When an Offer in Compromise Could Be the Right Move

Quick reality check

An Offer in Compromise (OIC) is not a shortcut — it’s a formal settlement process for taxpayers who cannot reasonably pay their full federal tax debt. The IRS will only accept an OIC when evidence shows the amount offered represents the most it can reasonably collect within a reasonable period. For many taxpayers that means an OIC is appropriate only after you’ve exhausted other options like installment agreements or currently not collectible (CNC) status.

When an OIC typically makes sense

The IRS evaluates offers under three legal grounds (see IRS guidance):

• Doubt as to collectibility: The most common basis. You can’t pay the full amount now or in the foreseeable future based on your assets and income.
• Doubt as to liability: You legitimately dispute the accuracy of the assessed tax (for example, the IRS assessed tax for the wrong year or amount).
• Effective tax administration: You can pay but doing so would create exceptional hardship or would be unfair or inequitable to collect (rare and fact-specific).

If your situation fits one of the above, an OIC may be the right move. Documentation and a clear calculation that shows the IRS would receive more by accepting the offer than by continuing collection are essential.

Who must be current to apply

You cannot apply for an OIC if certain conditions aren’t met. The IRS requires that:

• You have filed all required tax returns.
• You are current on estimated tax payments and filing requirements for the current tax year, if applicable.
• You are not in an open bankruptcy case.
• You have paid any required non-IRS debts the IRS instructs be paid first (in limited situations).

Refer to the IRS Offer in Compromise page for the most current eligibility rules (IRS.gov/OfferInCompromise).

How the IRS calculates what it can collect (Reasonable Collection Potential)

The IRS builds a collection picture called Reasonable Collection Potential (RCP). RCP combines two pieces:

1. Net realizable equity in assets: fair market value of assets minus the amount required to satisfy secured creditors and typical selling costs.
2. Future income collection potential: the IRS looks at monthly disposable income (income after allowable living expenses) and multiplies it by a look‑ahead period:

• Lump-sum offers (paid within five or fewer payments) are generally evaluated using 12 months of future income.
• Periodic-payment offers (paid over longer terms) generally use 24 months of future income.

The offer the IRS expects to receive equals the sum of these components. If your offer is equal to or greater than the RCP, acceptance is more likely. For more detail on these calculations, see our guide on how OIC amounts are calculated: “How Offer in Compromise Amounts Are Calculated: A Simple Walkthrough” (https://finhelp.io/glossary/how-offer-in-compromise-amounts-are-calculated-a-simple-walkthrough/).

Forms, costs and payment rules (high-level)

• Primary form: Form 656, Offer in Compromise (include the signed form and required documents). See the Form 656 instructions on the IRS website.
• Financial information: Form 433‑A (for individuals) or Form 433‑B (for businesses) or the updated financial statement requested by the IRS.
• Application fee: The IRS charges an application fee (currently $205 as published on Form 656 instructions), though the fee may be waived for taxpayers who meet the low-income certification.
• Initial payment rules: If you submit a lump-sum offer (five or fewer payments) you generally must include 20% of the offer amount with the application. For periodic offers you must include your first proposed payment and continue payments while the offer is pending. Low-income taxpayers may be exempt from the fee and initial payment.

Check the latest Form 656 instructions on IRS.gov before filing to confirm fee amounts and payment rules.

Step-by-step application overview

1. Pre-qualify: Use the IRS Offer in Compromise pre-qualifier tool and review your finances. Our practical eligibility walkthrough can help: “Understanding the Offer in Compromise Pre-Qualifier: Am I Eligible?” (https://finhelp.io/glossary/understanding-the-offer-in-compromise-pre-qualifier-am-i-eligible/).
2. Prepare financial package: Gather pay stubs, bank statements, asset documentation, and completed Form 433 series. See our documentation checklist: “Preparing an Offer in Compromise: Documentation Checklist” (https://finhelp.io/glossary/preparing-an-offer-in-compromise-documentation-checklist/).
3. Complete Form 656 and include required signatures, fees, and initial payment as applicable.
4. Submit the offer package to the IRS. Maintain copies and track delivery.
5. Respond to IRS requests for additional information promptly. The IRS often requests substantiation of expenses or asset values.
6. Wait for IRS decision. The IRS may accept, reject, or return your offer. Processing time varies.

Typical timeline

Processing can range from several months to over a year depending on complexity and IRS workload. While your offer is pending, the IRS generally suspends collection actions if you comply with the rules and keep current on tax filings and payments. Expect to be responsive: delays in providing requested documentation can add months to the process.

Pros, cons and consequences

Pros:

• Potentially settle for less than the full amount owed and stop additional interest and penalties from accumulating on forgiven balances.
• Once accepted and paid, the remaining liability is legally discharged for the taxable periods covered.

Cons and consequences:

• Not easy to qualify — the IRS requires thorough financial disclosure.
• The process can be lengthy and invasive of personal finances.
• The IRS may file or maintain a federal tax lien during the process; lien release timing varies and may require additional steps after acceptance.
• There can be income tax consequences in some scenarios if cancelled debt is considered taxable income — consult a tax professional.

Alternatives to an OIC

Before applying, compare alternatives. An installment agreement, Currently Not Collectible (CNC) status, or bankruptcy might be better depending on your situation. For a direct comparison, read: “Choosing Between an Installment Agreement and an Offer in Compromise” (https://finhelp.io/glossary/choosing-between-an-installment-agreement-and-an-offer-in-compromise/).

Common mistakes I see in practice

• Under-documenting living expenses or asset values. The IRS expects substantiation.
• Offering less than the IRS’s RCP without a strong argument (like effective tax administration).
• Failing to remain current on filings and estimated tax payments during the process.
• Hiring an unscrupulous preparer promising guaranteed acceptance — there are no guarantees.

In my practice as a CPA, careful record-keeping and a conservative RCP calculation are the two most important preparation steps I recommend. I also encourage clients to run a full cost/benefit analysis against installment plans or CNC designation before submitting an offer.

After a denial — next steps

If the IRS rejects your offer, you have options: you can appeal the decision, submit a new offer with better documentation or revised terms, or pursue alternative collection strategies. See our page on “Options After a Denied Offer in Compromise” for stepwise options and appeals guidance (https://finhelp.io/glossary/options-after-a-denied-offer-in-compromise/).

Practical tips before you file

• Use the IRS pre‑qualifier tool to get an initial sense of eligibility (IRS.gov/OfferInCompromise).
• Keep your documentation airtight: pay stubs, bank statements, lease or mortgage documents, insurance premiums, child support paperwork, and appraisals for valuable property.
• Consider professional help: a CPA or enrolled agent familiar with OICs can reduce errors and improve presentation.
• Don’t stop filing returns or making required estimated payments while your offer is pending.

Frequently asked brief answers

• Are OICs commonly accepted? Acceptance rates vary and are case-specific. Well-documented offers that meet RCP criteria have the best chance.
• How long does it take? Often several months; complex cases can take a year or longer.
• Is acceptance final? Yes, a properly accepted OIC is binding; failure to comply with the terms may void the agreement.

Authoritative sources

• IRS — Offer in Compromise (official page): https://www.irs.gov/individuals/offer-in-compromise
• IRS — Publication/Booklet: Offer in Compromise Booklet (Pub 1854 or current publication on IRS.gov)
• IRS — Form 656 instructions (check IRS.gov for the latest version)

Disclaimer

This article is educational and does not replace personalized tax or legal advice. Tax rules change, and your situation may have complexities not covered here. Consult a qualified tax professional (CPA, enrolled agent, or tax attorney) before submitting an Offer in Compromise.