How does an Offer in Compromise (OIC) work and who qualifies?

An Offer in Compromise (OIC) is a tool the IRS uses to resolve unpaid federal taxes when full collection is unlikely or would cause undue hardship. The IRS evaluates the taxpayer’s financial situation and decides whether an offer represents the maximum the government can reasonably expect to collect within a realistic timeframe. OICs are not a quick or simple fix — they require thorough documentation, realistic offers based on IRS formulas, and ongoing compliance after acceptance.

Sources: IRS — Offer in Compromise (https://www.irs.gov/individuals/offer-in-compromise) and IRS — About Form 656 (https://www.irs.gov/forms-pubs/about-form-656).

Why the IRS offers this option

The OIC program exists because there are legitimate cases where a taxpayer’s financial reality makes full collection impossible or unfair. The IRS recognizes three legal bases for acceptance:

  • Doubt as to Collectibility (DAC): The taxpayer’s assets and future income won’t cover the tax.
  • Doubt as to Liability (DAL): There’s a legitimate question about whether the tax is actually owed.
  • Effective Tax Administration (ETA): The taxpayer owes the tax but paying it would create economic hardship or be unfair and inequitable.

Doubt as to Collectibility is the most common reason an offer is accepted. The IRS tallies a taxpayer’s Reasonable Collection Potential (RCP) — essentially the realizable value of assets plus projected disposable income — and expects an offer that reflects at least a portion of that amount.

Key forms and documents you’ll need

  • Form 656, Offer in Compromise — the formal application to the IRS (see IRS page above).
  • A completed collection information statement: Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses (these show assets, income, and monthly expenses).
  • Supporting documentation: bank statements, pay stubs, bills, mortgage/lease statements, asset appraisals, and any proof of exceptional circumstances.
  • Application fee (standard unless you qualify for a low-income waiver) and required initial payment depending on payment option.

Always submit a complete package. The IRS will not begin full review until the file is complete.

How the IRS calculates what to accept (RCP explained)

Reasonable Collection Potential (RCP) = Net realizable equity in assets + future disposable income available for collection over a defined period.

  • Assets: The IRS assesses marketable equity in real estate, vehicles, investments, cash, retirement accounts (with caveats), and other property. They use conservative estimates for liquidation costs and exemptions.
  • Income: The IRS uses a budget-based approach. They allow standard living expenses and some local adjustments but disallow many discretionary items.

If RCP is less than your tax liability, the IRS may accept an offer equal to or close to the RCP. That’s why realistic, well-documented offers are far more likely to succeed than “lowball” proposals.

Payment options and timing

There are two common offer payment options:

  • Lump-sum cash offer: Pay 20% of the offer with the application and pay the balance in five or fewer payments within five months if the offer is accepted.
  • Periodic payment offer: Make an initial payment with the application and monthly payments while the IRS considers the offer. If accepted, you continue payments until the offer amount is paid.

Application fee: The IRS charges a nonrefundable application fee unless you qualify for the low-income waiver. Check the latest fee and waiver rules on the IRS OIC page above.

While a “complete” offer is under consideration, the IRS will generally suspend most collection actions (levies and garnishments). Liens already in place usually remain until payment is complete or the lien is released per IRS procedures. Always confirm current collection suspension policies on the IRS site.

Eligibility basics — common requirements

  • You must be current with filing federal tax returns (or include required returns with the offer).
  • You cannot be in an open bankruptcy proceeding that affects the tax liability.
  • You must have made required estimated tax payments for the current year and remain compliant if the offer is accepted.
  • You must show that the proposed offer reflects the maximum the IRS can expect to collect within a reasonable period.

Applying while in an installment agreement is possible, but the IRS may require you to default the installment plan or meet other conditions; consult a professional before withdrawing from an agreement.

Alternatives to an OIC and how to choose

An OIC is not the only pathway to resolving tax debt. Consider other options first:

  • Installment agreement (monthly payments) — often the best choice when you can reasonably pay over time. See our guide on Installment Agreements for types and how to apply.
  • Partial Payment Installment Agreement — lets you pay less monthly based on ability to pay (not available in all situations).
  • Offer vs. Installment: If your RCP is close to the tax owed, an installment agreement may be faster and easier. See Choosing Between an Installment Agreement and Offer in Compromise for a direct comparison.
  • Collection Due Process (CDP) hearings or appeals — when tax assessments or levies are at issue.
  • Bankruptcy — only in certain cases and usually as a last resort; tax discharge rules are complex.

Internal resources:

Step-by-step application checklist

  1. Confirm you’ve filed all required tax returns and are current on estimated taxes.
  2. Collect supporting documents: bank statements (3+ months), pay stubs, bills, loan statements, proof of extraordinary expenses, and asset documentation.
  3. Complete Form 656 and the appropriate Form 433 (A or B) precisely.
  4. Decide lump-sum versus periodic payment and include required payments with your application.
  5. Submit a complete package to the IRS OIC address listed in the Form 656 instructions.
  6. Track communications from the IRS and be prepared to provide supplementary documentation quickly.

Timing: It commonly takes many months for the IRS to review an offer. Be prepared for requests for updated bank statements and pay stubs during the review.

Common mistakes and pitfalls

  • Filing an incomplete offer — causes delays and may lead to outright rejection.
  • Lowball offers that ignore RCP — unrealistic offers are rejected quickly.
  • Failing to remain compliant with current tax obligations — noncompliance can void an accepted offer or disqualify an application.
  • Not documenting monthly expense claims — the IRS scrutinizes nonstandard or high living expenses.

If your offer is rejected

You have appeal rights. Typically you can:

  • Request an appeal through the IRS Office of Appeals or the Collection Appeals Program (CAP), depending on the type of decision.
  • Provide additional documentation or a revised offer, although repeated lowball attempts reduce credibility.

If appeals fail, you can still pursue an installment agreement, levy release options, or explore other remedies with a tax professional.

Practical tips from a tax-resolution professional

  • Be realistic and transparent: the IRS’s financial analysis is methodical and data-driven.
  • Document extraordinary hardship carefully — medical bills, natural disasters, or other non-discretionary burdens can matter.
  • Don’t delay filing OIC documents if you genuinely cannot pay; the longer enforcement continues, the more penalties and interest accrue.
  • Use the internal documentation checklist to avoid omission mistakes (see our Documentation Checklist link above).

Final thoughts and disclaimer

An Offer in Compromise can provide real relief for taxpayers who can demonstrate that the full tax liability cannot reasonably be collected. However, OICs are often complex, time-consuming, and not guaranteed. In many cases, an installment agreement or other collection alternative is simpler and more likely to resolve the balance.

This article is educational and does not replace personalized tax advice. For case-specific guidance, consult a qualified tax professional or an enrolled agent experienced with Offers in Compromise and IRS collections.

Authoritative sources

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