Quick overview
An Offer in Compromise (OIC) is a negotiated settlement between a taxpayer and the IRS that resolves federal tax liabilities for an agreed reduced amount. The IRS grants OICs when it determines the taxpayer’s reasonable collection potential (RCP) — the total value the IRS could collect through assets, income, or enforced collection — is less than the total tax owed. The program is intended for taxpayers with true inability to pay, not simply those who prefer a discount.
Key official resources: IRS — Offer in Compromise (https://www.irs.gov/individuals/offer-in-compromise) and IRS Publication 594, The IRS Collection Process (https://www.irs.gov/pub/irs-pdf/p594.pdf).
Note: This article is educational and not individualized tax advice. Consult a qualified tax professional or CPA for decisions about your case.
How the IRS decides whether to accept an OIC
The IRS bases decisions on the taxpayer’s Reasonable Collection Potential (RCP). RCP equals the value of collectible assets plus income the IRS expects could be applied to the tax debt. The IRS considers:
- Current and projected monthly income and allowable expenses (using IRS collection financial standards).
- Equity in assets (bank accounts, vehicles, real estate, retirement accounts, business assets), reduced by realistic sale costs and exemptions.
- Your filing and payment compliance — you must be current with tax filings and required estimated tax payments.
The IRS uses Forms 656 (Offer in Compromise) and Form 433‑A (OIC) for individuals or Form 433‑B (OIC) for businesses to collect the financial picture (see IRS Form 656 and instructions) (IRS, Offer in Compromise).
Who typically qualifies — and who usually doesn’t
A suitable OIC candidate commonly meets these conditions:
- The taxpayer cannot pay the full liability through a reasonable installment agreement, or doing so would create a financial hardship.
- Filing and deposit compliance is met (returns filed, payroll deposits current if you run a business).
- The tax debt is not subject to a pending bankruptcy case and is a legally enforceable liability.
Situations that commonly do not qualify:
- Taxpayers who can reasonably pay the debt through an installment agreement or sale of nonessential assets.
- Those who intentionally withheld funds or hid assets to create an appearance of inability to pay.
Payment options inside an OIC application
The IRS offers two payment streams for offers:
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Lump-sum cash offer: Submit 20% of the total offer amount with Form 656 and make the remaining balance in up to five payments over a short period after acceptance (details on timing are in IRS guidance).
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Periodic payment offer: Submit the first proposed monthly payment with the application and continue monthly payments while the IRS evaluates the offer. If accepted, you finish the payments as proposed.
Low-income taxpayers may qualify for a waiver of the $205 application fee and for relief from the initial payment — check the IRS OIC page to see if you meet the low-income certification criteria (IRS, Offer in Compromise).
Application steps (practical checklist)
- Gather records: wage statements (W‑2s, 1099s), bank statements, recent tax returns, proof of monthly expenses, asset documentation, and any business financials.
- Complete Form 656: Offer in Compromise.
- Complete Form 433‑A (OIC) for individuals or Form 433‑B (OIC) for businesses to provide detailed financial data.
- Include the application fee ($205 unless you qualify for low‑income certification) and the required initial payment depending on your offer type.
- Mail the complete package to the address listed in the Form 656 instructions and keep copies of everything.
- Respond quickly to IRS requests for more information or clarification.
See our practical checklist for documentation: How to Prepare Proof of Income for an Offer in Compromise Application (https://finhelp.io/glossary/how-to-prepare-proof-of-income-for-an-offer-in-compromise-application/).
Typical timeline and outcomes
Processing times fluctuate with IRS workload. Simple offers may be decided in several months; complex cases or those requiring appeals can take a year or more. While many offers are denied, a properly documented submission that accurately reflects limited collection potential has a materially better chance.
If the IRS rejects your offer, you can appeal the decision within the IRS appeals process or request to reapply with new information. See Options When the IRS Rejects Your Offer in Compromise for next steps (https://finhelp.io/glossary/options-when-the-irs-rejects-your-offer-in-compromise/).
Common mistakes that reduce success rates
- Incomplete or inconsistent financial documentation.
- Underestimating asset equity or failing to disclose bank accounts, side income, or real property.
- Using optimistic future income projections rather than conservative, documented figures.
- Applying while out of compliance on filing or estimated tax deposits.
Avoid these errors by documenting every line item and using conservative figures for future income.
Tax consequences of a settled debt
An accepted OIC resolves the targeted federal tax liability, but canceled debt can have tax consequences. In many cases, the IRS will issue a Form 1099‑C or otherwise treat forgiven amounts as taxable income unless you qualify for an exclusion such as insolvency or bankruptcy discharge. Check IRS guidance on cancellation of debt (Topic No. 431) and consult your tax preparer about reporting requirements and possible exclusions (IRS, Topic No. 431).
When to consider alternatives
An OIC is one of several collection relief options. Alternatives include:
- Installment agreements (long‑term payment plans) — often the easiest solution if you can pay monthly.
- Currently Not Collectible (CNC) status — pauses enforced collection if you can’t meet basic living expenses.
- Bankruptcy — may discharge certain tax debts in limited circumstances but has long‑term credit impacts.
If you’re unsure which path fits, read Alternatives to an Offer in Compromise: When to Consider Other Options for a comparison of pros and cons (https://finhelp.io/glossary/alternatives-to-an-offer-in-compromise-when-to-consider-other-options/).
Practical strategies that help
- Start by getting current on filings — the IRS will not accept offers from noncompliant filers.
- Run a realistic RCP calculation. Use Form 433‑A (OIC) worksheets to list assets, allowable expenses and collection potential.
- Be transparent. Discrepancies discovered later can kill an offer and may trigger collection action.
- Consider professional help. Experienced CPAs, enrolled agents, or IRS-authorized attorneys understand the document presentation and negotiation nuances.
In my practice working with several hundred tax clients, applicants who prepared a full financial package and used conservative forecasts saw materially better acceptance outcomes than those who submitted minimal paperwork.
Documentation checklist (brief)
- Completed Form 656 and Form 433‑A (OIC) or 433‑B (OIC).
- Wage records (W‑2, 1099), recent pay stubs, and bank statements.
- Proof of regular monthly expenses (rent/mortgage, utilities, insurance, medical costs).
- Asset statements: titles, appraisals, recent account balances.
- Copies of filed tax returns required to be current.
- Any documentation supporting special circumstances (medical bills, job loss, disasters).
Key takeaways
- An OIC can offer a real path out of crippling tax liability for taxpayers with limited collection potential, but it is document‑heavy and closely scrutinized by the IRS.
- Be realistic, thorough and current with filings. Mistakes or missing documents are the most common causes of denial.
- Explore alternatives such as installment agreements or CNC status before applying, and consider professional help to present the strongest case.
For authoritative IRS guidance, start with the official Offer in Compromise page (IRS, Offer in Compromise) and Publication 594 on collections. This entry is educational; consult a tax professional for advice tailored to your situation.
