Offer in compromise: a smart way to settle IRS debt

Some of your clients may owe more than they can realistically pay. The IRS offer in compromise (OIC) program lets eligible taxpayers settle their debt for less than the full balance when specific criteria are met. With the right documentation, careful number-crunching and strategic planning, you can help clients resolve old tax debt and move forward with confidence.

Helping clients use offer in compromise the right way

The OIC is a hidden gem in the IRS collection toolkit, but one that requires careful mining. Many clients facing old tax debt feel stuck or overwhelmed, unaware that the IRS may be willing to settle for less when the numbers support it. Even some tax professionals hesitate to use OIC, unsure when it applies or how to build a strong case. When used strategically, the program offers real relief, but only if the IRS couldn’t collect more from assets or income before time runs out on the debt. Your expertise helps clients avoid empty promises from OIC mills and pursue outcomes that actually stick.

What the IRS will weigh

In a ‘doubt as to collectability’ OIC (OIC-DATC), the most common type, the IRS evaluates three factors to determine what it could reasonably collect:

• Net equity in assets (NEA): The quick-sale value of assets (less debts), with specific exclusions for the offer calculation, like a cash buffer and a per-vehicle allowance. 
• Monthly disposable income (MDI): Averaged household income minus "allowable" living expenses and certain actual costs, using Internal Revenue Manual (IRM) standards. 
• Collection statute expiration date (CSED): Time left for the IRS to collect. The client may qualify if NEA plus projected MDI before CSED is less than the balance owed. 

The payment method changes the offer math:

• Lump-sum offers use 12 months of MDI in the reasonable collection potential. 
• Periodic offers use 24 months. 

Choosing strategically between the two can materially lower the offer amount. 

Required forms for an offer in compromise

The primary IRS tax forms for OICs include:

• Form 656, Offer in Compromise
• Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals 
• Form 433-B (OIC), Collection Information Statement for Businesses

As you complete these forms, remember that Form 433-A/B (OIC) differs from the standard 433-A/B. Be sure to use the correct version. Additionally, submit Form 656 with the appropriate basis (doubt as to collectability, doubt as to liability or effective tax administration). Include the supporting financial statement (Form 433-A (OIC) for individuals and/or Form 433-B (OIC) for businesses. During this process, expect the IRS to develop its own asset/equity and income/expense worksheets, to ask for documents, and to propose changes. 

If the initial offer is rejected, you've got 30 days to appeal using Form 13711, Request for Appeal of Offer in Compromise. The offer is deemed accepted if the IRS doesn't act within 24 months, though in practice the agency rarely misses that window.  Low-income applicants may qualify for a waiver of the $205 application fee and initial payment, depending on their income and household size.

An example to help explain OIC to clients

Profile: Elyse, a single parent in North Carolina, owes $67,912 on a 2015 joint return. She rents, has an older, paid-off car and modest cash reserves. Her income plus child support covers necessities, with little left over each month.

Workup: You average three months of paystubs and bank statements, verify all tax returns are filed and that CSED has 72 months remaining, and inventory Elyse’s assets. Her NEA is minimal and unlikely to satisfy the IRS through enforced collection. After allowable standards and the older-vehicle operating-cost adjustment, her MDI for offer purposes rounds to zero.

Result: Elyse qualifies because NEA plus 72 months of realistic MDI is far below her balance owed. You select the lump-sum method and compute a minimal reasonable collection potential. During review, the IRS pushes back, stating that future refundable credits make the token $1 offer "not in the best interest of the government." You counter with a $1,000 lump-sum offer, which the IRS accepts. Elyse must stay tax-compliant for five years, or the IRS may reinstate her debt. 

Pro tips from the OIC playbook

• Start with due diligence. Build NEA and MDI from defensible documents, not client estimates. Average income long enough to smooth any volatility. 
• Use the rules to the client's advantage. Apply exclusions for cash and vehicles, and take advantage of the older-car operating allowance and the exemption for income-producing assets, when appropriate.
• Watch out for the "best interest" veto. If the IRS deems it can reasonably collect more before the CSED, expect a rejection or a required increase. Prepare to bring a data-backed counteroffer. 
• Protect appeal rights. If you disagree on asset value, dissipated assets or allowable expenses, appeal the IRS’s decision. Focus on whether the examiner followed the procedures and guidelines for the OIC program as outlined in IRM 5.8. 
• Plan for the terms. Clients must fund the offer and stay current with tax filings for five years going forward. Carefully screen small business owners and clients with a history of underpaying taxes, as they may struggle to meet post-acceptance compliance terms.

Use the full playbook to guide your next case

An offer in compromise isn’t for everyone, but when it’s the right fit, it can deliver lasting relief. If you’re unsure when an OIC is the better choice over an installment agreement or currently not collectible status, check out our comprehensive TAXPRO magazine article, “Steps to a Successful IRS Offer in Compromise.” It walks through every factor the IRS weighs, with real-world guidance to help you build winning offers.