11 Ways to Get Tax Debt Relief and Pay Less Than You Owe
11 Ways to Settle Your Tax Debt and pay as little as possible to the IRS
Owing back taxes can be very scary, but one of these 11 ways of settling your tax debt could save you thousands. They can also be used to settle your Maryland Comptroller Tax Debt.
Table of Contents
1-File Your Taxes
This may sound like a strange way to settle your tax debt, but it is not uncommon. Over the years, I have had many clients with several years of unfiled tax returns. One client didn’t have enough withheld so he ended up owing taxes. Then he lost his job during the great recession and had no ability to pay. When he did get back to work he was afraid to file his taxes. He was worried he would owe the old tax debt plus more, because he had gotten letters from the IRS saying he owed for other unfiled tax years.
Unfortunately, if the IRS gets a W-2 from your employer but doesn’t get a tax return from you, they can “assess” your taxes and send you a bill. Basically, they make up a tax return for you called a Substitute for Return (SFR). But they don’t give you credit for any or all deductions you may be allowed, so the assessment is usually for the maximum tax payable on your gross income. Then they send you a bill and try to collect this amount
In the above case, when my client got back to work, he was making less. So we got his taxes done properly and took all the deductions he was entitled to. He was actually owed refunds for several years. This more than offset the taxes owed and he walked away with money in his pocket.
Why Should I file my taxes?
First of all, it is a criminal offense to not file tax returns. It is unlikely the IRS will come after the average citizen but they do like to go after high profile people to set an example. Recently, the Baltimore City Police Commissioner was sent to federal prison for 10 months for not filing his taxes. You can also google “Wesley Snipes tax evasion” for an example of a movie star who really did not want to pay taxes and spending several years in jail as a result.
Even if you never hear from the IRS criminal division, not filing taxes could impact your job, security clearance or professional license. It could also make it difficult to get a loan or buy a house.
Second, you may be losing out tax refunds. Because tax laws are so complicated there may be deductions and credits you didn’t know were available to you. And tax laws change so even if you owed one year, you might get a refund the next. But you only have three years to claim your refund, otherwise the IRS gets to keep your money!
Third, filing your taxes is generally the first step to solving your tax problems. Almost every other option on this list requires that your taxes are filed before you can take advantage of them. By filing your taxes, you will know exactly how much you owe and that alone can be a huge relief. The human mind has a tendency to exaggerate problems so having an exact number can give you peace of mind. Getting your taxes filed also creates some momentum for continuing the process.
The State of Maryland will not negotiate any tax debt settlement until your returns are filed. The IRS, on the other hand, will gladly take your money for an installment agreement without a return. But you will be paying the amount they think you owe!
When it comes to tax debt, the IRS generally has up to 10 years from the date your taxes were assessed to collect from you. If you can make it past those 10 years, you may never have to pay back your taxes. This strategy will take longer for Maryland because they have 20 years to collect from you.
How long does the IRS have to collect my taxes?
The IRS doesn’t have forever to collect taxes from you. As a general rule, according to the statute of limitations, they can collect up to 10 years from the date your taxes were assessed. The date of assessment is usually the date the tax return is due or the date the return is actually filed, if you filed late. That’s another reason to make sure you file your returns, even if they are late and even if you owe money: If you don’t file the returns, the taxes may never expire!
Does the IRS ever have more than 10 years to collect against me?
Yes, this 10-year deadline can be extended. First, the IRS can ask you to voluntarily extend the deadline, in an effort to get more time to collect the taxes. Filing an OIC will also extend the deadline during the time the IRS is considering your offer – and remember, it can take up to 2 years for you to hear a decision from them. Finally, if you file for bankruptcy, the deadline will be “tolled” or extended by the amount of time you are in bankruptcy.
Note that if you are granted CNC status, the statute will continue to run and will not extend the 10-year deadline. The danger here is that in order to qualify for CNC status, you must give the IRS all your financial information, which may be used now or in the future to collect from you. Installment agreements that continue after the expiration date may not extend the deadline.
