Offer in Compromise: how the IRS calculates your reasonable collection potential

An Offer in Compromise (OIC) is the IRS settlement program. You pay less than the full balance; the IRS accepts the lesser amount as final resolution; the debt is closed. Marketing for tax resolution companies makes the program sound like a negotiation. It isn't. The IRS doesn't accept lower offers because you want relief. It accepts them when its own math says the offer is the most it can realistically collect from you.

That math has a name: Reasonable Collection Potential, or RCP. Your RCP is the dollar figure the IRS believes it could squeeze out of you over the remaining collection period if it pursued every available method. If your offer is at or above RCP, the IRS accepts. If it's below, the IRS rejects. There is some judgment at the margins, particularly in what counts as an allowable expense, but the core calculation is mechanical.

Understanding RCP before you file is the single most important step in submitting an OIC. The 20% deposit you pay with a lump sum offer is non-refundable; if the IRS rejects, the deposit applies to your balance and you don't get it back. The $205 application fee is also non-refundable unless you qualify for the low-income waiver. Filing an OIC that comes in below RCP isn't a strategic gambit; it's a guaranteed rejection that costs you the deposit and several months of waiting.

This is how the IRS does the calculation, where the judgment calls live, and what changes the answer.

The formula

RCP has two components. The IRS adds them together to produce your minimum acceptable offer.

Net Realizable Equity in assets. The combined value of everything you own, valued under IRS rules, minus what you owe against those assets.

Future income. Your monthly disposable income multiplied by either 12 months or 24 months, depending on how you structure your offer.

Statutory authority for the OIC program sits at IRC §7122. The implementing rules live in Treasury Regulation §301.7122-1 and in IRM 5.8, the Offer in Compromise section of the Internal Revenue Manual. The financial analysis procedures are concentrated at IRM 5.8.5.

Two structural choices you make in the offer affect the math.

If you offer a lump sum, defined as full payment within five months of acceptance, future income multiplies by 12 months. If you offer periodic payment, defined as six to twenty-four monthly installments, future income multiplies by 24 months. The lump sum option produces a lower number, but it requires you to actually have the lump sum. Most OICs are submitted as lump sum offers because the future-income math is more favorable.

Your offer must equal or exceed the resulting RCP. Going higher is allowed and sometimes strategic; going lower is rejection.

Asset valuation: what the IRS counts and how

The IRS doesn't value your assets at retail. It values them at Quick Sale Value, defined as 80% of fair market value. The theory: a forced liquidation produces less than a willing-buyer sale. The practice: every asset gets a 20% haircut before the math starts.

From Quick Sale Value, the IRS subtracts encumbrances (loans, liens, and other secured debts against the asset). What remains is Net Realizable Equity, or NRE. NRE is what counts in the RCP calculation.

The specifics for common asset categories under IRM 5.8.5.

Cash and bank accounts. Valued at face value, not Quick Sale Value. Reduced by one month of allowable living expenses for your household; further reduced by an additional $1,000, without going below zero. The reduction reflects the practical reality that you need money to live next month.

Real estate. Quick Sale Value (80% of fair market value) minus the outstanding mortgage balance and any other liens. If you're underwater, the contribution to RCP is zero. If you have substantial equity, it counts. The IRS uses third-party valuation tools (Zillow, county assessor records, recent comparable sales) and may request an appraisal in disputed cases.

Vehicles. Quick Sale Value minus loan balance. For one vehicle per household, the IRS allows an additional $3,450 reduction (the 2026 vehicle equity exemption); for a second vehicle in a two-adult household, the same. Vehicles needed for work or medical purposes generally qualify for the exemption.

Retirement accounts. Here the math gets harsh. Quick Sale Value (80%) gets further reduced by the federal tax, state tax, and 10% federal early withdrawal penalty you'd pay to liquidate them. A $50,000 traditional IRA, after the 80% Quick Sale Value reduction, after federal tax at 22%, after state tax at a typical 5%, and after the 10% federal early withdrawal penalty, might contribute about $20,000 to RCP. Roth contributions (not earnings) come out tax-free under their own rules and contribute closer to their stated value.

Business assets. Inventory, equipment, accounts receivable. Quick Sale Value minus encumbrances. The IRS distinguishes between business assets necessary for income production and surplus business assets; the necessary ones may qualify for partial exclusion if their loss would prevent you from generating the income that funds the offer.

Cash value life insurance. The loan value (cash you could borrow against the policy) counts. Term life insurance with no cash value contributes zero.

Securities and investment accounts. Quick Sale Value minus margin loans or other encumbrances. Capital gains tax on liquidation is not deducted, which produces a harsher result than retirement account valuation.

