How the IRS Calculates an Offer in Compromise and Ways to Strengthen Your Application

An Offer in Compromise (OIC) allows certain taxpayers to settle an outstanding tax debt for less than the full amount owed. The IRS accepts an offer only when it determines it is unlikely to collect the full balance before the statute of limitations runs out or when collection would create an undue hardship. Understanding the formula the IRS uses is essential before submitting an application.

Grounds for Acceptance

The IRS may approve an OIC on three grounds:

• Doubt as to Liability – there is a legitimate dispute about whether the assessed tax is correct.
  
  

• Doubt as to Collectibility – the taxpayer’s assets and income are insufficient to pay the full liability within the statutory period.
  
  

• Effective Tax Administration (ETA) – full payment would be possible but would create exceptional economic hardship.
  
  

The IRS Reasonable Collection Potential (RCP) Formula

The offer amount must generally equal or exceed the IRS’s calculation of RCP, defined as:

RCP = Net Realizable Equity in Assets + (Future Monthly Income – Allowable Living Expenses) × Multiplier

• Net equity in assets includes bank accounts, vehicles, real estate, and business equipment reduced by any secured loans.
  
  

• Future income is disposable income after IRS National and Local Expense Standards.
  
  

• The multiplier is 12 months for lump-sum offers or 24 months for periodic-payment offers.
  
  

If the RCP is lower than the tax debt, the IRS may consider a compromise close to the RCP figure.

Preparing an Effective Application

Before applying, taxpayers must ensure that all required returns are filed and that they are current on estimated tax payments or withholding. Every income source and expense item must be fully documented — leases, utilities, insurance premiums, medical costs — and expenses must align with the IRS’s published standards.
An offer that is well-supported by documentation and consistent with the RCP calculation has the best chance of acceptance.

Frequent Reasons for Rejection

Applications are often denied because of omitted assets, unverifiable or excessive expenses, incomplete forms, missing signatures, or failure to remain compliant during the review period. Proposing an unrealistically low settlement without evidence of hardship is another common cause of rejection.

Professional Assistance

A qualified representative such as Pivot Tax can:

• review IRS transcripts and determine each year’s balance and collection-statute expiration date,
  
  

• prepare a compliant budget that meets the IRS standards,
  
  

• decide whether a lump-sum or periodic-payment offer will be more advantageous,
  
  

• prepare and submit Form 656 with the required Form 433-A(OIC) or 433-B(OIC), and
  
  

• negotiate with the IRS collections unit while monitoring the case through to resolution.
  
  

Conclusion

An Offer in Compromise is a powerful tool but requires rigorous financial analysis and strict adherence to IRS rules. Proper preparation improves the likelihood of acceptance and helps avoid delays or rejections.