Offers in Compromise: How To Document Hardship and Income

How the IRS evaluates financial inability to pay

The IRS evaluates an OIC through Reasonable Collection Potential (RCP), which estimates how much the government can collect from your assets and future income. RCP is the combination of:

• Equity in assets (bank balances, vehicles, real estate, investments) after allowable liens and statutory exemptions.
• Disposable income the IRS believes can be applied to tax debt after allowable living expense deductions (based on the IRS Collection Financial Standards).

To succeed you must make those figures verifiable and internally consistent across the application package. The IRS explains the program and the RCP concept on its site (IRS, Understanding Offers in Compromise: https://www.irs.gov/individuals/understanding-offers-in-compromise).

Forms, fees, and payment options (what you’ll file)

• Form 656, Offer in Compromise (complete the offer terms and payment choice). See: https://www.irs.gov/forms-pubs/about-form-656
• Form 433‑A (OIC) for individuals or Form 433‑B (OIC) for businesses — the OIC versions of collection information statements showing income, assets, and expenses. See: https://www.irs.gov/forms-pubs
• Application fee and initial payment: the IRS generally requires an application fee (currently $205) and an initial payment when you file, unless you qualify for the low‑income waiver. Lump‑sum cash offers normally require 20% of the offered amount as the initial payment; periodic offers require the first monthly installment with the application. Confirm current amounts on the IRS OIC page (https://www.irs.gov/individuals/understanding-offers-in-compromise).

Note: Low‑income taxpayers can qualify for an application fee waiver and initial payment exception; use Form 656 instructions and the IRS guidance to determine eligibility.

Document checklist: Hardship and income (organized and ready)

Below is a practical, prioritized checklist. Provide originals or certified copies where the IRS requests them.

1. Identification and compliance

• Copy of government‑issued ID (driver’s license, passport).
• Copies of filed federal tax returns for required years and current filing transcripts (IRS Get Transcript or Form 4506‑T). The IRS requires returns to be filed and current.

1. Proof of income (last 90 days to 12 months, depending on stability)

• Recent pay stubs (at least last 2–3 months).
• Year‑to‑date pay summaries and W‑2s or 1099s.
• For self‑employed: profit & loss statements, Schedule C, business bank statements, invoices, Forms 1099‑NEC, and signed statement of net income. Provide bookkeeping or accounting exports.
• Social Security, disability, unemployment, workers’ comp award letters, pension statements.
• Child support or alimony documentation (court orders and payment records).

1. Bank and asset documentation

• Last 3–6 months of bank statements for all accounts (checking, savings, brokerage).
• Statements for IRAs, 401(k)s, CDs, stock accounts, and title/loan statements for vehicles or other assets.
• Real estate deeds, mortgage statements, recent property tax statements, and documentation of market valuation if contesting equity.

1. Monthly expense documentation (prove allowable living costs)

• Rent or mortgage statements and a copy of lease or mortgage statement showing principal, interest, taxes, and insurance.
• Utility bills (electric, gas, water, phone, internet) covering recent months.
• Food, transportation, insurance premiums, court‑ordered payments, child care receipts, and documented medical expenses not covered by insurance. For recurring medical hardship, include provider bills and payment plans.

1. Evidence of special hardships

• Medical records and billing statements documenting chronic or catastrophic illnesses.
• Layoff notices, termination letters, or documentation of income reduction.
• Divorce decree, custody orders, or settlement documents showing legal obligations that affect ability to pay.
• Eviction notices or foreclosure papers.

1. Debts and third‑party obligations

• Statements for student loans, credit cards, auto loans, and other judgments.
• Documentation of co‑signed debts or support obligations.

1. Supporting statements and corroboration

• A concise, factual hardship letter explaining circumstances, dated and signed.
• Affidavits, letters from social workers, doctors, employers, or lenders that corroborate claims.

