Using Form 656: Preparing an Offer in Compromise Package

Quick overview

Preparing a strong Offer in Compromise (OIC) package around Form 656 means presenting a clear, well-documented financial picture to the IRS so the agency can lawfully conclude you cannot realistically pay the full tax debt. In practice, that requires accurate completion of Form 656 itself plus a financial disclosure (Form 433 series), supporting documentation, the correct payment option, and an understanding of how the IRS values your ability to pay.

Who should consider an Offer in Compromise?

An OIC is intended for taxpayers who can demonstrate one of three bases under IRS rules: doubt as to collectibility (you can’t pay the full amount), doubt as to liability (there’s a legitimate dispute about the tax), or effective tax administration (special circumstances make full collection unfair or inequitable). It is not a quick fix for avoiding taxes — the IRS requires full disclosure and documentation. If you’re current on filing and tax compliance, and your reasonable collection potential (RCP) is less than the tax owed, an OIC may be appropriate.

In my practice I’ve seen OICs work for taxpayers with limited income and no non-exempt equity in assets. Conversely, taxpayers with large non-exempt assets or steady disposable income often fare better with an installment agreement or other options. See our guide on when an installment agreement is a better choice for a side-by-side comparison.

Internal resources:

• Preparing the financial statement is essential; see Preparing the Financial Statement for an Offer in Compromise for a step-by-step approach.
• To understand the IRS valuation process, see How an Offer in Compromise Is Valued by the IRS.

Step-by-step: Building the Form 656 package

Below are the practical steps I use when preparing a client’s OIC. Follow them in order and keep copies of everything you send.

1. Confirm basic eligibility

• File all required tax returns and be current with estimated tax payments and tax deposits where applicable. The IRS requires compliance before it will accept most OICs (IRS, Offer in Compromise webpage).
• Identify the correct legal basis for your offer (doubt as to collectibility, doubt as to liability, or effective tax administration).

1. Choose the payment option on Form 656
   Form 656 lets you choose a payment option:

• Lump-sum cash offer (usually 20% of the offer with the application and the balance in five or fewer payments), or
• Periodic payment offer (first payment with application and remaining payments while the IRS considers the offer).

As of 2025, the IRS charges an application fee (check the Form 656 instructions for current amounts). Low-income applicants may qualify for a fee waiver; consult the Form 656 instructions for the low-income certification criteria (IRS, Form 656 Instructions).

3. Prepare and attach the financial disclosure (Form 433 series)

• Individuals normally use Form 433-A (or Form 433-A(OIC) specifically designed for OICs). Businesses use Form 433-B (or 433-B(OIC)). These forms list income, assets, and allowable living expenses and form the basis of the IRS’s Reasonable Collection Potential (RCP) calculation (IRS, Form 433-A and Form 433-B).
• Include supporting documentation: pay stubs, bank statements, mortgage statements, vehicle titles, retirement account statements, proof of recurring medical or childcare expenses, and any documentation showing a recent drop in income.

3. Calculate (and document) Reasonable Collection Potential (RCP)
   RCP = net realizable equity in assets + future monthly disposable income over a collection period. The IRS uses standardized allowances for many living expenses; make sure your package explains any unusual or necessary expenses.

4. Attach written explanations and evidence
   Write a concise cover letter explaining your basis for the OIC, the payment plan you propose, and any special circumstances (medical expenses, job loss, bankruptcy history, or other hardships). Attach supporting evidence that backs each point.

5. Complete Form 656 carefully
   Follow the Form 656 instructions line-by-line. Common mistakes (see below) include forgetting to sign the form, miscalculating offer amounts, or failing to indicate the correct legal basis for the offer.

6. Submit and track
   Mail your complete package to the IRS address shown in the Form 656 instructions for your state, or follow any IRS filing guidance current at submission time. Keep certified-mail receipts and a copy of every document you send. The IRS will hold collection activity while it considers a valid offer, but take care to remain current on filing and payment obligations.

