If you’re drowning in tax debt with no realistic way to pay it off, an Offer in Compromise (OIC) could be your lifeline. The OIC program allows qualifying taxpayers to settle their tax debt for less than the full amount owed, sometimes significantly less. But the process is complex, the acceptance rate is low, and navigating it without professional guidance can be challenging.

As a tax attorney who has helped countless clients successfully negotiate OICs, I’ve seen firsthand how this program can provide a fresh financial start. However, I’ve also witnessed the disappointment when applications are rejected due to preventable errors or misunderstandings about the process.

This guide will walk you through what an Offer in Compromise is, who qualifies, how to apply, and why professional representation dramatically increases your chances of success.

What Is an Offer in Compromise?

An Offer in Compromise is an agreement between a taxpayer and the IRS that settles a tax liability for less than the full amount owed. It’s designed for taxpayers who cannot pay their full tax debt or for whom doing so would create an economic hardship.

The IRS established this program because they recognize that collecting the full amount from some taxpayers is either impossible or would create severe financial hardship. In these cases, it’s in everyone’s best interest to settle for a lesser amount that the taxpayer can reasonably pay.

However, the IRS won’t accept an OIC unless they believe the amount offered represents the most they can reasonably collect within a reasonable timeframe. According to the IRS Topic No. 204, “In most cases, the IRS won’t accept an OIC unless the amount offered by a taxpayer is equal to or greater than the reasonable collection potential (RCP).”

Eligibility Criteria for an Offer in Compromise

Not everyone with tax debt qualifies for an Offer in Compromise. The IRS has strict eligibility requirements that must be met before they’ll even consider your offer.

Financial Analysis

The IRS conducts a thorough evaluation of your financial situation to determine if you qualify for an OIC. They examine:

• Income and expenses: The IRS analyzes your monthly income and allowable expenses to determine your ability to pay.
• Asset equity: They calculate the equity in all your assets, including real estate, vehicles, bank accounts, retirement accounts, and other investments.
• Future income potential: The IRS considers your education, profession, age, experience, and health to estimate your future earning potential.

This financial helps the IRS determine your “reasonable collection potential” (RCP)—the amount they believe they could realistically collect from you.

Compliance Requirements

Before the IRS will consider your OIC, you must be in compliance with all tax filing and payment requirements:

• You must have filed all required tax returns
• You must have received a bill for at least one tax debt included in your offer
• You must have made all required estimated tax payments for the current year
• If you’re a business owner with employees, you must have made all required federal tax deposits for the current quarter and the two preceding quarters

As stated in IRS Topic No. 204, “To qualify for an OIC, the taxpayer must have filed all tax returns, have received a bill for at least one tax debt included on the offer, made all required estimated tax payments for the current year, and if the taxpayer is a business owner with employees, the taxpayer must have made all required federal tax deposits for the current quarter and the two preceding quarters.”

Disqualifications

Certain circumstances will automatically disqualify you from the OIC program:

• You’re in an open bankruptcy proceeding
• You haven’t filed all required tax returns
• You haven’t made required estimated tax payments or federal tax deposits
• The IRS believes you can pay your tax debt in full through an installment agreement or equity in assets

The IRS won’t consider your OIC if you’re in bankruptcy because the Bankruptcy Code, not the Internal Revenue Code, controls the payment of your tax debts in bankruptcy proceedings.

Types of Offers in Compromise

The IRS accepts Offers in Compromise based on three grounds:

Doubt as to Collectibility

This is the most common type of OIC. It applies when you cannot pay your full tax liability and the IRS has doubts about ever collecting the full amount from you.

To qualify, you must demonstrate that you cannot pay the full amount through an installment agreement or by liquidating your assets. The IRS will analyze your income, expenses, asset equity, and future earning potential to determine if your offer represents the most they can reasonably expect to collect.

Doubt as to Liability

This type of OIC is appropriate when there’s a genuine dispute about the existence or amount of your tax debt. If you believe the IRS made an error in determining your tax liability, you may qualify for this type of offer.

For example, if the IRS assessed additional taxes based on incorrect information or misapplied the tax law, you might have grounds for a Doubt as to Liability Offer in Compromise. This type of offer requires different forms and doesn’t require the same financial disclosures as other OIC types.

Effective Tax Administration (ETA)

An ETA offer may be accepted when there’s no doubt that the tax is legally owed and that the full amount could be collected, but requiring payment in full would either:

• Create an economic hardship, or
• Be unfair and inequitable due to exceptional circumstances

For example, if you have the assets to pay your tax debt but doing so would leave you unable to pay basic living expenses due to a serious illness or disability, the IRS might accept an ETA offer.

According to the IRS Topic No. 204, “An offer may be accepted based on effective tax administration when there is no doubt that the tax is legally owed and that the full amount owed can be collected, but requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances.”

How to Apply for an Offer in Compromise

The OIC application process is detailed and requires careful preparation. Here’s a step-by-step guide:

Step 1: Complete the Pre-Qualifier Tool

Before investing time in the full application, use the IRS Offer in Compromise Pre-Qualifier Tool to determine if you’re a good candidate. This online tool asks basic questions about your financial situation and provides a preliminary assessment of your eligibility.

While the Pre-Qualifier Tool isn’t a guarantee of acceptance, it can help you avoid wasting time on an application that’s unlikely to succeed.

Step 2: Prepare Form 656 and Form 433-A (OIC)

If the Pre-Qualifier Tool indicates you might be eligible, you’ll need to complete:

• Form 656: Offer in Compromise – This is the main application form where you specify the amount you’re offering and the terms of payment.
• Form 433-A (OIC): Collection Information Statement for Wage Earners and Self-Employed Individuals – This detailed financial statement requires information about your income, expenses, assets, and liabilities.

