Filing an Offer in Compromise: Eligibility, Process, and Tips

Quick overview

An Offer in Compromise (OIC) is a formal IRS program that allows qualifying taxpayers to settle federal tax liabilities for less than the full balance owed. The IRS bases OIC decisions on a taxpayer’s ability to pay now and in the foreseeable future. The OIC is not a shortcut — it requires detailed financial disclosures, supporting documents, and strict compliance with filing and payment rules while the offer is pending and after acceptance.

Authoritative resources:

• IRS Offer in Compromise overview: https://www.irs.gov/individuals/offer-in-compromise (IRS)
• Form 656, Instructions, and requirements: https://www.irs.gov/pub/irs-pdf/f656.pdf (IRS)
• IRS Collection Financial Standards (allowable living expenses): https://www.irs.gov/individuals/collection-financial-standards (IRS)

Note: This article is educational only and does not replace personalized tax advice. For case-specific guidance consult a licensed tax professional or attorney.

Who can use an Offer in Compromise?

The OIC is intended for taxpayers who legitimately cannot pay the full tax debt through a lump sum, an installment agreement, or through collection of their assets. Eligibility highlights:

• You must owe federal tax (income, employment, certain employment taxes, etc.).
• You must have filed all required tax returns or have arrangements to file. (The IRS will generally not process an offer unless filing compliance is met.)
• You must be current with estimated tax payments and not in active bankruptcy that prevents processing (bankruptcy can complicate filing — consult counsel).
• You must show that your reasonable collection potential (RCP) — what the IRS can collect through assets and future income — is less than the liability.

The IRS also considers three legal grounds for acceptance:

1. Doubt as to collectibility (most common) — the taxpayer cannot pay the full amount.
2. Doubt as to liability — there is a genuine dispute that the assessed tax is correct.
3. Effective tax administration — paying the full amount would create an economic hardship or would be unfair.

For more on qualifying scenarios and examples, see our internal guidance on when an OIC makes sense: “When an Offer in Compromise Makes Sense: Practical Examples” (https://finhelp.io/glossary/when-an-offer-in-compromise-makes-sense-practical-examples/).

How the IRS computes a reasonable collection potential (RCP)

The IRS calculates an offer amount using RCP, roughly:

RCP = (Net realizable equity in assets) + (Future income available for collection)

• Assets: IRS uses fair market value minus selling costs and liens. Certain assets (basic tools, clothing, primary vehicle up to allowed equity) may be partially excluded.
• Income: The IRS looks at monthly income, subtracts allowable living expenses using the Collection Financial Standards, and treats the remaining “monthly disposable income” as available for tax collection over a defined period (typically 12 months for lump-sum calculations; periodic offers use a different schedule).

The result gives a floor for any offer. Offers below RCP are unlikely to be accepted unless other legal grounds apply.

Refer to the IRS Collection Financial Standards for the current expense allowances used in the calculation: https://www.irs.gov/individuals/collection-financial-standards.

Step-by-step filing process

1. Prepare documentation

• Copies of federal tax returns for required years (filed). If unfiled returns exist, file them before or with the OIC. The IRS may refuse to process an offer until returns are filed.
• Current pay stubs, bank statements (3 months), statements for retirement accounts, and documentation for other assets and liabilities.
• A completed financial statement: Form 433-A (individuals) or Form 433-B (business). These standard forms list income, allowable expenses, and assets.

1. Complete Form 656 (Offer in Compromise)

• Choose the reason for the offer (Doubt as to Collectibility, Doubt as to Liability, or Effective Tax Administration) and answer all questions.
• Decide on offer type: lump-sum cash or periodic payments.

1. Include required payments

• Application fee: The IRS currently requires an application fee (see Form 656 instructions). Low-income taxpayers may qualify for a waiver; check current IRS guidance in Form 656 instructions and the OIC overview (https://www.irs.gov/individuals/offer-in-compromise and the Form 656 instructions PDF).
• Lump-sum offer: generally submit 20% of the offer amount with Form 656. If accepted, the remainder is due under the lump-sum schedule.
• Periodic offer: submit the first proposed periodic payment with Form 656 and continue making payments while the offer is being considered. Missing payments can cause rejection.

1. Mail the packet to the IRS address shown in the Form 656 instructions along with Form 433-A/B, supporting documents, and payment. Keep copies of everything.

2. IRS review and decision

• The IRS will acknowledge receipt. Review time varies with case complexity; many offers take 6–12 months, sometimes longer.
• While the IRS considers your offer you must stay current with filing and payment obligations — failure to do so may result in rejection.

