If there is legitimate legal doubt about the existence or amount of tax you owe, you may qualify to reduce your tax liability through an offer in compromise based on doubt as to liability. These are complicated concepts, and for best results, you should work with a tax lawyer, Certified Public Accountant (CPA), or enrolled agent (EA).
To help you out, this guide explains the essentials. It provides examples of doubt as to liability, and it outlines how to apply for this type of offer in compromise.
An offer in compromise is an agreement between a taxpayer and the Internal Revenue Service (IRS) to settle the taxpayer's taxes for less than the full tax amount owed. Simply put, you "offer" how much you think you should pay, and if the IRS agrees, the agency "compromises" on the bill.
There are two main types of offers in compromise: doubt as to collectibility and doubt as to liability. Doubt as to collectibility comes into play when you can't afford to pay your tax debt. The IRS doubts that it will be able to collect the full amount, so it lowers your bill. This guide covers doubt as to liability.
In rare cases, the IRS also settles tax bills based on effective tax administration. This is a type of offer in compromise that can come into play when the other two options don't apply. There is more information on effective tax administration at the end of this page.
Doubt as to liability means there is a doubt that the liability exists. Depending on the situation, you may doubt the entire tax debt or just a portion. To reduce your tax debt, you need to convince the IRS that the doubt is legitimate.
You cannot apply for doubt as to liability if there is already a final court decision about the tax owed. Similarly, you cannot apply for this program if the tax due is based on current law.
Doubt as to liability usually applies when a tax examiner makes a mistake or ignores the information you provide. It can also apply when new evidence is available about the situation. Here are a couple of examples to help you understand when you can apply for doubt as to liability.
Imagine the IRS audited your tax return. A house fire destroyed your tax records, you moved to a new home, and in the shuffle, you missed the notice about the audit. The IRS decided to disallow many of your expenses, and as a result, you incurred a tax debt.
Because you didn't receive the mail, you weren't aware of the tax bill for quite a while, and it incurred penalties and interest. When you become aware of the tax bill, you requested an audit reconsideration.
Unfortunately, the IRS issued an adverse decision about the consideration, and you didn't appeal. So, you decided to apply for an offer in compromise based on doubt as to collectibility. During this process, you convinced the IRS that the expenses were reasonable, and you explained why you no longer had the records. The IRS agrees that there is a doubt that the liability exists and reduces your tax bill.
Here's another example. Say you filed a tax return that included the value of stock options from your employer, and you incurred the Alternative Minimum Tax (AMT). You paid most of your tax debt, but you couldn't afford to pay all of it.
A few months later, you learned that your employer over-valued the stock options. You filed an amended tax return showing the new value of the stocks. Unfortunately, the IRS said that you need to pay the full amount of the original tax due before requesting a refund.
You received an adverse decision on your amended return and didn't appeal. At this point, you can request an offer in compromise as to doubt as to liability. If the IRS agrees with your claim, it will reduce your tax debt.
As you can see, in both of these examples, the taxpayer sought a different resolution before applying for the Offer in Compromise. In many doubt as to liability cases, you must first explore other alternatives before applying for this program. A tax pro can help you decide if this is the right option for your situation.
The main requirement for a doubt as to liability offer in compromise is a legitimate doubt that the tax exists or a legitimate doubt of its amount. The doubt must be based on law. You cannot make this type of claim to make general disagreements about the fairness or constitutionality of income tax.
You do not qualify for this type of offer in compromise if any of the following apply:
To apply for an offer in compromise based on doubt as to liability, you need to file Form 656-L (Offer in Compromise (Doubt as to Liability)). Here is an overview of the instructions on how to fill out Form 656-L.
To get started, this form requires the basics such as your name, Social Security Number, address, and your spouse's information. Then, you note the tax period and the return filed. Form 656-L lists Forms 1040, 941, 940, and the Trust Fund Recovery Penalty, but if you owe other federal taxes, you can also note them.