What about my Maryland taxes?
Unfortunately, this strategy will take much longer with Maryland tax debt. The statute of limitations on tax debt in Maryland is 20 years, so your state tax debt will be around a lot long than your IRS debt. Worse yet, it continues to accrue interest at 13% per year. This means your debt will DOUBLE every 6 years. Ultimately, you will probably have to settle your Maryland tax debt by payment plan or bankruptcy.
3-Set Up an Installment Agreement (IA)
An installment agreement, which allows you to pay down your tax debt over a period of time, stops the IRS from pursuing its powerful collection methods – including the filing of a tax lien – against you.
What is an installment agreement?
An installment agreement (IA) is a payment plan that helps taxpayers who meet certain requirements get back on track so they can start paying down their debt. If you owe less than $10,000, the IRS will allow you to pay the back taxes over a period of 36 months. If you owe less than $50,000, the IRS will give you up to 72 months to pay.
A partial payment installment agreement allows you to pay less than the total amount owed by making monthly payments. Because the IRS is reducing the amount owed, you must fill out more detailed financial forms so the IRS can calculate the “reasonable collection potential” of the back taxes. Basically, the IRS looks at your assets, your income, and the statute of limitations on the taxes, and decides how much you can pay. If you make all the payments, any remaining balance is forgiven.
The biggest benefit of an IA is that the IRS will not file a tax lien against you. As previously mentioned, a tax lien can negatively affect your credit and prevent you from selling or refinancing your home.
I owe $10,000 or less…
The IRS will accept your proposed payment plan (or guaranteed installment agreement) if your outstanding balance is $10,000 or less, and, in the past five tax years, you:
Filed your tax returns on time.
Paid income tax due.
Have not previously requested an IA.
In addition, you must not have the current ability to pay the tax in full, which is a determination the IRS makes based on the information you submit.
Guaranteed installment agreements don’t require you to fill out any extensive financial disclosures. When you enter into a guaranteed installment agreement, you agree to pay your tax debt in full within three years.
I owe between $10,000 and $50,000…
There are two types of streamlined installment agreements. The first is the classic version, which requires the IRS debt to be less than $25,000, and repaid within five years. The IRS Fresh Start Initiative increases the debt limit to $50,000, with a repayment term of six years.
I owe more than $50,000 in IRS taxes…
While you may still be eligible for a repayment plan, there are a few more hoops you’ll have to go through, including a thorough financial disclosure to prove the plan is necessary in order for you to pay your tax debt.
You’ll need to complete Form 9465-FS, and attach a Collection Information Statement on Form 433-F. The IRS will conduct a more thorough investigation of your assets and liabilities to determine whether you qualify for the IA, and may also refuse your request if it deems you can pay your debt or are living a lavish lifestyle.
Another distinction if you owe $50,000 or more, is that the IRS will file tax liens against you until the tax debt has been paid in full.
How do I enter into an IA?
You or your tax representative will have to request it from the IRS. If you owe $50,000 or less in combined taxes, penalties, and interest, and have filed all required returns, you or your representative can either call the IRS, or use their Online Payment Agreement (OPA) tool. The OPA allows you near immediate notification of acceptance, which can take as little as 30 minutes.
If you owe more than $50,000, you’ll have to mail in your Form 9465 with the accompanying documentation and have it approved by the IRS. The IRS typically responds within one month.
Do I need to hire someone to help me resolve my tax debt?
Maybe not. If you owe less than $10,000, the IRS will accept any amount for your payment plan as long as you pay it off in three years. Most of the tax resolution firms out there will charge you thousands of dollars, which may be more than the penalties and interest you pay the IRS.
On the other hand, the more you owe, the more important it is to seek expert advice. An attorney with expertise in tax law can help you evaluate the options you have available to you to resolve your IRS debt, as well as any beneficial provisions applicable to your case, such as first-time tax abatements or a reasonable cause defense to penalties imposed – both of which can reduce the amount you owe.
