An Offer in Compromise is an agreement that lets you settle your federal tax debt for less than the full amount owed, authorized under 26 U.S.C. ยง 7122. The IRS accepts only about 15,000 to 17,000 of these each year, and it will generally agree to your number only when that number matches or exceeds what the agency believes it could collect from you by other means.1Internal Revenue Service. About Offers in Compromise Everything else about the program flows from that one rule.
The Three Grounds You Can Qualify Under
Every offer rests on one of three legal grounds, and you choose which one applies on Form 656. Pick the wrong one and you’ll wait months for a rejection that has nothing to do with the merits.
Doubt as to Collectibility
This is the most common basis by a wide margin. You’re saying you cannot pay the full bill within the time the IRS has left to collect. The agency generally has ten years from the assessment date to collect a tax, a deadline called the Collection Statute Expiration Date.2Office of the Law Revision Counsel. 26 U.S. Code 6502 – Collection After Assessment To evaluate a Doubt as to Collectibility offer, the IRS calculates your Reasonable Collection Potential, and that number becomes the floor for any offer it will accept.1Internal Revenue Service. About Offers in Compromise
Doubt as to Liability
Here you’re not arguing about your ability to pay; you’re arguing the debt itself is wrong. A typical example: the IRS issues a deficiency based on a Form 1099 reporting income you never actually received, and you have records to prove it. The burden of showing the assessment was incorrect falls entirely on you. Because the dispute isn’t financial, this type of offer doesn’t require a financial disclosure or the application fee.
Effective Tax Administration
The rarest and hardest ground. You concede you could pay in full, but argue that doing so would cause exceptional hardship or be otherwise inequitable. A taxpayer with enough assets to cover a $200,000 liability, where liquidating those assets would end ongoing medical care for a dependent, is the kind of situation the IRS designed this ground for. Evidence has to be strong and specific.
How the IRS Calculates the Minimum You Must Offer
For a Doubt as to Collectibility offer, your Reasonable Collection Potential is the entire ballgame. It has two parts: the net equity in your assets, and your projected future disposable income.1Internal Revenue Service. About Offers in Compromise
Net Equity in Your Assets
The IRS looks at everything you own with meaningful value: real estate, vehicles, bank accounts, investments, retirement accounts, personal property. For each asset it takes the fair market value, applies a quick-sale discount (typically 80%), and subtracts any loans secured by that asset. So a home worth $400,000 becomes $320,000 after the discount; subtract a $300,000 mortgage and the net equity is $20,000. That $20,000 is what enters your RCP. Real estate values usually need to be backed by professional appraisals or comparable sales data.
Watch out for dissipated assets. If you sold, transferred, or spent significant assets on non-priority expenses in the years before submitting your offer, the IRS can add the value back into your RCP as if you still had it. The agency generally looks back three years, but that window extends if the transfer happened close to the assessment date or during an audit.3Internal Revenue Service. IRM 5.8.5 – Financial Analysis Selling a rental property for $80,000 and using the money to pay off credit cards instead of the IRS can leave that $80,000 sitting in your RCP even though the cash is gone.
Future Disposable Income
The second half of the calculation multiplies your monthly disposable income by a set number of months tied to your payment option:3Internal Revenue Service. IRM 5.8.5 – Financial Analysis
- Lump sum offer, paid within five months of acceptance in five or fewer payments: monthly disposable income times 12.4Internal Revenue Service. Form 656 Booklet Offer in Compromise
- Periodic payment offer, paid over 6 to 24 months: monthly disposable income times 24.
If your monthly disposable income is $1,000, the income component is $12,000 under the lump sum path or $24,000 under periodic payments. Add $20,000 in net asset equity and your minimum offer is either $32,000 or $44,000. The lump sum lowers the floor but demands the cash faster.
Why Your Actual Living Expenses May Not Count
The “monthly disposable income” figure isn’t your real budget. The IRS uses standardized Collection Financial Standards, and this is where most disagreements happen.5Internal Revenue Service. Collection Financial Standards
National Standards cover food, clothing, housekeeping supplies, and personal care. You get the full standard amount for your household size regardless of what you actually spend. Spend less than the standard and you still get the full deduction.
Local Standards cover housing, utilities, and transportation, and they work as a ceiling. You’re allowed the lesser of what you actually spend or the standard for your area.6Internal Revenue Service. Local Standards: Transportation A $2,500 housing standard doesn’t help if your actual rent is $2,100; you get the $2,100. The IRS has discretion to allow actual expenses above a standard when circumstances warrant it, but you’ll need documentation and a compelling reason.
