Offer in Compromise Help: Overcoming Common Application Issues

Owing back taxes to the IRS can be overwhelming, but an Offer in Compromise (OIC) may provide a way to settle for less than what’s owed. However, many applicants face challenges that lead to delays or outright rejections. Understanding these common pitfalls can improve your chances of approval.

Avoidable mistakes such as paperwork errors, missing documentation, and misrepresentation of financial details often cause issues during the application process. Addressing these problems early on can save time and frustration.

Outstanding Filings

Before the IRS considers an Offer in Compromise, all required tax returns must be filed. Missing filings signal noncompliance, making it unlikely the agency will negotiate a reduced settlement. The IRS requires applicants to be current with their tax obligations, including estimated payments for self-employed individuals and businesses. If any returns are outstanding, the application will be returned without review.

Even if past-due returns are eventually submitted, delays can impact eligibility. The IRS may assess additional penalties and interest, increasing the total liability. Failure-to-file penalties accrue at 5% per month, up to 25% of the unpaid tax. For example, if a taxpayer owes $10,000 and files six months late, penalties alone could add $2,500, not including interest. These additional costs can alter the financial picture used to evaluate an OIC, potentially reducing the likelihood of acceptance.

Taxpayers should verify their filing history through their IRS account or request a transcript using Form 4506-T. If records are incomplete, reconstructing income using Forms W-2, 1099, or bank statements may be necessary. The IRS also provides wage and income transcripts, which can help fill in missing details. Ensuring all filings are up to date before submitting an OIC prevents unnecessary setbacks.

Misrepresentation of Assets

The IRS evaluates an Offer in Compromise based on a taxpayer’s ability to pay, which includes a thorough review of assets, income, expenses, and future earning potential. Providing inaccurate or incomplete financial information can lead to immediate rejection or even fraud penalties. The agency cross-references disclosures with third-party data sources, such as bank records, property deeds, and vehicle registrations, making it difficult to conceal assets.

One common issue arises when applicants undervalue or fail to disclose assets like real estate, retirement accounts, or business interests. For example, if a taxpayer owns a rental property but reports only the mortgage balance without including its fair market value, the IRS may uncover the discrepancy through county property records. Similarly, omitting a 401(k) or IRA can be problematic, as financial institutions report account balances annually to the IRS. If discrepancies are found, the agency may reject the offer and reassess the taxpayer’s ability to pay.

Liquid assets like bank accounts and investments are also closely examined. The IRS typically reviews account statements from the past three to six months to identify large withdrawals or transfers. If funds were moved to a relative’s account or withdrawn in cash to reduce the reported balance, this could be seen as an attempt to manipulate financial disclosures. Transactions that appear suspicious may trigger further scrutiny, delaying the process or leading to additional penalties.

Pending Legal Actions

Ongoing legal disputes can significantly impact an Offer in Compromise. The IRS generally does not consider an OIC if a taxpayer is involved in bankruptcy proceedings, as tax debts may be resolved through the bankruptcy process instead. Under federal tax law, the IRS is prohibited from accepting an OIC while a taxpayer’s case is pending in bankruptcy court.

State and federal tax liens also play a role. If the IRS has already placed a lien on a taxpayer’s property, it signals an attempt to secure repayment. While an OIC does not automatically remove existing liens, the IRS may release them once the offer is paid in full. However, if a taxpayer is contesting a lien or levy through an appeal, this unresolved dispute can stall the OIC review process. The IRS is unlikely to settle a debt while enforcement actions are being legally challenged.

Incomplete Forms and Documentation

Errors or omissions in an Offer in Compromise submission can halt the process before it even begins. The IRS requires Form 656, which outlines the settlement proposal, and Form 433-A (OIC) or 433-B (OIC) for individuals and businesses, respectively, to assess financial capacity. Missing signatures, unchecked boxes, or failure to include required attachments often result in immediate rejection without review.

Supporting documentation must align with what is reported on financial disclosure forms. Pay stubs, bank statements, and expense records should cover the required timeframe, typically the last three to six months. If utility bills, lease agreements, or insurance statements are outdated or incomplete, the IRS may question the accuracy of reported household expenses. For business owners, providing profit and loss statements alongside tax filings ensures a clear picture of cash flow and operational viability.

The application fee and initial payment, if required, must be included. Taxpayers qualifying for the low-income certification can waive these costs, but failing to check the appropriate box on Form 656 or omitting proof of eligibility can lead to unnecessary processing delays. Payment amounts should match the proposed offer terms, as discrepancies may cause the IRS to return the submission.

Repeatedly Rejected Submissions

A rejected Offer in Compromise does not necessarily mean the end of negotiations, but repeated denials often indicate deeper issues with the application. The IRS considers multiple factors when evaluating an offer, and if the same mistakes persist across submissions, it signals to the agency that the taxpayer is either unwilling or unable to provide an acceptable settlement proposal.

One of the most common reasons for repeated rejections is proposing an offer amount that does not align with the taxpayer’s reasonable collection potential (RCP). The IRS calculates RCP based on available assets and future income, and if an offer falls significantly below this amount, it is unlikely to be accepted. For example, if a taxpayer has $20,000 in liquid assets and a projected disposable income of $500 per month over the next 24 months, the IRS would expect an offer of at least $32,000. Submitting an offer of $10,000 in this scenario would likely result in rejection. Taxpayers should use the IRS’s OIC Pre-Qualifier Tool to estimate an appropriate offer before submitting a new application.

Another issue is failing to address feedback from previous denials. If an OIC is rejected due to incomplete financial disclosures or unrealistic expense claims, resubmitting the same information without adjustments will not yield a different outcome. Taxpayers should carefully review the rejection letter, which typically outlines the reasons for denial, and make necessary corrections. In some cases, requesting an appeal within 30 days of rejection may be a better option than submitting a new application, as it allows for further negotiation without restarting the process.

Insufficient Hardship Criteria

The IRS approves an Offer in Compromise when it determines that collecting the full tax liability would create an undue financial burden. However, many applicants fail to demonstrate sufficient hardship, leading to rejection. The agency evaluates whether paying the full amount would prevent the taxpayer from covering basic living expenses, but subjective claims of financial difficulty are not enough—documentation must support the case.

Living expenses must fall within the IRS’s allowable standards, which are based on national and local cost-of-living data. If a taxpayer claims excessive discretionary spending, such as high entertainment costs or luxury vehicle payments, the IRS may adjust the financial analysis to exclude these expenses. For instance, if a taxpayer reports $1,500 per month in car payments but the IRS standard for their region is $600, only the lower amount will be considered. This adjustment can increase the taxpayer’s disposable income calculation, making it harder to qualify for an OIC.

Medical conditions, job loss, or other extenuating circumstances can strengthen an OIC application, but they must be well-documented. A taxpayer citing a chronic illness should include medical bills, insurance statements, and physician letters explaining the financial impact. Similarly, those experiencing long-term unemployment should provide termination letters, unemployment benefit records, and job search documentation. Without clear evidence, the IRS may determine that the taxpayer has the ability to pay over time and reject the offer.