IRS Offer in Compromise: How the RCP Formula Actually Works

The IRS does not negotiate Offers in Compromise based on what feels fair or what you can comfortably afford. It uses a formula called the Reasonable Collection Potential (RCP), and the RCP sets the floor: the IRS will not accept an offer below it except in rare circumstances. Every rejected OIC and every overpriced offer traces back to someone not understanding this formula. The OIC honest assessment covers whether an OIC is the right strategy. This page is the math.

What is the RCP formula?

RCP = Net Realizable Equity in Assets + Future Income

Each component has its own calculation:

Net Realizable Equity in Assets = (Quick Sale Value of each asset - encumbrances on that asset), summed across all assets. Quick sale value (QSV) is typically 80% of fair market value (FMV), reflecting what the asset would sell for in a forced or expedited sale. Encumbrances are mortgages, car loans, and other secured debts. If QSV minus encumbrances is negative for an asset, it contributes zero (not a negative number) to the total.

Future Income = (Monthly gross income - allowable monthly expenses) x multiplier. The multiplier is 12 for a lump-sum offer or 24 for a periodic payment offer. Allowable expenses are determined using the IRS Collection Financial Standards, which cap expenses in categories like housing, transportation, food, clothing, and healthcare.

The formula is straightforward. The complexity is in how the IRS values each input.

How does the IRS value assets?

Bank accounts: Valued at the full balance (no QSV discount). The IRS uses the average of the last three months’ ending balances, or the current balance, whichever the IRS considers more representative. If you typically carry $5,000 in your checking account and $12,000 in savings, the asset value is $17,000.

Real estate: FMV determined by a recent appraisal, comparable sales, or the taxpayer’s estimate (which the IRS may challenge). QSV = FMV x 80%. Subtract the mortgage balance. If your home has an FMV of $400,000, a mortgage of $320,000, and QSV is $320,000 (80% of $400,000), the net realizable equity is $320,000 - $320,000 = $0. If the mortgage were $280,000, the equity would be $320,000 - $280,000 = $40,000.

Vehicles: FMV from Kelley Blue Book or NADA. QSV = FMV x 80%. Subtract the loan balance. A car worth $25,000 with a $15,000 loan has net equity of ($25,000 x 80%) - $15,000 = $5,000.

Retirement accounts (IRA, 401(k)): Valued at the current balance less a discount for taxes and penalties on withdrawal. The IRS typically applies a 25% discount (representing the approximate tax and early withdrawal penalty), so a $100,000 IRA has a net realizable value of approximately $75,000. This is one of the most frequently contested inputs: the actual tax on liquidation depends on your marginal rate and whether the early withdrawal penalty applies, so the 25% is a shortcut that may over- or under-state the real cost.

Life insurance (cash value): The cash surrender value minus any loans against the policy.

Investments (stocks, bonds, mutual funds): Valued at current market value (no QSV discount for publicly traded securities, because they can be sold at market). Subtract basis only if there would be a capital gains tax on sale. The IRS may reduce the value by the estimated tax on the gain.

Foreign assets: Valued the same way as domestic assets, converted at the current exchange rate. For cross-border filers with Canadian accounts, the RRSP, TFSA, and non-registered brokerage all count. The IRS applies the same QSV and encumbrance rules. Canadian retirement accounts (RRSP, LIRA) are valued at the balance less estimated Canadian withholding tax on withdrawal (typically 25% for non-residents of Canada) and US tax.

How does the IRS calculate future income?

Monthly gross income includes all sources: wages, self-employment, rental, investment, Social Security, pension, alimony, and any other recurring income. For cross-border filers, Canadian employment income counts even if it is not subject to US tax (the IRS is measuring ability to pay, not US taxable income).

Allowable monthly expenses are determined by the IRS Collection Financial Standards, not by your actual spending. The standards set national limits for food/clothing/miscellaneous ($785/month for a single person, $1,410 for a family of four, as of the most recent published standards), healthcare ($75 for under-65, $153 for 65+), and out-of-pocket medical. Housing and transportation allowances vary by location. The IRS publishes county-level housing standards and regional transportation standards.

If your actual expenses exceed the IRS standards, you can argue for higher allowable expenses, but you need documentation and a reason. A $3,500/month rent in Manhattan may be allowable if comparable housing in the area costs the same. A $3,500/month rent in a city where the standard is $2,000 will be questioned.