Eligibility Before You Apply
The IRS will reject the application outright if any of the following is true: you’re in an open bankruptcy proceeding; you haven’t filed all required tax returns; you haven’t made required estimated tax payments for the current year; or, if you own a business with employees, you haven’t made federal tax deposits for the current quarter and the two prior quarters.7Internal Revenue Service. Offer in Compromise The IRS also offers a free online Pre-Qualifier tool that gives you a non-binding estimate of your RCP before you commit to the full application.
The Forms and Documents
A Doubt as to Collectibility or Effective Tax Administration offer requires three forms, all bundled in the Form 656-B booklet:8Internal Revenue Service. About Form 656, Offer in Compromise
- Form 656, the offer itself, where you propose the settlement amount and identify the basis.
- Form 433-A (OIC), your personal financial statement.
- Form 433-B (OIC), a business financial statement, required only if the liability is business-related.
Expect to attach recent bank statements for every account, pay stubs or profit-and-loss statements, mortgage statements, property tax bills, and vehicle registrations. The Offer Specialist will verify these independently, so accuracy matters more than presentation.
Fee and Initial Payment
Most applicants must submit a $205 non-refundable application fee plus an initial payment:7Internal Revenue Service. Offer in Compromise
- For a lump sum offer, 20% of the total offer amount with the application.
- For a periodic payment offer, the first monthly installment with the application, with continued monthly payments while the offer is under review.
Both the $205 fee and the initial payment are waived if you meet the Low-Income Certification guidelines printed in the Form 656-B booklet.4Internal Revenue Service. Form 656 Booklet Offer in Compromise Missing the fee or the initial payment is one of the fastest ways to have the package returned unreviewed.
What Happens While the IRS Reviews Your Offer
Screening for completeness generally takes 30 to 45 days. If anything is missing, the entire package comes back as not processable. Once accepted for processing, an Offer Specialist or Revenue Officer rebuilds your RCP from scratch, verifies asset values, checks public records, and reviews bank transactions. This phase commonly takes six months and can stretch past a year on complex cases.
Two things happen in the background during that wait that catch people off guard.
Your ten-year collection clock pauses. The statute of limitations on collection is suspended from the date the offer is pending until it’s accepted, returned, withdrawn, or rejected, and the pause continues for an additional 30 days after a rejection, plus the full duration of any appeal.9Taxpayer Advocate Service. Understanding Your Collection Statute Expiration Date and the Time the IRS Can Collect Taxes An offer that takes a year to work through effectively gives the IRS an extra year to collect if the offer fails.
The IRS also keeps any tax refunds you’re owed through the date of acceptance and applies them to your overall debt rather than crediting them toward your offer amount. You can’t designate overpayments toward next year’s estimated taxes during this period either. Offers based solely on Doubt as to Liability are the exception.10Internal Revenue Service. Offer in Compromise – Frequently Asked Questions New liens and levies are generally paused while the offer is pending.
After the IRS Decides
If the Offer Is Accepted
Acceptance binds you to strict terms. Lump sum offers require the remaining 80% within five months of acceptance in five or fewer payments.4Internal Revenue Service. Form 656 Booklet Offer in Compromise Periodic payment offers give you up to 24 months from the acceptance date to finish.11Internal Revenue Service. IRM 8.23.1 – Offer in Compromise Overview
Beyond paying the offer amount, you must stay in full compliance with all federal tax filing and payment obligations for five years after acceptance: every return filed on time, every new tax paid in full, every required estimated payment made.12Internal Revenue Service. Monitoring Offer in Compromise Once you finish paying and clear the five-year compliance window, the IRS releases any federal tax liens tied to the compromised debt.
What a Default Costs You
Missing a payment or falling out of compliance during the five-year window triggers default. The IRS can reinstate the entire original liability, minus what you’ve paid, and add back all penalties and interest. Liens and levies return.10Internal Revenue Service. Offer in Compromise – Frequently Asked Questions Because the collection statute was paused during the offer, you can end up in a worse position than before you started.
If the Offer Is Rejected
A rejection letter gives you 30 days to request review by the IRS Independent Office of Appeals, using Form 13711 or a written letter explaining why the Offer Specialist’s decision was incorrect.13Internal Revenue Service. Appeal Your Rejected Offer in Compromise Miss the 30 days and you lose the right to appeal that particular offer. Many taxpayers rework their documentation, address the specific deficiencies the Offer Specialist flagged, and submit a fresh offer, but every new submission restarts the collection-statute pause.