What Is an OIC Tax and How Does It Work?

Dealing with tax debt can be overwhelming, but the IRS offers a potential solution called an Offer in Compromise (OIC). This program allows eligible taxpayers to settle their tax liabilities for less than the full amount owed if paying in full would cause financial hardship. While it can provide relief, not everyone qualifies, and the process requires careful preparation.

Successfully obtaining an OIC involves meeting strict eligibility criteria, submitting detailed financial records, and selecting an appropriate payment structure. Understanding how it works can help determine whether it’s a viable option for resolving tax debt.

Key Qualifications

The IRS evaluates a taxpayer’s ability to pay, income, expenses, and asset equity before accepting an Offer in Compromise. Applicants must prove that paying the full tax debt would create financial hardship or that there is doubt about whether the full amount is legally collectible. The IRS also considers whether collecting the balance would be unfair based on exceptional circumstances.

To qualify, all tax returns must be filed, and any estimated tax payments or required federal tax deposits for the current year must be made. Self-employed individuals with employees must ensure payroll tax obligations are current. Taxpayers in an open bankruptcy proceeding are ineligible, as the IRS does not negotiate OICs while bankruptcy protections are in place.

The IRS uses the Reasonable Collection Potential (RCP) formula to assess an offer’s acceptability. This calculation considers net realizable equity in assets—including real estate, vehicles, bank accounts, and investments—along with anticipated future income after allowable living expenses. If the IRS determines a taxpayer has the means to pay the full debt through these resources, the offer will likely be rejected.

Financial Records to Gather

A strong Offer in Compromise submission requires comprehensive financial documentation to substantiate an inability to pay. The IRS scrutinizes an applicant’s financial situation in detail, so providing accurate and complete records is necessary to avoid delays or rejection.

Bank statements for the past three to six months provide insight into income deposits, recurring expenses, and overall cash flow. The IRS analyzes these statements to verify earnings and expenditures, ensuring they align with financial disclosures on Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses. Any large or irregular transactions may require additional explanations.

Documentation of monthly expenses is another critical component. This includes rent or mortgage statements, utility bills, insurance payments, medical costs, and other recurring financial obligations. The IRS applies national and local expense standards to determine reasonable living costs, so discrepancies between reported expenses and these benchmarks may require justification. For example, if a taxpayer claims unusually high transportation costs, they may need to provide receipts, loan statements, or repair invoices.

Proof of income extends beyond pay stubs or business revenue statements. Social Security benefits, pension distributions, rental income, and other earnings must be documented. Self-employed individuals should provide profit and loss statements, business bank records, and contracts or invoices from clients. If income fluctuates significantly, a longer history of earnings may be necessary.

Asset documentation is equally important, as the IRS evaluates equity in real estate, vehicles, retirement accounts, and other investments. Recent mortgage or loan statements, property tax assessments, and vehicle valuation reports help determine net realizable equity. If a taxpayer claims minimal asset value, supporting evidence such as depreciation schedules or market comparisons may be required.

Application Steps

Submitting an Offer in Compromise requires careful completion of IRS Form 656, which outlines the specific tax debts being settled and the proposed offer amount. This form must be accompanied by a detailed financial disclosure using Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses. Accuracy is essential, as inconsistencies or missing information can delay processing or result in rejection.

A non-refundable application fee of $205 must be included unless the applicant qualifies for a low-income waiver. An initial payment is also required with the submission, the amount of which depends on the selected payment structure. If the offer is rejected, this payment is applied toward the outstanding tax liability rather than refunded.

Once submitted, the IRS may take several months to review the application. During this period, collection activities are generally paused unless the taxpayer is already in an active installment agreement. The IRS may request additional information, and failure to respond within the specified timeframe can result in automatic denial. If the offer is accepted, all agreed-upon payments must be made on time, and compliance with future tax obligations is required to prevent the agreement from being revoked.

Payment Structures

Applicants must choose a payment structure that aligns with their financial situation. The IRS provides multiple options, each with different timelines and requirements. Selecting the right approach is important, as failure to adhere to the agreed-upon terms can result in default, reinstating the full tax liability.

Lump Sum

A lump sum payment structure requires the taxpayer to pay at least 20% of the offered settlement amount upfront when submitting Form 656. If the IRS accepts the offer, the remaining balance must be paid in no more than five installments, typically within five months of acceptance. This option is preferred by those with access to liquid assets, as it allows for a quicker resolution and minimizes the risk of default.

The IRS evaluates lump sum offers based on the taxpayer’s Reasonable Collection Potential (RCP), which considers asset equity and future income. If the proposed amount is significantly lower than what the IRS believes can be collected, the offer may be rejected. For example, if a taxpayer owes $50,000 but has $30,000 in accessible savings and a steady income, an offer of $5,000 is unlikely to be accepted. However, if the taxpayer can demonstrate that liquidating assets would cause financial hardship, the IRS may consider a lower settlement.

Short-Term Installment

A short-term installment plan allows taxpayers to spread payments over six to 24 months after the IRS accepts the offer. Unlike the lump sum option, this structure requires the applicant to continue making monthly payments while the IRS reviews the offer, which can take several months. These payments are non-refundable and will be applied to the outstanding tax debt if the offer is denied.

This option benefits those who cannot afford a large upfront payment but can commit to a structured repayment schedule. The IRS calculates the acceptable offer amount by estimating the taxpayer’s disposable income over the payment period. For instance, if a taxpayer has $500 in monthly disposable income and selects a 12-month plan, the IRS may expect an offer of at least $6,000, plus any available asset equity. If the taxpayer’s financial situation changes during the review process, they may need to submit updated financial records.

Longer-Term Installment

For those unable to pay within 24 months, a longer-term installment plan extends payments beyond two years, though the total settlement must still be completed within the statute of limitations for tax collection, which is generally 10 years from the date of assessment.

The IRS evaluates long-term installment offers by projecting the taxpayer’s future income and expenses over the extended period. If a taxpayer proposes a settlement amount lower than what the IRS expects to collect over time, the offer may be rejected. For example, if a taxpayer has $400 in monthly disposable income and requests a 36-month plan, the IRS may require a minimum offer of $14,400 ($400 × 36), plus any available asset equity.

Taxpayers selecting this option must remain compliant with all future tax obligations, including timely filing and payment of estimated taxes. Any missed payments can result in default, reinstating the full tax liability with accrued penalties and interest.

Causes for Rejection

Even if a taxpayer meets the basic qualifications and submits all required documentation, the IRS may still reject an Offer in Compromise. The most common issue is that the proposed settlement amount is too low based on the IRS’s assessment of the taxpayer’s financial capacity. If the IRS determines that the individual or business has sufficient income or assets to pay more than what was offered, the application will likely be denied.

Another frequent reason for rejection is noncompliance with tax obligations. If a taxpayer has unfiled returns, missed estimated tax payments, or failed to make required federal tax deposits, the IRS will not approve the offer. Additionally, if the taxpayer does not respond to IRS requests for additional information within the specified deadline, the application may be denied. If an offer is rejected, the taxpayer has the option to appeal within 30 days by submitting Form 13711, Request for Appeal of Offer in Compromise.

Responsibilities After Approval

Once an Offer in Compromise is accepted, the taxpayer must adhere to strict compliance requirements. Payments must be made on time, and all tax obligations must be met for the next five years. If the taxpayer fails to comply, the IRS can rescind the agreement and reinstate the full tax liability. Additionally, any refunds due in the year the offer is accepted will be applied to the outstanding balance.