How an Offer in Compromise Works and Why It Matters
An Offer in Compromise (OIC) is a formal proposal to the IRS to accept less than the total tax, penalties, and interest you owe. The IRS will consider an OIC when full collection is unlikely or where collecting the full amount would be unfair under the circumstances (effective tax administration). OICs are most often used for doubt as to collectibility, where the taxpayer simply cannot pay the full liability now or in the foreseeable future.
Because an OIC can permanently resolve a tax debt, it’s a high‑stakes tool. In my practice I’ve seen OICs restore a client’s financial footing—but I’ve also seen offers rejected when applicants skip documentation or misunderstand how the IRS values assets and income.
Authoritative references: IRS Offer in Compromise page and Publication 656 explain the program and rules (IRS.gov/payments/offer-in-compromise; IRS Pub 656). See IRS forms and guidance at: https://www.irs.gov/payments/offer-in-compromise and https://www.irs.gov/pub/irs-pdf/p656.pdf.
Who Qualifies: The Three Legal Grounds for an OIC
The IRS evaluates offers under three basic standards:
- Doubt as to liability: You genuinely dispute the amount of tax the IRS claims. The IRS will review documents showing why its assessment is incorrect.
- Doubt as to collectibility (most common): You can’t pay the full tax now or in the foreseeable future. The IRS calculates your reasonable collection potential (RCP) based on assets and future income.
- Effective tax administration: Even if you could pay, collection would create economic hardship or be inequitable (rare and fact‑specific).
Qualification also requires you to be current on filing and payment obligations: you must have filed all required tax returns and made required estimated tax payments for the current year. The IRS will not process an OIC if you are in an open bankruptcy proceeding.
(See IRS guidance: Offer in Compromise — Offer Eligibility, and Publication 656.)
Required Forms, Fees, and Payments
To submit an OIC you must complete and submit:
- Form 656, Offer in Compromise (the offer itself).
- Form 433‑A (OIC) for individuals or Form 433‑B (OIC) for businesses — detailed financial statements specific to OICs.
- Supporting documentation: bank statements, pay stubs, proof of expenses, property valuations, medical bills, etc.
You must also include an application fee (currently $205 unless you qualify for the low‑income certification) and an initial payment. The payment rules depend on the offer type:
- Lump‑sum (Cash) Offer: You submit 20% of the offer amount with Form 656. If accepted, the remaining balance is paid in five or fewer scheduled payments.
- Periodic Payment Offer: You submit the first periodic payment with Form 656 and continue making the scheduled payments while the IRS reviews the offer.
Low‑income taxpayers may request a waiver of the $205 fee and the initial payment by completing the low‑income certification as explained on the IRS OIC page (check current fee amounts on IRS.gov before applying).
How the IRS Values Your Offer: Reasonable Collection Potential (RCP)
The IRS calculates RCP to determine the smallest amount it can reasonably collect. RCP equals the net realizable value of your assets plus the present value of your future income available after allowed living expenses.
Key points about RCP:
- Assets: The IRS uses conservative valuations—bank accounts, real estate equity, cars (based on fair market value less allowable costs), investments, and business property are included.
- Future income: The IRS looks at monthly disposable income after allowed living expenses. It applies national and local expense standards and may limit certain deductions if they appear excessive.
- The IRS will generally not accept an offer that is lower than the RCP—offers below RCP are usually returned or rejected.
Understanding how RCP works helps you decide whether to make an OIC or pursue other options such as an installment agreement.
Choosing Between an OIC and an Installment Agreement
An OIC is not the right choice for everyone. If you can pay over time, an installment agreement — including partial‑payment installment agreements (PPIA) — may be better. For a comparison and decision-making guidance, see our pieces “Choosing Between an Installment Agreement and an Offer in Compromise” and “When an Installment Agreement Is Better Than an Offer in Compromise.”
- Choosing between options: If your RCP is near or above the tax owed, an installment agreement or an Offer in Compromise may not help. If your RCP is significantly lower than the tax liability, an OIC could be appropriate.
Internal links:
- Choosing between installment and OIC: https://finhelp.io/glossary/choosing-between-an-installment-agreement-and-an-offer-in-compromise/
- When an installment agreement is better: https://finhelp.io/glossary/when-an-installment-agreement-is-better-than-an-offer-in-compromise/
- If you instead want to set up a payment plan: https://finhelp.io/glossary/setting-up-an-irs-installment-agreement-a-step-by-step-guide/
Common Pitfalls and How to Avoid Them
Many OIC applications fail for predictable reasons. Avoid these mistakes:
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Incomplete or inaccurate documentation: Missing bank statements, inconsistent income reporting, or missing valuation documents invite rejection. Double‑check every number on Form 433‑A/B.
