IRS Offer in Compromise: Settling Tax Debt for Less Than You Owe

Offer in compromise framework:

Three grounds for an OIC:

1. Doubt as to liability. You genuinely dispute that you owe the tax. This is rare and requires substantial evidence.
2. Doubt as to collectibility (most common). You owe the tax, but you don’t have the assets or income to pay the full amount within the collection statute (10 years from assessment).
3. Effective tax administration. You could technically pay, but doing so would create an economic hardship or would be inequitable.

The IRS formula (Reasonable Collection Potential, RCP):

• RCP = Net equity in assets + (Future income x multiplier)
• Net equity in assets: the quick-sale value (typically 80% of FMV) of all assets, minus any encumbrances (mortgages, liens)
  • Includes: real estate, vehicles, bank accounts, investments, retirement accounts (discounted), personal property
  • The IRS uses its own equity calculations, not the taxpayer’s
• Future income: monthly disposable income (gross income minus allowable expenses, using IRS Collection Financial Standards for food, housing, transportation, etc.)
  • Multiplier for lump-sum offer (paid in 5 months or less): 12 months of future income
  • Multiplier for periodic payment offer (paid in 6-24 months): 24 months of future income

Minimum offer = RCP. The IRS will not accept an offer below the RCP. The IRS pre-qualifier tool on irs.gov estimates this amount.

Application process:

• File Form 656 (Offer in Compromise) and Form 433-A (OIC) (Collection Information Statement for Individuals) or 433-B (OIC) (for businesses)
• $205 application fee (waived for low-income taxpayers)
• 20% initial payment with the offer (lump-sum offers) or first proposed monthly payment (periodic offers)
• Processing time: 6-12 months
• While the offer is pending: collection activity is suspended (levy, garnishment, seizure are paused)

Compliance requirement:

• The taxpayer must be current on all filing obligations (all returns filed)
• The taxpayer must be current on estimated tax payments for the current year
• For 5 years after the OIC is accepted: the taxpayer must file and pay all taxes on time. Failure to comply allows the IRS to default the OIC and reinstate the full original debt.