What Is an Offer in Compromise?

An Offer in Compromise is a program authorized by Internal Revenue Code Section 7122 that allows the IRS to settle certain tax liabilities for less than the full amount owed when specific legal requirements are met.

Most accepted Offers in Compromise are based on Doubt as to Collectibility, meaning the IRS concludes that the taxpayer’s assets and future ability to pay are insufficient to satisfy the entire liability before the collection period expires.

The IRS also recognizes Offers based on Doubt as to Liability and, in limited circumstances, Effective Tax Administration, but those involve different legal standards.

The IRS Does Not Negotiate Like a Collection Agency

Many taxpayers believe they can simply offer a percentage of the balance due and negotiate with the IRS.

That is generally not how the process works.

Instead, the IRS calculates what it calls your Reasonable Collection Potential (RCP). This calculation attempts to estimate what the government could reasonably expect to collect through voluntary payments or enforced collection before the Collection Statute Expiration Date expires.

If your offer is significantly lower than your calculated RCP, the IRS will generally reject it unless another legal basis for compromise exists.

The Five Primary Components of the IRS Calculation

1. Equity in Assets

The IRS evaluates the equity you have in assets that could potentially be used to satisfy the tax debt.

Assets may include:

• Checking and savings accounts
• Investment accounts
• Retirement accounts
• Real estate
• Vehicles
• Business interests
• Cash value life insurance
• Other valuable assets

The IRS generally considers the quick sale value of assets rather than simply their estimated fair market value.

2. Monthly Income

The IRS reviews virtually all sources of household income, including:

• Wages
• Self-employment income
• Pension income
• Social Security benefits
• Rental income
• Investment income
• Business distributions
• Other recurring income

Income is evaluated together with allowable living expenses to determine disposable monthly income.

3. Allowable Living Expenses

One of the biggest surprises for many taxpayers is that the IRS does not necessarily use their actual monthly spending.

Instead, the IRS often relies on National Standards and Local Standards for many categories of necessary living expenses.

These standards may apply to:

• Housing
• Utilities
• Food
• Clothing
• Transportation
• Vehicle ownership
• Health care
• Certain out-of-pocket medical costs

Actual expenses above the IRS standards are not automatically allowed, although exceptions may exist depending on the taxpayer’s circumstances.

4. Future Income Potential

After determining monthly disposable income, the IRS estimates how much of that income could reasonably be collected over time.

The amount included in an Offer calculation depends on several factors, including the payment option selected and applicable IRS procedures in effect at the time the offer is evaluated.

Future income is often one of the largest components of the IRS calculation and is frequently the area where taxpayers misunderstand how Offers in Compromise are evaluated.

5. Special Circumstances

The IRS may also consider circumstances that are not fully reflected in a mathematical calculation.

Examples may include:

• Serious medical conditions
• Advanced age
• Permanent disability
• Extraordinary hardship
• Unique financial circumstances

Whether these factors affect the final determination depends on the specific facts of each case.

Reasonable Collection Potential Is Not Simply Your Net Worth

Another common misunderstanding is that the IRS simply adds up your assets.

In reality, the calculation generally combines:

• Net realizable equity in assets
• Projected future collection potential
• Other available financial resources

This combined amount becomes the starting point for evaluating whether an Offer in Compromise is acceptable.

Common Reasons Offers Are Rejected

• The taxpayer can fully pay through an installment agreement.
• The offer is less than the calculated Reasonable Collection Potential.
• Required tax returns have not been filed.
• The taxpayer is not current with estimated tax payments or payroll deposits.
• Financial information is incomplete or unsupported.
• Asset values are understated.
• Income information is inaccurate.

Many rejected Offers are not rejected because taxpayers owe too much tax—they are rejected because they do not satisfy the IRS’s financial analysis or compliance requirements.

Can the IRS Accept Less Than the Formula Suggests?

Sometimes.

Although Reasonable Collection Potential serves as the foundation for most Offers based on Doubt as to Collectibility, each case depends on its facts. Certain statutory or administrative considerations may affect how the IRS evaluates an Offer.

For example, Offers submitted under Effective Tax Administration involve different considerations than Offers based solely on collectibility.

Should Everyone Apply for an Offer in Compromise?

No.

An Offer in Compromise is only one of several IRS collection alternatives.

Depending on your financial condition, another resolution may be more appropriate, including:

• Installment Agreement
• Partial Payment Installment Agreement
• Currently Not Collectible status
• Penalty Abatement
• Paying the balance in full

Submitting an Offer that has little chance of acceptance can delay resolution and may suspend certain collection time periods while the IRS reviews the application.

How Polaris Tax & Accounting Evaluates an Offer

Before recommending an Offer in Compromise, we review IRS transcripts, filing compliance, collection statutes, financial information, asset equity, monthly income, allowable expenses, and other available resolution options.

Our objective is not simply to submit an Offer—it is to determine whether an Offer is realistically supportable under current IRS standards and whether another collection alternative would better serve the client’s long-term financial interests.