Background

The Offer in Compromise (OIC) program allows taxpayers who cannot pay their full tax liability to propose a settlement for less than the amount owed. The IRS balances its duty to collect taxes with the taxpayer’s demonstrated inability to pay. The test used is whether the taxpayer’s liability is “reasonably collectible”—if not, an OIC may be appropriate (IRS, Offer in Compromise).

How the IRS Calculates Ability to Pay

  1. Collection Information Statement
  • The IRS relies on the Collection Information Statement—most commonly Form 433‑A (individuals), Form 433‑B (businesses), or the simplified Form 433‑F—to gather a full financial snapshot. Provide accurate, current versions and all required attachments (pay stubs, bank statements, bills). See IRS forms: Form 433‑A / Form 433‑B (IRS).
  1. Reasonable Collection Potential (RCP)
  • The IRS computes RCP = (monthly disposable income × a collection period) + net realizable equity in assets. If the RCP equals or exceeds the tax owed, the IRS generally will not accept an OIC because the liability is considered collectible. If the RCP is less than the liability, the taxpayer may qualify for a compromise (IRS, Offer in Compromise).
  1. What the IRS Counts
  • Income: wages, self‑employment income, investment and other regular receipts.
  • Allowable expenses: basic living costs using IRS allowable standards and actual necessary expenses for certain items (medical, childcare) when documented.
  • Assets: cash, bank accounts, equity in real estate, vehicles, retirement accounts (with special rules), and other property. The IRS expects realistic asset valuations and may impute value where assets are under‑reported.

Practical Steps to Prepare

  • Complete the right form: Use Form 433‑A for wage earners and self‑employed individuals, Form 433‑B for businesses, or Form 433‑F if a simplified statement is allowed (IRS forms).
  • Document everything: recent paystubs, 60–90 days of bank statements, medical bills, rent/mortgage statements, and valuations for vehicles and real estate.
  • Check allowable standards: the IRS publishes national and local expense standards (e.g., National Standards for food, clothing, etc.) and uses them when determining reasonable expenses. Document any necessary nonstandard expenses (medical, disability) with receipts or statements.

Examples from Practice

  • Self‑employed taxpayer with volatile income: showing several months of reduced revenue plus documented business expenses can lower monthly disposable income and improve OIC chances.
  • Medical hardship: large unreimbursed medical bills supported by statements can justify above‑standard expense allowances and reduce RCP.

Who Is Likely to Be Affected or Eligible

  • Individuals and small businesses with tax liabilities that exceed their RCP.
  • Taxpayers with limited or no nonexempt assets and monthly disposable income insufficient to pay the full liability.

Key Application Points and Timing

  • Offer amount: The IRS evaluates whether a lump‑sum or periodic offer will maximize collection. Offer payment options and required initial deposits depend on the payment option you choose—confirm current rules on the IRS OIC page.
  • When to apply: File when your financial picture reflects the lowest sustainable ability to pay—but do not omit temporary, recoverable income sources that will affect future collectability.
  • Appeals and reconsideration: If rejected, you can appeal or request reconsideration with new or corrected documentation; see internal guidance such as how to request reconsideration.

Common Mistakes and How to Avoid Them

  • Incomplete or inconsistent documentation: submit complete bank statements, paystubs, and bills.
  • Underreporting income or overclaiming expenses: the IRS will verify and may request supporting documents. Be conservative and accurate.
  • Ignoring asset valuations: provide recent statements or appraisals; the IRS will calculate net realizable equity if you do not.

Professional Tips

  1. Build a clear timeline of income and expenses covering several months to show trends rather than one‑off figures.
  2. If self‑employed, reconcile business bank statements with personal cash flow to accurately reflect available funds.
  3. Get valuations for significant assets before you file; accurate numbers prevent surprises later.
  4. Consider professional help—preparing a complete financial statement can materially affect outcomes; in my 15+ years advising clients, well‑documented files are accepted significantly more often.

Internal resources

Frequently Asked Questions

Q: Which form does the IRS use to check ability to pay?
A: Form 433‑A (individuals) or Form 433‑B (businesses) are standard; Form 433‑F is a simplified alternative in some cases (IRS forms).

Q: Will the IRS accept temporary hardship as a basis for an OIC?
A: The IRS looks for sustained inability to pay. Temporary setbacks may not be enough unless they show long‑term collectability issues.

Q: What happens if my financial situation improves after acceptance?
A: The IRS can review post‑acceptance changes; if material improvement occurs, you may be required to amend the terms or repay (IRS guidance).

Authoritative sources

Professional disclaimer

This article is educational and not personalized tax advice. For decisions about filing an OIC or representing you before the IRS, consult a qualified tax professional, enrolled agent, or CPA.

(Last reviewed: 2025 — verify current IRS forms and payment rules before applying.)