Overview

Deciding between bankruptcy and an Offer in Compromise (OIC) is a financial and legal judgment. Bankruptcy can wipe out qualifying tax debts and other unsecured liabilities; an OIC negotiates a lesser payment to satisfy the IRS. Use bankruptcy when you need broad debt relief or your tax debts meet bankruptcy discharge tests. Use an OIC when bankruptcy won’t discharge the tax or the IRS’s reasonable-collection-potential (RCP) calculation shows a smaller lump sum or payment plan is appropriate.

When bankruptcy may be the better choice

  • You need to eliminate multiple non-tax debts (credit cards, medical bills) at once — Chapter 7 or Chapter 13 can address both tax and non-tax liabilities.
  • Your tax debts meet bankruptcy discharge criteria (generally: required returns filed, return due date was more than 3 years before filing, return filed at least 2 years before filing bankruptcy, and tax assessed more than 240 days before filing) and there is no fraud or willful evasion. See IRS bankruptcy guidance for details.IRS bankruptcy info
  • Your assets are exempt or limited so Chapter 7 won’t cause significant loss, or you can manage a Chapter 13 plan to reorganize debts.
  • You can’t meet the IRS’s RCP for an OIC — meaning the IRS can reasonably collect the tax through liens, levies, or installment collections.

When an Offer in Compromise may be the better choice

  • You do not qualify for bankruptcy discharge (taxes too recent, or fraud suspected), but your RCP shows you can’t realistically pay the full amount. The IRS accepts OICs based on ability to pay, income and asset equity: IRS Offer in Compromise.
  • You want to avoid the bankruptcy process and its broader credit impact. An accepted OIC can satisfy the tax liability and, once complied with, can lead to lien release.
  • You have some assets or income to pay a reduced settlement but not the full debt — the IRS evaluates assets, including equity and non-exempt resources.

Key practical differences

  • Eligibility and proof: OIC requires full disclosure of finances and proof you can’t pay. Bankruptcy requires meeting legal tests (means test for Chapter 7; plan feasibility for Chapter 13).
  • Timeline: OIC decisions can take months to years; bankruptcy cases typically resolve faster but can still take months (Chapter 7 is often shorter than Chapter 13).
  • Credit impact: Both options hurt credit. Bankruptcy is usually more severe and longer-lasting; an accepted OIC satisfies the tax obligation but does not erase other debt problems.

Common traps and how I use them in practice

  • Don’t assume bankruptcy will discharge any tax debt. In my practice I always run the discharge checklist (filing dates, assessment dates, and fraud flags) before advising bankruptcy. If taxes are recent or involve fraud, recommend OIC or other IRS options instead.
  • Don’t submit an OIC without verifying it’s the best use of limited funds. If the IRS’s RCP shows you could pay more later, an OIC may be rejected. I prepare the complete financial package and, if needed, point clients to detailed application guidance such as our Offer in Compromise application checklist and asset valuation guidance.

Relevant resources and next steps

Decision steps I recommend

  1. Gather documents: tax notices, last three years of returns, paystubs, bank statements, asset lists.
  2. Confirm dischargeability: check dates and fraud indicators against bankruptcy rules.
  3. Prepare an RCP-style budget to compare realistic OIC amounts vs bankruptcy outcomes.
  4. Consult a tax attorney or CPA experienced with both bankruptcy and OIC—this choice often requires coordinated legal and tax strategy.

Professional disclaimer

This article is educational and not legal or tax advice. Rules for tax discharge in bankruptcy and OIC eligibility are fact-specific and change; consult a qualified tax attorney or CPA for advice tailored to your situation. Authoritative sources used include the IRS OIC page and IRS bankruptcy guidance (linked above).