Form 656: Offer in Compromise
Used to propose settling a tax debt for less than the full amount owed when you cannot pay your full tax liability or doing so would create a financial hardship.
Overview
IRS Form 656, Offer in Compromise (OIC), is the official application a taxpayer submits to propose settling a federal tax debt for less than the full amount owed. The program exists because Congress and the IRS recognize that rigidly pursuing uncollectible balances wastes resources and that a negotiated resolution can serve the public interest better than prolonged non-collection. The legal authority for the OIC program derives primarily from IRC § 7122, which grants the IRS broad discretion to compromise any civil or criminal case arising under the Internal Revenue Code.
There are three distinct grounds for an OIC: Doubt as to Liability (DATL), where the taxpayer legitimately disputes whether the assessed tax is correct; Doubt as to Collectibility (DATC), where the taxpayer's assets and future income make full payment unlikely; and Effective Tax Administration (ETA), where full payment is theoretically possible but would cause the taxpayer demonstrable economic hardship or would be inequitable given exceptional circumstances. Most accepted offers fall under DATC. Form 656-L is the separate variant used exclusively for Doubt as to Liability claims and is not covered here.
Submitting Form 656 triggers an immediate Collection Statute Expiration Date (CSED) suspension — the ten-year period the IRS has to collect tolls while the offer is pending and for thirty days after a rejection. This has meaningful implications for tax planning. The IRS's Offer in Compromise Pre-Qualifier tool can help advisors estimate whether a client is likely to qualify before investing time in a full submission, though the tool's output is not binding. Most CPA firms advise clients to exhaust installment agreement options and confirm all required returns are filed before submitting Form 656, as an incomplete filing history is among the most common rejection triggers.
Who Files This Form?
Any individual, sole proprietor, or business entity that owes a federal tax liability — including income tax, payroll tax, trust fund penalties, or other assessable taxes — may submit Form 656 if they meet one or more of the three statutory grounds for compromise.
For Doubt as to Collectibility (the most common basis), the IRS evaluates the taxpayer's Reasonable Collection Potential (RCP). RCP is calculated by adding net realizable equity in assets to the present value of future income available to pay taxes, less necessary living expenses (using IRS national and local standards). If the RCP is less than the total balance due, the taxpayer may be a candidate. There is no published minimum debt threshold, but in practice submissions involving very small balances are rarely cost-effective.
For Effective Tax Administration, the taxpayer must demonstrate that full collection would cause economic hardship or that compelling public policy or equity considerations apply. Elderly or seriously ill taxpayers with limited assets but theoretical ability to pay over time are typical ETA candidates.
Key eligibility prerequisites apply regardless of the grounds. The taxpayer must be current on all required federal tax return filings. Taxpayers currently in an open bankruptcy proceeding are ineligible — Form 656 will be returned without consideration. All estimated tax payments and federal tax deposits for the current year must be current. Business entities with employees must have made all required federal tax deposits for the current and prior two quarters.
Low-income applicants who meet the IRS Low Income Certification guidelines (based on income levels published in the Form 656-B Booklet, which is updated periodically) are exempt from the $205 application fee and from the required initial payment that accompanies the offer. Confirming low-income certification status before submission can materially reduce upfront client costs.
Key Fields
Section 1: Taxpayer Information
Identifies the taxpayer(s) making the offer, including Social Security Numbers or EINs. For joint liabilities, both spouses must sign even if only one is the primary filer. If the offer covers only one spouse's separate liability, list only that individual.
Section 2: Tax Periods and Type of Tax
Lists the specific tax years, form types, and assessment periods being compromised. Accuracy here is critical — any tax period not listed is not covered by the offer, and the IRS will not automatically include related periods. Double-check IRS account transcripts to capture all assessments, including Trust Fund Recovery Penalties assessed separately under IRC § 6672.
Section 3: Reason for Offer (Basis)
The taxpayer selects one or more statutory bases: Doubt as to Collectibility, Doubt as to Liability, or Effective Tax Administration. The selected basis drives which supporting documentation is required. Most practitioners select DATC, which requires Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses. Selecting both DATC and ETA simultaneously is permissible when warranted.
Section 4: Offer Amount
The dollar amount the taxpayer proposes to pay. This should be calculated based on RCP (net asset equity plus future income component), not simply a number the taxpayer finds palatable. Offering below RCP without strong justification is one of the most reliable ways to receive an automatic rejection or a significantly higher counter from IRS.
Section 5: Payment Terms — Lump Sum Cash Offer
For lump sum offers (payable in five or fewer installments within five months of acceptance), a nonrefundable initial payment of 20% of the offered amount must accompany the Form 656. This payment is applied to the outstanding liability regardless of whether the IRS accepts or rejects the offer. Low-income certified taxpayers are exempt from this requirement.
Section 5: Payment Terms — Periodic Payment Offer
For periodic payment offers (paid in monthly installments over 6–24 months), the taxpayer must include the first proposed monthly installment with the submission. Payments must continue monthly while the offer is under IRS review. These are also nonrefundable and applied to the balance. Stopping payments during review is treated as a withdrawal.
Section 6: Taxpayer Signatures and Date
The offer is a legal agreement, and the taxpayer (and spouse, if applicable) must sign under penalties of perjury. A power of attorney (Form 2848) must be on file if a representative is signing. An unsigned Form 656 is returned without processing.
