While it is possible to settle your tax debt with the IRS for pennies on the dollar, not everyone qualifies for this program. To be eligible, you must meet at least one of the three criteria established by the Internal Revenue Service. These criteria include reasonable doubt in regard to your ability to repay the taxes, the possibility your taxes were miscalculated and exceptional circumstances hindering your ability to pay (see Tips). If your situation falls under any of these categories, you may be able to settle your tax debt for pennies on the dollar by filing an offer in compromise with the IRS.
Calculate the amount of money you can reasonably pay to cover the debt. The IRS will only accept offers that are equal to or greater than a taxpayer's reasonable collection potential. This can be calculated by adding 100 percent of your cash, savings and investments with the realizable value of your assets such as your home, vehicles and other assets. The realizable value can be calculated by multiplying the fair market value of your assets by 80 percent and then subtracting any loans still owed. Add your estimated disposable income over the next 60 months to this figure to get your reasonable collection potential. If this figure is low enough, you can potentially have to pay only pennies on the dollar for your tax debt.
Obtain the form titled "Offer in Compromise" from the IRS website (see Resources).
Fill out the form by typing your answers in the designated blue boxes. Section 1 asks for your contact information. In Section 2, indicate the tax periods in question. For Section 3, check the box with your reason for applying and write a detailed description of your circumstances showing your inability to pay. Check the box in Section 4 if you meet the low income guidelines provided. Section 5 asks for the monetary amount of your offer and payment terms. Section 6 is optional and used to designate certain payments for specific tax years. Section 7 asks for the source of your funds.
Read through the terms of the agreement in Section 8 and type in the current date in Section 9. Section 10 must be filled out if a tax preparer is filling out the form, and Section 11 needs to be filled out if you want a third party to be able to discuss your case with the IRS.
Print two copies of the application. One is for the IRS and the other is for your records.
Sign in the designated space in Section 9.
Mail the completed application along with two checks, one for the application fee and the other for your first payment, to the IRS.
Doubt as to collectibility covers situations where a taxpayer's income and assets aren't sufficient to cover the tax liability. Doubt as to liability applies where the tax examiner made a mistake or the taxpayer has new evidence for their claim. Effective tax administration means the taxpayer has sufficient funds or assets to cover the debt, but exceptional circumstances exist preventing her from using these resources to pay the debt. An acceptable example would be caring for the medical needs of a child with a long-term illness.