What Is an Offer in Compromise and How Does It Work?

An Offer in Compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that resolves a tax debt for less than what was originally owed. The IRS may agree to an OIC when the offer represents the most the agency can expect to collect within a foreseeable timeframe. This resolution is considered after other payment options have been explored and is based on the taxpayer’s ability to pay, income, expenses, and asset equity. The program’s purpose is to provide a path to compliance for those facing tax liabilities they cannot realistically pay in full, especially if collection would cause financial hardship.

Determining Eligibility for an Offer in Compromise

Before the IRS will consider an Offer in Compromise, a taxpayer must meet several preliminary requirements. All required tax returns must be filed, and all estimated tax payments for the current year must be made. For business owners, this also includes making all required federal tax deposits for the current and preceding two quarters. A taxpayer cannot be in an open bankruptcy proceeding.

Once these initial hurdles are cleared, the IRS evaluates an OIC based on one of three grounds. The most common is “Doubt as to Collectibility,” which applies when a taxpayer’s assets and income are less than the full amount of the tax liability. The IRS concludes that it is unlikely to collect the full debt, making a compromise a practical alternative.

A less frequent ground is “Doubt as to Liability.” This involves a genuine dispute over whether the tax debt was assessed correctly. For these cases, the taxpayer must submit evidence and a written explanation using Form 656-L, which does not require an application fee or initial payment.

The final basis is “Effective Tax Administration” (ETA). An ETA claim can be made even if the taxpayer has sufficient assets to pay the full liability, arguing that collection would create economic hardship or would be fundamentally unfair.

Required Information and Forms for Submission

Applying for an Offer in Compromise requires a compilation of financial information and specific IRS forms. You must gather documentation for your financial situation, including recent statements for all bank accounts, details on investments, and valuations for real estate and vehicles. You must also document all sources of monthly income and provide a detailed breakdown of monthly living expenses.

The core of the application package consists of Form 656, Offer in Compromise, and a Collection Information Statement. Individuals and self-employed wage earners use Form 433-A (OIC), while businesses must complete Form 433-B (OIC). The Form 656-B booklet provides step-by-step instructions for the application.

The financial data is entered onto Form 433-A or 433-B, which requires you to list assets, income, and allowable expenses. The IRS has established national and local standards for living expenses, such as housing and transportation, which must be used. Any claimed expenses exceeding these standards require justification.

Form 656 is where you state your proposed offer amount and select payment terms. The application must include a non-refundable application fee of $205 and an initial payment. However, taxpayers who meet low-income certification guidelines can request to have both the fee and initial payment waived.

Calculating the Minimum Offer Amount

The IRS determines an offer’s acceptability by calculating a taxpayer’s “Reasonable Collection Potential” (RCP), which serves as the baseline for a minimum offer. The RCP is derived from a formula using the financial data on Form 433-A or 433-B. The formula consists of two main parts: the net realizable equity in your assets and your future remaining income.

Net realizable equity in assets is the first component. For each asset you own, you must determine its quick sale value—the amount it could be sold for quickly. From this value, you subtract any outstanding loans or liens secured by that asset to find your equity.

The second component is your future remaining income. This is calculated by taking your gross monthly income and subtracting the allowable monthly living expenses as determined by IRS standards. The resulting disposable monthly income is then multiplied by a specific number of months.

The standard multipliers are 12 for a lump-sum payment plan (paid in five or fewer installments) and 24 for a periodic payment plan (paid over six to 24 months). The sum of your net equity and future remaining income establishes the minimum offer amount. An offer below this RCP is unlikely to be accepted without a compelling argument for special circumstances.

The OIC Submission and Review Process

The complete submission must include the signed Form 656, the completed Form 433-A or 433-B with all supporting financial documents, the application fee, and the initial offer payment. The mailing address for the application is specified in the instructions for Form 656-B.

After the IRS receives the application, it will apply the fee and initial payment to your tax debt. These amounts are not refundable, even if the offer is rejected. You will then receive a letter from the IRS confirming receipt and notifying you that your case has been assigned to an OIC examiner.

The OIC examiner’s job is to verify all the financial information you provided. They will review bank statements, pay stubs, and other documentation to ensure accuracy. The examiner may contact you or your representative with questions or to request additional information, and this review process can take several months.

If the IRS does not make a determination on the offer within two years of the date they receive it, the offer is automatically accepted. This two-year period does not include any time the case is under appeal.

Upon completion of the review, the examiner will recommend acceptance, rejection, or a return of the offer. If accepted, you will receive a letter detailing the terms and must comply with all conditions, including making all payments and remaining current on tax obligations for five years.

If the offer is rejected, the IRS will provide an explanation and inform you of your right to appeal the decision by filing Form 13711 within 30 days. An offer may be returned if it is deemed unprocessable, for instance, if you file for bankruptcy after submission.