Offer in compromise

An offer in compromise is the IRS settling your tax debt for less than the full balance. It is the outcome the tax relief industry advertises, the reason "pennies on the dollar" entered the language, and the single most misunderstood programme the IRS runs.

It is real. It is also rationed by arithmetic rather than by negotiation, and understanding that arithmetic tells you within about ten minutes whether you have a case.

The rule underneath everything: reasonable collection potential

The IRS does not settle because you ask nicely, because your circumstances are sympathetic, or because your representative is persuasive. It settles when it calculates that it cannot collect the full amount before the collection period expires.

That calculation has a name — reasonable collection potential, or RCP — and it is roughly:

• The realisable equity in everything you own: property, vehicles, retirement accounts, cash, business assets.
• Plus your future monthly income after allowable expenses, multiplied by a fixed number of months.

If that total is less than what you owe, an offer at or above the RCP figure is likely to be accepted. If it is more than what you owe, the IRS believes it can collect in full and will decline, no matter how the offer is presented.

This is why a firm that promises a settlement before pulling your transcripts and reviewing your assets is not making a professional assessment. Nobody can know the answer without doing the sum.

Allowable expenses are not your actual expenses

The future-income half of RCP uses the IRS's own Collection Financial Standards, not your bank statements. There are national caps on food, clothing and out-of-pocket healthcare, and local caps on housing, utilities and transport that vary by county.

The practical effect surprises people: if your rent exceeds the standard for your county, the IRS may only allow the standard figure, treating the difference as money you could be paying them. Private school fees, credit card minimums and charitable giving are generally not allowable at all.

This is where competent representation earns its fee. Which expenses are allowable, which can be argued as necessary for producing income or for health and welfare, and how to document them, is genuinely technical work with real money attached.

Who actually qualifies

Broadly, offers succeed for people whose finances are genuinely constrained and who own little the IRS can reach.

• Modest or no home equity, or a home with a mortgage close to its value.
• Income that covers allowable living expenses with little left over.
• No substantial retirement balance or business assets.
• A balance large enough that the collection period will plausibly expire before it is paid.

Offers usually fail for people with meaningful equity, strong income relative to allowable expenses, or a large retirement account. Retirement savings catch people out repeatedly — the IRS counts the realisable value of a 401(k) or IRA as an asset even where withdrawing it would be painful and taxable.

Acceptance rates are published by the IRS in its annual Data Book and have historically run at roughly a third of offers submitted. That number is worth holding onto when someone quotes you a firm-specific success rate: a high rate mostly means a firm screens hard before filing, which is a good sign about the firm and tells you nothing about your odds.

The three types of offer

Doubt as to collectibility

The common one. You do not dispute that you owe it; you cannot pay it. This is the RCP calculation described above and accounts for the large majority of accepted offers.

Doubt as to liability

You dispute that you owe the amount at all — the assessment was wrong, a return was filed incorrectly, or the IRS filed a substitute return on your behalf that overstated the balance. This is a different form and a different argument, and it often gets confused with the collectibility route by people who would do better filing an amended return instead.

Effective tax administration

Rare. You could pay, and you do owe it, but collection would be inequitable — typically serious illness or circumstances where paying would create genuine hardship despite adequate assets on paper. Few of these are accepted, and they need careful documentation.

What it costs and how you pay

There is an application fee, which is modest relative to the balances involved and is waived for applicants below an income threshold. There is also a required initial payment submitted with the offer.

Both figures are adjusted periodically. Check the current amounts on the Form 656 booklet at irs.gov rather than relying on any third-party page, including this one.

You choose between two payment structures:

• Lump sum: a portion with the application, the balance in five or fewer instalments after acceptance. This uses a shorter future-income multiplier, so the offer amount is lower.
• Periodic payment: monthly instalments while the offer is considered and after acceptance. Longer multiplier, higher total, but easier on cash flow.

Payments made with the application are not refunded if the offer is rejected — they are applied to your balance. That is a real cost of trying.

What happens after you file

The IRS has two years to decide. If it has not decided within that window, the offer is deemed accepted by operation of law, which is a genuine protection rather than a technicality.

While the offer is pending, most collection action pauses. Levies generally stop. This is one reason offers are sometimes filed by firms as a delaying tactic rather than because they will succeed, which is worth knowing about the incentive structure.

The collection clock also pauses while the offer is pending, plus thirty days. Filing an offer extends how long the IRS has to collect from you — a cost that is rarely mentioned in the sales conversation.

If it is accepted

You must stay compliant for five years: file on time, pay on time. Fall out of compliance and the offer defaults, the original balance comes back reduced only by what you paid, and you are worse off than when you started.

The IRS also keeps any refunds for the year the offer is accepted.

If it is rejected

You have thirty days to appeal, and appeals succeed often enough to be worth taking seriously — an independent officer reviews the calculation, and calculation disputes are exactly what appeals are for.

The mistakes that sink otherwise good offers

• Filing while returns are outstanding. You must be in filing compliance. An offer submitted with unfiled years is returned, and you lose the application fee.
• Not making current-year estimated payments. Falling behind while the offer is pending is treated as non-compliance.
• Understating assets. The IRS verifies. A missing account converts a technical negotiation into a credibility problem.
• Treating the standards as negotiable without documentation. Above-standard expenses can sometimes be allowed, but only with evidence.
• Filing an offer when an instalment agreement would clearly serve better, purely because the offer was what was sold.

Doing it yourself versus hiring someone

Form 656 and Form 433-A (OIC) are public, and the IRS publishes a pre-qualifier tool that runs a rough version of the RCP calculation for free. If your finances are simple — one job, no property, no business — you can reasonably prepare an offer yourself.

Representation earns its fee where the financial picture is complicated: self-employment income that varies, assets with contested valuations, expenses that exceed the standards for defensible reasons, or a business in the mix. It also matters if you have already been rejected once and are appealing.

What representation cannot do is change the arithmetic. If your RCP exceeds your balance, no firm can make an offer succeed, and one that takes your fee to file anyway has sold you something it knew would fail.

Common questions

Will an offer stop a wage garnishment?

Filing generally suspends collection, including levies, while the offer is pending. But if a garnishment is already running and you need it stopped now, a levy release request is the faster instrument — see our guide to stopping a wage garnishment.

Does an offer hurt my credit?

The IRS does not report to credit bureaus. A federal tax lien is a public record, though, and lien filing is a separate question from the offer itself. Accepted offers usually lead to lien release once terms are met.

Can I settle state tax debt the same way?

Sometimes, but the programme is different in every state, and some states have nothing comparable. A federal offer does nothing about a state balance.

How long does the whole thing take?

Six to twelve months is typical from filing to decision. Add time for preparation beforehand, and for an appeal if it is rejected.

This guide explains a public IRS programme. It is not tax advice, it does not create a professional relationship, and your situation may turn on facts not covered here. Before filing, read the current Form 656 booklet at irs.gov, and consider speaking to a licensed enrolled agent, CPA or tax attorney.