With the economy in a persistent state of weakness, many Americans are agonizing over their delinquent income tax liabilities. And if the amount owed is unmanageable, you might feel overwhelmed and scared because it feels as if you will never be able to repay the debt. Fears of liens, levies and knocks on the door come to mind. Maybe such an event has already occurred causing you an inordinate amount of stress and financial difficulty.
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Then one day you hear a radio commercial or see a TV spot touting: “Step right up! Pay pennies on the dollar and get rid of your tax liabilities!” Sounds good, a solution is at hand. But if you’re smart, you’re skeptical. Does the IRS really compromise with taxpayers? Will it really let you off the hook that easily? And can these firms really help debt-laden taxpayers, or are they scamming them out of their money?
Well, it depends. In the next several segments, I will educate you on the topic of “Offers in Compromise” so that you will know whether your offer stands a chance before paying big bucks to a tax professional.
Offers in Compromise allow taxpayers to settle their tax debt for less than the full amount owed if they can’t afford to repay the liability. Five years ago, the IRS issued a warning (IR-2004-17) to taxpayers that they check carefully the rules surrounding these offers before applying. The IRS commissioner at the time, Mark Everson said in a statement, “This program serves an important purpose for a select group of taxpayers. But we are increasingly concerned about unscrupulous promoters charging excessive fees to taxpayers who have no chance of meeting the program’s requirements. We urge taxpayers to not be duped by high-priced promises.”
As of this writing, the IRS accepts only 34% of all presented Offers in Compromise offers. While this may seem like a small percentage, it’s up 10% from two years ago.
Here’s how to determine whether or not you meet the program’s requirements:
1) If you are looking to compromise payroll tax liabilities, forget about it! Most of the payroll taxes you failed to pay are considered a trust fund. They are made up of the employee’s withholding taxes, which was never your money to begin with. For that reason, the IRS will not compromise. If you have a choice, always pay your payroll tax liabilities before you pay your income tax liabilities. And if you can only pay part of a payroll tax liability, add up the trust fund portion (the employees’ withholdings) and pay for those. Be sure to indicate “trust fund-employee withholdings” on the memo line of your check. This will prevent future problems should you have a shot at an offer in compromise.
From what I have heard, there is a better chance of getting the employer’s portion compromised.
2) Determine the reason for the compromise request. There are two categories the IRS looks at:
Doubt as to collectability. You don’t have the money now, nor will you have it by the time the statue of limitations runs. It would be in the government’s best interest to get what they can and dismiss the remainder.
Doubt as to liability. This involves various issues concerning your responsibility for the debt. For example, you may be an innocent spouse (my flaky ex owes this, not me!). Or there were changes to your tax return creating a new liability that are the result of an audit or other adjustments. You disagree with the changes, but the statute period to prove your case has run out. Or perhaps you discovered additional documentation that would have considerably reduced a prior year tax liability but it’s too late to amend the tax return.
Most offers in compromise fall under the heading of doubt as to collectability.
The IRS expects you to pursue other routes before trying for an offer in compromise. If you have room on a credit card, they expect you to use it up to pay them. It wants you to tap into family members and friends for loans, or refinance the house (which in this economy is likely under water). It wants you to try for an installment agreement with the IRS, which involves completing IRS form 9465, Request for Installment Agreement.
In most cases, acceptance of an installment agreement is automatic. However, if the balance owed is too high or the repayment period is unacceptable, you will have to complete form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals. From the data collected here, the IRS will determine if you can comfortably make monthly payments toward your tax liability and pay it off before the statute of limitations runs. If it deems you can, then it is not going to settle for a lump sum payoff of a smaller amount.
If the IRS decides you cannot afford an installment agreement but you’re young and healthy with good prospects for the future, they may simply deem you temporarily “uncollectible.” This means you will be left alone for an entire year. No collection efforts, no garnishments, no liens, no levies; you enjoy a reprieve. Penalties and interest will continue to accrue, of course. But you won’t have to worry about agents showing up at your door.
Once the year is up, the IRS will send you a threatening letter designed to make you shudder, don’t be alarmed. It’s spit out from a computer and it’s just their way of getting your attention and making you respond. Do so. The IRS is just checking in, wanting to see if you finally got a job, or Aunt Sarah died and left you a hefty windfall, or some other miracle happened that gave you the ability to pay. Reevaluate your financial status and pay them off if possible or go for the installment agreement, or get deemed uncollectible again, or if it looks like your dire straits will continue unchecked forevermore, then consider an offer in compromise. You may just qualify.
Up next: I will discuss how to complete form 433-A. You might be surprised to find that the IRS has a different take on your finances than you do.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know,” available at all major booksellers. Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.