The Internal Revenue Code provides that taxpayers may settle their federal tax debts for less than the full amount due under certain circumstances.
First, an offer may be accepted when doubt as to the taxpayer’s liability for the tax exists. An example is when there is a genuine legal dispute as to the existence of the debt or of the amount of tax, which IRS claims is due. The latter instance often occurs when IRS asserts a liability based on an original return when an amended return has been filed to correct income and/or deductions set forth on the original
Second, an offer may be accepted when doubt as to collectibility from the taxpayer exists. This category is the one under which most Offers fall. Here, the taxpayer shows that the total financial resources available to him or her are less than the full amount of the tax due. To qualify under doubt as to collectibility, the taxpayer must submit to the IRS certain documentation about his assets, monthly gross income, and monthly expenses.
The third and last category for offers in compromise is effective tax administration. This category enables the IRS to accept offers, even if the taxpayer agrees that they owe the full amount of the tax and have sufficient financial assets to pay. Relief is provided, however, if the taxpayer can demonstrate that full payment would cause an economic hardship or would be unfair and inequitable.