It’s essential before you enter into any agreement with the IRS that you are fully aware of the terms and conditions you’re agreeing to. For example, when you enter into an IA, you agree to comply with all tax laws and make future filings and payments in a timely manner. Failure to do so results in default under the agreement.
Interest and penalties will continue to accrue on your unpaid tax balance, no matter which type of IA you enter into. A discussion with your lawyer may even help you determine what monthly payment will strike the balance between both protecting you from default, and paying down the most you can afford so you save big on accumulating interest.
4-Request Currently Non-Collectible Status (CNC)
If you have no assets and you can’t pay your current living expenses – you’re too poor to pay your tax debt – you can get the IRS to declare you currently not collectible. This will suspend all IRS collection activities, including levies and garnishments. The taxes are still owed and continue to accrue interest, but you have some breathing space. More importantly, the ten year statute of limitations continues to run, so you may be able to simply wait out the IRS and not have to pay back your tax debt at all.
What does Currently Not Collectible status mean?
Currently Not Collectible (CNC) is the designation assigned to taxpayers that cannot resolve their tax debt without incurring undue financial burden. If your account is placed in CNC status, it means the IRS cannot currently collect from you – or levy your assets or income – until your financial situation improves.
Keep in mind however, that while the IRS must cease all collection and enforcement activity, it will continue to charge interest and penalties to your account, and may arrange to apply any future tax refunds you are owed to your unpaid debt.
Furthermore, regardless of whether your account is in CNC hardship status, in many cases, typically those with a balance due of over $10,000, the IRS may file a Notice of Federal Tax Lien (NFTL). An NFTL can affect your credit rating, and impact your ability to sell your property or other assets.
Does CNC status mean I don’t ever have to pay my tax debt?
No. CNC status is not a permanent solution, and your tax debt is not forgiven. Your tax accounts remain in CNC status only as long as you cannot afford monthly payments. The IRS can continue to try to collect from you in the future, and will review your accounts annually to see if your ability to pay changes.
For example, let’s say the IRS closes your case as CNC at $50,000. If in the future your annual income exceeds this amount, the IRS will deem your financial situation has changed and you’re now able to pay your tax debt. Accordingly, your case will be reactivated and sent back to collection.
The IRS may also designate a follow-up date, reactivating the case on such date, and sending it back to collection regardless of any other factors. If at that time the IRS determines your ability to pay has improved, it can again commence its collection efforts.
What’s more, if you fail to file a tax return or continue to let back taxes accrue, which delinquencies can revoke your Currently Not Collectible status, the IRS can automatically re-open your case for collection.
How long does the IRS have to collect taxes from me?
The IRS can attempt to collect your taxes up to 10 years from the date they were assessed, after which time the taxes are no longer enforceable against you.
It’s worth noting that this 10-year period can be suspended in certain cases. For example, if the collection of taxes was delayed by the filing of an Offer in Compromise or bankruptcy, that will extend the time the IRS has to collect the tax over and above the 10-year limitation. An account in CNC status does not extend this 10-year period.
How do I apply for Currently Not Collectible status?
You need to contact the IRS and demonstrate that you cannot make monthly payments towards your tax debt, and that collection would create undue hardship by leaving you unable to pay your necessary living expenses.
You can either call the IRS, or fill out IRS Form 433-F, accompanied by a letter of request. If you decide to request CNC status, you should:
File tax returns for all prior years you were required to file a return;
Resolve any outstanding delinquent returns;
Continue to file your future returns on time, even if you cannot make payment, to prevent late filing penalties;
Gather information that will help verify your income, expenses, and debts, such as copies of your paycheck stubs, statements for monthly income you receive, such as Social Security benefits, pension, spousal or child support, TANF, etc., your lease or mortgage statement that shows your required monthly payment, property tax bills, utility bills, recent credit card statements, and so on; and
Provide the IRS any other financial information that will help it decide whether to grant your request.
