What Is an Offer in Compromise?
An Offer in Compromise (OIC) is an agreement between a taxpayer and the IRS that settles the taxpayer's tax debt for less than the full amount owed. It's designed for taxpayers who genuinely cannot pay their full tax liability, or for situations where there's a legitimate dispute about the amount owed.
The OIC program has been part of the tax code for decades and is administered by the IRS's Office of Offers in Compromise. Despite heavy advertising by tax relief companies, the OIC is not a guaranteed solution — the IRS rejected approximately 67% of applications in recent years.
That said, when properly prepared and filed with accurate financial documentation, an OIC can be a powerful tool for resolving tax debt. The key is understanding whether you're a viable candidate before investing the time and money to apply.
Eligibility Requirements
Before the IRS will consider your offer, you must meet several threshold requirements: all required tax returns must be filed, you must be current on estimated tax payments (if self-employed) or have adequate withholding (if employed), you cannot be in an open bankruptcy case, and you must have a valid tax liability.
The IRS also uses a pre-qualifier tool (available on irs.gov) that can give you a rough idea of whether your offer might be accepted. However, this tool is simplified and doesn't account for all the factors the IRS considers in a full review.
The three grounds for an OIC are: Doubt as to Collectibility (most common — you can't pay the full amount and won't be able to before the collection statute expires), Doubt as to Liability (you believe you don't actually owe the amount assessed), and Effective Tax Administration (you can technically pay but doing so would create economic hardship or would be unfair).
How the IRS Calculates Your Offer Amount
The IRS uses a formula called the Reasonable Collection Potential (RCP) to determine the minimum offer they'll accept. The RCP has two components: your asset equity (net realizable equity in your assets — roughly 80% of fair market value minus debts) plus your future income (monthly disposable income × a multiplier).
For lump sum offers (paid in 5 or fewer installments), the multiplier is 12 months of disposable income. For periodic payment offers (paid in 6-24 months), the multiplier equals the number of months remaining on the collection statute (up to 24).
Monthly disposable income = your gross monthly income minus allowable expenses. The IRS uses Collection Financial Standards to determine what expenses are 'allowable' — these standards set limits for housing, transportation, food, and other categories based on your location and family size. If your actual expenses exceed the standards, you may need to document why the higher amounts are necessary.
The Application Process
Filing an OIC requires: Form 656 (Offer in Compromise), Form 433-A (OIC) for individuals or 433-B (OIC) for businesses, a $205 application fee (waived for low-income applicants), and an initial payment — either 20% of the lump sum offer or the first monthly payment for periodic payment offers.
The documentation requirements are extensive. You'll need 3 months of bank statements, 3 months of pay stubs, recent tax returns, documentation of all assets (vehicles, real estate, investments), documentation of all debts, and proof of necessary expenses that exceed IRS standards.
After submission, the IRS assigns your offer to an Offer Examiner who will review your documentation, verify your financial information, and may request additional documents. This process typically takes 7-12 months. During processing, the IRS is prohibited from most collection activity.
Tips to Improve Your Chances
Be completely honest and thorough in your financial disclosure. The IRS will verify your information against their databases and third-party records. Hiding assets or income is the fastest way to get your offer rejected — and may result in additional penalties.
File before your situation improves. If your income is expected to increase significantly (new job, business growth), file the OIC while your income is still low. The IRS evaluates your current situation, and a higher future income means a higher required offer amount.
Include all necessary documentation with your initial submission. Incomplete applications create delays and may result in rejection. Many offers are rejected not because the taxpayer doesn't qualify, but because the application was poorly prepared.
Consider hiring a professional. While you can file an OIC yourself, the process is complex and the stakes are high. A qualified Enrolled Agent, CPA, or tax attorney can help you present your case in the strongest possible light and avoid common mistakes that lead to rejection.
What Happens After Your Offer Is Accepted
If your offer is accepted, you must comply with all terms for 5 years (the 'compliance period'). This means filing all required returns on time, paying all taxes owed on time, and not incurring any new tax debts. Failing to comply can result in the offer being defaulted, which means the original full tax debt is reinstated.
Federal tax liens are not released until the offer terms are fully satisfied and the compliance period has ended. However, the IRS may subordinate or discharge a lien in specific circumstances during the compliance period.
If your offer is rejected, you have 30 days to request an appeal with the IRS Office of Appeals. The appeal is an opportunity to present additional information or arguments for why your offer should be accepted. If the appeal is also denied, you can reapply with a new offer.