Documents checklist (minimum)

• Form 656, Offer in Compromise (signed)
• Form 433-A(OIC) or Form 433-B(OIC) plus supporting documents
• Proof of income: pay stubs (typically last 2–3 months), Social Security award letters, 1099s
• Bank statements (last 3 months)
• Proof of monthly expenses: leases, mortgage statements, insurance premiums, medical bills
• Documentation of assets: vehicle titles, retirement statements, brokerage statements
• Application fee or low-income certification (if eligible)
• Cover letter and statements explaining special circumstances

Common mistakes and how to avoid them

• Incomplete financial disclosure: The IRS will reject or deny offers when the 433 forms are incomplete or unsupported. Double-check everything.
• Overly optimistic expense claims: The IRS uses national or local allowances for living expenses. Provide documentation and reasoned explanations for any expenses that exceed standard allowances.
• Missing forms or signatures: Small omissions often cause delays or outright rejections. Use a final checklist.
• Ignoring alternatives: An installment agreement or currently not collectible status may be better options in some cases. Our article When an Installment Agreement Is Better Than an Offer in Compromise outlines those trade-offs.

What to expect after you submit

• Processing timeframe: Many offers take 6–12 months to resolve; complex cases can take longer. Keep copies and monitor IRS correspondence closely.
• During consideration: If you submit a periodic payment offer, you must continue those payments while the IRS evaluates the offer. Collection activity is generally suspended for a valid offer, but liens can remain in place.
• If accepted: The IRS will send an acceptance letter that describes the terms. You must comply with filing and payment requirements going forward and make any agreed payments.
• If rejected: You’ll receive a denial letter that explains the reasons and appeals options. You can appeal through the Collection Appeals Program or seek reconsideration; see Options After a Denied Offer in Compromise for practical next steps.

Example scenarios (real-world perspective)

• Medical hardship: A taxpayer with heavy, ongoing medical bills and limited retirement income may have little non-exempt equity. When we documented verified medical expenses and modest monthly disposable income, an offer reflecting the RCP stood a realistic chance of acceptance.
• Small business owner: In cases where business cash flow is variable, documenting business financials and legitimate business expense deductions on Form 433-B is crucial. Where owners retain significant business equity, the IRS may expect liquidation or higher offers.

These examples underline the need for honest, document-backed submissions.

Appeal options and next steps if denied

If your OIC is denied, the IRS provides a written explanation. Common paths after denial:

• Request administrative appeal through the IRS Collection Appeals Program (CAP) or Office of Appeals.
• Reapply with corrected or additional documentation if circumstances change materially.

See our detailed guides on appealing and reapplying for targeted checklists and timelines.

Practical tips from my practice

• Start with an accurate, conservative budget. Inflated expense claims undermine credibility.
• Use certified mail and maintain an indexed file of everything you send and receive.
• If you lack financial documentation (for example, informal freelance income), produce sworn statements plus bank records and 1099s.
• Consider professional help: experienced tax professionals save time, help avoid procedural mistakes, and can improve the chance of acceptance while ethically representing you.

Authoritative sources and where to verify details (2025)

• IRS Form 656 and instructions: Internal Revenue Service, Form 656: Offer in Compromise and Form 656 Instructions (see the IRS website for the latest PDFs).
• IRS Offer in Compromise general information and eligibility guidance (Internal Revenue Service).
• IRS Forms 433-A and 433-B for financial statements (Internal Revenue Service).

Always confirm fee amounts, mailing addresses, and forms on the IRS website before submitting; the IRS updates instructions and fees periodically.

Professional disclaimer

This content is educational and does not constitute legal or tax advice. For situation-specific guidance, consult a qualified tax professional or attorney experienced with Offers in Compromise.

For additional reading on building a financial disclosure or understanding OIC valuation, visit:

• Preparing the Financial Statement for an Offer in Compromise: https://finhelp.io/glossary/preparing-the-financial-statement-for-an-offer-in-compromise/
• How an Offer in Compromise Is Valued by the IRS: https://finhelp.io/glossary/how-an-offer-in-compromise-is-valued-by-the-irs/
• When an Installment Agreement Is Better Than an Offer in Compromise: https://finhelp.io/glossary/when-an-installment-agreement-is-better-than-an-offer-in-compromise/

If you want help assembling your package, consider contacting a CPA or tax resolution specialist familiar with OIC practice.