What about Maryland taxes?
There is no CNC status in Maryland, and even if there was, it would not likely help you avoid paying taxes. There is a 20 year statute of limitations on tax debt in Maryland. so your tax debt will take decades to expire. Moreover, taxes in Maryland accrue interest at 13% per year, so your debt will only continue to grow.
If you owe both the IRS and the state of Maryland, you may want to set up a payment plan with the state first. Then when you apply for CNC status, you should be able to include the payments you are making to the state in your expenses, making it easier to qualify for CNC status because your available income to pay your federal taxes will be reduced.
Do I need help to file for CNC status?
Many people who contact the IRS directly to work out their tax debt end up in IAs instead of CNC status. According to the Taxpayer Advocate Service, an estimated 300,000 taxpayers who should have qualified for CNC status actually ended up in payment plans. Does the IRS do this on purpose to squeeze more money out of struggling taxpayers? I can’t say for sure, but by dealing with them directly, you may not get the best result. A seasoned tax lawyer can represent you in your negotiations with the IRS.
5-File Chapter 7
If you have filed your returns and not committed fraud, bankruptcy can wipe out back taxes more than 3 years old. Used in combination with one of the above strategies, you can hold the IRS off for a year or two until the taxes are dischargeable.
Many people are surprised to learn that bankruptcy can wipe out back taxes. As a general rule, income taxes more than 3 years old can be wiped out. And while you must have filed your returns and not committed fraud, bankruptcy can be a powerful way to deal with the IRS.
How do you wipe out taxes with a Chapter 7 bankruptcy?
There are two types of bankruptcy, Chapter 7 and Chapter 13, and both types of bankruptcy stop the IRS and other creditors from trying to collect from you.
A Chapter 7 is a one time procedure and is usually over in about 90 days. When you file a Chapter 7, a Trustee is appointed by the bankruptcy court to review your assets (what you own) and you debts (what you owe). The Trustee’s job is to find assets that they can sell (liquidate) to raise money to pay off your debts.
But the Trustee can’t take everything you own and leave you living under a bridge. You are allowed to protect certain assets. You can exempt $12,000 in personal property, most retirement plans, personal injury settlements (car accidents or workers comp claims), and up to $23,000 in equity in your home. For most people, this protects everything they own and they lose nothing in a Chapter 7.
How can I determine whether my tax debt can be discharged in a Chapter 7?
This calculator will help you assess your case:
Have you filed all tax returns that are due? If NO, the you must file your returns ASAP and wait.
Do you owe taxes for any year? If NO, stop here. You don’t have any back taxes to be wiped out. If YES, proceed to the next question.
The 3-year rule: Has it been three years since the taxes were due? This due date is the filing deadline for the tax year, which is usually April 15, or sometimes April 16 or 17, not to be confused with the date you filed your taxes. For example, in 2015, taxes were due April 16, 2016, so the three-year period would be up April 16, 2019. If the answer is NO, then the tax is a priority tax debt and cannot be discharged in a Chapter 7 bankruptcy.
The 2-year rule: Were your returns filed more than 2 years before the filing of the bankruptcy? If YES, then proceed to Question 5. If NO, you must wait.
(IMPORTANT NOTE-there are cases in some states that hold that if your taxes were filed late, the tax debt can NOT be wiped out. Eventually the Supreme Court will resolve this split of opinions)
The 240-day rule: Were the taxes assessed within 240 days of filing for bankruptcy? The date of assessment is usually around the date the return was filed or the last date the return was due. If an amended return is filed, the 240-day period starts over. If the answer is YES, then the tax is a priority tax debt and cannot be discharged in a Chapter 7 bankruptcy.
Taxes are dischargeable – meaning they can be wiped out – if:
The return was filed on time, or if late, more than 2 years before the bankruptcy filing.
