Chances are you know someone right now that has huge tax problems. More people have tax issues than you may realize. I end up working with a lot of clients that need multi-year tax returns filed, as well as help with IRS or state tax authorities. Many avoid it because they can’t pay, or because they are embarrassed to ask for help. The fact is that tax problems are very commonplace and dealing with the problem is similar to paying down your credit card debts. The longer you let it go, the harder it will be to unwind. There is certainly nothing to be afraid of, unless you avoid the situation. More often than not, when I explain the options to a client and they understand how the process works, they feel much better. There are many options to dealing with tax debts and each option should be carefully considered in order to determine your best course of action. The objective of this article is to give you a crash course in dealing with tax problems and offer you some common sense, practical advice.
Whether the IRS is demanding full payment of all taxes owed, offering you an installment plan that you can’t pay, or threatening you with liens and collection efforts, the fact remains that a skilled CPA or EA can help you to resolve the debt in a way that is realistic and manageable. Contrary to what you may have heard, the IRS is not interested in making your life miserable or in taking your assets. What they are interested in is your money. And, they will do what needs to be done to get as much of it as they can. So, the largest part is to convince them as to exactly what “as much of it as they can” actually is. This does require some skill and know-how.
Most Common Methods for Resolving Tax Debts
1. Offer-In-Compromise – If you can’t afford to pay the taxes due, you can settle the debt with the IRS for less than the amount owed. You need to go through a process that is a lot like applying for a mortgage and convince the IRS that you cannot pay the tax debts owed. This method requires the most skill and experience of any of the various methods. And, it usually only makes sense for tax debts that are greater than $10,000 in aggregate (rule of thumb).
2. Payment Plans (aka Installment Agreements) – If you can’t pay the taxes in full but can pay them over a period of time, you can set up a payment plan with the IRS. As long as you comply with the plan set forth once it is approved by the IRS, they will take no further collection actions (such as garnishing wages or levying bank accounts).
3. Bankruptcy – In certain situations, a bankruptcy filing can eliminate all or part of your back taxes. You should only consider this option after trying to get the IRS to accept an Offer-In-Compromise, and certainly you will need to consult both a CPA and an attorney.
4. Innocent Spouse Relief – Sometimes, a spouse can prove that the taxes are owed due to the actions taken by his/her spouse and he/she can be relieved of tax debts. There are very specific rules in the IRC about this type of relief.
The IRS has made public the following objective for their Offer-In-Compromise (OIC) program:
The Service will accept an offer in compromise when it is unlikely that the tax liability canbe collected in full and the amount offered reasonably reflects collection potential.
As you are going through this process, I highly suggest you keep this statement in mind. The IRS agents clearly use this statement to guide them. So, in the big picture, everything you do should be geared toward this statement. They have showed their hand. Are you going to take advantage of that?
This is where experience comes into play, and where inexperienced people make a lot of mistakes. You need to take much due care when going through this process. If the IRS doesn’t think they can collect the full balance, they will take great diligence to see how much they think they can collect. Then, they will often times settle the debt with the taxpayer in a timely and orderly fashion. I also highly recommend you have a strategy in mind before going into the process.
When to Seek an Offer-In-Compromise (OIC)
1. There is no way you can pay the tax debt today and it is highly unlikely you will be able to pay it in the foreseeable future.
This is by far the most common reason that people file an OIC. The process starts with you making an offer to pay a certain amount and you send them some financial information. The process is a lot like applying for a mortgage. They are trying to see what you are able to pay. I cannot stress enough how much due care and experience is needed in this process. Most of the time, the first offer is rejected and eventually there is an agent assigned to your situation that can be verbally negotiated with. The best strategy here is to release as little information as possible with the goal being to get to the stage where you are negotiating with an IRS agent. They may seem nice on the phone, but rest assured they will try to trip you up. Remember, they want to collect as much money as possible from you. Here is what is in play: your assets, your income, and they may even look at family/friends or other means you have to pay the tax debt, even if they couldn’t attach a lien to it!
2. There is significant doubt that you even owe the tax. That is, you are in a disagreement with the IRS on whether the taxes are due or not. Sometimes this situation ends up in tax court.
This type of OIC can be very time consuming, as you effectively need to show the IRS agent why you disagree with the tax assessment and what argument you would be ready to make in court. The upside is that often times the agent assigned to your case is ill prepared or improperly trained to assess the situation, and the OIC is granted based on ignorance rather than merit.
