Effective tax administration offers: when the IRS settles a debt the taxpayer could pay

What makes an offer ETA

IRC 7122(d)(1) directs the Treasury to write guidelines for deciding whether an offer is adequate, and IRM 5.8.11.2 explains that Congress wanted those guidelines to allow the IRS to consider hardship, public policy and equity. Treas. Reg. 301.7122-1(b)(3) is the regulatory authority for ETA offers. The defining feature is stated in IRM 5.8.11.3: “By definition, ETA OICs apply only when the taxpayer can pay in full.” In an ETA offer, reasonable collection potential (RCP) is larger than the liability. The Tax Court treats that as a legal precondition, not an IRM preference: in Murphy v. Commissioner, 125 T.C. 301 (2005), aff'd, 469 F.3d 27 (1st Cir. 2006), it saw no error in refusing ETA consideration to a taxpayer who could not pay in full, because Treas. Reg. 301.7122-1(b)(3)(ii) “makes the ability to make full payment a precondition to any offer in compromise based on effective tax administration.”

That produces a sorting rule practitioners need to apply before choosing a box on Form 656:

IRM 5.8.4.2(4) says the factors establishing special circumstances under DATCSC are the same as those considered under ETA, so the analysis below applies to both. IRM 5.8.11.3 illustrates the line: a taxpayer who owes $20,000 with RCP of $25,000 may qualify for ETA; a taxpayer who owes $20,000 with RCP of $15,000 does not meet the ETA legal basis but could be accepted below $15,000 under DATCSC. The IRM also blocks a common tactic: “A DATC OIC does not convert to an ETA OIC if the Offer Examiner/Offer Specialist (OE/OS) and the taxpayer cannot agree on an acceptable OIC amount.”

Before any ETA offer is considered, IRM 5.8.11.3(6) requires three things: a liability that has been or will be assessed before acceptance, RCP greater than the amount owed, and exceptional circumstances (economic hardship, or compelling public policy or equity considerations).

Economic hardship

The hardship standard is borrowed from the levy release regulation, Treas. Reg. 301.6343-1(b)(4). IRM 5.8.11.3.1: “Economic hardship occurs when a taxpayer is unable to pay reasonable basic living expenses.” Unique circumstances count, but not maintenance of an affluent or luxurious standard of living. Because the test turns on living expenses, the IRM limits it to people: “Compromise on economic hardship grounds is not available to corporations, partnerships, estates, or other non-individual entities.” Sole proprietors qualify as individuals.

The examiner reviews the financial statement and the special circumstances together. Factors listed in IRM 5.8.11.3.1(5) and (6) include age and employment status, the number, age and health of dependents, local cost of living, extraordinary expenses such as special education, a medical catastrophe or natural disaster, and situations where:

• a long-term illness, medical condition or disability prevents earning a living and the taxpayer's resources will foreseeably be exhausted providing care;
• a fixed monthly income is exhausted each month caring for dependents and there is no other means of support; or
• the taxpayer has assets but cannot borrow against them, and liquidating them would leave the taxpayer unable to meet basic living expenses.

The IRM examples are instructive: a parent providing full-time care to a seriously ill child who will need the asset equity for the child's care; a retiree whose pension does not cover expenses and whose only asset is a retirement account large enough to pay the tax; a disabled taxpayer on fixed income whose only significant equity is a modest house specially equipped for the disability. In each, the compliance history must not weigh against compromise. Medical conditions and other hardships must be verified.

Collection Financial Standards are the starting point for basic living expenses, but IRM 5.8.11.3.1(4) allows a deviation, with reasonable substantiation, when a standard amount is inadequate for the specific taxpayer. See the Collection Financial Standards.

Public policy or equity

The second track, which the IRM calls non-economic hardship ETA (NEH-ETA), applies when there is no doubt as to liability, no doubt as to collectibility and no hardship. Per IRM 5.8.11.3.2, compromise is justified only where, due to exceptional circumstances, “collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner.” The IRS acknowledges that this treats the taxpayer better than others who paid in similar circumstances, and puts the burden squarely on the taxpayer: “Taxpayers seeking compromise on this basis bear the burden of demonstrating circumstances that are compelling enough to justify compromise notwithstanding this inherent inequity.”

All non-hardship ETA offers must show that the taxpayer has stayed compliant since incurring the liability, acted reasonably and responsibly in the situation that created it, and would not end up better off than if they had complied on time unless special circumstances justify it. Liabilities from abusive tax avoidance transactions generally will not be compromised. IRM 5.8.11.3.2.1 lists the issues that may support NEH-ETA:

What does not qualify: compromise is not “authorized based solely on a taxpayer's belief that a provision of the tax law is itself unfair” (IRM 5.8.11.3.2.1(11)). The IRM's examples are cancellation of debt income and a tax shelter investor who declined a global settlement and later sought better terms. Offers recommended for acceptance on factors not listed in the IRM require additional review because they can set policy.