How to document income when it fluctuates or you’re self‑employed

• Use a rolling 12‑month average when income varies. Attach ledgers, invoices, or bank deposits that show the trend.
• Provide a detailed profit & loss (P&L) statement and reconcile P&L to business bank accounts and Forms 1099 or 941 filings.
• If seasonal, explain the seasonality and provide prior‑year comparables.
• For gig/contract work, consolidate 1099s with bank deposits and a schedule of unpaid invoices.

In my practice, the strongest filings include a clean reconciliation table: reported income (tax return) → bank deposits → adjusted net income (P&L). This reduces confusion for the examiner and minimizes requests for follow‑up documentation.

Writing an effective hardship statement

A hardship letter should be short, specific, and backed by documents. Include:

• One‑paragraph summary of the event (job loss, medical crisis, natural disaster). Include dates.
• Bullet list of the major financial impacts (lost wages, increased medical bills, childcare, eviction risk).
• A final paragraph explaining your offer calculation and why full payment would create economic hardship or prevent basic living needs.

Attach corroborating documents referenced in the letter (termination notices, medical bills, collection letters).

Common mistakes that lead to delays or denials

• Incomplete or inconsistent numbers across Form 433‑series, bank statements, and paystubs.
• Failing to include supporting documents (especially bank statements and proof of recurring expenses).
• Hiding assets or underreporting income; the IRS verifies and will deny or reopen collection if misrepresentation is found.
• Submitting poorly organized folders — include a table of contents and label exhibits to make the reviewer’s job easier.

After you file: processing, negotiations, and appeals

• Processing time typically ranges from several months to over a year depending on complexity and IRS backlog. Keep filing status current and respond quickly to IRS information requests.
• If your offer is rejected you can appeal to the IRS Office of Appeals (follow instructions in the rejection letter) or consider alternatives such as an installment agreement, currently not collectible status, or bankruptcy when appropriate. See FinHelp articles on “Options After a Denied Offer in Compromise” and “How Offers in Compromise Are Evaluated” for practical next steps and examples:
• How Offers in Compromise Are Evaluated: A Step‑by‑Step Guide: https://finhelp.io/glossary/how-offers-in-compromise-are-evaluated-a-step-by-step-guide/
• Preparing a Strong Financial Package for an Offer in Compromise: https://finhelp.io/glossary/preparing-a-strong-financial-package-for-an-offer-in-compromise/

Practical tips to strengthen your package

• Organize: use a labeled binder or single PDF with a cover page and table of contents.
• Reconcile bank accounts for the period covered and highlight recurring deposits and withdrawals.
• Prioritize proof of unavoidable expenses (medical bills, child care, rent) over discretionary spending.
• If assets exist that you believe should be excluded or valued at less than market (e.g., mechanical problems with a vehicle), provide independent estimates or repair invoices.
• Consider professional help when business records are complex — a CPA or tax resolution pro can prepare reconciliations and improve credibility.

Legal and ethical notes

This article is educational and not a substitute for individualized advice. The IRS may update forms, fees, and standards — confirm current rules on the IRS OIC page: https://www.irs.gov/individuals/understanding-offers-in-compromise. Misrepresentation can lead to denial and penalties; always provide accurate, verifiable documentation.

Quick resources and authoritative references

• IRS — Understanding Offers in Compromise: https://www.irs.gov/individuals/understanding-offers-in-compromise
• IRS Form 656 (Offer in Compromise) and instructions: https://www.irs.gov/forms-pubs/about-form-656
• IRS Collection Financial Standards (for allowable expense amounts): https://www.irs.gov/businesses/small-businesses-self-employed/collection-financial-standards

Further reading on alternatives, appeals, and evaluation methodology is available at FinHelp: “Preparing a Financial Disclosure Package for an Offer in Compromise” (https://finhelp.io/glossary/preparing-a-financial-disclosure-package-for-an-offer-in-compromise/) and “Options After a Denied Offer in Compromise” (https://finhelp.io/glossary/options-after-a-denied-offer-in-compromise/).

Careful documentation, honest reporting, and an organized submission materially improve your chances of a fair OIC evaluation. When records are messy or income is volatile, invest time in reconciliations and clear explanations — examiners respond well to transparency and verifiable evidence.