The tax is not a priority tax debt.
You did not willfully evade taxes.
If all of the above are true, you should be able to wipe out your tax debt and make a fresh start. If not, you may want to consider a Chapter 13.
6-File Chapter 13
If you have taxes you can’t wipe out in a Chapter 7, you may want to consider a Chapter 13. A Chapter 13 is a payment plan that can last up to 60 months. It allows you to reduce the penalties and interest you pay the IRS, and when you get a discharge at the end of the Chapter 13 plan, you may be free and clear of all your IRS liabilities.
What’s the difference between a Chapter 13 and an Installment Agreement?
While a Chapter 13 and an Installment Agreement (IA) with the IRS may seem similar, this chart sets out some important differences:
Chapter 13 Bankruptcy vs. Installment Agreement (IA)
|Installment Agreement||Chap 13||Relief Needed:|
|72 Months||60 months||Maximum length|
|No||Yes||Pays newest taxes first|
|No||Yes for old taxes||Pay less than full amount|
|Usually No||Yes||Extends time for IRS to collect|
|No||Yes||Stops ALL creditors|
First, filing a Chapter 13 will stop the IRS – and all your other creditors – from trying to collect from you. Many times, when people are behind with the IRS, they are behind with other creditors and need protection from them as well. An IA with the IRS will only stop the IRS. Moreover, if you end up falling behind in your Chapter 13, creditors will have to get permission from the Court to take action against you. If you fall behind on an IA, the IRS can immediately start collection action again.
Second, a Chapter 13 will stop interest from accruing on your IRS debt. It may also stop or eliminate the penalties the IRS will add to your debt. When you agree to an IA, interest and penalties continue to accrue. In some cases, they are more than your monthly payments, so your IRS debt will continue to grow while you are in the IA.
Third, the IRS is a “priority” debt in bankruptcy. That means it gets paid before other less important debts. Many times, I see people making payments on credit cards, medical bills or payday loans, but not the IRS. This is because these less important creditors are more aggressive than the IRS. They will call you at home or work until you agree to pay, or sue you and get a garnishment. The IRS will almost never call you. (If you get a call from someone claiming to be from the IRS, it is most likely a scam!) The IRS does most of its collecting by mail and according to strict regulations. Thing is, the IRS is the most powerful creditor, with the most far-reaching means of collection, so they’re the ones you really should pay back before all the rest.
Fourth, if you complete your Chapter 13, you will get a discharge and you are done with the IRS. In an IA, you may still owe after you complete your payments.
During both a Chapter 13 and an IA, you must continue to file your taxes. If you fall behind during a Chapter 13, you may be able to add these new taxes to your plan. If you fall behind with the IRS, they may cancel your agreement and start collection actions again.
During a Chapter 13, the statute of limitation will be “tolled” or stopped. During an IA, the statute generally continues to run.
Chapter 13s last 36 to 60 months. IAs can last up to 72 months.
Both the Chapter 13 and the IA look at your income and expenses to determine your monthly payments. The bankruptcy court tends to be more flexible than the IRS in allowing expenses, so you may be better off in Chapter 13 in terms of the amount of your payment. Also, your Chapter 13 plan will deal with ALL of your debts at once, not just the IRS.
What about Maryland taxes?
The same rules that apply to the IRS, apply to state taxes. Since there is a 20 year statute of limitations for Maryland tax debt, bankruptcy may be the ONLY way to get rid of your state tax debt.
7-File Chapter 20
Not an official chapter of the bankruptcy code , but refers to filing a Chapter 13 after filing a Chapter 7. How can you do that? I thought once you filed bankruptcy you couldn’t file again for years?
There are actually 2 types of bankruptcy filed by most consumers. Most people are familiar with “regular” bankruptcy where you file the case, wipe out your debts and move on with your life. This is a Chapter 7 and you can only file this type once every 8 years.