Application Fee ($205)
The $205 application fee is required unless the taxpayer qualifies for Low Income Certification. The fee is nonrefundable and is not applied toward the tax liability. It must be submitted as a separate payment from the initial offer payment. Forgetting to include the fee is a common cause of return-without-processing.
Financial Disclosure (Form 433-A or 433-B)
While technically a separate form, the Collection Information Statement is packaged as part of the Form 656-B Booklet and is integral to the OIC submission. Form 433-A (OIC) is required for individual taxpayers; Form 433-B (OIC) is required for businesses. The data on these forms drives the IRS's RCP calculation and must reconcile with bank statements, pay stubs, and asset documentation submitted as attachments.
Filing Deadlines
$205 application fee (waived for low-income taxpayers); required initial payment with submission.
Step-by-Step Instructions
- 1
Verify eligibility prerequisites: confirm all required federal tax returns are filed, there is no open bankruptcy, and estimated tax payments and federal tax deposits are current. Request IRS account transcripts (IMFOL/BMFOL) to identify all assessed liabilities and confirm the CSED for each period.
- 2
Determine the basis for the offer. For most clients this will be Doubt as to Collectibility (DATC). Calculate the client's Reasonable Collection Potential using the IRS worksheet methodology: net realizable equity in assets (generally forced-sale value minus secured debt) plus a multiplier of net monthly income available for collection (48 months for lump sum, 24 months for periodic payment offers — confirm current IRS guidelines as these parameters can change).
- 3
Complete Form 433-A (OIC) for individuals or Form 433-B (OIC) for businesses. Gather and attach supporting documentation: last three months of bank statements, pay stubs or profit-and-loss statements, recent asset valuations (NADA for vehicles, comparable sales for real estate), monthly bills for allowable expenses, and any documentation of special circumstances.
- 4
Complete Form 656 itself: enter taxpayer identifying information, list every tax period and tax type to be compromised, select the basis, enter the calculated offer amount, and select payment terms (lump sum or periodic). Attach Form 656-L separately if any periods involve a Doubt as to Liability claim.
- 5
Determine whether the client qualifies for Low Income Certification by comparing household income and size against the thresholds in the current Form 656-B Booklet. If the client qualifies, check the certification box — no fee and no initial payment are required. If not, calculate the required 20% initial payment (lump sum) or first monthly installment (periodic).
- 6
Assemble the complete submission package: Form 656, Form 433-A or 433-B with all attachments, the $205 application fee (separate check or money order payable to the United States Treasury), the initial offer payment (separate check or money order), and any additional statements explaining special circumstances.
- 7
Mail the package to the appropriate IRS OIC processing center per the instructions in the Form 656-B Booklet (the mailing address varies by state and entity type). Send via certified mail or a trackable courier and retain proof of delivery. Document the submission date precisely, as it establishes the start of the CSED suspension.
- 8
Monitor the case. The IRS will issue acknowledgment within a few weeks. If assigned to an Offer Examiner, respond promptly to any requests for additional documentation — delays can result in the offer being returned as unprocessable. Ensure the client continues required monthly installments (periodic payment offers) and remains current on all tax obligations during review.
- 9
Upon acceptance, advise the client on the compliance terms in the acceptance agreement: typically five years of full tax compliance (filing and paying on time). Failure to comply during this period voids the offer and reinstates the original liability, less any amounts paid under the offer.
Common Mistakes to Avoid
Submitting without filing all required tax returns
The IRS will return the offer without consideration if any required return is unfiled. Pull a complete transcript before submission and file any delinquent returns, even if the client cannot pay the resulting balance.
Undervaluing assets to reduce RCP
The IRS examiner will independently verify asset values using public records, vehicle valuation guides, and financial institution data. Use realistic forced-sale values (typically 80% of quick-sale value for real estate per IRS guidelines) and document the methodology. Understating assets creates credibility problems and can trigger fraud referrals.
Failing to include the correct initial payment or application fee
Submit the $205 fee and the required initial offer payment as separate instruments from each other and from any other payments. Combining them on one check is a common cause of return-without-processing. Verify low-income certification eligibility before assuming the waiver applies.
Not listing all tax periods on Form 656
Only periods explicitly listed on the accepted offer are covered. Review transcripts to capture all assessments, including civil penalties, Trust Fund Recovery Penalties (IRC § 6672), and any recently issued notices of deficiency. A missed period means the IRS can still pursue collection on it even after the offer is accepted.
Stopping periodic payments during IRS review
For periodic payment offers, the taxpayer must continue monthly installments from the date of submission through the duration of IRS review. Missed payments are treated as a withdrawal of the offer. Set up calendar reminders and confirm the client understands this obligation at the outset.
Submitting an offer amount significantly below calculated RCP without explanation
The IRS calculates its own RCP independently. If the offered amount is below IRS's figure without a compelling written explanation (e.g., deteriorating health, depleted retirement accounts, exceptional local housing costs), expect a rejection or a counter. Include a detailed narrative statement addressing any discrepancies between the taxpayer's RCP calculation and what the IRS is likely to compute.
Frequently Asked Questions
The IRS generally takes between six months and two years to process an OIC, with a median closer to twelve months depending on complexity and IRS workload. The CSED (the IRS's ten-year collection window) is suspended during the entire review period plus thirty days after any rejection. Taxpayers should factor this CSED tolling into their strategy, particularly if the statute is close to expiring.
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