1. After decision

• If accepted: pay the remainder according to the terms. Maintain compliance for the required period (IRS typically requires compliance with filing and payment requirements for five years following acceptance).
• If rejected: you may seek reconsideration, appeal the decision through the IRS Office of Appeals, or consider other collection alternatives.

For guidance on reapplying or appealing a denied offer, see our article “How to Reconsider a Denied Offer in Compromise: Next Steps and Documentation” (https://finhelp.io/glossary/how-to-reconsider-a-denied-offer-in-compromise-next-steps-and-documentation/).

Documentation checklist (practical)

• Completed Form 656 (signed)
• Form 433-A or 433-B (completed)
• Copies of filed federal tax returns (all required years)
• Recent pay stubs and employer verification, if applicable
• Bank statements (3–6 months)
• Proof of monthly bills (rent/mortgage, insurance, medical, child support)
• Statements for retirement and investment accounts
• Vehicle titles and loan statements
• Written explanation for special circumstances (medical hardship, job loss)

Also include the required application fee or proof of low-income status if applying for a waiver.

Common mistakes and how to avoid them

• Incomplete forms and missing signatures — the IRS often rejects offers for avoidable procedural errors. Double-check every page.
• Underreporting assets or income — be transparent. Omitted items discovered later can lead to denial and penalties.
• Proposing an unrealistically low offer — use the Collection Financial Standards to model an offer that reflects RCP.
• Missing required payments while the offer is pending — if you chose periodic payments, make them on time. Missed payments frequently result in rejection.
• Ignoring filing compliance — file all required returns before or with the OIC.

For an extended guide on preventing procedural and valuation errors, see our related post on avoiding common mistakes on an OIC application: “Avoiding Common Mistakes on an Offer in Compromise Application” (https://finhelp.io/glossary/avoiding-common-mistakes-on-an-offer-in-compromise-application/).

Practical tips to improve your chances

• Do the math first. Use Form 433-A/B and the Collection Financial Standards to estimate RCP before you file. That helps set a realistic offer.
• Gather contemporaneous documentation. Clear, consistent records speed review and reduce follow-up requests from the IRS.
• Consider hiring a qualified tax professional. In my practice, offers with clear, well-documented disclosures and a strategic calculation of RCP are more likely to be accepted.
• Use the correct grounds. If you truly dispute the assessment, consider Form 656-L (Doubt as to Liability) and the evidence you need to support that claim.
• Be patient and responsive. Answer IRS requests quickly and completely. Timely replies shorten the review time and lower the chance of rejection.

Alternatives to an OIC

An OIC is not the only way to resolve tax debt. Consider other options depending on your situation:

• Installment Agreement — pay over time when you can manage monthly payments.
• Currently Not Collectible (CNC) status — the IRS temporarily suspends collection if you cannot pay essential living expenses.
• Bankruptcy — in limited circumstances some tax debts can be discharged; consult a bankruptcy attorney.

If you suspect an OIC may not be the right choice, review our alternatives article: “When an Offer in Compromise Is Not the Right Choice: Alternatives to Consider” (https://finhelp.io/glossary/when-an-offer-in-compromise-is-not-the-right-choice-alternatives-to-consider/).

Timeline and expectations

• Preparation: 2–8 weeks (document collection and form completion)
• IRS review: commonly 6–12 months; complex cases take longer
• If accepted: payment schedule begins immediately; stay compliant for the IRS-required period (typically five years)

Be realistic: the OIC process is document-intensive and often slow. Build time into your planning.

If your OIC is rejected

If the IRS rejects your offer you have options:

• Request reconsideration or filing an appeal through the IRS Office of Appeals. You can present new information or correct mistakes.
• Explore other collection alternatives, including installment agreements or CNC.
• Consult a tax attorney or enrolled agent to evaluate next steps and whether litigation or bankruptcy fits your situation.

See our step-by-step guide to reconsideration and appeals: “How to Reconsider a Denied Offer in Compromise: Next Steps and Documentation” (https://finhelp.io/glossary/how-to-reconsider-a-denied-offer-in-compromise-next-steps-and-documentation/).

Final checklist before you send your OIC

• All required returns filed
• Form 656 and Form 433-A/B complete and signed
• Supporting documents attached and organized
• Application fee or low-income waiver documentation included
• Payment included (20% for lump-sum or first periodic payment)
• Copies kept for your records

Professional disclaimer

This article provides educational information only and is not legal or tax advice. Tax laws and IRS procedures change; verify current rules on the IRS website or consult a licensed tax professional for guidance tailored to your facts.

If you want, I can prepare a one-page OIC documentation checklist you can fill in, or a short worksheet to estimate RCP using Form 433-A inputs.