Quick overview
An Offer in Compromise (OIC) is a formal IRS program that lets qualifying taxpayers resolve federal tax liabilities for less than the balance due. It’s not a quick fix or an easy “discount”; the IRS accepts OICs when its analysis shows the government is unlikely to collect the full tax or when paying the tax would create an unfair economic hardship (effective tax administration). See the IRS guide for details (IRS, Understanding Offers in Compromise: https://www.irs.gov/individuals/understanding-offers-in-compromise).
How the IRS decides whether to accept an Offer in Compromise
The IRS considers three legal grounds when evaluating offers. You only need to meet one of them, but the burden of proof and documentation is on the taxpayer:
- Doubt as to collectibility (DAC): The most common basis. The IRS calculates your reasonable collection potential (RCP) — the amount it can collect from your assets and future income — and will accept an offer if the OIC equals or exceeds the RCP.
- Doubt as to liability: This applies when there is a legitimate dispute about whether the tax assessed is correct. Good legal or factual support is essential.
- Effective tax administration (ETA): Used when full collection would create economic hardship or would be unfair because of exceptional circumstances. ETA is the most discretionary and typically requires strong documentation showing exceptional hardship.
The IRS relies on submitted financial information (Form 433-A (OIC) or Form 433-B (OIC)) and Form 656 (Offer in Compromise) to compute RCP and evaluate the case (IRS, Forms and instructions: https://www.irs.gov/forms-pubs).
What the IRS looks at in practice
The IRS uses the paperwork you submit to build a financial picture. Key elements include:
- Assets: The IRS values equity in real estate, vehicles, bank accounts, investments, and nonexempt personal property. Marketable assets are often considered at net realizable value after reasonable sales costs.
- Income: Monthly gross income, payroll deductions, allowable living expenses, and disposable monthly income. The IRS applies national and local allowances when analyzing living expenses.
- Expenses: Reasonable living expenses are allowed (per IRS national standards and local supplements), but excessive or undocumented expenses will be adjusted or disallowed.
- Future earning potential: For DAC offers, the IRS projects how much income could reasonably be collected over the remaining collection period.
Together these calculations produce the RCP figure: assets’ net realizable value plus projected collectible income. If your offer is less than or equal to the RCP, it is unlikely to be accepted.
Application mechanics — what to submit and fees
To apply you must file:
- Form 656, Offer in Compromise (complete the applicable sections).
- A completed financial statement: Form 433-A (OIC) for individuals (or Form 433-B (OIC) for businesses).
- The required application fee and initial payment: the normal application fee is $205. For a cash (lump-sum) offer the IRS generally requires 20% of the offer amount with submission. For a periodic payment offer you must include the first installment and continue monthly payments while the IRS considers the offer. Low-income taxpayers may qualify for an application fee waiver and a waiver of the initial payment — see IRS rules on low-income OICs (IRS: Offer in Compromise Application Fee: https://www.irs.gov/individuals/offer-in-compromise-application-fee-and-payment-options).
Make sure all required federal tax returns are filed. The IRS will not accept an OIC if required returns are unfiled, or if you are in an open bankruptcy proceeding. Payroll tax deposits and current estimated tax obligations must be met for business filers.
Timeline and processing
Processing time varies by complexity and IRS workload. Typical evaluations run from 6 to 12 months; complex or incomplete cases can take longer. During review, the IRS may request additional documentation and will expect timely responses. If your offer is rejected, you have appeal rights through Collection Appeals Program (CAP) or you can request a Collection Due Process hearing if other eligibility conditions apply.
Common reasons the IRS denies offers
- The offer amount is less than the calculated RCP.
- Financial statements are incomplete, inconsistent, or unsupported.
- Asset values are understated or income/expenses lack documentation.
- Offers based solely on deterrents like inability to pay without showing real hardship or correct legal basis for ETA.
Refer to practical guidance on avoiding application mistakes and on how to reconsider a denied OIC for ways to improve your submission: “Avoiding Common Mistakes on an Offer in Compromise Application” and “How to Reconsider a Denied Offer in Compromise: Next Steps and Documentation” (examples and checklists at FinHelp: https://finhelp.io/glossary/avoiding-common-mistakes-on-an-offer-in-compromise-application/ and https://finhelp.io/glossary/how-to-reconsider-a-denied-offer-in-compromise-next-steps-and-documentation/).
Realistic planning: examples and calculation notes
Example (simplified): If the IRS finds $5,000 of collectible equity in assets and $500/month of disposable income with 24 months left in the collection period, RCP = $5,000 + ($500 × 24) = $17,000. An offer significantly below $17,000 will likely be rejected on DAC grounds. Note: this is a simplified illustration — the IRS uses its own standards and may treat local allowances, asset discounts, and exceptional circumstances differently.
In my practice I’ve seen OICs approved when applicants fully document hardship, have no nonexempt assets, and offer an amount close to the RCP. Conversely, offers submitted with minimal documentation or with aggressive undervaluation of assets are often denied.
Practical tips to improve chances
- Be complete and honest: supply tax returns, pay stubs, bank statements, copies of bills, and valuation evidence. Incomplete disclosures lead to delays or denials.
- Use the proper forms: Form 656 plus Form 433-A (OIC) or Form 433-B (OIC). Follow the accompanying IRS instructions closely.
- Consider the offer type: a lump-sum cash offer (paid in five installments or as required) is sometimes more persuasive because it gives the government immediate funds. Periodic payment offers require you to make payments while the IRS evaluates them.
- Get professional help for complex cases: representation by a CPA, enrolled agent, or tax attorney familiar with OICs often avoids common pitfalls. For guidance on what financial disclosure to include, see FinHelp’s checklist: “What to Include in a Financial Disclosure for an Offer in Compromise” (https://finhelp.io/glossary/what-to-include-in-a-financial-disclosure-for-an-offer-in-compromise/).
Alternatives to an Offer in Compromise
OICs are not the only way to address tax debt. Depending on circumstances, alternatives include:
- An installment agreement (month-to-month payments), sometimes preferable for taxpayers who can pay over time. See FinHelp’s comparison: “Installment Agreements vs. Offers in Compromise: Which is Right for You?” (https://finhelp.io/glossary/installment-agreements-vs-offers-in-compromise-which-is-right-for-you/).
- Currently Not Collectible (CNC) status for temporary hardship.
- Innocent spouse relief, penalty abatement, or audit reconsideration if the liability or penalties are incorrect.
Appeals and reconsideration
If denied, you can request an appeal through the Collection Appeals Program (CAP) or seek administrative review. Many denials are due to missing documentation; a well-documented reconsideration or appeal can succeed. See FinHelp’s step-by-step guidance on reconsideration (https://finhelp.io/glossary/how-to-reconsider-a-denied-offer-in-compromise-next-steps-and-documentation/).
Final notes and professional disclaimer
Offers in Compromise are powerful but narrowly applied. They require accurate, comprehensive financial disclosure and a realistic offer amount. In my experience as a tax-resolution professional, the single biggest reason for a denied OIC is under-documentation and unrealistic valuation of assets or income.
This article is educational and not a substitute for individualized tax advice. For personal tax planning or representation before the IRS, consult a qualified tax professional (CPA, enrolled agent, or tax attorney). Authoritative resources: IRS — Understanding Offers in Compromise (https://www.irs.gov/individuals/understanding-offers-in-compromise) and IRS forms pages for Form 656 and the Form 433 series (https://www.irs.gov/forms-pubs).