There is another kind of bankruptcy that you can file anytime you need to, a Chapter 13. A Chapter 13 is a re-organization that forces your creditors to leave you alone while you set up a payment plan to pay them off.
Why would I need to file a Chapter 20?
Sometimes people have huge debts that would make a Chapter 13 impossible. I once had a client who was involved in a hit and run accident and was left with over a million dollars in medical bills. Because they could not work, they could not make payments of any amount, let alone enough to make a dent in the bills. Also, Chapter 13 has a limit of about $300,000 is unsecured debt, so they wouldn’t have qualified anyway.
So we filed a Chapter 7 and cleared the medical debt. Later on, when they got back to work, we filed a Chapter 13 to save a car and a house.
8- Make an Offer in Compromise (OIC)
If you can’t pay your taxes in full, the IRS may agree to settle your tax debt for less than the full amount owed. Recently, the IRS has approved nearly 40% of just such OIC offers submitted. The catch? You need to make rigorous financial disclosure on application, submit a non-refundable 20% down of your offer with your request, and stay current on all your tax filing and payment obligations for the next 5 years if your offer is accepted.
What is an Offer in Compromise?
Offers in Compromise (OICs) are what those TV and radio advertisements I mentioned a few chapters ago were trying to sell you on. More specifically, an OIC is an agreement between you (the taxpayer) and the IRS that settles a tax debt for less than the full amount owed.
They aren’t as common as those advertisements make them out to be though. To submit an OIC, you must complete detailed financial forms listing all your assets and income. The IRS will use this information to calculate your reasonable collection potential and decide how much to accept. Generally, you must make an appropriate offer based on what the IRS considers your true ability to pay. In 2010, the IRS accepted about 25% of offers submitted. This has increased to about 40% recently as the IRS tries to collect more money. Now may be the time to act. But first, let’s talk about the downsides to OICs.
What are some downsides to OICs?
Because of the number of frivolous offers previously submitted, the IRS now requires you to put a non-refundable 20% down of your offer upon filing your request. If the IRS decides they do not like your offer, they will reject your request and keep the money, which will be applied to any taxes you owe.
Importantly, if your offer is accepted, you must continue to stay current with all tax filing and payment obligations through the fifth year after your offer is accepted. This is very important. You must keep up on your taxes after your OIC is accepted – or else it may be revoked and you’ll end up owing the entire amount of your taxes.
Finally, don’t think you’ll receive instant approval or rejection of your offer. The IRS can take 12 to 24 months before it gets back to you with its decision.
Am I eligible for an OIC?
In order to be eligible, you must:
- File all tax returns you are legally required to file;
- Have received a bill for at least one tax debt included in your offer;
- Make all required estimated tax payments for the current year; and
- Make all required federal tax deposits for the current quarter if you are a business owner with employees.
Am I eligible if I am able to pay the full amount of my taxes?
Generally, the IRS will not accept an offer if you can pay your tax debt in full or through an installment agreement and/or equity in assets.
If I enter into an OIC, do I get to keep any refunds?
Generally, no. The IRS will apply those refunds to your taxes owed and will not consider it as part of your OIC.
What about penalties and interest?
Penalties and interest will continue to accrue during the consideration of your offer. After you file your offer, you must continue to timely file and pay all required tax returns, estimated tax payments, and federal tax payments.
What types of offers are there?
There are two types of offers. The first is a lump sum cash offer, which requires 20% of the total offer amount to be paid with the offer and the remaining balance paid in 5 or fewer payments within 5 or fewer months of the date your offer is accepted.
The second is a payment plan offer. This option requires the first payment (of 20%) to be paid with the offer, and the remaining balance paid within 6 to 24 months, in accordance with your proposed offer terms.
How does the IRS calculate the amount I need to pay?
