An offer in compromise is an agreement with the IRS to settle a tax debt for less than the full amount owed. Form 656 is used to submit most offers. This article explains when the IRS accepts offers, how the offer amount is calculated, and what the application requires.
What Is an Offer in Compromise?
Under IRC §7122 and Treas. Reg. §301.7122-1, the IRS may compromise a tax liability on one of three grounds:
Doubt as to collectibility: the taxpayer’s assets and income are less than the full amount of the liability.
Doubt as to liability: there is a genuine dispute about the existence or amount of the correct tax. These offers are submitted on Form 656-L rather than Form 656.
Effective tax administration: the tax could be collected in full, but doing so would cause economic hardship, or compelling public policy or equity considerations support a compromise.
According to the IRS, it generally approves an offer when the amount offered represents the most it can expect to collect within a reasonable period of time. The IRS also asks taxpayers to explore other payment options before submitting an offer.
Who Is Eligible
The IRS states that a taxpayer is eligible to apply if the taxpayer has filed all required tax returns and made all required estimated payments, is not in an open bankruptcy proceeding, has a valid extension for a current-year return if applying for the current year, and, if an employer, has made tax deposits for the current quarter and the two preceding quarters. The IRS’s Offer in Compromise Pre-Qualifier tool can help assess eligibility.
How the Offer Amount Is Calculated
For a doubt as to collectibility offer, the IRS calculates the taxpayer’s reasonable collection potential: the net realizable equity in assets, such as a home, vehicles, bank accounts, and retirement accounts, plus an amount of future income. Under the Internal Revenue Manual, future income is the taxpayer’s monthly disposable income (income less allowable living expenses) multiplied by:
12 months, for a lump sum offer paid in five or fewer payments within five months after acceptance.
24 months, for a periodic payment offer paid over six to 24 months.
For example, a taxpayer with $800 of monthly disposable income and $10,000 of net equity in assets would generally need to offer at least $19,600 under a lump sum offer ($800 × 12 + $10,000), or $29,200 under a periodic payment offer ($800 × 24 + $10,000). Allowable living expenses are generally measured against the IRS Collection Financial Standards.
The Application Package
Form 656. Individual and business tax debts are submitted on separate Forms 656.
Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses, with the required documentation.
A $205 application fee, which is non-refundable.
An initial payment, which is also non-refundable: 20% of the offer amount for a lump sum offer, or the first proposed monthly payment for a periodic payment offer, with monthly payments continuing while the offer is under review.
Individuals who meet the low-income certification guidelines do not send the application fee or the initial payment and do not make monthly payments during the review. No application fee is charged for an offer based solely on doubt as to liability. Individuals can also file an offer through their IRS Online Account.
The $205 fee and the initial payment are generally non-refundable and are applied to the tax debt even if the offer is not accepted, so eligibility and the reasonable collection potential should be reviewed before applying.
While the Offer Is Pending
According to the IRS, while an offer is being evaluated, payments and fees are applied to the tax liability, the IRS may file a Notice of Federal Tax Lien, other collection activity is generally suspended, and the time the IRS has to collect is extended. An offer is treated as accepted if the IRS does not make a determination within two years after receiving it, not counting any appeal period.
If the Offer Is Accepted or Rejected
An accepted offer comes with conditions, listed in Section 7 of Form 656, including filing all required returns and making all payments under the offer’s terms. Federal tax liens are not released until the offer terms are satisfied, and certain offer information is available for public inspection.
If the offer is rejected, the taxpayer can appeal within 30 days using Form 13711, Request for Appeal of Offer in Compromise. A new offer can also be submitted if circumstances change.
California Tax Debts
A federal offer does not resolve California tax debts. The Franchise Tax Board has its own offer in compromise program, with separate forms and standards, and California sales tax and payroll tax debts are handled by their own agencies.
The Bottom Line
An offer in compromise can resolve a tax debt that cannot realistically be paid in full, but the IRS evaluates it on the taxpayer’s actual ability to pay, using detailed financial information. Understanding the reasonable collection potential before applying helps set a realistic offer.
Considering an offer in compromise?
Tax attorney Cassra Minai, Esq. can review your situation in a confidential consultation.