Why Most Offer in Compromise Applications Get Rejected and How to Avoid Costly Mistakes

The Offer in Compromise program has a name that is exactly what it is: a legal avenue of paying off your tax debt to the IRS at a lower price than the price that you actually owes. To individuals who are already in arrears in back taxes, penalties and interest, it can really be a life line. The figures are draining, however. In fiscal year 2024 according to the IRS Data Book, of almost 33,600 applications received, only some 7,200 were accepted. A 21 percent approval rate that is.

Those numbers are not random. The majority of rejections occur due to avoidable and identifiable reasons. The key reason behind applications failing and what the IRS is really considering when it is reviewing your offer is the first step to making an application that has at least a real chance of succeeding.

What the IRS Is Reality Checking?

It is good to first know the structure in which the IRS considers all the offers before getting into the reasons of rejection. The basic idea is what has been dubbed as Reasonable Collection Potential, or RCP.

RCP is the sum of money the IRS feels they could potentially collect respectively out of you, by voluntary collection or coerced collection. It is determined by adding two items the amount of net realizable equity in your assets (the amount the IRS could recover in case it sold your property, less some allowable exemptions) and your future income potential (the product of your monthly disposable income and a certain number of months, depending on the payment option you choose).

Most cases do not accept an offer that is lower than your RCP by the IRS. It is this figure that grounds the whole process. You are loosely guessing when you place an offer without being aware of this calculation. And wrong guessing is not only costly in terms of application fee, but also months of lost time, lost finances, and a rejection going on your record.

Reason 1: Rejection: Your offer amount is lower than the RCP

This is the most prevalent reason of offers being rejected. Offers that are tendered by taxpayers on a regular basis are reasonable in a personal financial perspective but fail to match the IRS criteria of how much you can actually pay.

RCP formula contains rules of the valuation of assets. The IRS takes a so-called quick sale discount of 20 percent of the value of assets, which represents what might be actually recouped in a forced sale situation. This is also referred to as the 80 percent quick sale rule. Net realizable equity is computed by taking the difference between the value of the assets less liabilities that are secured by the assets and the application of this discount.

On the income side, the IRS relies on National and Local Standards to calculate the allowable living expenses, which are pre-determined tables of expenditures on such categories as food, housing, transportation, and healthcare. When you are actually spending more in these allowances, the IRS will not on an average appreciate the difference and thus when determining the amount of monthly income you can use to service your loan, it will not include the difference.

When you are attempting to estimate your RCP prior to filing, J. David Tax Law Offer in Compromise calculator can be used to determine an estimate of your specific financial input, based on official IRS formulas, with the 80 percent quick sale rule applied in valuing your assets. It is a good point of departure when trying to know whether your numbers are realistic or not before putting yourself down on a formal application.

Rejection Reason 2: Filed Tax Returns

The IRS does not consider an OIC unless you are up to date with all of the tax returns that have been filed. In case you have omitted returns to any tax year in which the offer applies, the application will usually be returned instead of formally considered.

This is a significant difference. An application that is returned is not considered as a formal rejection. In case of an offer returned, the taxpayer has no option of appealing the return. The application is merely returned to you, generally with a note of the reason why and you have to remedy the deficiency and then re-file.

The operational issue is that a large number of those seeking an OIC have years of tax issues, and missing returns are usually part of that scenario. Filing all returns is a pre-requisite that cannot be negotiable before submitting the offer. A tax lawyer will assist in determining the years to be reported on, prepare the returns and file, and arrange the whole procedure to prevent an early filing which is a waste of time and money.

Reason 3: Rejection, based on mistakes and omissions in the financial disclosure forms

The basic financial reporting forms of an OIC are 433-A (OIC) and 433-B (OIC) in individuals and businesses respectively. These are rigorous and elaborate forms. They will demand complete documentation of your income, monthly costs, bank statements, investment statements, real estate and automobiles and business interests and all other holdings.

The most common reasons of rejection are mistakes made on these forms, either willingly or out of honesty. The information that you submit is cross-referenced by the IRS with third-party data (such as 1099s, W-2s, property records, and other data). Differences are a red flag and may lead to the rejection of the offer despite your actual financial status that would otherwise justify a decent offer.

