The IRS Offer in Compromise Guide: How Federal Tax Debt Settlements Work

What Is an IRS Offer in Compromise?

An Offer in Compromise is a formal agreement between a taxpayer and the IRS under IRC Section 7122 that settles a tax liability for less than the full amount owed. The IRS considers three grounds for acceptance:

• Doubt as to Collectibility (most common): The IRS agrees that the taxpayer’s assets and future income are insufficient to pay the full tax debt within the remaining Collection Statute Expiration Date (CSED), typically 10 years from assessment.
• Doubt as to Liability: There is a legitimate dispute about whether the tax debt is actually owed.
• Effective Tax Administration: The taxpayer can technically pay but doing so would create an economic hardship or would be inequitable.

Step 1: Check Your Eligibility with the IRS Pre-Qualifier Tool

Before filing any paperwork, use the IRS Offer in Compromise Pre-Qualifier Tool (available at irs.gov) to determine whether you meet the basic eligibility requirements:

• All required tax returns must be filed. The IRS will not consider an OIC if you have unfiled returns. File all delinquent returns first.
• You cannot be in an open bankruptcy proceeding. If you are currently in bankruptcy, the OIC process is suspended under the automatic stay.
• Current year estimated tax payments must be current. If you are self-employed, all required quarterly estimated payments for the current year must be made.
• Employers must have current payroll tax deposits. If you have employees, all federal payroll tax deposits must be current.

Step 2: Calculate Your Reasonable Collection Potential (RCP)

The IRS determines what it will accept based on your Reasonable Collection Potential. This is the core formula that drives your offer amount:

Your minimum offer amount = Net Equity in Assets + Future Income component. The IRS will generally not accept less than the calculated RCP.

Step 3: File IRS Form 656 and Form 433-A (OIC)

The complete OIC application package requires:

• Form 656: The actual Offer in Compromise application form specifying your proposed settlement amount and payment terms.
• Form 433-A (OIC): Collection Information Statement for Wage Earners and Self-Employed Individuals. This is a comprehensive financial disclosure of all income, expenses, assets, and liabilities.
• Form 433-B (OIC): Required only if you have business income. Collection Information Statement for Businesses.
• $205 application fee: This fee is waived if your household income falls at or below 250% of the Federal Poverty Guidelines. Check the current poverty guidelines at aspe.hhs.gov.
• Initial payment: For a lump sum offer, include 20% of the total offer amount with your application. For periodic payment offers, include the first proposed monthly installment.

IRS Collection Financial Standards: Allowable Living Expenses

The IRS uses standardized expense allowances to determine your monthly disposable income. These are not your actual expenses but IRS-set national and local standards:

The Lump Sum vs. Periodic Payment Decision

• Lump Sum Cash Offer: Pay the full settlement within 5 months of acceptance. Requires 20% upfront deposit with application. Generally results in a lower total settlement because the IRS prefers immediate certainty.
• Periodic Payment Offer: Pay in monthly installments over 6 to 24 months. First installment must accompany the application, and payments continue during IRS review. Total offer must equal RCP based on remaining CSED months, which typically results in a higher total amount.

Strategic insight: If you can borrow from family, a 401(k) loan, or a home equity line to fund a lump sum offer, the total settlement is almost always lower than periodic payments.

What Happens After You Submit: The OIC Timeline

• Initial review (2-4 weeks): The IRS Centralized OIC Unit in Memphis or Brookhaven verifies completeness and assigns a case number.
• Investigation (3-9 months): An IRS Revenue Officer or Offer Examiner reviews your financials, may request additional documentation, and independently verifies asset values.
• Collection activity pauses: Under IRC Section 7122(e), the IRS suspends most collection activity (levies, garnishments) while an OIC is pending. However, the 10-year CSED clock also pauses.
• Decision: The IRS will accept, reject, or return your offer. If rejected, you have 30 days to appeal to the IRS Independent Office of Appeals.

Critical Post-Acceptance Compliance Requirements

Accepting an OIC comes with strict conditions for 5 years after acceptance:

• You must file all federal tax returns on time for 5 years.
• You must pay all federal taxes owed for 5 years.
• If you default on either condition, the IRS can reinstate the original full tax debt minus any payments made.
• Any federal tax refunds for the year the OIC was accepted and prior years are applied to the tax debt, not returned to you.

Companion Tax & Debt Resolution Guide

Continue your federal tax recovery and consumer debt strategy with our primary-source companion guides:

• The IRS Fresh Start Program: How to Set Up a 72-Month Tax Payment Plan and Remove Federal Tax Liens for Free
• The Form W-4 Withholding Overhaul: How to Stop Giving the IRS an Interest-Free Loan
• Debt Snowball vs. Debt Avalanche: Mathematical Comparison and Free Calculator Guide