Offer in Compromise

The IRS offer in compromise is solution to resolve back taxes owed to the IRS. The OIC provides a complete, permanent settlement of the taxpayer’s tax bill for less than the amount owed.

The IRS has three offer in compromise (OIC) solutions:

• Offer in compromise, doubt as to collectibility:  The taxpayer is unable to pay the liability in full before the CSED based on the net value of assets and future income.
• Offer in compromise, doubt as to liability:  The taxpayer disputes the existence or the amount of the tax liability.
• Offer in compromise,  Effective Tax Administration: Collection of the entire unpaid tax liability would cause the taxpayer economic hardship or would be unfair.

The OIC for doubt as to collectibility is the most used OIC.  In 2023, the IRS accepted 12,157 OICs for doubt as to collectibility.  The IRS only accepted 4 OICs for doubt as to liability and 550 for Effective Tax Administration.  OICs for doubt as to collectibility are the most popular because more taxpayers do not have the ability to pay the tax that they owe versus challenging the tax owed. 

How does a taxpayer qualify for an offer in compromise?

The OIC for doubt as to collectibility (OIC-DATL) is only available to taxpayers who cannot pay their tax bill with assets or monthly payments before the IRS collection statute of limitations expires.  The IRS collection statute expiration date (CSED) is 10-years from the date the tax was assessed. 

The taxpayer must know the amount they owe, their collection statute expiration date(s), their net equity in assets, and their monthly disposable income (the average amount of income leftover after paying “necessary” living expenses).  If the amount they can currently pay with asset equity and future monthly payments is less than the amount owed, they qualify for an OIC-DATC.

OIC qualification example

Assume the following facts for the taxpayer:

• Files an OIC with 72 months remaining on the collection statute
• Owes:  $50,000
• Net equity in assets (cash, investment accounts, home, retirement accounts, cars, recreational and personal assets – less amounts exempt under IRS rules):  $5,000
• Monthly disposable income (average monthly household income less average monthly household necessary living expenses):  $200

In this case, the taxpayer would qualify for an OIC-DATC because their ability to pay before the collection statute expires is less than the amount owed:

EXAMPLE	Qualification
Net equity in assets (1)	$5,000
Monthly disposable income	$200
Remaining Collection Statute (expires in 6 years)	72 months
Future Monthly Payments (2)	$14,400
Ability to Pay before Collection Statute expires (1)+(2)	$19,400
Tax balance owed	$50,000
Qualification	YES (Ability to pay<tax owed)

How much to offer the IRS?

There is a second computation in an OIC-DATC:  how much to offer the IRS to settle (the “offer amount”).   The offer amount is different from the qualification computation in two ways:

• Net equity in assets and monthly disposable income computation:  in an offer amount, the taxpayer will be allowed special considerations for how much cash and car equity goes into their net equity in assets.  The IRS will also allow additional expenses in some areas such as transportation expenses for older cars.  These two changes can reduce the overall offer amount.
• Future monthly payments:  in an OIC-DATC, a taxpayer will only have to offer a certain number of months of future monthly disposable income (MDI).  The taxpayer will offer only12 or 24 months depending on the type of OIC payment method.  There are two types of payment methods:  the lump-sum payment method which requires the taxpayer to pay the full offer amount within 5 months of the OIC acceptance, and the periodic payment method which allows the taxpayer to pay the full offer amount over 24 months, starting with the date of the offer application. The lump-sum payment method only requires the taxpayer to pay 12 months of MDI whereas the periodic payment method requires 24 months of MDI in the offer amount.

OIC offer amount example

For our example, assume the taxpayer will select the lump-sum payment method and that the computation of net equity in assets and MDI is not different between the qualification and the offer amount computations.

In our case, the taxpayer would offer $7,400 to settle their tax bill.  If the taxpayer properly calculated net equity in assets and monthly disposable income AND there is little potential for future equity or income, the IRS would likely settle the $50,000 tax bill for $7,400.

EXAMPLE	Qualification	Offer amount
Net equity in assets (1)	$5,000	$5,000
Monthly disposable income	$200	$200
CSED (expires in 6 years)	72 months	N/A
Future Income Multiplier	N/A	12 months
Future monthly payments (2)	$14,400	$2,400
Ability to pay/future income for offer (1)+(2)	$19,400	$7,400
Tax balance owed	$50,000	$50,000
Qualification	YES (Ability to pay<tax owed)
Offer amount		$7,400

What do taxpayers need to know about the OIC

The OIC is a rare option for those in financial hardship.   In 2023, 42% of applicants qualified and received an OIC.   Many taxpayers do not qualify if they have significant equity in their home or other assets such as a retirement plan.  Taxpayers whose monthly expenses are far more than what is allowed by the IRS as “necessary” living expenses also find it hard to utilize the program.  Taxpayers who sold assets while they owed back taxes (called “dissipated assets”) also face disqualification.

The OIC terms also require the taxpayer remain in compliance for the next 5 years.  Filing and paying timely are critical to finalizing the OIC.    Many self-employed taxpayers may qualify for an OIC but continue to file with an unpaid balance owed.  These taxpayers cannot utilize the OIC.  Taxpayers must stay compliant or the tax bill will be reinstated.

The IRS can also reject an OIC if they believe it does not meet good “public policy” or is “not in the best interests of the government.”   The common example is a taxpayer who could pay the IRS a significant sum of monthly payments before the statute expires.  They may qualify, but an OIC would not be in the best interest of the government because they would forego significant future payments.  In these cases, the IRS may ask the taxpayer to obtain another options such as a payment plan or not-collectible status.

An OIC application, investigation, and approval process can take up to a year to finalize if no appeal is requested.   Normally, OICs take around 6-7 months, depending on the complexity of the taxpayer’s finances and the amount owed.

The most difficult part of an OIC is computing net equity in assets and monthly disposable income.   The IRS has specific rules on what is allowed.  Taxpayers can use the IRS” OIC Pre-qualifier online tool.  However, taxpayers should be wary of the tool as it computes the offer amount, and not qualification and how to compute net equity in assets or MDI.   As such, a “false positive” result can occur, leaving the taxpayer to pick another solution.

The taxpayer may also have “special circumstances” that would lower the offer amount to the IRS or qualify them for an “Effective Tax Administration” OIC.    For example, the taxpayer may have $50,000 in the bank that would be included in the OIC qualification and offer amount computations.  However, they may have a pending medical procedure that would take these funds.  In this case, the taxpayer could claim “special circumstances” and attempt to exclude the cash from the OIC computations.

To file for an OIC, taxpayers use IRS Form 656 and include one or more of the applicable Forms 433 found in the OIC Booklet (Form 656-B).   In an OIC, the taxpayer will provide the IRS extensive documentation proving their circumstances and ability to pay.