What is an offer in compromise?

What is an OIC?

Designed by the IRS, the OIC is a program to assist people who have tax debt and need tax relief. The IRS has many requirements that you must meet for the agency to consider you as a qualified applicant. Those granted an OIC could have their tax bill significantly reduced, possibly by more than half. There's also a fee and an initial payment to include with your application without a guarantee that the IRS will accept your OIC.

Who qualifies for an OIC?

To be eligible to apply for an OIC, you must meet these requirements:

• You filed all your 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.
• If you own a business and have employees, you’ve made federal tax deposits for the current quarter and the two previous quarters.

» MORE: Best tax software and services

How to apply for an offer in compromise

Navigating this process can seem overwhelming, but understanding how to apply is essential for success. Here’s how you apply for an OIC.

1. Fill out and complete Form 433-A and Form 656 for individuals and Form 433-B for business tax debt.
2. Pay a nonrefundable $205 application fee. The IRS may waive this fee if you meet its low-income certification guidelines.
3. Choose how you'll pay and include the initial payment based on the 656 form in your application.
   • The lump-sum cash payment 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 is a payment plan where you 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.
4. Be prepared to include information regarding your monthly income and assets, such as a home or car(s), cash, investments and any debts. Also, include living expenses, such as rent or mortgage, utilities, groceries and other essential monthly expenses.

» 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 you include in your application will increase the likelihood of having your application accepted.

Be responsive to IRS queries

Once you've submitted your application, make sure you're responsive to any IRS queries. "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 when you submit your OIC application to when the IRS makes a decision, will increase your chances of acceptance. "Sometimes, the IRS personnel reviewing your offer in compromise will request updated financial information — including bank statements," said Allec.

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

Stay compliant

Make sure to continue to stay in compliance with your tax obligations while your IRS reviews your application. According to Allec, "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."

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

How much will the IRS settle for?

The IRS relies on the financial information you provide to calculate and determine what they think a taxpayer can pay. That’s known as reasonable collection potential. Assets, including property and vehicles, bank accounts, current and future income and living expenses are used to calculate RCP.

Before applying, 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. 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.

Bottom line

Taxpayers with tax debt and difficulty paying their tax bill can apply for an offer in compromise. However, even if a taxpayer qualifies for the program, it doesn’t guarantee the IRS will accept their offer. The application requires a nonrefundable $205 application fee and a nonrefundable initial payment. You can apply on your own or seek professional tax advice.