The Hidden Pitfalls of an Offer in Compromise

Why Even Qualified Taxpayers Should Think Twice

If you’re floundering in a sea of tax debt, an offer in compromise might seem like the lifeboat you have been waiting for. You may have seen ads claiming that this payment option lets you settle your debt for pennies on the dollar. It’s hard not to think about what life could look like without tax debt constantly hanging over your head. 

The fact is, though, that many people do not qualify for the offer in compromise program. Those who do often still have to pay a sizable chunk of what they owe—not “pennies on the dollar.” For those who qualify, the strings attached to this program may make it not worth it. The hidden downsides include required tax compliance, loss of tax refunds, and intense financial scrutiny.

As you consider your tax payment options, don’t forget to consider the downsides of an offer in compromise. For more guidance regarding your unique tax situation, call Seattle Legal Services at 206-536-3152.

Key takeaways:

• Not everyone qualifies for an offer in compromise. And those who do should still consider the potential disadvantages of this option.
• Your accepted offer in compromise is public record, and you must undergo intense public scrutiny. Your privacy is limited with this option.
• You must be compliant with tax requirements for five years after your accepted offer.
• If your offer is rejected, you lose your application fee, and any money paid toward the offer will be kept by the IRS and credited to your tax debt.

Quick Refresher: What Exactly is an Offer in Compromise?

The offer in compromise program is a legally binding agreement that allows qualifying taxpayers to settle their tax debt for less than they truly owe. The IRS only accepts an offer in compromise if there is doubt as to collectibility, doubt as to liability, or if accepting the offer allows for effective tax administration.

Few people genuinely qualify for this program. The IRS releases statistics each year, and in 2023, approximately 40% of offers were accepted. That doesn’t account for the many people who started the application process, realized they didn’t qualify, and stopped midway through. 

The Elephant in the Room—You Might Not Actually Qualify

This is one of the biggest downsides of the offer in compromise program: the majority of people simply do not qualify. 

Consider this from the IRS’s point of view: a taxpayer legitimately owes x amount but only wants to pay a fraction of x. Before they accept that offer and willingly give up potential money, the IRS wants to make sure that there is no other way for you to pay your tax debt in full. Before they accept an offer in compromise, they need to verify that you are unable to pay in installments, tap into equity in your home or other assets, or use credit cards. 

This may mean giving up private school for your kids, taking out a home equity line of credit, or draining your savings account. This is where a lot of people mistakenly think they qualify; they don’t realize that the IRS expects paying taxes to come before luxuries, other debt payments, and savings.

Even worse, you could be out extra money if you apply and are rejected. You have to pay a $205 application fee plus a down payment when requesting an offer in compromise—and you don’t get that money back if your offer is rejected. The application fee is gone, and any down payment or monthly payments made go toward the balance of your tax debt.

Money on the Line: Sneaky Financial Implications

The financial demands of an offer in compromise can be draining. To start, you must have your finances completely in order so you can present a full and accurate view of your financial status to the IRS. This may mean taking an uncomfortably close and critical look at your debts and assets. 

Even if you do your best to provide accurate information to the IRS, mistakes do happen. Taxpayers may forget about certain debts, assets, or available lines of credit. Should the IRS discover this error while processing your application—and they generally do—you could have your application automatically denied or even face an audit. Their investigation may uncover assets or income that may drive up the amount you have to pay for an acceptable offer in compromise.

You also have to think about how a rejected offer in compromise could affect your finances. There’s the $205 application fee and required down payment, which you can only get waived if you meet certain low-income requirements. However, most people do have to pay these upfront costs. Should your offer get rejected, you get nothing back. The required down payment for a lump sum offer is 20%. If you offer a periodic payment plan, you continue to make monthly payments until the IRS makes a decision on your application.

Imagine this scenario: You have tax debt of $15,000, which you’re trying to settle for $5,000. You have to pay $205 plus a down payment of 20%, or $1,000. You send off $1,205 to the IRS, no small amount, when you’re grappling with tax debt. You ultimately find out that your offer is rejected. You’re out $1,205—yes, $1,000 goes toward your tax debt, but it’s a drop in the bucket compared to what you still owe.

