Background

An Offer in Compromise (OIC) lets taxpayers settle federal tax debt for less than the full amount when full collection is unlikely or would create economic hardship. The IRS evaluates offers under three grounds (doubt as to liability, doubt as to collectibility, and effective tax administration), but most successful OICs rely on proving limited ability to pay — the Reasonable Collection Potential (RCP). See the IRS overview for current rules (IRS, Offer in Compromise).

How the IRS defines RCP (quick summary)

  • Net realizable equity in assets: fair market value minus selling costs and any secured debt. Examples: non-exempt bank accounts, investment accounts, second cars, business assets not essential to income generation.
  • Future income (disposable income): monthly income after allowable IRS national and local living-expense standards and certain necessary expenses. The IRS typically multiplies monthly disposable income by 12 to estimate collectible future income.

Step-by-step walkthrough to calculate a reasonable offer amount

1) Gather documentation

  • Recent pay stubs, bank statements, retirement statements, and proof of all income sources.
  • Asset statements (home equity summary, vehicle values, brokerage statements).
  • Expense documentation: rent/mortgage, utilities, medical bills, child support, and any extraordinary expenses.
  • Use Form 656 and Form 433-A (OIC) or 433-B (OIC) as the working templates (IRS forms guide).

2) Determine net realizable equity in assets

  • List each asset, estimate fair market value, and subtract costs to sell (real estate commissions, payoff amounts on liens).
  • Exclude exempt items (e.g., certain retirement accounts may be given limited protection) per IRS guidance.

3) Calculate monthly disposable income

  • Start with gross monthly income then subtract payroll taxes and allowable adjustments.
  • Subtract IRS national and local standards (housing, food, transportation) and documented necessary expenses not covered by standards. The remaining amount is monthly disposable income.

4) Compute the RCP

  • RCP = Net realizable equity in assets + (Monthly disposable income × 12).
  • For many OICs, the IRS considers 12 months of future income when deciding collectibility. Use this RCP as the baseline for a reasonable offer.

5) Decide offer type and final number

  • Lump-sum cash offers require an initial payment (often 20% of the offer) and full payment within five months.
  • Periodic-payment offers require payments while the offer is pending. The offer amount generally should equal or slightly under RCP to allow negotiation room.
  • Consider effective tax administration if unique hardship exists — this can justify offers below RCP but requires strong documentation.

Practical example (rounded numbers)

  • Assets: $4,000 available in bank accounts + $6,000 net equity from a vehicle = $10,000.
  • Monthly disposable income: $200.
  • RCP = $10,000 + ($200 × 12) = $12,400.
  • Reasonable offer: $12,000 (lump-sum or structured to reflect cash availability). This falls at or below RCP and is more likely to be accepted than an offer far below the RCP.

Documentation checklist (what the IRS will want)

  • Completed Form 656 and Form 433-A (OIC) or Form 433-B (OIC).
  • Up-to-date pay stubs (30 days), two recent bank statements, and asset account statements.
  • Proof of extraordinary expenses (medical bills, court-ordered support), and business profit/loss statements for self-employed taxpayers.

Common mistakes to avoid

  • Underreporting income or assets (the IRS verifies with third-party data).
  • Using unrealistic expense numbers instead of IRS national/local standards.
  • Submitting an offer far below RCP without strong effective tax administration justification.

Helpful internal resources

Professional insight
In my practice, the most common reason an OIC is rejected is weak documentation of allowable expenses or missed income sources (bonuses, rental income, side gigs). Be thorough: the IRS cross-checks with wage and information returns.

Disclaimer
This article is educational and not personalized tax advice. Use it to prepare, then consult a qualified tax professional or the IRS for decisions specific to your case.

Authoritative sources