EA Part 3 Offer in Compromise: Eligibility, Calculation, and Common Mistakes

What Is an Offer in Compromise?

An Offer in Compromise (OIC) is an agreement between a taxpayer and the IRS that settles a tax liability for less than the full amount owed. The OIC program is often misunderstood — it is not a blanket debt-forgiveness program, and acceptance is far from automatic. The IRS accepts offers only when accepting them is in the government's best interest. For Part 3, candidates must understand the three grounds for an OIC, how the settlement amount is calculated, and the procedural rules that govern submission and processing.

The Three Bases for an OIC

1. Doubt as to Liability (DATL)

The taxpayer genuinely disputes that the tax is legally owed. DATL is appropriate when there is a legitimate question about whether the assessment was correct — for example, when a taxpayer was not given adequate opportunity to dispute the liability before assessment. DATL does not require financial hardship; it requires a factual or legal basis for questioning the underlying tax.

DATL offers use Form 656-L (not the standard Form 656).

2. Doubt as to Collectibility (DATC)

The taxpayer acknowledges the liability is correct but cannot pay the full amount from current and future assets and income. This is by far the most common basis for OIC submissions. The IRS will accept a DATC offer when the offered amount equals or exceeds the taxpayer's Reasonable Collection Potential (RCP).

3. Effective Tax Administration (ETA)

The taxpayer could theoretically pay the full liability, but doing so would create an economic hardship or would be inequitable or inequitable to enforce the tax. ETA is a narrow exception — the IRS acknowledges the tax is correct and collectible but determines that requiring full payment would undermine sound tax administration. ETA cases typically involve exceptional circumstances such as a serious illness, advanced age, or a situation where the taxpayer relied in good faith on IRS advice.

Calculating Reasonable Collection Potential (RCP)

RCP is the cornerstone of DATC offers. The IRS calculates RCP as:

RCP = Net Equity in Assets + Future Income

Net Equity in Assets

The IRS looks at the quick sale value of the taxpayer's assets (typically 80% of fair market value for most assets) minus any liabilities secured by those assets. Assets include bank accounts, investment accounts, real property, vehicles, business assets, and retirement accounts (reduced by early withdrawal penalties and taxes for IRAs and 401(k)s).

Future Income

Future income is the amount the IRS could collect from the taxpayer's income over the remaining collection period. The calculation depends on the payment option chosen:

• Lump Sum Cash offer (paid in 5 or fewer installments within 5 months of acceptance): Future income = monthly net income × 12
• Periodic Payment offer (paid over 6–24 months): Future income = monthly net income × 24

Monthly net income is calculated using IRS National and Local Standards for allowable living expenses. Expenses that exceed the standards are generally not allowed.

Payment Options and Offer Amount

The taxpayer's minimum offer amount equals their RCP. Two payment structures are available:

• Lump Sum Cash: 20% of the offered amount is required with the application as a non-refundable payment. The remaining balance is paid in 5 or fewer installments within 5 months of acceptance.
• Periodic Payment: The taxpayer makes monthly payments during the processing period and then continues payments under the agreement terms (6–24 months after acceptance).

Low-income taxpayers who meet the Low Income Certification requirements are exempt from the application fee and initial payment requirements.

Automatic Rejection: Compliance Requirements

A taxpayer is not eligible to submit an OIC unless they are in full compliance with all filing and payment requirements. This means:

• All required tax returns must be filed
• Current year estimated tax payments must be current
• Federal tax deposits (for businesses) must be current

The IRS will return — not reject — an offer without processing if the taxpayer is not in compliance. A returned offer does not toll the CSED. Candidates regularly miss this distinction between a returned offer and a formal rejection.

OIC Timeline and Effect on CSED

Once submitted, an OIC can take 12–24 months to process. During this time, and for 30 days after a final determination, the CSED is tolled. This means the 10-year collection clock is paused while the IRS evaluates the offer.

If the IRS rejects the offer, the taxpayer has 30 days to appeal the rejection to the IRS Office of Appeals.

If the taxpayer's offer is accepted, they must:

• Pay the offer amount per the agreed terms
• File all required returns and pay all taxes for 5 years following acceptance
• Comply with all terms of the agreement

A default on any of these conditions allows the IRS to reinstate the original liability.

Common Mistakes EA Candidates Make on OIC Questions

Confusing the payment multipliers: Lump sum offers use a 12-month income multiplier; periodic payment offers use 24 months. This distinction directly affects the offer amount calculation.

Overlooking compliance requirements: The exam may present a scenario where a taxpayer has an unfiled return. An OIC cannot be submitted — or will be returned if submitted — until compliance is achieved.

Mixing up DATL forms: DATL offers use Form 656-L, not Form 656. DATC and ETA offers use the standard Form 656 with Form 433-A (OIC) or 433-B (OIC) financial statements.

Ignoring the CSED tolling: An OIC that is under consideration + 30 days pauses the collection clock. A taxpayer with a CSED approaching soon should consider how the tolling period affects their options.

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