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Underestimating RCP: Applicants sometimes assume the IRS will accept lower valuations for assets or higher living expenses than the IRS allows. Use conservative, supportable figures.
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Noncompliance with filing or payment obligations: You must be current on tax filings and estimated taxes. The IRS will suspend OIC processing if you’re not compliant.
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Relying on OIC as an immediate relief tool: The IRS can take months to decide. If you need short‑term relief, consider an installment agreement or a temporary hold (currently not a long‑term solution).
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Hiring an inexperienced practitioner or paying large upfront fees to promoters: Use qualified tax professionals—CPAs, enrolled agents, or tax attorneys—and confirm credentials. Avoid firms promising guaranteed acceptance.
Practical Application Steps (Checklist)
If you decide to apply, follow this checklist:
- Gather documentation: last 12 months of pay stubs, bank statements, recent mortgage statements, vehicle titles with valuation, business accounting records, proof of medical expenses, and any supporting letters for hardship.
- Complete Form 656 and the correct Form 433‑series form for OIC (433‑A for individuals, 433‑B for businesses).
- Prepare the application fee ($205 unless you qualify for the low‑income waiver) and initial payment per the offer type.
- Mail the completed package as instructed on Form 656 or submit electronically where available.
- Maintain compliance: file any missing returns and pay current tax obligations during the review.
- Respond promptly to IRS requests for additional information and keep detailed records of all correspondence.
Timeline and What to Expect
Processing times vary. The IRS typically takes several months to a year to process an OIC. Factors that extend the timeline include incomplete submissions, a backlog at the IRS, and complex financial situations. During the review, the IRS may request additional documentation or propose a different settlement amount.
If your offer is accepted, you must meet the payment schedule and remain compliant for a specified period (commonly five years) or the IRS can reinstate the original debt. If the offer is rejected, you will receive a written notice explaining why and your appeal rights.
Appeals and Appeals Rights
If the IRS rejects your OIC, you have appeal rights. Publication 656 explains how to request an appeal through the IRS Independent Office of Appeals. Many rejections can be appealed successfully if new evidence or a clearer explanation of financial hardship is provided.
Real Client Insight (from practice)
In my 15 years working with tax clients, the most successful OICs are those that:
- Present clear, well‑documented financials;
- Show the applicant tried other options (e.g., installment agreements) but proved they were not feasible; and
- Explain non‑recurring factors that reduce collectibility (job loss, medical debt, uninsured losses).
One client example: a sole proprietor with a sharp revenue drop and large medical bills submitted a clean Form 433‑B with bank statements and valuation documentation. The IRS accepted a lump‑sum offer after the taxpayer included the required initial payment and the $205 application fee.
When Not to Use an OIC
Do not pursue an OIC when:
- You can reasonably pay the liability with an installment agreement, or
- The RCP shows the IRS can collect most of the liability in the future.
If you are able to pay over time, a partial‑payment installment agreement (PPIA) or streamlined installment plan may be more appropriate (see linked resources above).
Final Practical Tips
- Run the IRS pre‑qualifier as a first step to gauge whether an OIC is worth pursuing, but don’t rely on it exclusively.
- Work with a qualified tax professional who knows OIC valuation rules and can help assemble supporting documentation.
- Keep copies of everything you send the IRS and use certified mail or documented delivery methods when mailing your application.
Professional Disclaimer
This article is educational and does not constitute legal or tax advice. Rules, fees, and forms may change—verify current requirements with the IRS or a qualified tax professional before applying. For the official IRS rules and current forms, see the IRS Offer in Compromise page and Publication 656: https://www.irs.gov/payments/offer-in-compromise and https://www.irs.gov/pub/irs-pdf/p656.pdf.
Additional authoritative resources
- IRS Offer in Compromise (forms, fee, eligibility walkthrough): https://www.irs.gov/payments/offer-in-compromise
- IRS Publication 656, Offer in Compromise: https://www.irs.gov/pub/irs-pdf/p656.pdf
Internal resources on related payment options:
- Choosing Between an Installment Agreement and an Offer in Compromise: https://finhelp.io/glossary/choosing-between-an-installment-agreement-and-an-offer-in-compromise/
- When an Installment Agreement Is Better Than an Offer in Compromise: https://finhelp.io/glossary/when-an-installment-agreement-is-better-than-an-offer-in-compromise/
- Setting Up an IRS Installment Agreement: A Step-by-Step Guide: https://finhelp.io/glossary/setting-up-an-irs-installment-agreement-a-step-by-step-guide/
If you want, I can create a printable OIC application checklist tailored to your situation or review a sample Form 433 submission for common errors.
