Do You Qualify for an IRS Offer in Compromise?

Key Takeaways

Understanding IRS Offer in Compromise eligibility can help taxpayers settle tax debt for less than the full amount owed, but qualification requires meeting strict financial and procedural criteria.

• File all returns first: You must have filed all required tax returns and received a tax bill before applying for an Offer in Compromise.

• Three qualification paths exist: Doubt as to Collectibility (most common), Doubt as to Liability (disputing the debt), and Effective Tax Administration (economic hardship cases).

• RCP determines your offer amount: The IRS calculates your Reasonable Collection Potential using asset equity plus 12-24 months of disposable income as the minimum acceptable offer.

• Application costs $205 plus initial payment: Submit Form 656 with a non-refundable fee and 20% of your offer amount (or first installment for payment plans).

• Process takes 6-24 months: Use the IRS Pre-Qualifier Tool first to assess eligibility, then prepare for a lengthy evaluation period during which penalties and interest continue accruing.

The OIC program provides genuine relief for taxpayers facing financial hardship, but success depends on demonstrating inability to pay the full debt while meeting all procedural requirements and maintaining future tax compliance.

What is an IRS Offer in Compromise?

The IRS Offer in Compromise (OIC) lets taxpayers settle their tax liabilities by paying less than what they owe. This program helps qualified people with unpaid taxes to negotiate a lower settlement amount that clears their debt.

Taxpayers facing financial hardship can find relief through the OIC program. The IRS aims to reach a compromise that works for both parties and encourages compliance with future tax obligations.

Taxpayers must suggest a payment amount based on what they can afford. This includes their assets, income, expenses, and future earning potential. The IRS reviews this offer against the taxpayer's specific situation. They usually approve offers that represent the maximum amount they expect to collect within a reasonable timeframe.

Taxpayers must meet these requirements to qualify:

• Filed all required tax returns

• Received a bill for at least one tax debt included in the offer

• Made all required estimated tax payments for the current year

• Completed all required federal tax deposits for the current quarter and two preceding quarters (for business owners with employees)

The IRS looks for offers that match or exceed what they call the "reasonable collection potential" (RCP). RCP shows how much a taxpayer can pay by adding up their asset values (real property, vehicles, bank accounts, etc.) plus predicted future income after basic living expenses.

The application needs Form 656 (Offer in Compromise) with a $205 fee, though some low-income taxpayers might not need to pay this fee. You must also include an initial payment with your application. The IRS might take up to 24 months to investigate your offer, depending on how complex your case is and their current workload.

Accepted offers require taxpayers to pay the agreed amount and stay compliant with tax filing and payments for five years after acceptance. The IRS will also keep any tax refunds due through the acceptance date and apply them to the outstanding debt.

OIC isn't the right solution for everyone. You probably won't qualify if you can pay your tax debt through installment agreements or other methods. The IRS offers a pre-qualifier tool that helps you calculate a preliminary offer amount and check if you might be eligible.

Who qualifies for an Offer in Compromise?

You need to meet several specific criteria to qualify for an IRS Offer in Compromise. We checked all tax returns and received at least one tax debt bill included in their offer. You can't be in an open bankruptcy proceeding. You must also make all required estimated tax payments for the current year.

Business owners who have employees need to meet extra requirements. They must make tax deposits for the current and past two quarters before they apply. Anyone with a current year tax debt needs a valid extension for that year's return.

The IRS looks at three basic conditions to decide if you qualify:

1. Doubt as to Liability - Evidence shows the assessed tax might be incorrect

2. Doubt as to Collectability - You can't reasonably pay the full amount owed

3. Effective Tax Administration - Paying everything would cause economic hardship or be unfair due to special circumstances

The IRS gets a full picture of your financial situation by looking at:

• Income and available resources

• Necessary living expenses

• Asset equity (property, vehicles, accounts)

• Future earning potential

The IRS usually rejects offers unless the amount matches or exceeds their "reasonable collection potential" (RCP) calculation. If your calculations are wrong or not enough, the IRS will work out the right amount. You'll get a chance to increase your offer.

Some taxpayers don't have to pay the application fee if they qualify for low-income certification. This happens when their adjusted gross income is at or below 250% of federal poverty guidelines based on family size and location. You can check if you qualify by using the IRS Pre-Qualifier Tool online.

Unresolved issues can affect your OIC eligibility substantially. The IRS might pause investigating your offer if there are pending matters like innocent spouse claims or ongoing tax audits. You should wait for these issues to be resolved before submitting an offer.

The IRS reviews offers carefully to spot any false information that could lead to civil or criminal penalties. If they reject your offer, you might want to look into installment agreements as another way to pay.

Types of IRS Offer in Compromise

The IRS has three different types of Offers in Compromise. Each type serves a specific situation. Let's look at which one might work best for your case.

Doubt as to Collectibility

Doubt as to Collectibility stands out as the most common IRS Offer in Compromise. This option works best if you know you owe taxes but can't pay everything. The IRS might accept a lower amount if your assets and income won't cover your tax debt.

The IRS reviews these offers using the Reasonable Collection Potential (RCP) formula to figure out how much you can pay. They look at your income sources, living expenses, assets, and other debts. Your offer needs to be higher than your disposable income for 12-24 months before the IRS will say yes.

Doubt as to Liability

Doubt as to Liability comes into play when there's a real question about whether you actually owe the tax debt or if the amount is correct. This applies if you believe the IRS made a mistake about what you owe.

You'll need to fill out Form 656-L instead of the regular Form 656. Your application should explain why you think the tax debt is wrong. You'll also need documents that support your case. Remember, you can't use this option if a court has already made a final decision about your tax debt.

