How Bankruptcy Affects An Offer In Compromise With The Internal Revenue Service
Richard Fonfrias, J.D.
Chicago’s Financial Rescue & Bankruptcy Lawyer
Fonfrias Law Group, LLC
An Offer In Compromise (OIC) is an IRS program that allows you to settle your tax debt for less than the full amount you owe.
An OIC is a legal option if you cannot pay your taxes in full, or if paying the full amount would create a financial hardship on you and your family. When considering your offer, IRS looks at your ability to pay, income, expenses and equity in assets.
Your Offer in Compromise During Bankruptcy
IRS will not consider an OIC while you are in bankruptcy. When you file bankruptcy in Illinois, the federal Bankruptcy Code dictates how the IRS’s claim will be resolved.
IRS will not consider an OIC until the bankruptcy is concluded. In Chapter 7 cases, a compromise can be considered after you receive a discharge. In Chapter 13 cases, a compromise will not be considered until you finish payments under the plan or until the bankruptcy is dismissed by the court.
If you are in bankruptcy when your OIC is submitted – or during a pending offer investigation – your offer is returned as “non-processable”. Returning the offer is not a rejection of the offer and does not entitle you to appeal the matter to Appeals.
Your Offer in Compromise Before Bankruptcy
1. When you or your representative states during an offer investigation that a bankruptcy will be filed if your offer is not accepted, the examiner must determine whether the potential for a bankruptcy filing truly exists – and the impact the possible bankruptcy filing may have on collecting the taxes you owe.
2. To decide whether your OIC is reasonable, IRS will consider whether you have been involved in previous bankruptcies and/or if any of your tax liabilities may potentially be discharged.
3. The following procedures will help determine the impact a potential bankruptcy filing may have on the offer investigation. In addition, if you or your representative indicates that you are considering filing bankruptcy, IRS will immediately make a lien filing determination to learn whether filing a notice of federal tax lien (NFTL) is needed to protect the government’s interest in assets while the offer is being investigated.
4. If you do not file bankruptcy and if IRS accepts your OIC, the IRS benefits as follows:
- IRS can negotiate for money from future income and from assets beyond the government’s reach that may not be collected if you file bankruptcy.
- Negotiations may result in an offer amount that is greater than the amount IRS would recover in a bankruptcy proceeding.
- Terms for payment of an offer may result in money being collected in a shorter time than through bankruptcy.
- The terms of the OIC include a requirement that you file and pay all taxes owed for the next five years.
5. If you do not file bankruptcy and if IRS accepts your OIC, you benefit as follows:
- You will not have a bankruptcy on your credit rating.
- Since bankruptcy does not discharge all taxes owed, you will likely still owe taxes even after your bankruptcy. Your OIC will include all taxes you owe.
- IRS will not file an NFTL, which, if it were filed, would remain against certain assets even after bankruptcy.
6. While deciding whether your OIC is acceptable under the threat of bankruptcy, IRS will determine the reasonable collection potential (RCP) as defined by law. If the amount you owe is greater than the RCP, IRS will continue with the offer investigation. IRS will also consider special circumstances or hardship issues before investigating the effect a potential bankruptcy may have on an acceptable offer amount.
7. If bankruptcy proceedings were filed, IRS’s analysis of the potential amount collectible should include (1) analyzing your collection information statement(s), (2) analyzing your other financial statements, (3) analyzing your draft bankruptcy schedules (if available), and (4) a determination of which tax liabilities may be discharged. This will result in IRS’s ability to make an informed decision regarding the OIC so it can begin negotiating with you.
8. When completing the analysis, IRS must consider the following questions:
- Is the taxpayer an individual? The potential bankruptcy filing of an entity other than an individual – or from a taxpayer whose only liabilities include employment taxes – will not be considered when calculating the RCP to determine whether an OIC is acceptable.
- Is IRS the sole or major creditor?
- Would taxes be dischargeable in bankruptcy?
- Does the amount equal or exceed what IRS can reasonably expect to recover from bankruptcy?
- Are there other considerations, such as (1) what could be collected on liabilities that would not be discharged, or (2) what could be collected from property outside of the bankruptcy, including third parties.
Note: IRS will not accept less than the amount of money it would recover from a Chapter 7 bankruptcy unless special circumstances exist.