How to (legally) Pay $0.00 to Settle Your Tax Debt

How to (legally) Pay $0.00 to Settle Your Tax Debt

You may have seen those “Pennies on the dollar” ads on TV or heard them on the radio that promise that you can settle your huge tax debts for very little money. But is it possible to get rid of tax debt and pay NOTHING?

in some cases, the answer is yes. Tax collectors may be bureaucratic, but they are not stupid. If you have income or assets, you probably aren’t walking away without paying something. But there are at least 4 methods of resolving your tax debt by paying the IRS or Maryland $0.00.

Wait them out

The IRS only has 10 years to collect income taxes from you. If your taxes are already several years old and your income is limited, you may be able to ignore them until they expire. What you need to figure out is the Collection Statue Expiration Date (CSED) which is the date the IRS assessed the taxes. This can be found by getting an IRS transcript which will give you the exact dates. The CSED can be extended by filing for Innocent Spouse relief, bankruptcy relief or applying for an Offer in Compromise.

If the IRS does come knocking, you might want to apply for Currently Non-Collectable status to get them to leave you alone. To be granted CNC status, you can’t have any excess income after paying basic living expenses. As long as you remain in this status, you can avoid paying one nickel and the CSED will continue to run.

This strategy will not work as well with Maryland income taxes. Maryland has up to 20 years to try to get you to pay so the wait is much longer. Also, Maryland does not have a CNC status. Instead you can apply for “hardship status” but this may only last a few weeks or months.

If you owe Maryland taxes and the IRS, you may want to consider setting up a payment plan for the Maryland taxes. Why? Because the IRS allow you to deduct state tax payments from your income. This may reduce your excess income enough to qualify for CNC status with the IRS .

“Waiting them out” is the “default” method chosen by many tax payers. 30-50% of all people who owe taxes do nothing to attempt to solve the problem. Many people put their heads in the sand and ignore the problem. Because owing taxes is so scary and they don’t know what to, it is easier to not think about the problem and hope that it will go away. This may work if you have no assets and no income because you are “judgment proof”. There isn’t a whole lot the IRS or any other creditor can do to you to force you to pay.

But if you are working or have assets, eventually the IRS or Maryland will catch up to you and force you to pay. Since they are the government, they have more information about you than other creditors. They know where you work so they can easily garnish your paycheck. They also have other enforcement methods like intercepting your tax refund or holding up your diver’s license. Because interest and penalties will have been added to your original debt, you will probably end up paying much more in the long run.


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:

  1. Have you filed all tax returns that are due? If NO, the you must file your returns ASAP and wait.
  1. 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.
  1. 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.
  1. 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)

  1. 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.
  1. 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.

The same rules apply to Maryland tax debt so you may be able to pay $0.00 to both the IRS and Maryland!

Innocent Spouse

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.

Debt forgiveness

If you borrow money and then settle with the creditor for a lesser amount, the IRS considers this income. For example, if you borrow $10,000 on a credit card and later pay $2,000 to settle it with the credit card company, the IRS looks at the $8,000 as “Income” to you. They assess taxes on that amount and send you a bill. Talk about kicking you when you are down!

Generally, the IRS finds out about the settlement because the creditor will send a 1099-C to the IRS with a copy to you. The IRS then collects these along with W-2s and any other income documents and matches them with your tax return. If they don’t see the 1099-c on your tax return, they may asses you taxes in that amount.

This happened a lot after the “Great Recession” as banks settled and charged off billions of dollars in credit card and mortgages. We got many calls from clients asking why they were being hit with tax bills seemingly out of the blue.

The good news is that if are “insolvent” at the time you settled the debt, you do not have to pay taxes on the forgiven amount. Insolvent means that your total debts were MORE than your total assets at the time you settled the debt. If this is the case, the you may be able to submit IRS Form 982 and avoid paying any taxes!

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