Tax Settlement

Death and taxes are life’s two great certainties, but every year a sizeable number of people who owe the Internal Revenue Service act as if they don’t grasp the maxim.

Falling behind on income tax payments is almost always a very bad idea. The government eventually will catch on and hit you with a bill for what you didn’t pay. With interest added! And, oh, the longer you delay, the worse the consequences.

Fortunately, the IRS will sometimes work a deal with those who can demonstrate that they couldn’t pay taxes because they didn’t have the money, not because they were hellbent on cheating the government. (Those hellbent people should be researching options on how to avoid going to jail for tax debt.) For those who want to settle their tax debt but are so strapped that they can’t immediately pay what they owe, the IRS offers options. You need to understand the options and choose a strategy that works for you.

Keep in mind, though, that a tax settlement attempt won’t succeed for everyone. Nor is everyone even eligible to try; in fact, most taxpayers aren’t. And beware of the sweet-sounding promises often made by tax settlement firms who, for a price, claim they will work with the IRS on your behalf to get you some tax debt relief. In many cases, their promises are too good to be true.

What Is Tax Settlement?

A tax settlement is a negotiation in which a dispute between a taxpayer and the IRS is resolved and the taxpayer’s debt is reduced. There are several different avenues to a tax settlement, as well as an option to create a payment plan that allows the taxpayer to meet his or her obligation over time rather than under standard IRS deadlines.

The IRS wants all its money, of course. So why would it agree to a tax settlement? Because when it’s convinced it won’t get everything it claims to have coming from you, it understands that something is better than nothing.

Not surprisingly, the prime benefit to a successful tax settlement from your perspective is that you’ll pay less than what you owe. But there are other advantages, too, that are related to the consequences of not paying your taxes.

For example, a settlement can help you avoid a tax lien, which is when the government goes after assets such as your personal property or business over your failure to pay your taxes. A settlement can also keep the IRS from garnishing your wages, which would require your employer to send a specified percentage of your regular paycheck amount to the government until your tax debt is discharged.

If you can dodge those two IRS land mines, you’ll be in a much better position to protect your credit score, which could crater in the wake of a tax lien or wage garnishment.

If you can’t pay the government what you owe, a tax settlement is preferable to most of the alternatives.

Who Is Eligible for a Tax Settlement?

The special circumstances that might qualify you for tax settlement aren’t pretty. In general, you’ll have to convince the IRS that you’ve tried everything possible to meet your tax obligations and failed, and/or that the reason you’ve failed is due to circumstances beyond your control. Do that, and there’s a chance the IRS will work with you to provide some tax debt relief.

There is math involved (go figure!) when the IRS is deciding on your eligibility. It starts with an examination of your assets and household income against your expenses to establish the state of your finances.

Based on those numbers, the IRS determines how much it thinks you could pay each month toward your tax bill. If the amount it deems possible for you to pay is less than your tax liability, you’ve got prospects for a settlement. But you won’t be eligible for a tax settlement if you already have a pending bankruptcy filing.

There are three basic pathways to a tax settlement, depending on the taxpayer’s circumstances:

• If you simply can’t afford to pay the entirety of your tax bill, you might be eligible for a settlement under an IRS provision called “Doubt as to Collectability.” This is the most common route.
• If you have a convincing argument that you shouldn’t owe as much as the IRS has billed you, you might be eligible under the “Doubt as to Liability” provision.
• If you can afford to pay your tax bill but can show that it will create a dire financial hardship, you might be eligible under the “Exceptional Circumstances” provision.

Here are some of the eligibility factors the IRS will consider in a delinquent taxpayer’s financial hardship case:

• A long-term illness, medical condition or disability that makes it impossible to earn a living.
• The demands of caring for dependents who have no other means of support.
• A natural disaster that causes extreme financial difficulties.
• An inability to borrow against the equity in a taxpayer’s assets, and liquidation of those assets to pay the tax bill would make it difficult to cover basic living expenses.

One other important thing to remember in maximizing your eligibility for a tax settlement: The IRS loves its paperwork. You’ll need to make sure you jump through every filing hoop the IRS throws at you during the settlement process. You’ll have to have filed all the required tax returns and made all your estimated payments, plus you’ll have to have secured a valid extension for the current year’s return if that’s the year for which you’re applying for a settlement. And that’s before you get to the specific settlement forms. (More on them later.)

How to Settle Your IRS Tax Debt

Those three pathways to a tax settlement we outlined in the previous section are what the IRS calls Offers in Compromise, which is how you can settle IRS debt for less than the full amount you owe. We’ll dig a little deeper into Offers in Compromise in a bit.

But there are other ways to get help with tax debt, too. For example, under some circumstances, the IRS will allow you to pay your tax bill in installments over time rather than in a lump sum and by the deadline that applies to most taxpayers.

There is also an option to get relief from a penalty the IRS imposed for a tax delinquency, assuming you can make the case that you tried to pay your bill, but couldn’t because of circumstances beyond your control. That option is called Penalty Abatement. There are several additional alternatives that might be worth exploring, too, depending on your circumstances.

And, of course, the IRS promises to at least listen when you request an extension to the date your payment is due.

In the next few sections, we’ll explore some of these options in greater detail.

Installment Plans

Installment plans are like home mortgages, but instead of paying a lender every month, you pay the IRS every month.

A tax-payment installment plan is an agreement with the IRS. To enter the installment plan, you need to satisfy IRS requirements, including:

• You are up to date in filing tax returns.
• Your state income taxes, and late fees, are mostly paid.
• You can make the monthly minimum payments that the IRS requires.

