Quick overview

An Offer in Compromise (OIC) lets the IRS accept less than the full amount of tax, penalties, and interest if the agency determines that collecting the full amount would be unrealistic or unfair. The IRS evaluates each application against objective financial data and uses a calculation called “reasonable collection potential” to determine the smallest amount it can reasonably collect. The program can provide meaningful relief for individuals and businesses—but it requires full documentation, patience, and an accurate assessment of your finances.

Sources: IRS Offer in Compromise page (irs.gov/individuals/offer-in-compromise).

Who can apply and basic eligibility

You must meet several baseline rules to submit an OIC:

  • All required tax returns must be filed. The IRS will not consider an OIC if returns are missing. (IRS: Offer in Compromise)
  • You must have made required estimated tax payments and payroll tax deposits, as applicable. Business deposit requirements must be current.
  • You may not be in an open bankruptcy case.

Beyond those administrative rules, the IRS evaluates offers under three main grounds:

  1. Doubt as to Collectibility (DATC): You can’t pay the full amount within the time allowed by law. The IRS estimates your assets and future income to determine whether collection is feasible.
  2. Doubt as to Liability (DATL): You genuinely dispute the amount the IRS says you owe. DATL requires documentary proof that the liability is wrong.
  3. Effective Tax Administration (ETA): You can pay but doing so would create economic hardship or would be unfair and inequitable. ETA is harder to qualify for and is used only in limited situations.

The IRS calculates a taxpayer’s Reasonable Collection Potential (RCP) — the sum of available asset equity plus the amount it can expect to collect from future income — and will generally accept offers at or above the RCP.

Source: IRS Offer in Compromise (irs.gov).

Step-by-step: How to prepare and submit an OIC

  1. Use the IRS pre‑qualifier tool (if available) to see if an OIC is likely to be considered. It’s not binding, but it helps screen obvious mismatches.
  2. Gather documentation: recent pay stubs, bank statements, proof of monthly living expenses, mortgage and car loan statements, appraisals for significant assets, and all required tax returns.
  3. Complete Form 656 (Offer in Compromise) and the appropriate financial statement form (Form 433‑A for individuals or Form 433‑B for businesses). Include supporting schedules and third‑party verification where possible.
  4. Include the application fee and required initial payment unless you qualify as a low‑income taxpayer and are exempt from the fee. For non‑low‑income offers, the IRS generally requires a deposit with the application: a lump‑sum offer usually requires 20% of the offer amount; a periodic (installment) offer requires the first proposed payment with the application. Check the current Form 656 instructions for exact amounts and low‑income rules.
  5. Mail the packet to the address listed in the Form 656 instructions or submit electronically when available.
  6. Be responsive. The IRS may ask for additional information. Failure to respond is a common cause of denial.

Note: Processing commonly takes several months; complex cases can take 12 months or more. The IRS must investigate and verify financial information before accepting, rejecting, or returning an offer.

Source: IRS Form 656 instructions and Offer in Compromise guidance.

What happens while the IRS reviews your offer?

  • Collection activity: Generally, the IRS will suspend most enforced collection actions (levies, garnishments) while it considers a timely and complete OIC. However, there are exceptions and taxpayer behavior (missed payments, incomplete submissions) can allow the IRS to continue collections. Always confirm the status in writing with the IRS representative handling your case.
  • Liens: A federal tax lien may remain in place while an offer is pending. If an offer is accepted, the IRS will typically release the lien when the terms are satisfied (for example, after full payment or completion of the installment schedule).

Source: IRS collection procedures and OIC guidance.

Costs, deposits, and low‑income exceptions

There is normally an application fee for Form 656 and an initial payment deposit tied to the type of offer you submit. Low‑income taxpayers—those with incomes at or below certain IRS published levels and who meet Form 656 instructions—may be exempt from the application fee and from the initial deposit requirement. Always confirm the current fee and deposit rules on the IRS website or the Form 656 instructions before filing.

Source: Form 656 instructions and IRS Offer in Compromise details (irs.gov).

What the IRS looks at: Reasonable Collection Potential (RCP)

The IRS will not accept an offer simply because you claim you can’t pay. It uses RCP to measure collectibility:

  • Equity in assets: market value minus secured debt. This includes real estate, vehicles (equity above allowed necessary transportation), investments, and other nonexempt property.
  • Future income: the IRS considers monthly disposable income (income minus allowed living expenses). The IRS typically multiplies monthly disposable income by a set collection period (often 12 months for many determinations) to estimate what it could collect in the near term.

The sum of asset equity and projected collections from income becomes the RCP. Offers lower than the RCP are generally rejected; offers equal to or above the RCP have a higher chance of acceptance.

Source: IRS OIC methodology (irs.gov) and Form 433 instructions.

Common mistakes that lead to denial

  • Incomplete or inaccurate financial statements.
  • Missing required tax returns or payroll deposits.
  • Failing to include the correct application fee or initial payment when required.
  • Overstating monthly living expenses without documentation.
  • Waiting too long to respond to IRS requests for additional information.

In my practice advising clients, the most frequent cause of denials is incomplete documentation—especially missing proof for claimed living expenses or unreported income sources.

Alternatives if an OIC isn’t right for you

  • Installment Agreements: If you can pay over time, an installment agreement may be easier and faster to obtain. See our guide on IRS installment agreements for types, costs, and application tips: IRS Installment Agreements: Types, Costs, and Application Tips.

  • Currently Not Collectible (CNC) status: If you truly cannot pay anything without causing severe hardship, CNC status temporarily pauses collection. CNC is not forgiveness; penalties and interest continue to accrue and the debt remains. Learn more: What ‘Currently Not Collectible’ Really Means for You.

  • Bankruptcy: In some cases, certain tax debts may be dischargeable in bankruptcy. This is complex and must be evaluated with a bankruptcy attorney.

  • Innocent Spouse Relief or Offer challenges: If liabilities stem from a former spouse’s actions, Innocent Spouse Relief or other remedies may apply.

Practical tips for a better chance of acceptance

  • File all returns first. The IRS will typically dismiss an OIC when returns aren’t current.
  • Be realistic. Prepare your financials honestly and conservatively; the IRS will verify.
  • Keep documentation organized: bank ledgers, medical bills, proof of childcare or eldercare costs, and car repair receipts can support legitimate expense claims.
  • Consider professional representation. A CPA, enrolled agent, or tax attorney experienced in offers in compromise can improve presentation and avoid procedural mistakes. In my experience, reasonable professional preparation reduces back-and‑forth and shortens decision time.

After an offer is accepted or rejected

  • Accepted offers: You must comply with the terms—payments on schedule and filing and paying future taxes on time—or the IRS will reinstate collection of the original debt. An accepted OIC becomes a legally binding contract.
  • Rejected offers: The IRS will explain reasons for rejection. You can appeal the decision (Collection Appeal Program), submit a new offer if circumstances materially change, or pursue other remedies like installment agreements or CNC status.

Source: IRS appeals and collection guidance.

Final notes and disclaimers

An Offer in Compromise can be a powerful tool, but it’s not a quick fix and it’s not appropriate for everyone. Before pursuing an OIC, verify current fee and deposit rules, use the IRS pre‑qualifier tools, and consider professional help if your case is complex. This article is educational and not personalized tax advice. For guidance specific to your situation, consult a qualified tax professional or attorney.

Authoritative references:

Additional internal resources:

If you decide to move forward, assemble your documentation first and consider running the IRS pre‑qualifier to set realistic expectations.