How does the IRS evaluate your financial position for an Offer in Compromise?

The IRS evaluates an Offer in Compromise (OIC) by calculating your Reasonable Collection Potential (RCP) — a single-dollar estimate of what the IRS believes it can collect from you now and over a defined future period. The RCP combines the net realizable value of your assets (equity after liens and selling costs) with your future ability to pay based on monthly disposable income. If your offer equals or exceeds the RCP, the IRS is more likely to accept. Source: IRS — Offer in Compromise.

Below I explain the key components the IRS reviews, how to prepare the financial package, common pitfalls, and practical strategies I use in practice to help clients improve their prospects.

Author credentials

I’m a CPA and CFP® with over 15 years advising individuals and small businesses on tax problems, including Offers in Compromise. In my practice I prepare OIC packages, calculate RCPs, and negotiate with IRS settlement officers. This article summarizes best practices and authoritative guidance but does not replace personalized tax advice.

Brief background and purpose of the program

The OIC program exists to let the IRS collect the most it can when a taxpayer cannot pay the full amount. It is not a debt-elimination tool for those who can pay. The IRS created formal OIC procedures to balance tax collection with taxpayer fairness; the program today is governed by IRS criteria and forms, including Form 656 and supporting financial statements (Form 433-A(OIC) and Form 433-B(OIC)). See the IRS OIC overview: IRS — Offer in Compromise.

What the IRS reviews: income, expenses, assets, and compliance

  1. Income and monthly disposable income
  • The IRS looks at gross income from wages, self-employment, rental income, retirement, and other sources.
  • Allowable monthly expenses reduce gross income to arrive at monthly disposable income. Acceptable expenses generally follow national and local standards the IRS recognizes, plus documented out-of-pocket items (e.g., medical expenses not covered by insurance).
  1. Allowable expenses and standards
  • The IRS uses national and local standards for housing, food, transportation, and other living costs. These standards are published and updated; use the instructions to Form 433-A(OIC) for current figures.
  1. Assets and equity
  • The IRS counts equity in real estate, vehicles, bank accounts, retirement accounts (subject to limited exclusions), and business assets. Equity equals fair market value minus selling costs and outstanding liens.
  1. Compliance checks
  • The IRS requires you to be current with tax filings and estimated tax obligations. You generally must be compliant before an OIC will be considered. See IRS forms pages: About Form 656 and Form 433-A(OIC).

Reasonable Collection Potential (RCP) explained

RCP is central to every offer. It represents the IRS’s realistic expectation of collection from a taxpayer. The RCP includes:

  • Net realizable value of assets (cash, equity in the home after lien & selling costs, vehicle equity, business assets)
  • Future monthly disposable income multiplied across the IRS’s collection period (the period used to estimate how long the IRS could reasonably expect to collect from you)

If an offer is less than the RCP, acceptance is unlikely unless there are compelling special circumstances (serious illness, imminent insolvency, or other hardship). For guidance on how the IRS values offers, see How an Offer in Compromise Is Valued by the IRS.

Step-by-step: preparing and submitting an OIC

  1. Confirm eligibility and compliance
  • File all required tax returns and be current on estimated tax payments or have a plan for current year taxes.
  1. Complete the right forms
  • Form 656 (Offer in Compromise)
  • Form 433-A(OIC) for individuals or Form 433-B(OIC) for businesses
  • Attach supporting documents (pay stubs, bank statements, proof of medical expenses, appraisal for real estate if needed)
  • Refer to the IRS instructions for the latest form revisions: IRS Form 656 and supporting forms.
  1. Choose a payment option
  • Lump-sum cash offer (typically paid in 5 payments — initial payment with submission plus installment payments during review) or periodic payment offer (payments while the IRS reviews the offer).
  • Include the application fee (currently $205 as of 2025) unless you qualify for a low-income waiver. Confirm the fee on the IRS site before filing.
  1. Assemble the financial package
  • Organize documentation that substantiates income, expenses, assets, and hardship. A clear package reduces review time and avoids needless back-and-forth.
  1. Submit and monitor
  • Mail the package to the IRS address specified in the Form 656 instructions and monitor for Written requests from the IRS. Respond promptly to any requests for additional information.