3. Paying the tax debt would cause you undue or unusual economic hardship, or to make you pay the tax debt is clearly not in line with good public policy (termed Effective Tax Administration).
This is a less common angle to take when applying for an OIC. The strategies behind this stance are numerous and are beyond the scope of this article. However, know that there are ways other than #1 or #2 above to reduce your tax debt. Sometimes, it doesn’t make logical sense for you to pay the entire balance. For example, think about someone that was granted stock options and didn’t really understand them. The stock options generated a $100k tax liability and then became worthless. The tax liability remained. The taxpayer might be able to pay $20k per year to settle the debt. But, I would argue with the IRS and file an OIC under Effective Tax Administration theories.
Frequently Asked Questions
Q: I haven’t filed tax returns in a few years, and I have some past due tax returns. Can I file an Offer-In-Compromise?
A: An Offer-In-Compromise will not be considered until you have filed all necessary returns and/or you have no returns in delinquent status.
Q: My back taxes owed are more than ten years old. Is it true that I no longer owe them?
A: Yes and No. It is true that the IRS only has 10 years to collect taxes from the initial date of assessment. It is not true that they are automatically wiped clean. An experienced CPA can navigate through the process to get the tax debts wiped clean for you.
Q: Does it sometimes make sense to “do nothing” and just wait for the ten year statute of limitations to run its course?
A: Yes. Depending on your circumstances, in certain situations, this could be a good strategy for you. But, you should carefully talk through this with a CPA to evaluate your options.
Q: What percentage of the total tax debt will the IRS accept in an Offer-In-Compromise?
A: This is a very common misconception. There are no hard and fast rules to what they can and cannot accept. The bottom line is that they will accept what they think they are better off taking now instead of trying to collect later. This part of the game requires experience and skill to know how to position you, and how to negotiate with IRS agents.
Q: If I file for an Offer-In-Compromise, how much should I offer?
A: It is more likely than not that your first offer will be denied, unless you foolishly offer a higher amount than you should. In practicality, you should not offer a penny more than you can comfortably pay.
Q: Is it free to apply for an OIC? What money do I have to send in to get started?
A: No, it is not free. There is a $150 application fee. And, the IRS is talking of making that higher in order to discourage frivolous applications and/or applications that are clearly abusing the system just to buy more time. If you are making a lump sum cash offer, then you need to submit 20% of the offer amount with the application. If you are offering periodic payments, you need to make the payments you are asking to make during the review process. If your OIC is denied, all funds you paid will be refunded to you. The $150 application fee is not refundable, however.
Q: What happens if I miss a payment?
A: If your application is under review, your application is then deemed abandoned by you. If you are making payments under an agreed upon and executed OIC, then the IRS has the option of voiding the deal. From a practical standpoint, there is some grace period. Usually, if there is a good reason for your payment being late, they will reinstate everything. But, I would never recommend taking that risk.
Q: Is there any risk in submitting an OIC just to see if I can get the tax amount reduced?
A: Yes, if you file a “frivolous” offer or an offer clearly to just delay collection, you may be subject to civil penalties and/or fines. This is rare but is a possibility, nonetheless.
Q: How long does the OIC process take?
A: I have seen it take as little as 3 months, but be prepared to saddle up for 6-9 months. Now, the IRS only has 24 months to make a determination on your OIC. If they do not, your OIC is deemed accepted.
If you honestly cannot pay your tax bill, you will probably be ok. The IRS’ programs are actually quite accommodating, though they can be frustrating and time consuming. Overall, you can get tax relief if you really need it under one of the methods described above. This article is a very simple and condensed summary of what is available. But, I think it gives someone with no knowledge enough information to determine their next steps.
The worst thing a taxpayer can do is ignore their tax debts. There are definitely more favorable results for a taxpayer that appears in good faith and is trying to be a good tax-paying citizen. A very common misconception is that there is some sort of formula out there for the IRS to settle tax debts. This is not so. The IRS agents are people who can show compassion for some and annoyance and a sense of justice for others. Yes, they want to collect as much as they can, and that is their job. But, the cooperative and responsive taxpayers definitely get better treatment than the apathetic and “avoiding the situation” taxpayers. Let’s just say, your credibility does come into play during the negotiation process.
Co-authored by Dan Lucas, CPA and Adam Lucas, EA