Effective Tax Administration

Effective Tax Administration (ETA) works differently. It's for situations where you can pay your taxes, but doing so would cause economic hardship or be unfair because of special circumstances. The catch is that you must legally owe the tax, and the IRS must be able to collect it.

The IRS looks at ETA offers in two ways:

1. Economic Hardship - This applies if paying taxes would make it impossible to cover your basic living costs. People with chronic illnesses or those taking care of sick family members often fall into this category.

2. Public Policy or Equity - This comes into play when collecting the full amount seems unfair, even though you can pay. This might happen if the IRS gave you wrong information or if someone else's criminal acts led to your tax problem.

The IRS expects you to follow all tax laws since the debt started if you want an ETA offer.

How the IRS decides if you qualify

The IRS uses a step-by-step evaluation process to decide if taxpayers qualify for an Offer in Compromise. They look at the taxpayer's financial capacity and their chances of collecting the outstanding tax debt.

Reasonable Collection Potential (RCP)

RCP is the life-blood of the IRS's decision-making process for Offer in Compromise applications. The IRS calculates RCP as the amount they believe they could collect from a taxpayer within the remaining collection period. This amount becomes the minimum acceptable offer in most cases. The calculation adds two key parts: the taxpayer's disposable monthly income over a specific timeframe and their asset's equity. The IRS won't accept an offer below the calculated RCP unless there are special circumstances.

Income and Expenses

The IRS looks at all income sources including wages, self-employment earnings, rental income, and other revenue streams. They use strict national and local standards instead of actual costs to evaluate expenses. These standard allowances cover simple living necessities like housing, utilities, food, and transportation. Money spent above these published limits usually counts as funds available to pay tax debt. Note that the IRS might allow exceptions to these standards if they don't cover basic living expenses in specific situations.

Asset Equity

The IRS values assets at their "quick-sale value" - 80% of fair market value - to figure out equity. This method accounts for selling assets quickly, usually within 90 days. They subtract any loans that take priority over the federal tax lien from this value. The assets they look at include real estate, vehicles, bank accounts, investments, retirement funds, valuable personal property, and business assets. The IRS often reduces personal bank account balances by $1,000 in their equity calculations.

Future Earning Potential

Future income projections affect the qualification decision by a lot. The IRS multiplies monthly disposable income by 12 months for lump-sum payment offers or 24 months for periodic payment arrangements. A person's education, skills, employment history, and career advancement opportunities help project future earning capacity. This forward-looking assessment shows whether the taxpayer could pay their full tax liability over time.

How to apply for an Offer in Compromise

The IRS Offer in Compromise application needs specific forms and payments. Your chances of getting accepted improve with proper preparation of your application materials.

Form 656 and Form 433-A or 433-B

You'll need Form 656 (Offer in Compromise) as your main application document. Individual taxpayers should fill out Form 433-A (OIC) with their financial details. Business owners need Form 433-B (OIC) to show their business finances. These forms need complete supporting documents like bank statements, pay stubs, asset valuations, and proof of monthly expenses. The IRS rejects most applications because of missing documents.

Application fee and initial payment

You must include a non-refundable $205.00 application fee. Lump sum offers require an upfront payment of 20% of your total offer amount. If you choose periodic payments, send your first installment with the application. You might qualify for fee waivers if you're a low-income taxpayer, based on your family size and where you live. The IRS accepts payments through check, money order, Electronic Federal Tax Payment System (EFTPS), Individual Online Account, or Direct Pay.

Using the IRS pre-qualifier tool

The IRS Pre-Qualifier Tool (IRS.gov/OICtool) is a great way to get a preliminary eligibility assessment. This tool calculates a rough offer amount based on your finances and tax filing status. You don't have to use it, but it's worth checking if an OIC application makes sense for your situation.

Where to send your application

Mail your complete application package to the address listed in Form 656-B instructions. You can also email it to one of two designated sites or file through your Individual Online Account. Sending physical applications through certified mail proves delivery.

What happens after you apply

The IRS checks if your application is complete. They'll send you a letter with an estimated contact date if they can process it, and might ask for more documents. An offer examiner reviews your case, which takes 6-24 months depending on how complex it is. The IRS stops collection activities during evaluation, but penalties and interest keep adding up. Your offer gets automatically accepted if the IRS doesn't decide within 24 months.

FAQs

Q1. What is an IRS Offer in Compromise? An IRS Offer in Compromise is an agreement between a taxpayer and the IRS that allows settling tax debt for less than the full amount owed. It's designed to provide relief when paying the full tax liability would create financial hardship.

Q2. Who is eligible for an Offer in Compromise? Eligibility depends on various factors, including having filed all required tax returns, received a bill for at least one tax debt included in the offer, and not being in an open bankruptcy proceeding. The IRS evaluates each case based on the taxpayer's ability to pay, income, expenses, and asset equity.

Q3. What are the different types of Offers in Compromise? There are three types: Doubt as to Collectibility (when you can't pay the full amount), Doubt as to Liability (when you dispute the tax debt), and Effective Tax Administration (when paying would cause economic hardship or be unfair due to exceptional circumstances).

Q4. How does the IRS determine if I qualify for an Offer in Compromise? The IRS uses a Reasonable Collection Potential (RCP) calculation, which considers your income, expenses, asset equity, and future earning potential. They typically won't accept an offer unless it equals or exceeds the RCP.

Q5. How do I apply for an Offer in Compromise? To apply, you need to submit Form 656 along with Form 433-A (for individuals) or 433-B (for businesses), detailing your financial information. You must also pay a $205 application fee and make an initial payment, though low-income taxpayers may qualify for fee waivers. Using the IRS pre-qualifier tool can help determine if you're eligible before applying.