What Is an Offer in Compromise?

Legal grounds for an offer in compromise

According to the IRS, the organization may accept an offer in compromise based on doubt as to liability, doubt as to collectibility and effective tax administration.

Doubt as to liability

In this situation, there’s a genuine dispute about the amount of the correct tax debt under the law, or even about its existence.

Doubt as to collectibility

In this situation, there’s doubt that the amount the taxpayer owes is fully collectible. Doubt as to collectibility exists whenever the taxpayer’s income and assets are less than the tax liability amount.

Effective tax administration

Unlike the two examples above, there’s no doubt here that the taxpayer legally owes the taxes and that the IRS can collect them fully. However, if collecting the full amount of taxes would create economic hardship or would be otherwise unfair “because of exceptional circumstances,” the IRS may accept an OIC in this situation.

Eligibility requirements for an OIC

Designed by the IRS, the OIC is a program to assist people who have tax debt and need tax relief.

You must meet several requirements for the agency to consider you a qualified applicant. You’ll also need to include a fee and an initial payment with your application, without a guarantee that the IRS will accept your OIC.

Who qualifies for an OIC?

You may be eligible to apply for an OIC if you meet these requirements:

• You filed all the tax returns you're required to file.
• You have a bill for at least one tax debt in your offer.
• All required estimated taxes are paid for the current tax year.
• You are not in an open bankruptcy preceding.
• If you own a business and have employees, you’ve made federal tax deposits for the current quarter and the two previous quarters.

You can check your eligibility using your Individual Online Account on the IRS website, where you can file your OIC application and make payments.

» MORE: Best tax software and services

How to apply for an offer in compromise

Navigating the offer in compromise application process can seem overwhelming, but understanding how to apply is essential for success. Here’s how to apply for an OIC.

Application forms and documentation

You’ll fill out Form 656 to request an offer in compromise, along with Form 433-A for individuals or Form 433-B for business tax debt.

Be prepared to include information regarding your monthly income and assets, such as a home or car(s), cash, investments and any debts. You should also include living expenses, such as rent or mortgage, utilities, groceries and other essential monthly expenses.

Payment options and fees

You’ll need to pay a $205 nonrefundable application fee, though the IRS may waive this fee if you meet its low-income eligibility guidelines or if your OIC is based on doubt as to liability.

Choose how you’ll pay your tax debt, and include the initial payment based on the 656 form in your application.

• Lump-sum cash payment: The initial payment for the lump-sum option is 20% of your tax debt. You must pay the remaining balance within five months and in five payments or less based on the date the IRS accepts your offer. The payment is nonrefundable, so if the IRS doesn't accept your offer, it will apply it to your tax bill.
• Periodic payment: With this payment plan, you’ll pay your monthly balance in installments while the IRS evaluates your offer. You must pay the remaining balance within six to 24 months based on your proposed terms. Continue to pay monthly while the IRS evaluates your offer. If your offer is accepted, you'll pay the monthly installments until payment is complete.

» MORE: Pros and cons of IRS payment plans

How to increase your chances of the IRS accepting your OIC

Before you apply for an OIC, you must understand how the IRS decides a taxpayer's eligibility. "If the IRS determines that your reasonable collection potential (RCP) exceeds your tax debt, it will likely reject your offer in compromise," said Logan Allec, the founder of Choice Tax Relief.

Fill out the proper forms

Make sure to fill out Forms 433-A and 656 as thoroughly and accurately as possible. Make a realistic offer based on your situation and how the IRS calculates eligibility.

Providing documentation to support the information in your application will increase the likelihood of the IRS accepting your offer.

Be responsive to IRS queries

Once you've submitted your application, make sure you're responsive to any questions from the IRS.

"You can increase your chances of the IRS accepting your offer in compromise by promptly responding to any requests from the IRS for more information or documentation pertaining to your offer in compromise," said Allec. "Failing to respond to a request by a deadline could result in the IRS rejecting your offer."

Maintain financial stability

Maintaining a stable financial situation during the process, from the time you submit your OIC application to when the IRS makes a decision, can increase your chances of acceptance. "Sometimes, the IRS personnel reviewing your offer in compromise will request updated financial information — including bank statements," Allec said.

If your finances are going in a positive direction, your chances may have a similar outcome.

According to Allec, "If your financial situation has changed for the better since you initially submitted your offer in compromise paperwork, this could change the IRS' analysis of whether you qualify for an offer in compromise or not — as well as how much your offer in compromise should be if you do qualify."

Stay compliant

Continue complying with your tax obligations while the IRS reviews your OIC application.

"For example, if you submit an offer to the IRS to compromise your pre-2024 tax debt, it's important that you make sure you're all paid in throughout the year on your 2024 taxes — either through wage withholdings if you're an employee or through estimated tax payments if you're self-employed," Allec said.

If you fail to meet your current tax obligations, the IRS will likely reject your offer.

» READ MORE: What is Tax Resolution?

How much will the IRS settle for?

Each taxpayer's case is unique, so the offers the IRS will accept will vary. The IRS has its set of protocols to determine what it deems a taxpayer is capable of paying.

The IRS relies on the financial information you provide to calculate and determine what it thinks a taxpayer can pay. This is known as reasonable collection potential. Assets, including property and vehicles, bank accounts, as well as current and future income and living expenses are used to calculate RCP.

Before applying for an offer in compromise, make sure you understand that the IRS generally denies any application where the taxpayer offers equal or less than the RCP. The IRS will consider your RCP to determine the settlement amount.

Bottom line

Taxpayers with tax debt and difficulty paying their tax bill can apply for an offer in compromise. But just because a taxpayer qualifies for the program, the IRS isn’t guaranteed to accept their offer. The application requires a nonrefundable $205 application fee and a nonrefundable initial payment. You can apply for an OIC on your own or seek professional tax advice.