If you're requesting a compromise on business taxes from Form 1120, 940, 941, etc, you must fill out section two of Form 656-L. This section is for taxpayers who doubt the liability of corporate income tax, employment tax, federal unemployment tax (FUTA), or other federal business taxes.
In section three of Form 656-L, you make your offer. The offer amount is the only thing you note in this section. When you're applying for doubt as to liability, the offer must be at least $1, and it should represent the amount you believe you owe for the tax.
Section Four of Form 656-L doesn't require any information from you. Instead, it lists the terms of the offer in compromise. When you sign at the end of the form, you agree to the following terms:
By submitting an offer in compromise application, you agree to extend the statute of limitations on tax assessment for the length of time while the offer is pending, plus an extra year if the IRS rejects or terminates your agreement. If you don't want to extend the statute, you can still apply, but the IRS doesn't have to consider your offer. In this case, the statute will still be extended for the length of time the offer was pending plus an extra month after rejection or termination.
Section five is the most important part of Form 656-L. In this section, you get to explain why you believe that you don't owe the tax. To be effective, you need to be thorough and have a good understanding of the tax code. A tax pro can help to ensure you complete this part correctly. If you need extra room, attach additional sheets. Note your Social Security Number or Employer Identification Number on each sheet for references.
In section six, you and your spouse sign your names. Corporate officers should sign in this section if you're applying for a business. You can also check a box to allow the IRS to contact you by phone about your offer.
If someone filled out this form for you, you should note their information in this section. You can note anyone who helped you. This section isn't just for paid preparers.
Paid preparers should fill out section eight. If you handle this form on your own, simply leave this section blank. If you want someone to represent you about this matter to the IRS, you should also attach Form 2848 (Power of Attorney and Declaration of Representative) or Form 8821 (Tax Information Authorization).
When you file Form 656-L, you must include documents supporting your claim. The documents will vary depending on your situation. A tax pro can help you ensure you include the right documents.
Here is an overview of several different situations where your tax debt may be incorrect. Still, you shouldn't necessarily apply for an offer in compromise based on doubt as to liability. Instead, you should use the other resolution programs explained below.
If you agree with the amount of tax due but cannot afford to pay it, you can still apply for an offer in compromise. But rather than applying based on doubt as to liability, you need to apply based on doubt as to collectibility. Use Form 656-B (Offer in Compromise Doubt as to Collectibility).
In this situation, you should amend your return. Depending on the return you filed, you should use Form 1040-X (Amended US Individual Income Tax Return), Form 1120-X (Amended US Corporation Income Tax Return), or Form 709 (US Gift Return).
If the IRS rejects your amended return, you may be able to appeal or request an audit reconsideration. Alternatively, rather than appealing, you may apply for an offer in compromise based on doubt as to liability.
In some cases, when you don't file a tax return, the IRS may file a return on your behalf. The agency may file a substitute-for-return for your individual or business returns. These returns are often incorrect.
In this case, you should file the return that was filed on your behalf. Depending on the situation, this may be Form 1040 (Individual Income Tax Return or a business return such as Form 941 (Employer's Quarterly Federal Tax Return).
If the IRS changes your return due to an audit, you may end up with a tax debt you don't agree with. To contest the tax, you should request an audit reconsideration. Requesting an audit reconsideration reopens the audit and allows you to present new information.
Note that you can't request reconsideration if you already paid the full tax debt. Instead, you should file an amended return.
If you disagree with penalties, you may qualify for penalty abatement. The IRS is often willing to remove penalties, especially for first-time offenders who have reasonable cause. To request penalty abatement, file Form 843 (Claim for Refund and Request for Abatement).
This scenario occurs when the IRS's info on file doesn't match the info on your return. For instance, if the income you report is lower than the income shown on the W2 your employer sent to the IRS, you have unreported income. Similarly, if the IRS receives a 1099 form in your name but doesn't see the income on your return, you also have unreported income.