The most common errors are to not include all the bank accounts, reporting less income on self-employment, not including retirement accounts or equities on real estate property, and misclassification of monthly expenses. Even minor mistakes provide the IRS with the reasons to doubt the correctness of the whole application and reject it with this reason only.

Rejection Reason 4: Failure to remain abreast of New Tax Obligations

The IRS stipulates that even as your OIC application is being considered, you are supposed to pay all the prevailing tax requirements. This will consist of paying any estimated tax required within the current year and, as a business owner who has employees, being up-to-date on federal tax deposits within the current quarter and the previous two quarters.

To the extent of failing to meet new obligations but your offer remains open, the IRS can draw on this as their reason to reject it. This surprises a number of applicants. They are preoccupied with the debt that they are attempting to settle, and ignore the constant compliance demands that are operating concurrently.

Reason 5: Rejection You are actually not qualified.

Not all people can enjoy the OIC. The qualifications typically require the fulfillment of one of three conditions. The former is Doubt as to Collectibility that is used in cases where your assets and income are actually lower than what tax liability is due. This is what the majority of OIC are based on. The second is Doubt as to Liability that is applicable in the case of a genuine disagreement on whether the tax debt is legally correct or otherwise. The third one is Effective Tax Administration and is a case when in effect the entire debt may be technically collectable but it will cause hardships to the economy or will be unfair in specific situations when exceptional circumstances arise.

Taxpayers not in default of the installment agreement, or other ways of paying liability in full, usually will not meet the requirement of an OIC by the Doubt as to Collectibility standard. Placing an offer when none of these grounds have been met is a waste of resources and process time.

Rejection Reason 6: Applying As long as an audit is in progress.

Typically, you are not allowed to file an OIC regarding the tax years that are under audit until the audit is closed. In case of application during an examination of the same tax periods, the application can be returned or dismissed due to procedural reasons. Sequencing counts and rushing into an OIC application before they sort out the existing compliance problems is a typical strategic mistake.

The distinction between a Rejection and a Return.

These two outcomes are confused by many applicants and such a misconception is expensive. Apple rights are initiated by a formal refusal. During the 30 days of the date of the rejection letter, you may file a Request for Appeal of Offer in Compromise on Form 13711. That will be appealed to the IRS Independent Office of Appeals, which analyses the case separately of the initial examiner.

An application that is rejected is otherwise. This occurs when the offer is rejected due to flaws in the procedures, e.g., the absence of forms, undisbursed filing fees, unfiled returns, or the lack of the first necessary payment. In the case where an offer is returned, appeal is not allowed. The deficiency is just corrected by the taxpayer and can be resubmitted.

It is knowing of what situation you find yourself in that dictates what you can do and the speed at which you must do it. The failure to avail the 30 days appellate period on a formal rejection is a forfeiture of the right to appeal the decision of the IRS though the same avenue, thus the early nature of legal intervention is such a big deal.

The impact of the Payment Option Choice on the Minimum Offer.

An OIC has two modes of payment, and which one you use directly impacts the amount of minimum acceptable offering that IRS will calculate.

The former is Lump Sum Cash offer. In this alternative, you will make an offer to pay the settlement amount in five or less installments within 5 months of acceptance. In this alternative, the IRS multiplies your monthly disposable income by 12 in computing RCP.

The second one is a Periodic Payment offer. In this alternative, you will make your payments of the offer price on 6 or more monthly payments during a stretch of not more than 24 months. In this case, the IRS will multiply your monthly disposable income with 24.

The effect of that difference on the amount of total minimum offer is substantial. A lump sum offer in most instances leads to a smaller amount of cash that is required in the offer, however more cash is needed initially. Periodic payment suggestion can be less difficult to obtain yet demands an increased overall settlement. This tradeoff should be understood prior to such an offer to be submitted so as to structure it correctly.

It should also be mentioned that an initial payment is to be made during the submission. In case of a lump sum offer, you should send 20 percent of what you are offering with the application. In the case of periodic payment offer, you will have to incorporate the initial installment payment that has been proposed. Such amounts cannot be refunded even in case of the offer rejection. There is also a non-refundable application fee of $205 but low-income taxpayers can have a fee waiver.

The reason Professional Representation Makes a Difference.