Qualifying for a tax installment plan isn’t always possible. The IRS, as a tax collection agency, always prefers receiving tax payments to not receiving them. But it also isn’t interested in entering a payment agreement with a truant taxpayer who is unable to make the monthly installments.

The IRS won’t deal with you when you are more than $50,000 in arrears. But if you meet the debt criterium and have filed your past tax returns, the IRS will use a formula to arrive at a monthly payment. You should consult a certified tax resolution specialist, or an attorney specializing in tax debt relief to review your options and negotiate a payment plan with the IRS.

Offer in Compromise

As we’ve mentioned, the IRS will sometimes consider a settlement that allows you to pay a reduced amount of what you owe in back taxes, which is called an Offer in Compromise. You must convince the IRS that you can’t afford to pay what you owe and offer to pay the reduced amount in a lump sum or in short-term installments.

Though you might have seen television commercials suggesting that paying the IRS pennies on the dollar can be easily accomplished, such ads are misleading. The IRS has a special form that you need to complete when proposing a compromise, and it charges a $186 filing fee. The form requires detailed information about your income, spending habits, assets, and any equity you might have in investments. If you are working for wages or for yourself, you’ll also need to submit a collection information statement that is used to evaluate your ability to pay.

In evaluating your application, the IRS will consider your net worth and your sources of credit such as credit cards and home equity lines of credit. It will then compare your income with your monthly expenses to determine what you can afford to pay each month.

Again, you can’t apply for a compromise if you have an open bankruptcy filing. If you are accepted into a compromise agreement, you will have two years to settle your tax debt.

Release Wage Garnishments

If you owe money and haven’t reached a payment agreement, the IRS can move to garnish your wages. It also can garnish federal payments (Social Security, tax refund, etc.) until your tax debt is paid or the statutory time limit for collecting has passed. If you’re hit with a garnishment and can’t afford to live on the money left over, contact the IRS to propose a modification. If the IRS agrees, the amount it garnishes might be reduced.

Innocent Spouse Programs

When you file a joint tax return with your spouse, even if you are legally separated, you can be held individually responsible for an underpayment. But the IRS offers some relief for married or separated couples if a spouse, or former spouse, hides a tax liability from the other.

If one partner can demonstrate that the other failed to report income, reported income improperly or took deductions or credits that weren’t permitted, the partner who was misled can seek relief from tax liability.

To qualify for innocent spouse relief, you must be able to show that your spouse misled you either by not reporting income or by taking deductions or credits that weren’t permitted. Generally, you have two years from the time the IRS first attempted to collect the unpaid taxes to file for relief.

The IRS allows two other provisions for couples with a tax reporting problem:

• Separation of liability relief offers an exemption for divorced or legally separated partners who haven’t shared a household for 12 months prior to a relief application. Relief applies to those who signed a joint tax return that understated how much was owed when one partner was unaware of erroneous information contained in the return.
• Equitable tax relief is available to those who don’t qualify for innocent spouse relief or separation of liability relief, if they can show that something not reported on a joint tax return was solely the responsibility of the other spouse. Equitable relief can also apply when the tax reported on the joint return was correct but wasn’t paid with the return.

Innocent Spouse programs are complicated. The IRS offers a publication explaining the programs and a form that can be completed to seek relief.

Statute of Limitations

The IRS has 10 years from the date of assessment, which is usually soon after the filing date, to collect taxes, interest, and penalties. Tax lawyers and other advisors sometimes try to use the statute of limitation to resolve a tax case. Even if the IRS attempts to collect a tax debt, the taxpayer can file collection appeals to try to stall a tax levy, lien, or seizure prior to the statute of limitations deadline.

Trying to wait out the statute of limitations is a risky strategy. If you fail, your unpaid interest and penalties will have increased, and you will be liable for an even larger payment to the government.

Currently Not Collectible

If you can offer reasons why you simply aren’t able pay your tax now, the IRS can put your case on hold, labeling your tax debt currently not collectable. The “not collectable” status is temporary, and the IRS will tell you when you’re expected to pay. The advantage is the distinction puts a hold on tax levies, wage garnishments and liens on your property.

Work with a Tax Professional

Hiring a tax professional or attorney to help you with your compromise application is worth investigating. If your dispute with the IRS is complicated and the amount of back taxes, interest and penalties is high, it might be worth the cost.

As a rule of thumb, if your debt is less than $10,000, it’s usually best to contact the IRS yourself to try to arrive at a payment agreement. If your debt exceeds that amount but is less than $25,000, you should probably seek advice from a lawyer or tax pro. If it’s more than $25,000, contact a professional to assist in settling your tax debt.

Bankruptcy: Does It Ever Work?

Bankruptcy can eliminate your tax debt, but it’s not a sure thing. You need to examine your finances through the lens of the Chapter 7 and Chapter 13 bankruptcy codes to see if you qualify for a discharge of tax debt. You should also remember that bankruptcy can have severe financial consequences that can damage your credit rating, making buying a home or borrowing money extremely difficult for years after the bankruptcy is settled. It can also force you to liquidate nearly all your assets to satisfy creditors.

Other Tax Relieving Options

If you can take steps to lower your tax debt to $50,000 or less, you can qualify for an IRS installment payment plan. If you have credit cards, particularly those that offer cash-back rewards, it might be wise to use your plastic to pay down your tax debt to $50,000.

Racking up credit card debt that you can’t repay within a month is often a bad idea, but if it allows you to avoid IRS penalties, it might work for you. Before using credit cards for taxes, make a budget so you know you can afford to make payments. You should also consider discussing your plan with a debt management or credit counselor.

Finally, if you enter an installment agreement with the IRS, make sure you make all payments on time. The IRS has little patience for those who don’t stick to its agreements, and it will quickly impose penalties and back interest on your tax debt.