Now, imagine you offer a periodic payment plan that would allow you to pay off your offer in 12 monthly payments. As per the terms of your agreement, you continue to make payments while waiting for the IRS’s decision. They ultimately decide to reject your offer after eight months. You are now out approximately $3,500 and still owe close to $12,000. That’s a big financial hit to take.

Say Goodbye to Future Refunds

What about tax refunds? You could lose a good chunk of change to your offer in compromise via your tax refunds. If the IRS accepts your offer, they will keep any refund you receive up until the date of acceptance as part of your contract. 

Note that this amount does not count toward your offer. It is entirely separate. So if you owe $10,000, offer $3,000, and get a tax refund of $2,000, you still owe $3,000 after the IRS applies your tax refund to your balance. This can be a hard financial hit for many, especially those who get the earned income tax credit or other large tax credits. 

Consider this scenario: you end up deep in tax debt because your withholdings were inaccurate, leaving you with a big tax bill. The next year, you completely change your withholdi,ngs so the IRS keeps more of your paycheck every two weeks. You request an offer in compromise and do your taxes while you wait. Because of your changed withholdings, you have a large refund due—but because of your offer in compromise, you get none of it. You received less money throughout the year, and at the end of it all, you didn’t get your refund.

The IRS generally cannot keep future refunds toward your offer in compromise, but they can do so if you submit a signed written request. This could extend the financial losses for several more years.

The Stress of the Waiting Game

You already know what a heavy mental burden tax debt can be. Even small purchases can feel like you’re sinking yourself into financial distress because it’s a little bit more money that isn’t going toward your taxes. Finally having some form of relief can feel like a massive weight off of your shoulders—but you don’t get that automatically with an offer in compromise.

On average, an offer in compromise application takes between six and 12 months to be processed. Technically, the IRS can spend up to two years processing your application. That is a lot of time to be stuck in limbo, not sure if you’ll owe your original tax debt or the offer you made. 

To add to that, you have to watch for any letters or notices from the IRS during this time. They may send their final decision, but they may also reach out to, you asking for more information. Failing to respond to these inquiries could lead to extra delays or an unnecessary rejection.

Your Private Financial Details on Display

No one likes having their financial dealings in the public eye, especially when those dealings involve tax debt. But if you have an accepted offer in compromise, certain details will be publicly available. Public inspection files can be pulled with a simple written request. This means that anyone can request information on your accepted offer and find out:

• Liability amount
• Terms of your offer
• The tax periods in question
• The reason for acceptance of the offer

This information can be devastating to your reputation if you are a business owner or public figure. Even if you’re not, knowing that this information is out there can be stressful.

Rejected? The Financial and Emotional Fallout

You’ve waited patiently for the IRS to make a final decision after spending a substantial amount of time gathering financial records, making copies, and submitting the strongest application possible. Unfortunately, you find out that the IRS has rejected your offer in compromise, kept your application fee, and kept all the payments made toward the offer.

This is painful in a number of ways. First, you could be out a sizable amount of money, depending on the size of your down payment or how many monthly payments you made. Second, you probably put a lot of effort into your application—only to have your offer rejected. Finally, a rejected offer can lead to a crushing loss of hope. Many taxpayers hang all their hopes on the possibility of an accepted offer, and the loss of that opportunity can make it very difficult to face the debt they still have to pay off.

You could appeal the decision, but this is also risky. You may have to spend more money on legal or professional fees, invest even more time into appealing their decision, and know that there’s still a good chance the decision will be upheld.

Accepted? The Five-Year Compliance Trap

Your offer was accepted—congratulations! This is a huge relief for many people. You get to pay off the rest of your lump sum offer or finish out your monthly payments, and then you’re done—right?

Not quite. For the next five years, you have to comply with all federal tax requirements. This includes filing your taxes on time and paying them in full on time. This may not seem too bad on its face; you’ve likely made changes to your withholdings or your quarterly payments to avoid falling behind again. 

