax administration: full repayment would create economic hardship, or exceptional circumstances make doing so unfair or inequitable.

When deciding whether to accept an offer in compromise, the IRS applies the Reasonable Collection Potential formula, which estimates the minimum amount the IRS can reasonably expect to receive from a taxpayer’s assets and future income. The formula evaluates the taxpayer’s net realizable equity plus future monthly disposable income multiplied by 12 or 24 months, depending on whether the offer is paid as a lump sum or in periodic installments. If the offer does not meet or exceed that number, the IRS rejects it, no matter how sympathetic the taxpayer’s story.

What Is an Installment Agreement?

An installment agreement is a formal agreement to pay the full balance over time, rather than all at once. Unlike an offer in compromise, it does not reduce the total amount owed. An installment agreement may be appropriate for:

• Taxpayers who owe less than $50,000 in combined taxes, penalties, and interest generally qualify for a Simple Payment Plan that can be set up online with no financial disclosure required.
• Taxpayers who owe less than $100,000 may qualify for a short-term plan of up to 180 days with no setup fee.
• Larger or more complicated balances typically require a full financial disclosure and a negotiated long-term agreement.

Under an installment agreement, for taxpayers who filed on time, the failure-to-pay penalty drops from 0.5% to 0.25% of the unpaid balance per month while the agreement is in effect. However, interest will continue to accrue on the unpaid balance.

The Third Option: Partial Payment Installment Agreement

The Partial Payment Installment Agreement is a third option, and potentially the most beneficial arrangement. A Partial Payment Installment Agreement may be available when the taxpayer’s total resources over the permissible collection period are insufficient to finance a full payment. A Partial Payment Installment Agreement allows a taxpayer to pay less than the full balance through the installment agreement process, with the IRS reassessing the payment amount every two years as the taxpayer’s income changes. For many taxpayers, the Partial Payment Installment Agreement is preferable to an offer in compromise because the process is more straightforward and avoids the uncertainty that accompanies an offer in compromise.

Which One Is Best for Your Situation?

For taxpayers who can pay the full amount owed over time, an installment agreement is faster, easier to set up, and far more likely to be approved. Generally, an offer in compromise is only worth pursuing when the taxpayer’s equity and future earning capacity fall meaningfully short of the total amount owed.

Choosing between an offer in compromise and an installment agreement is not mutually exclusive. A taxpayer can request an installment agreement to cease collection activity while preparing an offer in compromise. Likewise, a taxpayer whose application for an offer in compromise was rejected can immediately request an installment agreement.

How a Qualified and Experienced Tax Attorney Can Help

The choice between an offer in compromise and an installment agreement is a math problem more than anything else. But making the wrong choice can cost a taxpayer months of time and, in cases of an offer in compromise, presents a real chance of rejection. An experienced tax attorney can help you evaluate your options and enter into a plan that is right for your situation.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. He helps taxpayers evaluate their Reasonable Collection Potential and choose the option that is best for their unique situation. Contact Joe Viola today to schedule a consultation.