IRS Form 656 – Offer in Compromise

Over 11 million Americans owe back taxes to the IRS, with many facing growing interest, penalties, and monthly tax liens. For taxpayers struggling to cover basic living expenses, these tax bills can quickly spiral into an overwhelming financial burden. Ignoring tax debt can result in levies, wage garnishments, and damage to your credit history, making it harder to recover financially.

IRS Form 656, the official application for the Offer in Compromise (OIC) program, allows qualified taxpayers to settle their tax debt for less than the full amount owed. This compromise program considers your unique financial condition—including income, expenses, and assets—to determine whether a reduced settlement is in the government’s best interest.

Resolving your tax liability through an OIC can stop aggressive IRS collection actions and give you a path toward financial stability. Understanding how IRS employees review each case, what supporting documentation you must provide, and the factors the IRS considers will help determine your eligibility. Taking action early is key to avoiding additional interest and penalties and getting back on track with your taxes.

What Is IRS Form 656?

IRS Form 656 is the official document used to request participation in the IRS Offer in Compromise program. This program allows taxpayers to settle their tax debt for less than the full amount owed. The form is part of a comprehensive compromise booklet with detailed instructions and supporting documentation requirements. This program is designed to help taxpayers who cannot pay their due amount, even through an installment agreement, without causing significant financial hardship.

When reviewing an Offer in Compromise, the IRS evaluates several factors to determine whether accepting the offer is in the government’s best interest. These include your income, allowable expenses, asset equity, and overall financial condition. IRS employees look at what they can reasonably expect to collect from you over time. They may accept your proposal if the offer matches or exceeds what they could collect through enforced measures such as liens or levies.

An accepted offer can eliminate a significant portion of your tax liability, stop collection activities, and give you a clear path to resolve your tax debt. However, it is not automatic. The process involves submitting complete forms, paying the required fees, and demonstrating through documentation that you cannot afford to pay the full amount. This makes IRS Form 656 a critical step in settling your tax obligations.

Why You Might Receive IRS Form 656

Receiving IRS Form 656 or being directed to the Offer in Compromise program usually means the IRS believes you may qualify for tax debt relief. Here are the most common reasons:

• Limited Ability to Pay: Your income barely covers basic living expenses, making it impossible to pay your tax bill in full.
  
  
• Extraordinary Circumstances: You face unique challenges such as medical emergencies, job loss, or natural disasters that affect your ability to pay.
  
  
• Minimal Assets: You own few assets, or those assets cannot be easily sold or used to cover your tax liability without creating further financial hardship.
  
  
• Prevention of Collection Actions: Filing an OIC can stop the IRS from pursuing levies, liens, or wage garnishments while your offer is under review.
  
  
• IRS Outreach: You may have received a notice or letter from the IRS suggesting you explore the compromise program if you cannot resolve your tax debt another way.
  
  
• Eligibility Indicators: If your tax returns are up to date and you are not in an open bankruptcy proceeding, you may meet the basic criteria to submit a formal offer.

It is important to take action when you receive a notice. Ignoring the opportunity to respond could mean losing the chance to settle your tax debt for less and avoid growing penalties and interest.

Consequences of Ignoring Tax Debt

Failing to take action on your tax bill can quickly lead to severe financial and legal consequences. Here’s what you risk if you ignore your tax liability:

• Tax Liens: The IRS may file a federal tax lien against your property, affecting your credit and ability to get loans.
  
  
• Levies and Garnishments: The IRS can seize funds directly from your bank account or garnish wages until the debt is paid.
  
  
• Growing Penalties and Interest: Your balance increases monthly as interest and penalties accumulate, making the total amount even more challenging to resolve.
  
  
• Loss of Refunds and Credits: Any future tax refunds or credits may be applied to your outstanding debt, leaving you with no refund until the balance is cleared.
  
  
• Collection Notices and Enforcement: You may receive repeated letters, phone calls, or in-person contact from IRS employees until the issue is addressed.
  
  
• Increased Financial Stress: Ignoring the problem can lead to mounting anxiety and limited options as the IRS takes more decisive enforcement actions.

Taking early steps to resolve your debt—whether through an Offer in Compromise, payment plan, or other relief—can prevent penalties, protect your assets, and prevent long-term financial harm.

Eligibility and Requirements

Before submitting IRS Form 656, you must meet strict eligibility rules set by the IRS. Use this checklist to confirm you are ready to apply:

• Filed All Tax Returns: All required tax returns must be filed for previous years. If you have missing returns, file them first.
  
  
• Current on Estimated Tax Payments: If you are self-employed or have other income, your estimated payments for the current year must be made.
  
  
• No Open Bankruptcy: You cannot be in an open bankruptcy proceeding. If you are, wait until it is resolved before applying.
  
  
• Employment Tax Deposits: If you own a business with employees, you must complete all current and past two quarters of employment tax deposits.
  
  
• Application Fee and Initial Payment: You must include the $205 application fee and initial payment unless you qualify for the low-income waiver.
  
  
• Accurate Financial Documentation: Submit complete and accurate information about income, assets, expenses, and liabilities.
  
  
• Valid Extension (if applicable): You must have a valid extension if you are filing during the current tax year.

Meeting these requirements helps ensure your offer is processed rather than returned or rejected. Missing even one step—such as failing to file a return or omitting key financial details—can result in delays or outright denial.

Relief and Resolution Options

If IRS Form 656 or the Offer in Compromise program is not the right fit, you still have other ways to resolve your tax debt. The IRS provides multiple programs designed to help taxpayers get back into compliance.

Offer in Compromise (OIC)

• When to Use: This option is best for taxpayers who cannot pay their tax bill in full without creating financial hardship.
  
