USTaxPenaltySaverWhat Is an Offer in Compromise?
An Offer in Compromise (OIC) is a formal agreement with the IRS that allows you to settle your tax debt for less than the full amount owed. It is one of the Fresh Start Initiative programs designed to help taxpayers who genuinely cannot pay their full tax liability. The IRS accepts an OIC when it believes the offer represents the maximum it can reasonably expect to collect.
The IRS may accept an OIC for three reasons: (1) Doubt as to Liability, when there is a genuine dispute about whether the tax is legally owed, (2) Doubt as to Collectibility, when your assets and income are less than the full tax debt, or (3) Effective Tax Administration, when you can pay in full but doing so would create economic hardship or be unfair due to exceptional circumstances. Most OICs are based on doubt as to collectibility.
An OIC is not a tax loophole or a way to avoid legitimate tax obligations. The IRS carefully evaluates your ability to pay using a specific formula. If you can pay through an installment agreement or other means, you generally will not qualify for an OIC. The program is for taxpayers who truly cannot pay their full balance.
Eligibility Requirements
Before applying for an OIC, you must meet several basic requirements. First, you must be current on all tax filing requirements. All required tax returns must be filed before the IRS will consider your offer. If you have unfiled returns, file them first.
Second, if you are a business owner with employees, you must have made all required federal tax deposits for the current quarter and the two preceding quarters. The IRS will not negotiate while you are accumulating new tax debt.
Third, you cannot be in an open bankruptcy proceeding. If you are in bankruptcy, the automatic stay prevents the IRS from negotiating your tax debt outside the bankruptcy process. Wait until your bankruptcy is closed.
Fourth, and most importantly, the IRS must determine that your offer equals or exceeds your Reasonable Collection Potential (RCP). This is the IRS formula for how much they could collect from you through normal enforcement. If you can afford to pay more than you offered, your OIC will be rejected.
How to Calculate Your Minimum Offer (RCP)
Reasonable Collection Potential (RCP) is the key to a successful OIC. The formula is: RCP = Net Realizable Value of Assets + Future Income. Your offer must be at least equal to your RCP to have a chance of acceptance. Offering less is almost guaranteed to result in rejection.
Net Realizable Value of Assets is the quick-sale value of your assets minus any secured debts. Quick-sale value is typically 80% of fair market value. This includes bank accounts, investments, real estate equity, vehicle equity, retirement accounts (the IRS includes these), and other property. The IRS allows exemptions for necessary items like basic household goods and one vehicle.
Future Income is your monthly disposable income multiplied by either 12 (for lump sum offers) or 24 (for periodic payment offers). Disposable income is your gross monthly income minus allowable living expenses. The IRS uses Collection Financial Standards to cap certain expenses, so your actual expenses may be reduced to IRS-allowed amounts.
Example: You have $5,000 in assets (after quick-sale reduction and exemptions) and $500 per month in disposable income. For a lump sum offer, your RCP is $5,000 + ($500 x 12) = $11,000. Your offer must be at least $11,000 to be considered. For a periodic payment offer, it would be $5,000 + ($500 x 24) = $17,000.
Application Process and Fees
To apply for an OIC, you need to submit: Form 656 (Offer in Compromise), Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses, the $205 application fee, and your initial payment. All forms are available in the Form 656 Booklet on IRS.gov.
For a lump sum offer, you must submit 20% of your total offer amount with your application. If you offer $10,000, you send $2,000 with the forms. The remaining balance is due within 5 payments after acceptance. For a periodic payment offer, you submit the first monthly payment with your application and continue making monthly payments while the IRS reviews your offer.
Low-income taxpayers may qualify to have the $205 fee waived, the initial payment waived, and monthly payments during review waived. You qualify if your income is at or below 250% of the federal poverty level. Complete the low-income certification on Form 656.
Processing time ranges from 12 to 24 months. The IRS will not take collection action while your offer is being considered, but interest and penalties continue to accrue. If the IRS does not make a decision within 2 years of receiving your offer, it is automatically accepted.
Why OICs Get Rejected (And How to Avoid It)
The most common reason for OIC rejection is offering less than your Reasonable Collection Potential. The IRS uses a formula, and if your math does not match their math, you will be rejected. Use the IRS OIC Pre-Qualifier tool on IRS.gov to estimate whether you might qualify before applying.
Another common rejection reason is incomplete or inaccurate financial information. The IRS will verify your income, assets, and expenses. If you underreport assets or income, your offer will be rejected, and you may face accuracy penalties. Be thorough and honest on Form 433-A.
Taxpayers who can afford an installment agreement are often rejected for OIC. If the IRS calculates that you could pay your full balance through monthly payments within the 10-year collection statute, they will deny your OIC and suggest a payment plan instead.
Finally, offers are rejected when taxpayers are not in filing compliance. Make sure all required returns are filed before you submit your OIC. If the IRS discovers an unfiled return after you apply, your offer will be returned.
After Your OIC Is Accepted
If your OIC is accepted, you will receive written confirmation with payment instructions. For lump sum offers, you must pay the remaining balance within 5 payments. For periodic payment offers, continue your monthly payments as agreed until the full offer amount is paid.
For 5 years after acceptance, you must remain in full compliance. This means filing all required tax returns on time, paying all taxes when due (including estimated taxes), and not incurring new tax debt. If you fail to comply, the IRS can default your offer.
If you default, the IRS reinstates your original tax debt minus any payments made under the offer. You also lose the right to contest the amount. Stay compliant for the full 5 years to ensure your offer remains in effect.
Key Takeaways
An Offer in Compromise lets you settle IRS tax debt for less than you owe. The application fee is $205, and you must submit an initial payment (20% for lump sum or first monthly payment for periodic). Low-income taxpayers may qualify for waivers.
Your offer must equal or exceed your Reasonable Collection Potential (RCP), which is your asset value plus future income. Use the IRS OIC Pre-Qualifier tool to see if you might qualify before spending $205 on an application.
The OIC acceptance rate was 21.4% in 2024. Most rejections occur because the offer was less than RCP or the taxpayer could afford a payment plan. If you qualify, an OIC can be a powerful way to resolve tax debt, but it requires full compliance for 5 years after acceptance.