The IRS is looking to get the maximum amount out of you, but it can’t get more than what you have. To figure out what you can pay, they require you to fill out a Collection Information Statement. On this form, you must list all your assets, debts, income, and expenses. The IRS will look at assets including bank accounts, investment accounts, retirement accounts, life insurance, real estate, cars, and valuable property (artwork, jewelry, or collectibles). They do not care about your clothing, furniture, or other personal household goods. By adding all these up and subtracting any debts on them, the IRS calculates your Available Individual Equity.
Then the IRS looks at your income and expenses to calculate your Remaining Monthly Income. If you are making a lump sum offer, you multiply the Remaining Monthly Income by 12 and add it to the Available Individual Equity to calculate your Minimum Offer Amount. If you are making a payment plan offer, you multiply the Remaining Monthly Income by 24 and add that to the Available Individual Equity.
As an example, if you have $50,000 in assets (your Available Individual Equity) and $500 in Remaining Monthly Income, your offer would be:
- Lump Sum: $50,000 plus $6,000 = $56,000.
- Payment Plan: $50,000 plus $12,000 = $62,000.
Maryland’s OIC Program
Maryland has its own Offer in Compromise program which can be used for all taxes administered by the Comptroller, including the Admissions and Amusement Tax, Income Tax, Sales and Use Tax, and Withholding Tax. Under the program, Maryland will look at your available assets, consider your circumstances, and arrive at a fair resolution of your liability by considering a reduction of the amount due.
Am I eligible for a Maryland OIC?
In order to apply for this program, you must meet the following requirements:
- You have incurred a delinquent tax liability that has resulted in an assessment.
- You have exhausted all other avenues of administrative appeal.
- There is no issue remaining that can be appealed.
- Two years must have passed since you became liable for the tax.
- You must be current with respect to all returns filed or required to be filed to the Comptroller’s Office.
- You must not be currently involved in an open bankruptcy proceeding.
- You are unlikely to be able to make payment in full any time in the foreseeable future due to your financial situation.
- You either are without resources or unable to apply present and/or future resources to paying the outstanding tax liability.
What are the downsides to a Maryland OIC?
You must remain current with respect to future filings for at least three years after the Offer in Compromise is accepted. If you do not, you’ll owe all the taxes immediately, and the Comptroller can take all necessary action to collect.
Can I appeal Maryland’s OIC decision?
All decisions under the Offer in Compromise Program are final and cannot be appealed. This is why you should carefully consider the facts and arguments you submit with your offer. The Comptroller’s Office will consider another OIC if your circumstances change.
Offer in Compromise vs. Chapter 7
|Amount Paid||Pennies on the dollar||Nothing (in most cases)|
|Must file returns||Yes||No (generally)|
|Must wait 3 years||No||Yes|
|Must keep filings current||Yes||No|
|Income taxes only||No||Yes|
|Deal with state taxes||No||Yes|
|Wipe out other debts||No||Yes|
|How long does it take?||8-24 months||4 months|
|% approved||About 40%||99%|
|Best for||New taxes and low income||Large older tax debt|
9-Request a Penalty Abatement
There are 4 types of IRS penalty abatement relief available
First Time Penalty Abatement is the most common abatement. You can get this if you have filed all returns which you are required to file for the past 3 years, you didn’t owe any previous penalties for those years and you have paid or arranged to pay any taxes your owe. Basically, you tell the IRS ”Hey I screwed up but I’ve been good in the past-give me a break”.
Reasonable Cause Abatement means you acted in good faith to comply with the tax laws, but something happened which you could not foresee or control. For example, you got sick or there was a natural disaster. These are determined are a case by case and year by year basis and are very fact driven.
Administrative Waivers are sometimes granted by the IRS for specific circumstances. After the great recession, the IRS waived penalties for people experiencing economic hardship. Is seems likely that there will similar relief during the Covid-19 crisis.
Statutory Abatements are available for other specific situations. For example, if you are serving in a combat zone you may be exempt from penalties. Or if the taxes owed are less than $1,000 and you are newly retired you may be able to avoid some penalties.
