How the IRS decides whether you qualify for an Offer in Compromise

An Offer in Compromise (OIC) is not a lottery; it’s an administrative decision the IRS makes after a financial review. Eligibility comes down to three core things: (1) your financial picture and what the IRS could reasonably collect from you (the “reasonable collection potential” or RCP); (2) whether you meet program rules (current filings, no open bankruptcy, etc.); and (3) the basis you claim for the offer (doubt as to collectibility, doubt as to liability, or effective tax administration). The IRS explains the program on its Offer in Compromise page: https://www.irs.gov/payments/offer-in-compromise.

Below I walk through the practical steps the IRS takes, the documents you’ll need, how RCP works in plain terms, and realistic strategies to improve your chance of acceptance. In my practice advising taxpayers for more than 15 years, careful documentation and conservative valuation of assets materially improve outcomes.

The three bases the IRS uses to accept an offer

  • Doubt as to collectibility (most common). The taxpayer shows the tax cannot be fully collected within the statute of limitations for collection. The IRS compares total RCP to the offer amount. If RCP is less than the liability, an offer may be accepted.
  • Doubt as to liability. The taxpayer has a legitimate dispute that the assessed tax is incorrect. This requires strong, often document-based legal or factual disagreement with the IRS assessment.
  • Effective tax administration. The taxpayer can pay but acceptance would be unfair and inequitable, for example because of exceptional hardship or unusual circumstances. This is a narrow category and applied sparingly.

(See IRS guidance: https://www.irs.gov/payments/offer-in-compromise)

What the IRS reviews: a step-by-step practical walkthrough

  1. Initial eligibility checks
  • Are all required federal tax returns filed? The IRS expects current returns before approving an OIC. (IRS instructions to Form 656: https://www.irs.gov/pub/irs-pdf/f656.pdf)
  • Is the taxpayer in an open bankruptcy case? If yes, you generally cannot apply while bankruptcy is open.
  • Are there assessed liabilities that the offer would cover (returns filed and amounts assessed)?
  1. Financial package submission
  • Individuals use Form 433-A (OIC); businesses use Form 433-B (OIC). These collect income, assets, monthly living expenses, and asset equity information.
  • You must include documentation: bank statements, pay stubs, bills, proof of expenses, asset titles, and appraisals where appropriate.
  • Application fee: as of 2025 the standard OIC application fee is $205, but low-income taxpayers may have the fee waived; verify current fee and waivers on the IRS page above before filing.
  1. Calculation of Reasonable Collection Potential (RCP)
    RCP is the centerpiece of a collectibility offer. In simple terms:

  • RCP = Net realizable equity in assets + future income available for collection.

  • Net realizable equity: what the IRS estimates it could get by selling or otherwise liquidating assets after allowances for liens and reasonable selling costs.

  • Future income available for collection: the IRS looks at monthly disposable income (income minus allowable living expenses under the IRS Collection Financial Standards) and multiplies that by a collection horizon (months left before the collection statute of limitations expires or a period the IRS deems appropriate). The Collection Financial Standards (national and local housing allowances) are available on the IRS website and set the allowed living expense figures: https://www.irs.gov/irm/part5/irm_05-006-001.

    Example (simplified):

  • Tax liability: $30,000

  • Equity in assets (after liens/allowances): $2,000

  • Monthly disposable income (after allowable expenses): $200

  • Months IRS uses for collection horizon: 12

  • RCP = $2,000 + ($200 × 12) = $4,400. An offer near or above $4,400 gives the IRS reason to accept under doubt as to collectibility. If an offer is significantly lower than RCP, the IRS will almost always reject it.

  1. Compare RCP to the offer amount and administrative factors
  • If the offer equals or exceeds RCP, and the taxpayer is compliant with filing/payment requirements, the IRS is more likely to accept.
  • For effective tax administration offers, the IRS weighs fairness and hardship beyond RCP. This is subjective and used less frequently.

