Owing money to the IRS can feel overwhelming, but there's a program that might help you settle your tax debt for less than you owe. Form 656, the centerpiece of the Offer in Compromise (OIC) program, provides eligible taxpayers a legitimate path to resolving tax problems they genuinely cannot afford to pay. Here's everything you need to know in plain English.

What Form 656 Is For

Form 656 is the official application for an Offer in Compromise, which is essentially a settlement agreement between you and the IRS. When you submit this form, you're proposing to pay less than your full tax debt—but only if you can prove you truly cannot pay the full amount through normal payment plans or by liquidating your assets.

The IRS considers three situations for accepting an offer:

• Doubt as to collectibility – you genuinely can't afford to pay
• Doubt as to liability – there's a legitimate question about whether you actually owe the tax
• Effective tax administration – collecting the full amount would create economic hardship or would be unfair

Most people apply based on doubt as to collectibility—meaning they simply cannot pay the full amount without serious financial hardship.

This isn't a discount program for convenience. The IRS will thoroughly investigate your financial situation, examining your income, expenses, assets, and future earning potential. They'll only accept an offer that represents the most they can realistically expect to collect from you within a reasonable timeframe.
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When You’d Use This Form

You cannot use Form 656 until you've completed some important prerequisites.

Key Prerequisites

• All required tax returns filed — both personal and business
• At least one IRS bill received for the tax debt you want to compromise

You can't preemptively offer to settle before the IRS has assessed and billed you.

Timing Considerations

There's no concept of filing Form 656 “late” in the traditional sense, but timing matters.

• Wait until you've resolved open audits or innocent spouse claims.
• If you’re in bankruptcy, you’re not eligible until your bankruptcy is discharged and closed.

If you discover errors in your original tax returns that reduce what you actually owe, don’t use Form 656—file amended returns instead.

Use Form 656-L for cases where you doubt you owe the tax at all.
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Key Rules and Requirements

Eligibility Checklist

• All tax returns filed (including valid extensions with required payments)
• All estimated tax payments current for the current year
• Employers current on federal tax deposits for the current and past two quarters
• Not in an open bankruptcy proceeding
• No deactivated Individual Taxpayer Identification Number (ITIN)

Low-Income Certification

If your adjusted gross income falls below certain thresholds (based on family size and location), you’re exempt from paying the $205 application fee and initial offer payment while your application is under review. See Section 1 of Form 656 for income chart details.

What the IRS Will Examine

The IRS will scrutinize:

• Cash, investments, and available credit
• Real estate, vehicles, retirement accounts, life insurance, business interests
• Monthly income and living expenses (based on national and local standards)

Disallowed expenses: private school tuition, college expenses, and charitable contributions.
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Important Restrictions

• For five years after acceptance, you must file and pay all taxes on time.
• The IRS can reinstate the original debt if you fail to comply.
• The IRS keeps any tax refunds for periods before your offer acceptance.

Step-by-Step Filing Process (High-Level)

Step 1: Pre-Qualify Yourself

Use the free Offer in Compromise Pre-Qualifier tool to check eligibility and estimate your offer amount.

Step 2: Gather Financial Documentation

Collect:

• Bank statements and investment account records
• Retirement account and real estate details
• Pay stubs or profit-and-loss statements
• Monthly household income and expense details

Step 3: Complete the Required Forms

• Form 433-A (OIC) – for individuals (wage earners and self-employed)
• Form 433-B (OIC) – for businesses
• Form 656 – listing all tax years and types of tax to compromise

If you owe both individual and business tax debt, file separate Forms 656 for each, with individual application fees.

Step 4: Choose Your Payment Option

• Lump Sum: Pay 20% upfront, then balance within five months of acceptance
• Periodic Payment: Make your first payment with the application, then monthly payments over 6–24 months

Step 5: Submit Your Application

Include:

• Completed forms
• Supporting documentation
• $205 application fee (unless exempt)
• Initial payment

Mail everything to the address on the Application Checklist (Form 656-B, page 29) or submit online via your IRS Online Account.
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Common Mistakes and How to Avoid Them

Mistake #1: Applying When You Can Actually Pay

If the IRS determines you can pay in full through installment payments or asset liquidation, they’ll reject your offer. Assess your finances honestly.

Mistake #2: Not Staying Current While Pending

If using periodic payments, you must continue making them while under review. Missing payments or failing to file new returns voids your offer.

Mistake #3: Lowballing the Offer Amount

The IRS uses formulas based on your equity and income. Offering too little without justification results in rejection. Use the Pre-Qualifier tool to estimate accurately.

Mistake #4: Incomplete or Missing Documentation

Missing forms or supporting materials delay processing or cause automatic returns. Always follow the Application Checklist.

Mistake #5: Providing Inaccurate Financial Information

False statements or hidden assets can result in rejection, fraud charges, and ineligibility. Always be truthful.
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What Happens After You File

Initial Processing (30–60 Days)

The IRS reviews your application for completeness and eligibility. If accepted for review, you’ll get a contact letter.

Investigation Period (Up to 24 Months)

An Offer Examiner or Specialist may request documentation, conduct interviews, or verify asset values. Respond quickly to avoid having your offer returned.

During this time:

• Penalties and interest continue
• Most collections stop
• No need to make prior installment payments
• Liens may still be filed
• Collection period is extended
• Offer is automatically accepted if no decision within 2 years

The Decision

The IRS will send a written determination:

• Accepted: Follow payment terms exactly.
• Rejected: You have 30 days to appeal using Form 13711.
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FAQs

How much should I offer?

The IRS calculates your reasonable collection potential (RCP) as your asset equity plus future income potential (monthly disposable income × 12 or 24 months). Your offer should meet or exceed this. Use the Pre-Qualifier tool to estimate.

Can I use my tax refund to pay my offer amount?

No. Refunds from tax periods before acceptance are applied to your old debt and don’t count toward your offer. You also can’t use expected refunds or seized funds.

Will the tax lien on my property be removed?

Not until you’ve paid your offer in full. Once cleared, the IRS releases the lien (usually within 30–120 days depending on payment method).

What happens if I can’t make a payment after acceptance?

You may request a one-time extension, but defaulting reinstates your full original debt with penalties and interest. The IRS can resume collection actions.

Can married couples with joint tax debt file separately?

Yes. One spouse can file individually for their share of joint debt, or both can file together. Separate debts require separate Forms 656 with individual fees.

How long does the entire process take?

Typically up to 24 months, depending on complexity. Simpler cases may finish sooner; complex cases involving businesses or asset disputes take longer.

What if the IRS values my assets differently than I do?

You can submit supporting documentation, request a conference, or apply for Fast Track Mediation (if eligible).
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Additional Resources

• Official Form 656-B Booklet: IRS.gov/pub/irs-pdf/f656b.pdf
• Offer in Compromise Pre-Qualifier Tool: IRS.gov/OICtool
• Complete OIC FAQ: IRS.gov/businesses/small-businesses-self-employed/offer-in-compromise-faqs

The Offer in Compromise program represents a genuine second chance for taxpayers facing insurmountable tax debt, but it requires complete honesty, thorough documentation, and patience. If you qualify, it can provide real financial relief and a path to compliance.