Process of Negotiating with the IRS to Reduce Tax Debt
Last Updated: August 2008
So, you are proud of how you've handled many areas of your life: you've built a successful business, have a nice home, a solid family life, even have a fair credit score. But somehow, the taxes owed to good ole Uncle Sam just didn't quite have the priority as other items, and here you are; with a rather large tax debt to the IRS. Of course you know it will catch up with you and when it does, what to do?
Well, if your fairytale life is as described in the previous paragraph the answer is most likely "pay up". In order for the IRS to consider relieving you of some portion of your tax debt, you will have to show conclusively that you really are not able to pay. Makes sense to me; I don't want to make up for irresponsible taxpayer's debt by paying more as a taxpayer to cover OTHER's deficit. You do have some options though, such as working out a payment, or installment plan, over a period of time; Let's go into the options in more detail as follows.
Your Options Regarding IRS Debt
Submit an Offer in Compromise: An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayer's tax liabilities for less than the full amount owed. Absent special circumstances, an offer will not be accepted if the IRS believes that the liability can be paid in full as a lump sum or through a payment (installment) agreement.
In most cases, the IRS will not accept an OIC unless the amount offered by the taxpayer is equal to or greater than the reasonable collection potential (RCP). The RCP is how the IRS measures the taxpayer's ability to pay and includes the value that can be realized from the taxpayer's assets, such as real property, automobiles, bank accounts, and other property. The RCP also includes anticipated future income, less certain amounts allowed for basic living expenses.
The IRS may accept an offer in compromise based on one of the following three grounds:
- Doubt as to Collectibility - Doubt exists that the taxpayer could ever pay the full amount of tax liability owed within the remainder of the statutory period for collection.
Example: A taxpayer owes $20,000 for unpaid tax liabilities and agrees that the tax she owes is correct. The taxpayer's monthly income does not meet her necessary living expenses. She does not own any real property and does not have the ability to fully pay the liability now or through monthly installment payments.
- Doubt as to Liability - A legitimate doubt exists that the assessed tax liability is correct. Possible reasons to submit a doubt as to liability offer include: (1) the examiner made a mistake interpreting the law, (2) the examiner failed to consider the taxpayer's evidence or (3) the taxpayer has new evidence.
Example: The taxpayer was vice president of a corporation from 2004-2005. In 2006, the corporation accrued unpaid payroll taxes and was assessed a trust fund recovery penalty as a responsible party of the corporation. The taxpayer was no longer a corporate officer and had resigned from the corporation on 12/31/2005. Since the taxpayer had resigned prior to the payroll taxes accruing and was not contacted prior to the assessment, there is legitimate doubt that the assessed tax liability is correct.
- Effective Tax Administration - There is no doubt that the tax is correct and there is potential to collect the full amount of the tax owed, but an exceptional circumstance exists that would allow the IRS to consider an OIC. To be eligible for compromise on this basis, a taxpayer must demonstrate that the collection of the tax would create an economic hardship or would be unfair and inequitable.
Payment Options for Offers
In general, a taxpayer must submit a $150 application fee and initial payment along with the Form 656, Offer in Compromise. This is one of the changes that was implemented in the last 5 years; requiring an upfront fee has served to reduce the number of applications, thus effecting the statistics. Taxpayers may choose to pay their offer in compromise in one of three payment options:
- Lump Sum Cash Offer - Payable in non-refundable installments, the offer amount must be paid in five or fewer installments upon written notice of acceptance. A non-refundable payment of 20 percent of the offer amount along with the $150 application fee is due upon filing the Form 656.
If the offer will be paid in 5 or fewer installments in 5 months or less, use the realizable value of assets plus the amount that could be collected over 48 months of payments or the time remaining on the statute, whichever is less.
If the offer will be paid in 5 or fewer installments in more than 5 months and within 24 months, use the realizable value of assets plus the amount that could be collected over 60 months of payments, or the time remaining on the statute, whichever is less. If the offer will be paid in 5 or fewer installments in more than 24 months, use the realizable value of assets plus the amount that could be collected over the time remaining on the statute.
- Short Term Periodic Payment Offer - Payable in non-refundable installments; the offer amount must be paid within 24 months of the date the IRS received the offer. The first payment and the $150 application fee are due upon filing the Form 656. Regular payments must be made during the offer investigation.
The offer amount must include the realizable value of assets plus the total amount the IRS could collect over 60 months of payments or the remainder of the statutory period for collection, whichever is less.
- Deferred Periodic Payment Offer - Payable in non-refundable installments; the offer amount must be paid over the remaining statutory period for collecting the tax. The first payment and the $150 application fee are due upon filing the Form 656. Regular payments must be made during the investigation.
He offer amount must include the realizable value of assets plus the total amount the IRS could collect through monthly payments during the remaining life of the statutory period for collection.
The IRS is not bound by either the offer amount or the terms proposed by the taxpayer. The OIC investigator may negotiate a different offer amount and terms, when appropriate. The investigator may determine that the proposed offer amount is too low or the payment terms are too protracted to recommend acceptance. In this situation, the OIC investigator may advise the taxpayer as to what larger amount or different terms would likely be recommended for acceptance.
An offer in compromise payment options comparison table is available for taxpayers to compare the requirements associated with each payment option.
For a complete explanation of the steps involved in filing an offer of compromise, and well as definitions and eligibility requirements, you will want to review this 44 page IRS publication 656. The brief description included above is only a start in helping you understand how offers in compromise work.
Hiring a Tax Resolution Company: In your Best Interest?
The long and short of it? The answer is most likely a resounding NO! While there are probably some reputable and honest tax resolution companies, and some individuals that just don't have the time or inclination to pursue the proper avenues with the IRS directly, the research we've done for this article indicates they typically don't deliver the promises that they offer. A recent Wall Street Journal article that we found provided some very interesting facts and stories of disgruntled consumers who dealt with the nation's largest tax resolution firm, JK Harris. According to the article, JK Harris recently settled with 18 states over allegations that it "misled consumers and failed to produce results"; here is a link to a press release this past June regarding the allegations and settlement details. Interestingly, as we did further research on similar companies, the negative comments and stories of unhappy customers just went on and on; here is a link to a bunch of folks who share their stories on the JK Harris fiasco.
Here are some tips if you feel that a tax resolution company is your only option:
- Stay away from any firm that won't let you speak to the people who are on the Power of Attorney before you sign a contract.
- Stay away from any website that doesn't clearly give the names and bios of the licensed (Enrolled Agents, CPAs & Attorneys) employees.
- Ignore guarantees, promises and so-called testimonials; do your own research.
- Ask tough questions. If the answers don't make sense, don't hire the firm. As examples, ask, "Are you an EA, CPA or attorney?" When they say, "I'm a tax resolution specialist", ask them, is that a state or Federal license?
A good place to start is to contact the IRS taxpayer advocacy service. The service is an independent organization within the IRS whose charter is to help taxpayers resolve problems with the IRS and recommend changes that will prevent the problems. If you decide that you need additional help, rather than hiring a Tax Resolution company, you may consider hiring an accountant to assist you in the paperwork and filing process.