But what happens if you lose your job, misunderstand your deductions, or fail to account for bonuses and raises? You could end up, once again, with a large tax bill. But this time, not paying on time doesn’t just mean you’re on the hook for penalties and interest. It may also mean that your offer in compromise is withdrawn, forcing you to pay the original amount you owed minus anything you have already paid toward it. Five years is a long time to assume that you’ll never miss a quarterly payment or need an installment agreement.

If you do get your offer accepted, you must be vigilant about your tax obligations for the next five years. File well in advance of the deadline, make payments before they are due, and respond to all communications from the IRS. This can help you stay compliant and avoid unintentional non-compliance.

Alternatives to an Offer in Compromise

There are other options you may want to check out. These may be viable options if you don’t qualify for an offer in compromise or if you do qualify but don’t want to take the risk. Potential relief options include:

• Installment agreements: This is generally the most straightforward option, and as an added benefit, there’s very little need for financial documentation. Financial forms are only required in certain cases. To qualify for an installment agreement, you must be able to pay your debt off in full within the next 72 months by making monthly payments. Another less common option is a partial payment installment agreement, which requires smaller monthly payments. However, this does require proof of your inability to pay.
• Penalty abatement: The IRS may waive penalties for those who have a history of tax compliance and those who have reasonable cause for failing to pay on time. Depending on how much you owe and how late your taxes are, this could take care of a sizable amount of your tax debt without the extra work of an offer in compromise application.
• Currently not collectible: If you cannot make any payments and cannot take the risk of potential rejection and loss of money, consider requesting currently not collectible status. This is a temporary solution that halts collection efforts until your financial situation changes or the Collection Statute Expiration Date passes.
• Bankruptcy: This should be considered a last resort, as it has a massive impact on your credit, your overall financial well being, and even your ability to keep your home and vehicles. However, in some cases, bankruptcy can wipe away tax debt and give you a fresh start.

Is an Offer in Compromise Worth the Gamble?

For some people, an offer in compromise is a lifeline that gets them out of the mental and financial strain of tax debt. However, you cannot ignore the potential risks—non-refundable fees and payments, financial scrutiny, your finances becoming public record, and required compliance—if you choose to go this route. 

It’s important to remember that even though tax relief firms may portray this as an easy solution that clears your tax debt for a small payment, it simply is not that easy.

Instead, take some time to weigh your options, talk to an enrolled agent or tax attorney, and figure out which option is best suited to your unique financial circumstances. When you do this, you can feel confident that you are making the right choice for your and your family’s future.

Frequently Asked Questions

What are the most common mistakes people make when they apply for an offer in compromise?

Taxpayers may fail to consider all of their assets and income sources, forget to include important documentation, or forget about the equity in their home and retirement accounts. All of these can disqualify them and lead to an avoidable rejection.

How long can an offer in compromise negatively affect my financial records?

An offer in compromise can affect your financial records for up to five years. During that five-year period after an accepted offer in compromise, the IRS can revoke your accepted offer at any time if you fail to comply with all federal tax regulations.

Does applying for an offer in compromise put me under IRS scrutiny indefinitely?

For five years, you will essentially be held to a higher standard. The IRS will require you to comply with all filing and payment requirements to keep your offer in compromise agreement. However, you shouldn’t expect them to watch you indefinitely after that.

Are there lower-cost alternatives that don’t have strict compliance requirements?

Yes. You may look into installment agreements, which have much lower fees if you apply online and opt for a Direct Debit Installment Agreement. While the IRS does require you to comply with filing and payment requirements, those who accrue additional tax debt may be able to roll their new tax debt into their installment agreement.

What if I can’t pay the application fee for an offer in compromise?

If you qualify for low-income status, you can have your application fee and deposit requirements waived.

Get Help From Seattle Legal Services Today

Looking for more personalized guidance on your tax debt? Let’s talk. Call Seattle Legal Services at 206-536-3152 or reach out to us online to set up a time to talk now. If an offer in compromise is right for your situation, we’ll help you get the best offer possible. But if not, we’ll guide you to other options.