The dissipated asset rule sits at IRM 5.8.5.18. If you transferred or spent significant assets in the five years before filing your OIC (gifts to family members, lump-sum debt payments, large discretionary purchases), the IRS may add those values back into your RCP as though you still had them. The 2026 dissipated asset review tightened. Exception: if the asset went to necessary living expenses, federal tax payments, or documented hardship needs, the dissipated portion isn't added back. The taxpayer carries the burden of documenting where the money went.

Future income: the second component

The future income component is your Monthly Disposable Income (MDI) multiplied by either 12 or 24 depending on offer structure.

MDI is gross monthly income minus allowable monthly expenses. Both halves of that calculation involve judgment, and that's where most OICs succeed or fail.

Gross income. Wages, self-employment net income, rental income, investment income, pension and Social Security payments. Self-employment income is averaged over the prior 12 months; the IRS will pull tax transcripts and bank statements to verify. Variable income (commission, freelance) gets averaged similarly. If your income has dropped recently, document the change with employer letters, contract terminations, or year-to-date pay stubs.

Allowable expenses. This is where the IRS replaces what you actually spend with what it thinks you should be allowed to spend. The IRS uses two sets of standards under Collection Financial Standards published annually.

National Standards apply uniformly across all 50 states for five categories: food, clothing, housekeeping supplies, personal care products, and miscellaneous expenses. The 2026 National Standards allow approximately $797 monthly for a single person, scaling up by household size. These are caps. If you actually spend more, only the standard amount counts.

Local Standards vary by county and cover housing and utilities (combined), and transportation (split into ownership costs and operating costs). The Local Standard for housing in Manhattan, New York County is several thousand dollars monthly; in rural Indiana counties it's under $1,500. The IRS publishes the tables at IRS.gov/businesses/small-businesses-self-employed/collection-financial-standards. The 2026 Housing and Utility tables were updated to reflect increased home insurance premiums in disaster-prone areas; if your tax professional is using 2024 tables, the calculation is wrong.

Two categories use actual expenses rather than standards: out-of-pocket healthcare costs (with a minimum allowance under National Standards at $84 monthly for those under 65 and $149 for those 65 and over), and court-ordered payments (child support, alimony).

Several common expenses are categorically not allowed: credit card minimum payments on unsecured debt, voluntary 401(k) contributions, private school tuition, charitable contributions, and entertainment costs beyond what's covered in the National Standard miscellaneous allowance. The IRS reasoning is that these expenses come behind the federal tax liability in priority.

The result is often a positive MDI even when you feel cash-poor. If your actual housing costs $2,300 but the Local Standard allows $1,700, the $600 difference shows up as MDI. Multiply that by 12 for a lump sum offer and your RCP just absorbed $7,200 more than felt right.

A worked example

A self-employed contractor in Marion County, Indiana, owes $48,000 in federal income tax across three years.

Assets: a 2019 vehicle worth $14,000 with a $9,000 loan balance; a primary residence worth $185,000 with a $172,000 mortgage; a Traditional IRA balance of $30,000; $1,800 in checking; no other significant assets.

Income and expenses: gross income $5,200 monthly; actual housing costs $1,650 (Local Standard for Marion County allows $1,800); actual transportation $590 in ownership costs and $420 in operating costs (Local Standards allow $580 and $390 respectively); food and personal care $850 (National Standard at this household size allows $797); health insurance and out-of-pocket medical $310; no other expenses.

NRE calculation. Vehicle: $14,000 × 0.80 = $11,200, minus $9,000 loan, minus $3,450 vehicle equity exemption = zero contribution. Real estate: $185,000 × 0.80 = $148,000, minus $172,000 mortgage = zero contribution. IRA: $30,000 × 0.80 = $24,000, minus federal tax at 22% ($5,280), state tax at 3.15% ($756), federal penalty 10% ($2,400), liquidation costs $100 = approximately $15,464. Cash: $1,800 minus one month allowable expenses (food/personal at $797 plus housing at $1,800 plus transport at $970 plus healthcare at $310 = $3,877) brings cash to zero, minus the additional $1,000 reduction stays at zero.

Total NRE: $15,464.

MDI calculation: gross income $5,200 minus housing $1,650 (actual amount used when below the Local Standard) minus transportation ownership $580 (capped from $590) minus transportation operating $390 (capped from $420) minus food/personal $797 (capped from $850) minus healthcare $310 = $1,473 MDI.

For a lump sum offer: $1,473 × 12 = $17,676 future income component.

Total RCP: $15,464 + $17,676 = $33,140.

The minimum acceptable offer is $33,140 against a $48,000 balance: a settlement of roughly 69 cents on the dollar, not the "pennies on the dollar" that tax resolution marketing promises but a meaningful $14,860 reduction against the full balance.