The difference between 21% overall rate of acceptance and the outcomes that can be achieved as a result of getting an experienced legal representation is large. J. David Tax Law, a company that has been servicing OIC cases on behalf of clients in all 50 states, records a 95% acceptance rate of the offers written and presented by them on behalf of their qualified clients. That figure represents the disparity between an application that has been gathered by an individual well-versed in IRS evaluation guidelines and one that has been gathered by an individual going through the procedure the first time.

Tax counsel with such firms as J. David Tax Law are familiar with how to calculate RCP correctly, prepare Form 433-A (OIC) or 433-B (OIC) correctly, sequence the application in a way that meets the requirements of eligibility, select the appropriate payment option, and place the offer in a manner that reflects the letter of IRS requirement and the financial reality of the client situation.

The OIC procedure is normally six to a dozen months, since the time of submission to a decision. That is long time to wait and long time to have the collection activity halted until the time when the offer is pending. It is a waste of time to make an application that has slim chances of being approved leaving you at square one with fewer choices.

What You Should Do when Your Offer is Rejected

In case the offer is formally rejected by the IRS, there is a possibility to act. The 30-day appeal time is absolute hence time is of the essence. The request is filed on 13711 form and forwarded to IRS office of Appeals which will examine your case separately. Negotiated counter-offers LGBTQ+ Negotiation may also lead to an acceptance of a pre-existing offer, a negotiated counter-offer, or a renegotiated settlement on increased financial terms.

In case the financial circumstances deteriorated after the initial filing, that is some new information that the appeals officer can take into consideration. In case IRS was erroneous in computing your RCP or in misclassifying some of your income and expenses, those errors can be appealed.

In case of the denial of the appeal as well or just in case you conclude that an OIC is not the ideal way to go, then there are alternative methods of resolution. Installment agreements, Currently Not Collectible status, penalty abatement are all individual programs and they have their eligibility requirement which can be assessed by a tax attorney on your situation.

Frequently Asked Questions

How successfully does an Offer in Compromise get accepted? 

According to the IRS statistics of fiscal year 2024, the IRS allowed about 21 percent of OICs applications, with nearly 7,200 applications approved of the almost 33,600 cases that were submitted. With the help of a dedicated tax law firm, the chances of qualified applicants are much higher.

What is Reasonable Collection Potential and how does the IRS have to compute it? 

Reasonable Collection potential (RCP) is the approximate figure made by IRS of the maximum collection of the taxpayer. It is determined by summing the net realizable equity of the taxpayer in assets (but at a quick sale discount of about 20 percent) and the future income capacity of the taxpayer (a monthly disposable income times 12 or 24 months in case of a choice of option of payments). An offer lower than this will not be normally accepted by the IRS.

What lies between an OIC rejection and a returned application?  

Formal rejection is accompanied with a notice as to the reason of denial and initiates a right to appeal within a period of 30 days under the IRS Office of Appeals. An application is returned on a basis of procedural deficiencies (missing forms, unfiled returns, unpaid fees, and others) and does not allow any right to appeal. It is possible to correct the deficiency which means that the taxpayer can resubmit after that.

What is the duration of time spent under the Offer in Compromise procedure? 

The process of OIC normally requires 6-12 months between submission and final decision. The IRS collection activity is usually halted during this period but installment agreement payments that may still exist need to be paid.

Am I eligible to apply to an Offer in Compromise when I have late tax returns?

No. The IRS does not give an OIC application much thought until all the necessary tax returns are submitted. An offer made when the returns are pending will most probably be returned instead of being recalled.

What will become of me when I fail to comply with the 30-day deadline of OIC rejection?

The deadline is missed and you lose your right to have that particular rejection appealed by the IRS Office of Appeals. It is possible that you still can apply to OIC after correcting the cause of the initial rejection, but you will miss the chance to appeal against that very decision by an official method.

Does a submission of an Offer in Compromise prevent IRS collection efforts?

In most cases, in the course of the review of a valid OIC application, IRS postpones the enforced collection activity (including levies) up to 30 days after a rejection. When you request a rejection to be appealed, the suspension would last throughout the period of appeal.

Nevertheless, collection action might still be pursued by the IRS under some conditions, and obligation payments like installments should not be stopped.