Documents you should prepare (practical checklist)

  • Completed Form 656 (Offer in Compromise).
  • Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses and supporting schedules.
  • Six to 12 months of bank statements and pay stubs.
  • Documentation for housing, medical, transportation, childcare, and other allowable expenses (receipts, court orders, lease agreements).
  • Documentation of asset values: vehicle titles, real estate valuations, retirement account statements (note: certain retirement account equity may be excluded or given limited weight).
  • Proof of filing compliance: copies of recently filed returns or transcripts.

For more detail on assembling the packet, see our guide: Preparing a Strong Financial Package for an Offer in Compromise (https://finhelp.io/glossary/preparing-a-strong-financial-package-for-an-offer-in-compromise/).

Common mistakes that lead to denials (and how to avoid them)

  • Under-documenting expenses or claiming unsupported deductions. The IRS will disallow expenses that aren’t documented or that exceed Collection Financial Standards.
  • Overvaluing expenses or undervaluing assets intentionally. The review is document-driven; inconsistencies lead to denial.
  • Submitting an offer far below RCP. If the IRS calculates RCP much higher than your offer, the offer will be denied. Work with a professional to estimate RCP before filing.
  • Filing while unfiled returns or unresolved penalties exist. Be current on filings to avoid immediate rejection.

If an offer is denied, you can appeal or reapply with updated information. See Options After a Denied Offer in Compromise (https://finhelp.io/glossary/options-after-a-denied-offer-in-compromise/) for next steps.

Real-world examples (illustrative)

  • Example 1: Individual with medical debt and job loss. A taxpayer with a $30,000 liability shows minimal asset equity and limited monthly disposable income. After documenting medical bills, unemployment income, and allowable expenses the calculated RCP was $3,200. The taxpayer offered $3,000 as a lump sum and provided the documents the IRS required; the OIC was accepted. Meticulous documentation of hardship and conservative asset valuation were key.

  • Example 2: Small business owner with $50,000 tax debt. An unprofitable year produced near-zero disposable income. The business had little net realizable equity and the owner’s personal living expenses were within Collection Standards. The RCP was low, and an offer structured as periodic payments for a short period was accepted by the IRS.

These examples reflect typical acceptance scenarios; your facts will matter.

Timing and outcomes

  • Typical processing time: 6–12 months, depending on complexity and IRS workload. Complex offers or appeals can take longer.
  • If accepted, you must meet the terms: lump-sum payment (accompanied by a portion of your offer with submission) or periodic payments as agreed. If the terms are not met, the IRS may default the agreement and restore collection activity.

Practical strategies to improve eligibility

  1. Be accurate and thorough. Complete financial disclosure and third-party documentation reduce friction and build credibility with the examiner.
  2. Use the IRS Collection Financial Standards correctly. Don’t assume every expense is allowable—attach documentation and explanations where applicable.
  3. Consider timing. If your financial condition is temporary but improving, you might wait to file until your situation clearly supports an OIC or consider alternative collection options.
  4. Get help. In my experience, taxpayers who work with experienced CPAs, enrolled agents, or tax attorneys achieve better results because the package is organized, realistic, and defensible.

See our practical templates and valuation tips: How to Build a Financial Package for an Offer in Compromise (https://finhelp.io/glossary/how-to-build-a-financial-package-for-an-offer-in-compromise/).

Appeals and reapplication

If denied, you can:

  • File an appeal under IRS administrative appeals procedures; or
  • Reapply with new or corrected financial data.

Before reapplying, step back and confirm whether RCP changed, whether you missed allowable deductions, or whether you can present new evidence to support effective tax administration.

For guidance on appeals and reapplying, see Reapplying After a Denied Offer in Compromise: What to Change and When (https://finhelp.io/glossary/reapplying-after-a-denied-offer-in-compromise-what-to-change-and-when/).

Final notes and authoritative references

Professional disclaimer: This article is educational and does not constitute individualized tax advice. For advice tailored to your situation, consult a qualified tax professional. In my practice, careful planning and documentation are the most reliable ways to increase the chance of an acceptable Offer in Compromise.