Offers in Compromise: Three Grounds, Minimum Offer, and Review

An Offer in Compromise is an agreement with the IRS that settles your federal tax debt for less than the full amount you owe. The program is authorized under 26 U.S.C. § 7122, and the IRS accepts roughly 15,000 to 17,000 of these settlements in a typical fiscal year. Approval is not automatic. The agency will generally sign off only when your proposed amount meets or exceeds what it calculates it could otherwise collect from you before its collection window closes.

The Three Grounds for an Offer

Every application rests on one of three legal grounds, and you pick which one on Form 656. Each requires a different kind of proof, so choosing the wrong basis wastes months.

Doubt as to Collectibility

This is the common path. You are telling the IRS you cannot pay the full bill within the time it has left to collect. The agency generally has ten years from the date a tax is assessed, a deadline called the Collection Statute Expiration Date.¹ To evaluate the claim, the IRS computes your Reasonable Collection Potential, which becomes the floor for any acceptable offer.²

Say you owe $150,000, have $20,000 in net asset equity, and the IRS projects $30,000 in future disposable income over the relevant period. Your Reasonable Collection Potential is $50,000. An offer at or above that number has a realistic chance.

Doubt as to Liability

Here you are not pleading inability. You are arguing the debt itself is wrong, and the burden of proof is on you. A typical fact pattern: the IRS assesses tax based on a Form 1099 reporting income you never received, and you have records to prove the figure was erroneous. Doubt as to Liability offers do not require a financial statement or the application fee, because the dispute is not about your ability to pay.

Effective Tax Administration

The rarest ground. You concede you could pay the full amount, but argue that doing so would cause exceptional hardship or be inequitable. A taxpayer with assets sufficient to cover a $200,000 liability may still qualify if liquidating those assets would end ongoing medical care for a dependent. You need documentation and a compelling story.

How the IRS Sets Your Minimum Offer

For Collectibility offers, everything comes down to Reasonable Collection Potential. It has two parts: the net equity in your assets and your projected future disposable income.²

Net Equity in Assets

The IRS looks at real estate, vehicles, bank accounts, investments, retirement accounts, and personal property with meaningful value. For each asset, it takes fair market value, applies a quick-sale discount (typically 80 percent for most assets) to reflect what a forced sale would yield, and subtracts any loans secured by the asset.

If your home has a $400,000 fair market value, the quick-sale figure is $320,000. Subtract a $300,000 mortgage and net equity is $20,000. That $20,000 is the asset component of your Reasonable Collection Potential. Appraisals and comparable sales support the numbers you report, and the Offer Specialist will verify them independently.

Watch out for dissipated assets. If you sold, transferred, or spent assets on non-priority items before applying, the IRS can add that value back into your Reasonable Collection Potential. The agency generally looks back three years, with a longer reach if the transfer happened near the assessment date or during an audit.³ Selling a rental property and paying off credit cards instead of your tax bill can leave you with the proceeds counted as if you still had them.

Future Income Component

The second half captures income you are expected to earn going forward. The IRS takes your average monthly gross income, subtracts allowable monthly living expenses, and multiplies the remainder by a fixed number of months tied to your payment option.³

Lump sum offer: paid within five months of acceptance in five or fewer payments. Monthly disposable income is multiplied by 12.⁴
Periodic payment offer: paid in monthly installments over 6 to 24 months. Monthly disposable income is multiplied by 24.³

With $1,000 in monthly disposable income, the income component is $24,000 under periodic payment or $12,000 under lump sum. Add $20,000 in asset equity and your minimum offer is either $44,000 or $32,000. The lump sum path lowers the number, but you need the cash faster.

How the IRS Measures Your Living Expenses

Allowable expenses are not what you actually spend. The IRS uses standardized tables, and deviating from them is the most common source of friction during review.⁵

National Standards cover food, clothing, housekeeping supplies, personal care, and similar essentials. You get the full standard amount for your household size regardless of what you spend. If the standard says $1,800 for a family of four and you spend $1,400, you still deduct $1,800.

Local Standards cover housing, utilities, and transportation, and they work the opposite way. You get the lesser of your actual spending or the standard amount for your area.⁶ If the local housing standard is $2,500 but your rent is $2,100, you deduct $2,100. The standard is a ceiling. If unusual circumstances leave you unable to cover basic needs under the standards, the IRS has discretion to allow higher actual expenses, but you need documentation and a reason.⁵

Eligibility, Forms, and Fees

Before you build a package, confirm you can submit one. The IRS will reject your application outright if you are in an open bankruptcy. You must have filed all required returns, made all required estimated tax payments for the current year, and, if you own a business, made employment tax deposits for the current quarter and the two prior quarters.⁷ A free online Pre-Qualifier tool gives a rough estimate of your Reasonable Collection Potential before you commit to the full application.