Where judgment changes the answer

The mechanical calculation produces an RCP figure. Several judgment calls can move that figure substantially.

Expense framing. If you have a documented medical condition requiring expensive ongoing treatment, the out-of-pocket healthcare allowance can be increased beyond the standard minimum with documentation. If you have a child with a disability requiring specialized schooling, the IRS may allow private school tuition under IRM necessary expense framing. If a vehicle is required by your employment (delivery drivers, traveling sales, certain skilled trades), additional vehicle costs may be allowed.

Income volatility. If you're self-employed with a recent income drop, the IRS will look at the trailing 12 months. Documenting that the drop is structural rather than seasonal (lost contracts, closed clients, industry downturn) can lower the income figure used in the calculation.

Asset characterization. Some assets are negotiable in valuation. Closely-held business interests, partial ownership of inherited property, and contested receivables can receive lower valuations with documentation of the discount. The IRS may use a valuation engineer in disputed cases.

Future income period. A lump sum offer uses the 12-month multiplier; a periodic offer uses 24. The lump sum produces lower RCP, but it requires you to actually have the lump sum. If you can borrow the lump sum from family or a retirement loan, that's often the right structure.

Effective Tax Administration. Under IRM 5.8.11, the IRS can accept an offer below RCP in two narrow circumstances: economic hardship (the RCP calculation produces a number you technically could pay, but paying it would leave you unable to meet basic living expenses) or public policy/equity (paying the full RCP would be inequitable due to exceptional circumstances, such as serious illness or IRS error). These are rare paths but real ones.

The three grounds for OIC acceptance

The OIC program technically operates on three legal grounds under IRC §7122. Practitioners conflate them sometimes; the IRS does not.

Doubt as to Collectibility. This is the standard OIC: your RCP is less than the assessed liability, and the IRS accepts the lower amount. Roughly 90% of accepted OICs fall here. Form 656 with the Doubt as to Collectibility box checked.

Doubt as to Liability. You can show the underlying tax assessment is wrong: the IRS calculated wages you didn't earn, attributed deductions that don't apply, or made a computational error. Form 656-L instead of 656. Rare in practice; if the assessment is wrong, the cleaner path is usually audit reconsideration or a request for abatement, not an OIC.

Effective Tax Administration. Either economic hardship (you could technically pay but paying would leave you unable to live) or public policy/equity (exceptional circumstances make full collection inequitable). Filed on Form 656 with the ETA box checked. Approval requires documenting the specific basis. Most ETA offers are denied; the bar is genuinely high.

What to do next

If you've worked through the math and your RCP comes in below your balance, the OIC is worth pursuing.

Pull your IRS account transcript at IRS.gov/account to confirm the assessed balance and verify there are no unfiled years. If unfiled years exist, file those first; the IRS won't process an OIC while filing compliance is incomplete.

Gather supporting documentation: 12 months of bank statements for every account, year-to-date pay stubs or self-employment ledger, current mortgage statement, current vehicle loan statement, current retirement account statement, current health insurance and medical expense documentation, recent utility bills.

Complete Form 433-A(OIC) for individuals or 433-B(OIC) for businesses. The form walks through each asset and expense category. Document everything with the supporting paperwork; the IRS will request documentation in the review.

Complete Form 656 with the appropriate grounds box checked, the offered amount calculated, and the payment structure (lump sum or periodic) specified.

Pay the $205 application fee, or check the low-income certification box if your household income falls at or below 250% of the federal poverty level. Pay the 20% deposit (lump sum) or first installment (periodic).

Submit to the appropriate processing center: Memphis, Tennessee for taxpayers in eastern states, Holtsville, New York for taxpayers in central states, Fresno, California for taxpayers in western states. The current submission addresses are listed in the Form 656 Booklet.

The IRS pauses active collection during OIC review. Levies in place may continue, but new levies are suspended. The review typically takes six to twelve months. Most cases are assigned to a Centralized Offer in Compromise unit; complex cases route to Field Offer in Compromise specialists.

If accepted, the five-year compliance covenant begins on the acceptance date. File on time, pay on time, every year for five years. Default reinstates the full original liability minus payments made.

If rejected, you have 30 days to file an appeal with the IRS Office of Appeals using the procedure described in your rejection letter. Appeal review typically takes another six months. If the appeal sustains the rejection, the deposit applies to your balance and you can either accept the result or refile with corrected RCP analysis later.

The OIC program is real, the savings can be substantial, and the math is more knowable than the marketing suggests. What the program doesn't do is reward want over capacity. The IRS settles for less when its own math says less is the most. Building an accurate RCP picture before you file is the work that determines whether your offer succeeds or your $205 fee and 20% deposit fund someone else's federal tax liability.