Overview

When tax debt becomes unmanageable, pick the option that minimizes long-term harm: an Offer in Compromise (OIC) reduces an IRS liability if the agency determines the amount you offer is the most it can collect; bankruptcy provides court-ordered relief from many kinds of debt but has strict rules for discharging taxes (see IRS and U.S. Courts guidance) (IRS: https://www.irs.gov/individuals/offer-in-compromise-1; U.S. Courts: https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics).

A short decision framework (practical)

  • If your tax debt is the main problem, you have little disposable income or few nonexempt assets, and the IRS’s reasonably collectible income (RCI) calculation favors a compromise, an OIC may be best. (IRS OIC program criteria: doubt as to collectibility, doubt as to liability, or effective tax administration.)
  • If you have many unsecured creditors (medical bills, credit cards) or need a structured court plan to stop collection actions and discharge eligible debts, bankruptcy (Chapter 7 or Chapter 13) often makes more sense.
  • If both tax and non-tax debts are high and your tax debts meet bankruptcy discharge timing rules, bankruptcy may produce broader relief.

How an Offer in Compromise works (key facts)

  • You apply with Form 656 and a Collection Information Statement (usually Form 433-A or 433-B) and pay the required initial payment (for a lump-sum OIC, that’s 20% of the offer amount; for periodic offers you must include the first installment) (IRS: Offer in Compromise page).
  • The IRS evaluates current assets, allowable expenses, and future income to calculate what it considers “reasonably collectible.” Acceptance is not guaranteed.
  • OIC outcomes: accepted (tax liability is settled per offer and remaining liability is forgiven), returned (no action), or rejected. You can appeal rejections through IRS appeal channels.

How bankruptcy handles tax debts (practical rules)

  • Bankruptcy does not automatically erase taxes. For priority income taxes to be dischargeable, common tests include: the tax return was due at least three years before the bankruptcy filing, the return was filed at least two years before filing, and the tax was assessed at least 240 days before filing (exceptions and nuances apply). Fraud, willful evasion, or late-filed returns can prevent discharge. (U.S. Courts guidance; IRS: Bankruptcy and the IRS).
  • Chapter 7 can discharge many unsecured debts and may discharge old income taxes that meet the tests. Chapter 13 reorganizes debts into a repayment plan (typically 3–5 years) and may allow you to pay a portion of tax debt through the plan.

When OIC is usually a better choice

  • Your assets are mostly exempt and you have minimal excess monthly income, but a large tax balance remains.
  • You can demonstrate the IRS cannot collect more than the reduced offer (RCI shows low collectibility).
  • You want to avoid the stigma or collateral effects of bankruptcy on non-tax debts or retain certain nonexempt assets.

When bankruptcy is usually a better choice

  • You have substantial unsecured debts (credit cards, medical bills, personal loans) in addition to taxes and need broad relief.
  • Your tax debts qualify for discharge under bankruptcy timing rules and you prefer a court-ordered process that stops collections and garnishments immediately.
  • You need a structured repayment over time (Chapter 13) to keep assets like a home.

Examples

  • Example 1 (OIC success): A low-income taxpayer with $50,000 in assessed tax, little nonexempt equity, and minimal monthly disposable income whose RCI calculation supported a $15,000 settlement—accepted by IRS after full documentation.
  • Example 2 (Bankruptcy better): A taxpayer with $30,000 in tax debt plus $80,000 in credit-card and medical debt who qualifies for Chapter 7 or needs Chapter 13 to protect a house—bankruptcy provided broader, faster relief.

Key practical steps to decide

  1. Gather docs: recent tax returns, pay stubs, bank statements, asset titles, and debt balances.
  2. Run a reasonably collectible calculation (estimate nonexempt asset equity + future monthly surplus times collection horizon). The IRS uses similar logic; get professional help to model outcomes.
  3. Compare likely outcomes: estimated recoverable amount via OIC vs. discharge or plan outcome in bankruptcy.
  4. Consult a tax professional or bankruptcy attorney—both perspectives matter. In my practice I run both scenarios side-by-side and present the likely IRS offer range, timeline, and bankruptcy discharge prospects.

Common mistakes to avoid

  • Assuming OIC is guaranteed—IRS acceptance rates are low without solid documentation and correct valuations.
  • Filing bankruptcy assuming all taxes will be wiped out—many tax debts remain nondischargeable unless they meet legal tests.
  • Skipping the Collection Information Statement or understating income/expenses—this triggers delays or denials.

Short FAQ

  • Can I apply for both? You can pursue both, but timing and strategy matter. Often you’ll choose one path to lead; concurrent filings can complicate outcomes.
  • Does OIC affect credit? An accepted OIC by itself is not a public bankruptcy filing, but tax liens or collection history can already have impacted credit. Bankruptcy will appear on credit reports and affect credit differently.

Resources and next steps

Internal resources

Professional disclaimer
This article is educational and does not substitute for personalized legal, tax, or financial advice. Rules for OIC and bankruptcy are technical and fact-specific; consult a qualified tax professional or bankruptcy attorney before taking action.