The Tax Court has endorsed that limit. In Speltz v. Commissioner, 124 T.C. 165 (2005), the taxpayers owed alternative minimum tax on incentive stock options whose stock had collapsed, offered $4,457 against a liability over $125,000, and argued in a lien CDP hearing that IRC 7122 required the IRS to compromise a tax that was unfair in their circumstances. The court sustained the rejection: “We do not discern in section 7122 an intent of Congress to override application of specific provisions of the tax laws in every instance in which the liability is perceived to be unfair or inequitable,” and “we cannot conclude that it is an abuse of discretion for the Appeals officer to decline to do so.” It found the regulation and IRM definitions of special circumstances and public policy “are not unreasonable” and that the Appeals officer had correctly applied the IRM passages cautioning against relief that would undermine congressional intent. The consequence for an equity offer is that the narrative must show something about this taxpayer's situation other than the statute's effect, such as IRS error, erroneous advice or a third party's fraud, and must fit a factor the IRM already recognizes. Note also that the Speltz offer was filed as a DATC offer with no ETA box checked, which is the mismatch the filing steps below warn against.

The compliance screen

No ETA offer, hardship or equity, can be accepted if it would undermine compliance. IRM 5.8.11.3.3 lists factors that support (but do not conclusively establish) that finding: an overall history of noncompliance with filing and payment requirements, deliberate actions to avoid payment, and encouraging others to refuse to comply. Expect the examiner to pull filing and payment history for several years, and address any gaps in the narrative rather than leaving them to be discovered.

How the acceptable amount is set

Because RCP exceeds the liability, the amount is a judgment call that must be documented.

Hardship offers. IRM 5.8.11.5.3 says the acceptable amount “must include all RCP that is not reasonably established to be essential for health and welfare.” The examiner works out how much of the equity the taxpayer will reasonably need. The IRM scenarios show the method: a taxpayer owing $100,000 with $125,000 of retirement equity who will need $75,000 to cover medical and living costs that exceed income has an acceptable offer of $50,000; a retiree whose expenses exceed income by $200 a month is estimated to need about 120 months of supplements ($24,000), so the examiner asks for the remaining investment equity. The examiner may not reduce asset values or invent encumbrances to make RCP match the offer. Temporary hardship, such as short-term unemployment with equity in a home, points toward currently not collectible status rather than an offer.

Equity and public policy offers. IRM 5.8.11.5.3.1: “the IRS expects the taxpayer to offer an amount that is fair and equitable under the circumstances, versus nominal or token funds.” Where IRS error or delay caused the problem, the target is the position the taxpayer would have been in without the error. For an operating business harmed by a third party, the IRS generally expects the full remaining tax, exclusive of interest and penalties, with more flexibility for payroll service provider cases.

Filing an ETA offer

1. Confirm the basis. Run the full-pay and RCP computation first. If RCP is below the liability, check DATC or DATCSC instead; the IRM requires the basis in AOIC to match Form 656, and an offer filed on the wrong basis can be rejected even where another basis would have worked (IRM 5.8.11.4(5)).
2. Complete Form 656 selecting one reason, with Form 433-A (OIC) or 433-B (OIC). IRM 5.8.11.4(2) says to clarify and secure an amended Form 656 when more than one box is checked; a taxpayer claiming that payment in full would harm the household is asking for hardship consideration, not NEH-ETA.
3. Write the Section 3 narrative (or an attachment) explaining why full collection would cause hardship or why public policy or equity justifies compromise, with documentation: medical records, care costs, proof of IRS error or advice, police reports or court records for third party fraud.
4. Pay the $205 application fee and the initial payment unless the taxpayer meets low-income certification (Form 656 Booklet, Rev. 4-2026). IRM 5.8.11.4(4) applies the same processability rules as other offers.
5. Expect routing: hardship offers are worked in Centralized or Field OIC; offers submitted solely on NEH-ETA grounds go directly to the NEH-ETA group (IRM 5.8.11.4).

A taxpayer whose DATC offer is under investigation can add ETA consideration by submitting an additional Form 656, which is treated as an amended offer (IRM 5.8.10.14(3)). Rejected ETA offers carry the same 30-day appeal right as other offers. See the offer overview and package checklist.

Payroll service provider failures

The IRM gives specific attention to businesses whose payroll service provider (PSP), professional employer organization or reporting agent took the deposits and did not remit them. Factors showing the business acted reasonably include monitoring deposits through EFTPS, checking the provider's references, licensing and corporate filings before engaging it, acting immediately once the misconduct surfaced, and mitigating events such as serious illness (IRM 5.8.11.3.2.1(6)). A business that hired an unknown provider, never monitored deposits and handed IRS notices to the provider is the IRM's example of unreasonable conduct.

For acceptable amounts in PSP cases, IRM 5.8.11.5.3.2 asks whether paying RCP or the remaining tax would affect current expenses, other tax obligations, employment, services to the community, or the business's survival, and requires reimbursements from bonding companies, insurers or restitution to be included or secured by collateral agreement. Victims of PSP fraud can also offer without the TFRP determinations normally required for trust fund offers (Form 656 Booklet). See the trust fund recovery penalty.

Questions practitioners ask