Of all the debts it’s possible to owe, federal tax debt surely is the scariest. After all, Washington’s power to collect virtually limitless plus bringing taxpayers into compliance can involve harsh penalties and interest, confiscate or place liens on property, invade your bank account, even garnish your paycheck.
Small wonder tax debt relief is a key component of modern life in America.
While many taxpayers receive refunds at tax time, coming up short is not unusual. In recent years, roughly 20% of taxpayers — one in five — file a return with a balance due of about $3,000. (Word to the wise: File your taxes! Even if you’re unable to come up with the payment; then contact the agency about getting yourself out of federal hock.)
Luckily, because what the IRS (and any other tax-enforcement agency) really wants is what the government is owed, there are ways out of tax-debt trouble. Despite its intimidating reputation, it’s not the IRS’s intention to punish out of spite. Moreover, because it knows it can collect money only if the moneyactually exists, the agency has payment options for taxpayers in tough situations.
What is Tax-Debt Relief?
Tax-debt relief is a broad concept covering assorted options, each designed to make the best possible peace between taxpayers who have fallen behind and the IRS. (We’ll discuss state and local taxing agencies later.)
Relief usually takes the form of a payment plan or a debt settlement, also known as an offer-in-compromise. Which one is right for the tax-debtor hinges on his/her overall financial condition.
Who might need tax-debt relief?
- Taxpayers who have fallen behind and lack the resources to pay their debt via personal loan, home equity loan, credit card, investments, etc.
- Taxpayers in arrears who have come to the attention of private debt collectors hired by the IRS.
- Those who have failed to file tax returns for any number of years, but who have (so far) managed to operate beneath the radar of the IRS.
- Taxpayers whose debt is so “seriously delinquent” ($50,000 or more) the IRS has instructed the State Department to deny, revoke or confiscate their passports.
The IRS offers programs for delinquent taxpayers trying to get themselves square. Any of the programs can be self-initiated by the taxpayer. However, for those reluctant to go it alone, a tax-settlement industry has emerged to help consumers navigate the agency’s rules.
In advertisements, some of the players claim impressive credentials, experience, and miraculous outcomes. Watch out.
While most tax settlement services tout rosters of former IRS agents and other tax experts ready to use their expertise to slash what you owe, the reality is something different. Tax settlement companies tend to be populated primarily by low-wage customer service representatives with slender amounts of expertise.
Done right, a tax settlement company will:
- Learn why the customer has fallen behind or failed to file
- Obtain the proper financial information from its customer
- Provide a realistic assessment of what the company can do
- Match the troubled taxpayer’s situation with the best available IRS program
- Charge a reasonable fixed fee
IRS Relief Options
As mentioned above, the IRS offers a handful of options for delinquent taxpayers: payment plans, offers in compromise, filing as not currently collectible.
Installment agreements operate like any other loan: You pay a set amount each month over a period of time (up to six years) until your tax bill is paid off. Entering an installment agreement ends the accrual of penalties, but, like any loan, it does carry interest. There also will be processing fees.
If you owe less than $50,000 in combined taxes, interest and penalties, it’s possible to apply for an installment agreement online via IRS.gov. The upside to installment agreements: You can stave off liens, levies, garnishments and other collections activities.
Taxpayers who can prove that paying the full amount due — now or over time — would be ruinous may qualify for an offer in compromise (OIC): that is, an agreement to settle their tax debt for less than the amount owed. The IRS weighs a host of factors, among them ability to pay, income, expenses, and asset equity. The agency generally approves an offer in compromise only when the amount offered represents the most it can expect to collect in a reasonable period of time.
Applications must be accompanied by a payment of 20% of the total offer amount, plus a nonrefundable $186 fee.
If accepted, offers in compromise can be paid two ways: in a lump sum, or in monthly installments. However, because the IRS rarely accepts them (again, despite heavy advertising suggesting otherwise by some tax relief companies), an OIC shouldn’t be your go-to option.
In some circumstances, delinquent taxpayers who have next to no money left each month after meeting essential expenses — rent, utilities, groceries, commuting, and certain other payments (see below) — can qualify for a deferral. If the IRS deems taxes “Currently Not Collectible,” the agency will cease collection efforts, giving the taxpayer some breathing room, as well as release from the fear of the IRS breathing down his or her neck.
However, there are downsides: The tax debt remains; the balance will continue to accumulate interest and late penalties; and the IRS may file a lien against the taxpayer’s property (which shows up on credit reports). Oh, and taxpayers expecting a refund in subsequent years can forget about that; the IRS will apply those to any unpaid past-due taxes.