How do I apply for an abatement?
You can submit a written request along with your tax return asking that the IRS not assess the penalty. If the penalty has already been paid, you can submit IRS Form 843 to request a refund.
In either case, you will need to submit an explanation as to why you are entitled to relief so you should include as much documentation as possible.
10-Request Innocent Spouse Relief
If you are married, or were married, to someone who ran up a bunch of tax debt, the IRS may hold you liable and try to collect from you. Fortunately, Congress realized that sometimes spouses don’t know what the other one was up to and created some relief. Basically, if you filed a joint return and there was an understatement of tax liability, the IRS considers both people to be jointly and severally liable for the debt. This means they can collect the entire amount due from either one of you. Even if you have a divorce decree that’s says the other spouse is liable, the IRS can still collect from you.
In order to avoid the liability, you must prove to the IRS that you had no knowledge of the error and the IRS agrees that it is unfair to make you pay the tax. In many other areas of tax law the burden is on the IRS to prove that you owe the tax. Here the burden is you to prove that you were “innocent” i.e did not know that the tax return was wrong. This makes getting innocent spouse relief much more complicated and should probably not be attempted without professional advice.
In order to apply for innocent spouse relief, you will need to complete and submit IRS Form 8857. You must submit this from within 2 years of the date the IRS starts trying to collect from you. If you end up going to court, some judges may find that you only owe part of the debt.
If you have settled a debt with a creditor for less than you owe, you may end up with a tax debt instead. How? Because the IRS looks at forgiven debt as “income” and taxes you accordingly. Since most people are settling debts because they are struggling financially, this is really being kicked while you are down.
How does this work? If you owe $10,000 to a creditor and you settle it by paying $6,000, the IRS will consider the $4,000 forgiven as income. Depending on your tax bracket, you could owe up to 38% of this amount in taxes.
How do I know if I owe these taxes? When you settle the debt, the creditor is supposed to send a 1099-C to you and to the IRS. If you get this from, you should make sure to include this amount when you file your taxes. Unfortunately, many times people don’t include this form either because they didn’t get it or they didn’t realize its importance. Then months later they get a letter from the IRS saying they owe additional taxes.
This is because the creditor has also sent the 1099-C directly to the IRS. One thing the IRS is very good at is using massive computing power to match SSNs. For every W-2 and 1099 they get from employers , they match to the W-2s and 1099 submitted with tax returns. If they find missing form, they calculate the tax and send out the nasty letter!
What can I do do avoid this tax? Fortunately, there is relief available. The IRS will give you a break if you are “insolvent” at the time you settle the debt. Insolvent means that your debts (who you owe) are greater than your assets (what you own).
For most people settling debts, this is not a difficult test to pass since they are already struggling. And many creditors will only settle for less after verfiy that you don’t have any assets you can sell to pay them.
To avoid this tax, you will nee to submit IRS Form 982 along with your tax return. This form allows you to exclude from your income forgiven debt up to the amount of your insolvency. So if your assets are $30,000 and your debts are $50,000, you can exclude up to $20,000 in forgiven debts. You would check Line 1b of the form and put the amount of debt in Line 2.
You can also use this form if you have filed for bankruptcy. This is what “Discharge of indebtedness in a title 11 case” means. Bankruptcy law is part of title 11 of federal laws which says that any debts wiped out in bankruptcy are not considered income.
What happens is I get the 1099-C after I file my taxes?
This is not an uncommon situation. We have had clients get letters from the IRS, sometimes years after the returns were filed.
You can still submit the Form 982 along with an amended return for that tax year. if you filed bankruptcy, you should include a copy of your discharge.
If all else fails, Pay the Taxes
If none of the prior 11 methods is going to help you, then you may have no choice but to pay the taxes. Because the penalties and interest accrue rapidly, you may want to borrow the money to pay. Even if it is on a high interest credit card, it may still be cheaper than what the tax man is charging.