The offer in compromise is an agreement between a taxpayer and the IRS, which eases IRS problems by settling the taxpayer’s liability for some amount which is less than the full amount due. The IRS has the authority to settle or compromise federal tax liabilities by accepting less than full payment under certain circumstances. This agreement is made when the IRS accepts the "Offer in Compromise" made by the Taxpayer.

The taxpayer makes an Offer in Compromise, on Form 656, and if the IRS accepts the Offer in Compromise, then a contract is formed in which the IRS agrees to cancel the tax debt in return for the payment of the agreed sum. The IRS has a whole set of rules, policies and procedures which govern when it will accept an offer in compromise.

There are Three Types of Offers: 1) Doubt as to Liability, 2) Doubt as to Collectibility, 3) Effective Tax Administration.

Doubt as to liability means that there is some reason that you don’t owe the tax or doubt exists that the assessed tax is correct. This does not mean that you have doubt that you don’t owe the tax or part of it. It means that the IRS has doubts about you owing the tax, and in my experience the IRS never doubts that you owe the tax.  An offer in compromise based upon doubt as to liability is very seldom accepted by the IRS.

They are in the business of taking your money, why would they ever wonder of care if there was a possibility that you did not owe the tax. It is not their job to care about you.

However, if there is clear evidence that you don’t owe the tax or part of it, a professional can usually get all or part of the tax abated without you having to pay anything. We have not found offer in compromise based on Doubt as to Liability to be very useful. Let's be clear about that, usually when taxpayers owe the IRS unpaid taxes, the liability is legally established, and there is no doubt that they have a valid assessment. That is not to say the assessment is correct. The IRS is always making mistakes, but the taxpayer must defend against the assessment before it is made. Once an assessment is made there is a strong legal presumption it is correct.

Doubt as to Collectibility is where the IRS has doubts that you could ever pay the full amount. I have to emphasize the word "ever." If the IRS feels that if there is a chance that you could ever pay the liability prior to the running of the ten year statute of limitations, they will not accept your offer in compromise and you will still have your IRS problems.

Effective Tax Administration is where there is no doubt that the tax is correct and no doubt the amount owed could be collected, but an exceptional circumstance exists that allows the IRS to consider the offer in compromise. To be eligible for an offer in compromise on the basis of Effective Tax Administration you must demonstrate that collection of the tax would create an economic hardship or would be unfair and inequitable. That’s the official party line.

These are some non exclusive factors, outlined in the IRS training materials, to be used to determine when there is an economic hardship.

• Long term illness, medical condition, or disability that renders the taxpayer incapable of earning a living.
• Liquidation of assets to pay the tax liability would create an inability to meet reasonable basic living expenses.
• Taxpayers are unable to borrow against the equity in assets and sale of the asset would have sufficient adverse consequences such that enforced collection is unlikely.

Sometimes the IRS encounters situation where it would get a lot of bad publicity if it tried to collect the tax, like foreclosure on an orphanage. In such a case they try to bend the rules to classify he account as uncollectible.

This is the example the IRS gives its employees when describing an offer in compromise that should be accepted on the basis of Effective Tax Administration.

"The taxpayer is disabled and lives on a fixed income that will not, after allowing basic living expenses, permit full payment of the liability through an installment agreement. The taxpayer owns a house that has been specially equipped to accommodate his disability. There is sufficient equity in the house to full-pay the liability. However, because of his fixed income and limited earning potential, the taxpayer is unable to obtain a mortgage or borrow against the equity. In addition, because the taxpayer’s home has been specially equipped to accommodate his disability, forced sale of the residence would create severe adverse consequences for the taxpayer, making such a sale unlikely."

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