For Collectibility and Effective Tax Administration offers, the Form 656-B booklet bundles the core forms:⁸

Form 656, the offer itself, where you propose the settlement amount and select your basis.
Form 433-A (OIC), your personal financial statement for income, expenses, assets, and liabilities.
Form 433-B (OIC), the business financial statement, required for employment tax or business liabilities.

Expect to send bank statements for every account, pay stubs or profit-and-loss statements, mortgage statements, property tax bills, and vehicle registrations as backup. The Offer Specialist verifies the figures, so accuracy matters more than presentation.

Most applicants pay a $205 non-refundable application fee and an initial payment with the package.⁷ For a lump sum offer, that initial payment is 20 percent of the proposed total. For a periodic payment offer, it is the first monthly installment, and you keep making monthly payments while the IRS reviews. Taxpayers who meet the Low-Income Certification thresholds in the Form 656-B booklet have both the fee and the initial payment waived.⁴ Missing the fee or initial payment is one of the fastest ways to get the package returned without review.

What Happens While the IRS Reviews

After an initial completeness screening of roughly 30 to 45 days, an Offer Specialist or Revenue Officer conducts an in-depth financial investigation that rebuilds your Reasonable Collection Potential from scratch and compares it to your proposal. Six months is a reasonable expectation, and complex cases run past a year.

Once the IRS records your offer, collection activity is generally suspended. No new liens or levies while the offer is pending. Two things happen behind the scenes that often catch people off guard.

First, your ten-year collection clock pauses. The statute is suspended from the date the offer is pending through acceptance, return, withdrawal, or rejection, with an additional 30 days if rejected and through the entire appeal if you appeal.⁹ An offer that sits for a year effectively gives the IRS an extra year to collect if the offer fails.

Second, the IRS keeps any tax refunds you are owed through the date of acceptance and applies them to your overall tax debt, not toward the offer amount. You cannot designate overpayments toward next year’s estimated taxes during this period. The exception is offers based solely on Doubt as to Liability.¹⁰

After the IRS Decides

Acceptance and the Five-Year Compliance Window

Acceptance binds you to strict terms. Lump sum offers require the remaining 80 percent within five months of acceptance in five or fewer payments.⁴ Periodic payment offers must finish within 24 months of acceptance.¹¹

Beyond paying the offer, you must stay in full compliance with all federal tax filing and payment obligations for five years following acceptance.¹² File every return on time, pay any new tax in full, and make required estimated payments. Once you complete payment and the five-year window, the IRS releases any federal tax liens tied to the compromised debt.

Default

Missing a payment or falling out of compliance during the five-year window triggers default. The IRS can reinstate the entire original liability, minus what you have already paid, and add back penalties and interest. Liens and levies return.¹⁰ The compromise evaporates, often leaving you worse off than before because the collection clock paused during the offer.

Rejection and Appeal

A rejection letter gives you 30 days to request review by the IRS Independent Office of Appeals. You submit Form 13711 or a written letter explaining why the Offer Specialist’s decision was incorrect.¹³ The Appeals Officer is independent from the original examiner. Miss the 30 days and you lose the right to appeal that offer.

Many taxpayers rework their documentation, fix the deficiencies the Offer Specialist flagged, and submit a new offer. Each new submission restarts the collection-statute pause, giving the IRS more time to collect if the offer ultimately fails.

1
Office of the Law Revision Counsel. 26 U.S. Code 6502 – Collection After Assessment
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Internal Revenue Service. About Offers in Compromise
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Internal Revenue Service. IRM 5.8.5 – Financial Analysis
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Internal Revenue Service. Form 656 Booklet Offer in Compromise
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Internal Revenue Service. Collection Financial Standards
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Internal Revenue Service. Local Standards: Transportation
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Internal Revenue Service. Offer in Compromise
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Internal Revenue Service. About Form 656, Offer in Compromise
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Taxpayer Advocate Service. Understanding Your Collection Statute Expiration Date and the Time the IRS Can Collect Taxes
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Internal Revenue Service. Offer in Compromise – Frequently Asked Questions
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Internal Revenue Service. IRM 8.23.1 – Offer in Compromise Overview
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Internal Revenue Service. Monitoring Offer in Compromise
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Internal Revenue Service. Appeal Your Rejected Offer in Compromise