Business owners may also need to complete Form 433-B (OIC) for their business finances.

These forms require extensive documentation, including:

• Bank statements
• Pay stubs or proof of income
• Investment account statements
• Vehicle registration and loan information
• Real estate documentation
• Proof of expenses (utilities, medical bills, etc.)

The accuracy and completeness of these forms are critical to your OIC’s success. Even minor errors or omissions can result in rejection.

Step 3: Submit the Application and Initial Payment

Your OIC application must include:

• Completed Form 656
• Completed Form 433-A (OIC) and/or Form 433-B (OIC)
• All required supporting documentation
• Application fee of $205 (unless you qualify for a low-income certification)
• Initial payment based on your proposed payment option

There are two payment options:

1. Lump Sum Cash: 20% of the offer amount must be submitted with your application, with the remainder paid in five or fewer installments.
2. Periodic Payment: The first proposed monthly installment must be submitted with your application, and you must continue making these monthly payments while your offer is being evaluated.

Low-income taxpayers may qualify for a waiver of the application fee and initial payment requirements.

Step 4: Wait for IRS Review

Once submitted, your OIC application will undergo a thorough review process:

1. The IRS first checks if your application is complete and if you meet the basic eligibility requirements.
2. If accepted for processing, your case is assigned to an OIC examiner who will verify your financial information.
3. The examiner may request additional documentation or clarification.
4. Based on their analysis, the examiner will recommend acceptance, rejection, or a counter-offer.

This process typically takes 6-12 months, though complex cases may take longer. During this time, the IRS will generally suspend collection activities, but interest and penalties continue to accrue on your tax debt. If your OIC is approved, you will be required to adhere to the terms of the offer or else you will be considered in default. If, however, your OIC is rejected, you do have the option to appeal the decision. A tax debt relief attorney can also assist you with the appeals process. Remember that your appeal will need to be filed within 30 days of the rejection.

Benefits and Risks of an Offer in Compromise

Benefits

An accepted OIC offers several significant advantages:

• Settle for less than you owe: You can resolve your tax debt for a fraction of the original amount.
• Fresh financial start: Once you complete the terms of your OIC, you’re free from the tax debt that was compromised.
• End of collection actions: The IRS will release tax liens and stop collection activities like levies and garnishments.
• Improved financial future: Resolving your tax debt can improve your credit score and financial stability over time.

Risks

However, the OIC process also comes with potential downsides:

• Low acceptance rate: The IRS accepts only about one-third of OIC applications.
• Continued accrual of interest and penalties: During the review process, interest and penalties continue to accumulate on your tax debt.
• Disclosure of financial information: You must provide detailed financial information that the IRS can use for collection if your offer is rejected.
• Compliance requirements: If your offer is accepted, you must remain in compliance with all tax filing and payment requirements for five years.
• Potential for default: If you fail to meet the terms of an accepted offer, the IRS can revoke the agreement and reinstate the full original tax debt.

State-Specific Considerations: Offers in Compromise in Michigan

Michigan has its own Offer in Compromise program that’s similar to the federal program but with some key differences.

The Michigan Department of Treasury established its OIC program under Public Act 240 of 2014, which amended the Revenue Act. Like the federal program, Michigan’s OIC allows taxpayers to settle their state tax debt for less than the full amount owed.

According to the Michigan Department of Treasury, a taxpayer may submit an Offer in Compromise if one or more of the following grounds exist:

1. The taxpayer has received an Offer in Compromise from the IRS for the same tax periods and tax types for which the taxpayer is requesting state relief. This only applies to individual income tax, withholding tax, and/or corporate income tax.
2. A doubt as to the collectability of the tax debt exists. The taxpayer must show both:
   • The amount offered is the most that can be expected to be paid or collected from the taxpayer’s present assets and income; and
   • The taxpayer does not have reasonable prospects for acquiring increased income or assets that would enable the taxpayer to pay a greater amount of the tax debt than the amount offered, within a reasonable period of time.
3. A doubt as to the liability for the tax debt exists. Based on a review of evidence provided by the taxpayer, Treasury must determine that the taxpayer would have prevailed in a contested case if the taxpayer had appealed the assessment.

To apply for a Michigan OIC, you must submit Form 5181 (Michigan Offer in Compromise) along with a non-refundable initial payment of $100 or 20% of your offer, whichever is greater.

It’s important to note that Michigan’s program is more limited than the federal program in terms of which taxes can be compromised. For example, sales tax cannot be compromised under the ground of having received a federal OIC because the federal government doesn’t impose sales tax.

Why Work with a Tax Attorney for an Offer in Compromise?

The OIC process is complex, time-consuming, and has a relatively low acceptance rate. Working with a tax tax attorney who specializes in tax resolution can significantly improve your chances of success.

At Ayar Law, our tax attorneys can

• Evaluate your eligibility: Determine if an OIC is your best option or if another tax resolution strategy would be more appropriate.
• Calculate an optimal offer amount: Analyze your financial situation to determine the lowest offer the IRS is likely to accept.
• Prepare a compelling application: Ensure all forms are completed correctly and all supporting documentation is included.
• Communicate with the IRS: Handle all communications with the IRS offer examiner, including responding to requests for additional information.
• Negotiate on your behalf: Advocate for your interests if the IRS proposes a counter-offer.
• Explore alternatives: If your OIC is rejected, help you pursue other options like applying for an installment agreement or Currently Not Collectible status.

According to IRS data, taxpayers represented by professionals have a significantly higher OIC acceptance rate than those who apply on their own.