  
• Key Benefit: You can settle your tax debt for less than the total amount owed.
  
  
• Considerations: This requirement requires complete financial disclosure and supporting documentation. IRS employees review income, expenses, and assets to determine whether to accept.

Installment Agreement (Payment Plan)

• When to Use: It is ideal if you can afford monthly payments over time.
  
  
• Key Benefit: It stops aggressive collection actions while you pay your balance in smaller installments.
  
  
• Considerations: Setup fees may apply. Payments must be made on time to avoid default.

Currently Not Collectible Status (CNC)

• When to Use: If you cannot pay anything toward your tax bill.
  
  
• Key Benefit: It temporarily suspends IRS collection activity until your financial condition improves.
  
  
• Considerations: The IRS may review your status periodically and resume collections when you can pay.
  
  

Penalty Abatement & Taxpayer Advocate Service

• Penalty Abatement: It removes penalties if you meet specific criteria, such as first-time relief or reasonable cause.
  
  
• Taxpayer Advocate Service: This is an independent organization within the IRS that helps resolve complex or delayed cases.

Comparison Table: OIC vs. Payment Plan vs. CNC

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How to Respond to IRS Form 656

Taking the proper steps after receiving IRS Form 656 ensures your application is reviewed quickly and accurately. Here’s a simple process to follow:

Step 1: Determine Your Eligibility

Use the IRS Offer in Compromise Pre-Qualifier Tool or log in to your individual online account to check balances and confirm you meet eligibility requirements. Review your income, expenses, and assets to ensure you can support your claim of financial hardship.

Step 2: Gather Supporting Documentation

Collect everything the IRS will need to evaluate your offer:

• Filed tax returns and any valid extensions
  
  
• Recent pay stubs or income statements
  
  
• Bank statements (last 3 months)
  
  
• Asset valuations (home, vehicle, retirement accounts)
  
  
• Monthly expense records (housing, utilities, insurance, food)
  
  
• Business documents (if applicable), such as accounts receivable and financial statements

Step 3: Complete and Submit the Application

Fill out Form 656 accurately and attach Form 433-A (individual) or Form 433-B (business). Include the $205 application fee and initial payment unless you qualify for the low-income waiver. Submit the entire package by mail to the IRS address listed in the instructions.

Step 4: Communicate with the IRS During Review

You may receive a notice or letter from IRS employees requesting additional information. Respond promptly with the requested documentation to avoid delays or rejection.

Step 5: Wait for the Final Decision

The IRS will issue a written acceptance or rejection letter. If accepted, complete all payments as agreed. If rejected, you may appeal or consider other resolution options like a payment plan or a Currently Not Collectible status.

Professional Help and Resources

For many taxpayers, the Offer in Compromise process can feel overwhelming. If your situation is complex or you are unsure about completing the forms correctly, professional help may be the best way to protect your interests.

When to Seek Professional Assistance

• Complex Financial Situations: If you have business tax debt, multiple years of unfiled returns, or high-value assets, a tax professional can help present your case clearly.
  
  
• Previous OIC Rejections: Experts can review why your offer was rejected and help you submit a stronger application.
  
  
• Representation Needs: If you want someone to act on your behalf in communicating with the IRS, a qualified tax relief company or enrolled agent can handle all correspondence and negotiations.

Trusted Resources

• Taxpayer Advocate Service: This is an independent organization within the IRS that helps taxpayers resolve problems they cannot handle through normal channels.
  
  
• Reputable Tax Relief Companies: Look for companies with transparent fees, clear communication, and a history of successfully resolving cases.
  
  
• Government and Nonprofit Guidance: Check IRS.gov for the latest compromise booklet and official guidance, and consult nonprofit credit counseling services for additional financial planning.

Professional support can save you time, reduce stress, and help ensure your application package is complete and accurate before submission.

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Frequently Asked Questions (FAQs)

How does IRS Form 656 affect my tax liability?

Submitting IRS Form 656 allows you to reduce your total tax liability by negotiating with the IRS. If accepted, your offer will enable you to settle your tax debt for less than the full amount owed. The IRS will review your financial condition, including income, assets, and expenses, and decide whether it is in the government’s best interest to approve your offer.

Can I file an Offer in Compromise if I already have a tax bill or payment plan?

You can submit an Offer in Compromise even if you have a tax bill or an installment agreement. Filing an OIC will temporarily pause your payment plan while the IRS reviews your offer. If you are eligible, this process may result in a lower settlement amount. If the IRS decides not to accept your offer, you can resume payments or request new terms.

Does IRS Form 656 work for everyone who owes taxes under current tax laws?

Not everyone qualifies. You must meet strict IRS criteria and prove that paying the full amount would cause financial hardship. The IRS considers income, assets, and special circumstances before it decides. If you are not eligible, you may need to explore other resolution options like a payment plan, penalty abatement, or Currently Not Collectible status to manage your debt under existing tax laws.

What if the IRS rejects my Offer in Compromise?

If your offer is rejected, you have 30 days to submit an appeal using IRS Form 13711. The IRS will review any additional documentation or exceptional circumstances before deciding. If the offer remains denied, you may still be eligible for other options like installment agreements or Currently Not Collectible status to resolve your tax debt in a manageable way.

Will submitting IRS Form 656 stop collections on my tax bill?

Yes, in most cases, IRS collection activities such as levies or garnishments are suspended while your offer is under review. However, penalties and interest may continue to accrue until a decision is made. If the IRS decides to accept your offer, collection stops once you complete your payment terms. If rejected, you will need to act quickly to avoid enforced collections.