When this happens, the IRS will send you a CP2000 notice. The notice outlines the steps you should take if you disagree with the IRS's changes to your return.
At the end of the year, employers send W2 and W3 forms to the Social Security Administration (SSA) to report how much their employees have earned through the year. Most employers also file Form 941 quarterly. Or they may file one of the following returns annually: Form 943 for farmworkers, Form 944 for very small employers, Form 945 for non-employees, or Schedule H for household employers.
The IRS and SSA use Combined Annual Wage Reporting (CAWR) to ensure their information matches. If there is a discrepancy that indicates an underpayment of tax, the IRS will send you a notice and open a CAWR case. To address the issue, figure out which form had the mistake. Then, submit a corrected version of the form to the IRS or SSA.
The Affordable Care Act (ACA) allowed the government to assess a penalty on your tax return if you didn't have health insurance for the full tax year. The penalty was eliminated at the end of 2018. As part of the ACA, the government also issues tax credits to people who purchase insurance on the marketplace. If your income is too high, you may have to repay some of the credits.
If you have a tax liability due to these types of issues and you disagree, you should not use the doubt-as-to-liability program. Instead, you should file an amended return. The amended return should clearly indicate that you do not owe the ACA or marketplace tax.
Your employment status has a direct effect on your tax liability. If your employer misclassifies you as an independent contractor, you will incur self-employment tax. This covers Medicare and Social Security, and it's double the amount you pay as an employee.
On the other hand, if your employer misclassifies you as an employee, you will not be able to deduct expenses from your income as you can when you're an independent contractor. Depending on the situation, both types of misclassifications can create an incorrect tax debt.
If you're dealing with this issue, you should file Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding). The IRS will use the information on this form to determine your correct employment status. Then, your tax debt will be adjusted based on the determination.
If the tax is due exclusively to your spouse or ex-spouse's actions, you should apply for innocent spouse relief. For example, imagine your spouse was hiding income from you. They didn't report it on your tax return, and the IRS sent you a bill for the tax and penalties. Because you didn't know about the underreported income, you may qualify for this program. If you don't qualify for classic innocent spouse relief, you can apply for separation of liability relief or equitable relief.
To apply, file Form 8857 (Request for Innocent Spouse Relief). If the IRS has kept your joint refund to cover a liability due just to your spouse (such as child support or back taxes), you may need to file Form 8379 (Injured Spouse Allocation).
If you have exhausted all of these other options, you can apply for doubt as to liability. Doubt as to liability cases requires a very firm understanding of the tax code. If you want your claim to be successful, you should work with a tax pro who has experience with this program.
As indicated above, the doubt-as-to-liability program applies when you doubt the liability of the tax. If you agree with the legitimacy of the tax, you should not use this program. Instead, you need to apply for an offer in compromise based on doubt as to collectibility.
If you submit applications for both types of offers in compromise, the IRS will return the doubt as to collectibility application. The agency will not review that application.
Effective tax administration (ETA) produces equity and fairness in the tax collection system. This option doesn't apply to people who doubt the legitimacy of the tax. Instead, it comes into play if you can technically afford to pay the tax or an offer, but doing so would cause economic hardship. ETA can also apply in cases where there is a compelling equity consideration for compromising the tax.
You need exceptional circumstances to qualify for this option. Most people who settle taxes this way are very advanced in age or have serious illnesses. For example, imagine someone who could sell assets to pay their taxes. However, their child has a chronic illness, and they may need to sell the assets to cover their child's expenses.
Facing a tax debt that you don't think is legitimate? Not sure what to do? You may qualify to reduce your tax debt based on doubt as to liability. To learn more, contact a tax professional today.
Using TaxCure's search feature, you can search for a local tax pro experienced with offer in compromise filings. They can talk with you about your situation and help you find the best resolution option for your situation.