Monthly disposable income = gross income - allowable expenses. This is the amount the IRS considers available to pay the tax debt each month.

The multiplier: 12 months for a lump-sum offer (you pay within 5 months of acceptance), 24 months for a periodic payment offer (you pay over 6 to 24 months). The lump-sum multiplier is lower, which means the RCP is lower, which means the minimum offer is lower. This is why lump-sum offers are generally cheaper if you can fund them.

What variables can I influence?

The RCP formula is mechanical, but the inputs are not fixed. Here is where legitimate planning can lower the RCP:

Timing of the offer. If you recently sold an asset (proceeds are in your bank account), the bank balance inflates the RCP. Waiting until the proceeds are used for legitimate expenses (paying down the mortgage, medical bills, tuition) before filing the OIC can produce a lower bank-account input. Do not hide or dissipate assets. The IRS looks back at asset transfers and can reject the OIC for bad faith.

Allowable expense documentation. If your actual housing or medical expenses exceed the IRS standards, provide documentation: lease, mortgage statement, medical bills, prescriptions. The IRS can approve expenses above the standard limits when the taxpayer demonstrates necessity. A $400/month prescription drug cost is allowable even if the IRS standard is $75, because reducing the medication is not a viable option.

Asset valuation. Get a real appraisal for real estate and valuable personal property. The IRS defaults to estimates that may overvalue or undervalue assets. If your home’s FMV is $350,000 (supported by an appraisal) but the IRS’s estimate is $400,000, the appraisal moves the QSV from $320,000 to $280,000, which changes the equity calculation.

Income timing. If you have irregular income (bonuses, commissions, seasonal work), the month you file the OIC matters. The IRS averages recent income, and filing during a low-income month can produce a lower monthly income figure. This is legitimate timing, not fabrication.

Retirement account treatment. Challenge the IRS’s 25% discount if your actual tax rate on withdrawal would be higher (because you are in a high-tax bracket and would owe state tax) or lower (because you are over 59.5 and the early withdrawal penalty does not apply). The actual tax cost on liquidation is a fact-specific calculation, and the IRS’s shortcut may not match your facts.

What about the cross-border calculation?

For US persons living in Canada, the RCP calculation has several wrinkles:

Canadian income counts. Even if your Canadian employment income is offset by the foreign earned income exclusion or foreign tax credits on the US return, the IRS includes it in the monthly gross income calculation for the RCP. The IRS is measuring economic capacity to pay, not taxable income.

Canadian assets count. RRSP, TFSA, non-registered investments, Canadian bank accounts, and Canadian real estate are all included. Convert at the current exchange rate. The IRS may not have visibility into Canadian accounts (FATCA reporting to the IRS covers US-person accounts at Canadian financial institutions), but the Form 433-A requires full disclosure, and failure to disclose is grounds for rejection.

Canadian expenses may differ from US standards. The IRS Collection Financial Standards are designed for US costs of living. If you live in Vancouver or Toronto, your housing costs may exceed the US county-level standards, and you will need to argue for a Canadian-equivalent allowance. The IRS does not publish Canadian-specific standards, so you document actual costs and argue necessity.

RRSP withdrawal tax. A Canadian RRSP held by a US person living in Canada faces Canadian tax on withdrawal (at the marginal rate) plus potentially US tax (unless the treaty election was made). If you are a non-resident of Canada, the Canadian withholding is 25% on lump-sum withdrawals. The net realizable value of the RRSP should reflect the actual after-tax proceeds, not the gross balance.

Exchange rate risk. The RCP is calculated in US dollars. If the Canadian dollar weakens between the date of the 433-A and the date the IRS evaluates the offer, Canadian-denominated assets are worth less in USD, which lowers the RCP. This is not something you can control, but it is something to be aware of.

What should I do next?

Fill out the Form 433-A (OIC) with accurate, documented financial information. Calculate the RCP using the formula: net realizable equity in assets (QSV minus encumbrances) plus future income (monthly disposable income times 12 for lump-sum or 24 for periodic). Compare the result to the total balance owed. If the RCP is substantially below the balance, an OIC can save significant money. If the RCP is close to or exceeds the balance, an installment agreement or Currently Not Collectible may be the better path.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.