IRS Forgiveness Program
With installment agreements and offers in compromise, the IRS’s Fresh Start Initiative was already luring troubled taxpayers into compliance, but the expanded program is even friendlier, making it easier than ever to qualify for installment programs or offer-in-compromise settlements.
Among the highlights:
- For offers that will be paid off in five or fewer months, the agency looks at only one year of future income (down from four years) when assessing a taxpayer’s reasonable collection potential. For longer payoffs — six to 24 months — the IRS looks at only two years of future earnings (down from five years).
- The IRS expanded the Allowable Living Expense calculation to include credit card payments, bank fees and charges, and certain other assorted allowances.
Penalty & Interest Abatement
It doesn’t happen often, but in rare situations, the IRS may offer penalty abatement for delinquent taxpayers who can demonstrate a special hardship. Under its First Time Penalty Abatement policy, the IRS may grant administrative relief for failing to file a return, pay on time, and/or to deposit taxes.
The agency lays out the following criteria:
- You didn’t previously have to file a return or you have no penalties for the three years prior to the tax year in which you received a penalty.
- You filed all currently required returns or filed an extension of time to file.
- You have paid, or arranged to pay, any tax due.
Interest abatement is even more limited, and is rarely approved.
However, neither form of relief eliminates the tax bill owed, and the failure-to-pay penalty will continue to accrue until your tax is paid in full. Because you don’t want a partial waiver, it may be to your advantage to wait until you fully pay the overdue tax before requesting relief under the first-time penalty abatement policy.
Other Debt-Relief Options
In genuinely desperate situations — and only if several provisions apply — older income tax debt (at least three years old) can be eliminated through Chapter 7 personal bankruptcy.
Tax debt also can be discharged via the statute of limitations. Taxes the IRS has attempted, but been unable, to collect, are erased after 10 years.
A less extreme measure would be consulting a reputable tax debt relief service, which may be able to intervene to relieve liens, bank account seizures, or wage garnishments.
Signs of a Tax-Debt Relief Scam
As with any industry — especially one that deals with desperate, panicky clients — there are companies that are on the up-and-up, and there are predators.
That is absolutely true in the tax debt relief arena.
Begin by not buying into the advertising hype: For most tax debtors, resolving their trouble for pennies on the dollar is a pipe dream. Next, do your homework. Search beyond the advertising for neutral-observer rankings of legitimate tax relief companies. Finally, arm yourself with knowledge about when you’re dealing with a bad actor.
Signs that a purported tax debt relief company is attempting to swindle you include:
- Demanding payment before the company has done anything for you is a key indicator
- Promising, upfront, a drastic reduction in a customer’s taxes
- Pledging to eliminate or radically reduce penalties and interest
- Failure to ask the client why (s)he is behind with the IRS
- Failure to fully assess your financial background (because the IRS certainly will before it approves any OIC; any company that doesn’t take the lead here probably can’t, or won’t, help you)
- Contacting you directly via letters or email
- Applying delaying tactics: for instance, asking for the same documents repeatedly
- Finally, after you’ve paid in and waited months, being told your debt relief window has closed, or the IRS rejected your OIC application; oftentimes, the companies in question have done absolutely nothing except take your money and string you along
There are horror stories that add insult to injury. Taxpayers who signed on with one or another tax debt relief company (and paid thousands of dollars in upfront fees) complained to the Federal Trade Commission about unauthorized charges on their credit cards, or withdrawals from their bank accounts.
Innocent Spouse Relief
The IRS sympathizes with spouses or former spouses who, through no fault of their own, find themselves on the hook for back taxes. Couples who file joint returns are both liable for taxes owed, but in some cases will relieve one partner of any taxes, interest or penalties.
To be eligible, the spouse must meet certain criteria:
- Filed joint return containing an erroneous understatement of tax responsibility relating directly to their spouse
- Must have lacked knowledge of the error
- Once identified, the IRS must consent to relieve the innocent spouse of the tax in dispute
- Spouse must apply for relief within two years of when the IRS initiates collection
State & Local Taxes
Falling behind on state and/or local taxes is a completely different ballgame. While states and local taxing authorities also offer debt settlement programs similar to those of the IRS, there can be important differences. Some states allow waiving interest, but not penalties; other states offer the reverse. Your results may vary.
For more information, contact your state comptroller’s office. Visit nasact.org for a state-by-state listing of state auditors, comptrollers and treasurers.