Why thorough proof of income matters

An Offer in Compromise (OIC) asks the IRS to accept less than the full tax debt based on your inability to pay. The IRS evaluates that inability primarily by comparing your verified income and allowable expenses to determine your reasonable collection potential. Clear, consistent proof of income speeds review, reduces requests for supplemental documentation, and raises the likelihood your offer is handled on its true merits (IRS, Offer in Compromise). For current IRS guidance and forms see: https://www.irs.gov/businesses/small-businesses-self-employed/offer-in-compromise and Form 656 instructions at https://www.irs.gov/forms-pubs/about-form-656.

Core documents to assemble

Collecting the right documents is the first step. Below are the most common items the IRS expects with an OIC submission; include originals only when requested—copies are standard unless the IRS asks otherwise.

  • Government-issued photo ID (driver’s license or passport)
  • Form 656 (Offer in Compromise)
  • Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses (supports the numbers you report)
  • Recent federal tax returns (last 2–3 years; some reviewers ask for last 3)
  • Pay stubs: last 2–3 months (or payroll summary if paid biweekly/monthly)
  • Bank statements: last 2–3 months for all personal and business accounts
  • Form 4506‑T (to allow IRS transcript checks) — https://www.irs.gov/forms-pubs/about-form-4506-t
  • Profit & loss statement and business bank deposits for self‑employed taxpayers (rolling 12 months recommended)
  • Social Security statements, unemployment, pension or other benefit statements
  • Documentation of regular, recurring non-taxable income (e.g., SNAP) if you include it in budgeting
  • Third‑party records for non‑payroll income (rental agreements, contract payments, 1099s)

See our detailed documentation checklist for an OIC for a complete pack: Offer in Compromise documentation checklist.

How to calculate income for the OIC

The IRS focuses on net monthly available income when weighing an OIC. How you calculate that depends on your employment type:

  • Employees: Use gross pay less payroll deductions (pre-tax retirement, health premiums) to show monthly take‑home. Average the last 2–6 months if income fluctuates.
  • Self‑employed: Provide a rolling 12‑month profit & loss statement and reconcile deposits to business bank statements. Use Schedule C, but also supply a P&L that reflects current operations.
  • Seasonally employed or irregular income: Calculate a 12‑month average and supply supporting schedules showing seasonality (month-by-month income).
  • Investment, rental, or other passive income: Supply bank deposit records, rental ledgers, and signed lease agreements.

Practical example: If your gross seasonal receipts for the last 12 months are $36,000, use a rolling 12‑month average of $3,000/month as the income input, ensuring you provide month-by-month backup to show the seasonal pattern.

For an explanation of how the IRS values offers and calculates reasonable collection potential, see: How Offer in Compromise amounts are calculated: A simple walkthrough.

Special guidance for self‑employed taxpayers

Self‑employed filers are the most frequently challenged group because business records often differ from personal withdrawals. Follow these rules to reduce friction:

  1. Produce a rolling 12‑month P&L (monthly columns) and reconcile deposits into your business and personal bank accounts.
  2. Supply business receipts and major expense invoices for large fluctuations (e.g., equipment purchases, seasonal payroll).
  3. If family members draw wages or you transfer funds between business/personal accounts, document those transfers.
  4. Provide third‑party validation when possible (merchant processor reports, 1099s, and invoices).

A clean reconciliation between your bank activity and the P&L is often decisive in my practice: when records agree, IRS reviewers accept reported net income more readily.

Document presentation and organization (the reviewer’s preference)

Make your package easy to follow. The IRS receives thousands of pages—presentation matters.

  • Start with a one‑page cover letter summarizing your situation and the exact offer amount and type (lump‑sum vs periodic).
  • Include a 1–2 page summary schedule: monthly income, recurring expenses, and a short reconciliation note for any unusual items.
  • Index documents and use tabs or a digital PDF bookmark structure. Label items (e.g., “Pay Stub — Nov 2024”).
  • Redact unrelated account numbers but leave names, dates and deposit amounts visible.
  • Highlight (in color or with sticky notes) deposits that represent wage income or other key entries.

When I submit packages for clients I add a short index and a reconciliation memo that explains any discrepancies between the Form 433 and the tax returns—this reduces follow-up requests.

Dealing with common issues and IRS follow‑up

Expect the IRS to request clarifications. Typical triggers include:

  • Mismatched income figures between tax returns and bank deposits.
  • Unexplained large deposits.
  • Inconsistent months of income for seasonal businesses.

If the IRS sends a request for additional information, respond quickly and include a numbered cover note referencing the IRS request. Failure to timely produce supporting documents can lead to rejection.

Be truthful. Intentionally misstating income or inventing documents can result in penalties and criminal exposure. Always retain originals and make reproducible copies for submission.

Common mistakes to avoid

  • Submitting only one pay stub or one month of bank statements.
  • Failing to include spouse or household income if it affects ability to pay (the IRS considers household resources).
  • Not reconciling cash deposits or third‑party payments.
  • Providing unverifiable “estimates” without supporting backup.
  • Omitting required forms (Form 4506‑T allows the IRS to check transcripts and is standard).

Our article on preparing the financial statement for an Offer in Compromise walks through what numbers the IRS expects on Form 433 and how to support them: Preparing the financial statement for an Offer in Compromise.

Timing, processing, and expectations

Processing time for an OIC can vary. Historically, straightforward offers may be addressed in several months; more complex cases with many follow‑up requests can take 6–12 months or longer (IRS guidance). Submitting a complete, well‑organized proof‑of‑income package is the best way to keep the review efficient.

If the IRS returns your offer as ineligible or proposes rejection, you have appeal rights and may be able to supply supplemental documentation or request a review.

Professional tips that make a difference

  • Create a one‑page “Income Narrative” that explains income sources, seasonal patterns, and recent disruptions (job loss, medical events). Keep it factual and succinct.
  • Use bank transaction export (CSV) and provide a reconciled spreadsheet if you have many deposits.
  • If you’ve recently reduced living expenses (sold a vehicle, moved), include proof (sale receipts, new lease) to show reduced monthly living costs.
  • For nonfilers or those missing returns, file delinquent returns before or with the offer when possible—OIC reviewers will want to see recent filing compliance.

In my practice, applicants who provide a reconciled P&L plus three months of bank statements and a short narrative typically see fewer IRS follow‑up requests than those who submit raw, unannotated documents.

When to get professional help

If your income streams are complex (multiple 1099s, rental properties, partnership K‑1s) or you face possible collection actions, a CPA, enrolled agent, or tax attorney can prepare schedules, craft a realistic offer, and communicate with the IRS on your behalf. A professional also helps avoid mistakes that lead to delays or denials.

Final checklist before mailing or e‑filing

  • Completed Form 656 and the appropriate Form 433 (A or B) signed and dated
  • Form 4506‑T signed
  • Last 2–3 years of federal tax returns
  • Last 2–3 months of pay stubs and bank statements; 12 months P&L for self‑employed
  • Cover letter, one‑page income narrative, and index
  • Copies of third‑party income evidence (1099s, rental agreements)

Disclaimer

This article is educational and reflects my experience helping taxpayers prepare Offer in Compromise packages. It is not individualized tax advice. For advice specific to your situation, consult a qualified tax professional or attorney. Official IRS resources include the Offer in Compromise page and instructions for Forms 656, 433‑A (OIC), 433‑B (OIC), and 4506‑T at https://www.irs.gov.

Sources and further reading

If you’d like a template checklist or a sample income narrative I use with clients, consult a tax professional or visit the FinHelp glossary pages above for downloadable worksheets.