For a checklist that helps you build a strong submission, see our guide: How to Prepare a Strong Offer in Compromise Package.

Payment options and practical effects

  • Lump-sum (Shortened Pay): A reduced amount payable in five or fewer payments; the IRS considers the amount available now.
  • Periodic payment (Deferred): Payments during the evaluation; the IRS factors in future payments into RCP.

Selecting the wrong payment option can reduce the chance of acceptance. I usually model both scenarios before filing so clients can see which produces a lower RCP.

Typical timeline and what to expect

Processing times vary. Many offers take six months to a year to resolve; complex cases may take longer. During review, the IRS continues most collection actions unless you’ve submitted a timely-received offer with required payments and asked for a hold. Always plan for collection activity to continue and consult counsel if a levy or seizure is imminent.

If the IRS rejects your offer, you can appeal the decision (Collection Appeal Program) or submit a new offer after addressing deficiencies. See our page on options after rejection: Options When the IRS Rejects Your Offer in Compromise.

Real-world examples (anonymized)

  • Example A — Medical hardship: A taxpayer with $50,000 in back taxes had negligible disposable income after catastrophic medical expenses. After documenting medical bills and disability-related income loss, we calculated an RCP of $18,000; the IRS accepted a comparable offer.

  • Example B — Small business distress: A small business owner with a large tax balance but little business equity and seasonal income provided careful bank reconciliations and expense records showing sustained losses; the IRS settled for a fraction of the original debt.

These examples illustrate how full documentation and realistic RCP calculations improve outcomes.

Who should consider an OIC — eligibility checklist

  • You cannot pay the full tax liability within a reasonable period.
  • You have filed all required returns and are current with estimated taxes.
  • You can prove your income, allowable expenses, and assets through documentation.
  • You’re not seeking OIC solely to avoid taxes you could pay through an installment agreement.

If you’re unsure whether OIC is the best path, compare alternatives like installment agreements, currently not collectible status, or bankruptcy. See our comparison: When to Consider an Offer in Compromise vs Bankruptcy for Tax Debt.

Practical tips and strategies I use with clients

  • Start with accurate, conservative numbers. Overstating expenses or understating assets risks rejection and penalties.
  • Provide primary-source documentation (cancelled checks, bank statements, medical bills) rather than estimates.
  • If you have nonexempt retirement accounts, be prepared to explain hardship; the IRS often expects retirement funds to be available for collection.
  • Model multiple offer amounts. Small increases can move an offer from rejection to acceptance without overpaying.
  • Consider professional help when asset valuation, business income, or special medical issues complicate the RCP calculation.

Common mistakes and misconceptions

  • Assuming an OIC will stop all collection activity — it usually does not unless accompanied by required payments and a stay of collection.
  • Submitting incomplete documentation — incomplete forms or missing bank statements are leading causes of rejection.
  • Believing OIC is faster than other options — it can take many months and sometimes longer than negotiating an installment agreement.

Tax consequences of settled debt

Tax canceled in an accepted OIC might be taxable income on your federal return, unless an exclusion applies (for example, insolvency or bankruptcy). Always check current IRS guidance or consult a tax advisor before filing.

After acceptance or rejection: next steps

  • If accepted: Make required payments on time and remain compliant with future tax filings; the IRS can reinstate the liability if you default.
  • If rejected: Consider appeal through the Collection Appeals Program, restructure your offer, or evaluate alternatives. For practical next steps after a denial, visit: Options When the IRS Rejects Your Offer in Compromise.

Resources and authoritative references

Disclaimer

This article is educational and does not constitute tax, legal, or financial advice. Your situation may involve complex facts and rapidly changing IRS procedures. Consult a licensed tax professional (CPA, tax attorney, or enrolled agent) for individualized guidance.

If you want, I can prepare a customized checklist or model RCP worksheet based on your numbers to assess whether an OIC might be viable. Contact a tax professional before filing.