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When you owe more federal income tax than you can afford to pay, you may hope for IRS debt forgiveness.
Having a creditor forgive some or even all your debt may be possible for other types of debt, like student loans or even credit card balances — although it almost always comes with negative consequences. But the IRS doesn’t typically work that way.
While IRS payment plans or installment agreements can help you pay your full tax debt over time, an offer in compromise is about as close as anyone can come to total IRS debt forgiveness.
Let’s cover offers in compromise so you can understand how you might be able to settle a tax debt for less than the full amount you owe.
- What if I can’t pay my tax bill?
- Can I qualify for an offer in compromise?
- Applying for an offer in compromise
- Determining the offer amount
- Initial costs
- IRS response
If you can pay off your tax bill, you’ll save money in the long run. That’s because the IRS charges interest and a penalty on any past-due unpaid tax until you pay in full — even if you arrange for a payment plan or have an offer in compromise accepted.
So if you’re struggling to pay the tax you owe, the worst thing you can do is avoid it. In fact, if you don’t pay your tax bill in full, the IRS could place a federal tax lien against property you own, like a house, and can even garnish your wages through a federal tax levy.Tax liens 101: What you should know about tax liens and levies
Instead, making a payment arrangement might allow you to avoid the worst consequences of a past-due tax bill. And if your situation is dire enough, you might even qualify for partial IRS debt forgiveness in the form of an offer in compromise.
Not everyone who asks for an offer in compromise from the IRS will get one. In fact, your chances might be slim. In 2017, the IRS received 62,000 offers in compromise and accepted only 25,000 of them — that’s a success rate of roughly 40%.
The criteria for qualifying are strict. Here are three situations the IRS will consider for an offer in compromise.
- Doubt as to liability: There’s a genuine dispute about the amount you owe, or whether you owe anything at all.
- Doubt as to collectability: Your assets and income are less than the full amount of the tax liability, and the IRS believes your tax debt may not be fully collectible.
- Effective tax administration: There’s no doubt that you owe the full amount and that the IRS could collect it, but paying in full would create a financial hardship — or there are exceptional circumstances that would make it unfair and inequitable for the IRS to collect the full amount.
There are also other requirements you’ll need to meet to qualify, including …
- You’ve filed all tax returns that you’re legally required to file.
- You’ve received a bill for at least one tax debt that you include in your offer.
- You’ve made all required estimated tax payments for the current tax year, if applicable.
- If you’re a business owner with employees, you’ve made all required federal tax deposits for the current quarter.
- You or your business aren’t currently in an open bankruptcy proceeding.
- You don’t have an open audit or outstanding innocent-spouse claim with the IRS.
- The IRS hasn’t referred your case to the Department of Justice.
If you’re not sure whether you’re eligible, use the IRS offer in compromise prequalifier tool to help you find out.
If you have reason to believe that you could qualify for IRS debt forgiveness through an offer in compromise, you should take a look at the offer in compromise booklet and Form 656. If you feel overwhelmed or need help, consider hiring a tax professional who can walk you through the form and give you general guidance.
An offer in compromise starts with you, the taxpayer, making an offer to the IRS using Form 656 — but you can’t just offer any amount you wish as a settlement for your debt.
The IRS usually expects the amount you offer to be equal to or greater than the value of your assets — real property, vehicles and bank accounts — as well as anticipated future income minus basic living expenses. The IRS terms this your “reasonable collection potential.”
In order to determine your ability to pay your outstanding tax debt, the IRS may require you to complete and submit Form 433-A. The form gathers details of a wage earner’s or self-employed person’s financial situation, including a taxpayer’s assets and expenses.
“You always have to put down some kind of an amount for an offer,” says Josh Dixon, a certified public accountant and owner of J. Dixon Tax Advisory Services. “It could be as little as $1, but [the IRS] will not accept $0 on an offer.”
When it comes to figuring out an offer, there may be a lot of math involved.
“The IRS wants to look at your financial picture and your ability to pay,” says Dixon, “and then they’re going to look at their ability to collect.”
Don’t worry too much about getting the number exactly right, though. If you qualify for the program and your offer is too low, the IRS will allow you to update your offer.
An offer in compromise isn’t a get-out-of-jail-free card — in fact, you’ll have to pay the IRS just to make the request.
You’ll typically need to enclose a $186 fee with your application. But it may be waived if you meet the agency’s low-income certification guidelines or if the offer in compromise is based on doubt as to your liability.
While filling out your offer in compromise, you can choose from two payment options.
- Lump sum — Include at least 20% of your offer upfront and then pay the remaining balance in five or fewer payments within five months of the date the IRS accepts the offer.
- Periodic payment plan — Include your first payment with the offer and then pay the remaining balance within six to 24 months, based on your proposed terms. You’ll also need to continue making payments while the IRS is considering your offer. Otherwise, it will be rejected without appeal.
The fee and your payments are nonrefundable, but the amounts get applied to your tax liability. If you qualify for a low-income exception, you won’t need to include an initial payment or make monthly payments while the IRS considers your terms.What is the Taxpayer Advocate Service and can it help me?
If the IRS accepts your offer in compromise, you’ll need to meet all the terms of your agreement with the agency. If you fail to comply with the agreement, the IRS can sue you for up to the original amount of the tax debt plus penalties and interest (minus any payments you’ve made).
If the IRS rejects your offer, you’ll have 30 days to file an appeal. The agency has an online tool that can help you determine whether you should request an appeal.
Heads-up: Watch out for tax-relief scams
There are companies, some legitimate and some not, that will offer to help you obtain tax debt relief. These companies may charge thousands of dollars in fees for something you can do on your own for less.
Beware: A company may try to scam you by taking your fee without actually submitting your offer in compromise to the IRS, or even add unauthorized fees on top of the upfront charge.
If the offer sounds too good to be true, it probably is. And if a company makes promises or guarantees, it may be a scam.
“A lot of times, you’ll want to just contact the IRS first,” says Dixon.
Owing the IRS is no joke, so it’s important to have a plan to pay what you owe. If you can’t afford your full tax bill, either immediately or through a payment plan, you may qualify for IRS debt forgiveness in the form of an offer in compromise.
But offers in compromise are difficult to get, and you’ll need to follow all the IRS rules for applying for an offer in compromise and fulfill the terms of the offer if it’s accepted. If you think you might be eligible, take your time to go through the process and make sure you read the fine print in the agreement. If everything goes well, you may be able to settle with the IRS for less than what you owe.
Knowing how you’ll handle your tax debt starts with knowing whether you’ll owe at all. And the sooner you find out, the sooner you can plan on making arrangements to pay what you owe.