Few debts are as difficult to deal with as back taxes, so it’s sometimes surprising to learn that there are several methods available to reduce your tax liability with the IRS for less than what you owe. This article will explain what these options entail, how they work, and other information to help you decide if they’re options that you should consider when dealing with your tax bill.
Written by Attorney Curtis Lee.
Updated June 15, 2021
Tax debt owed to the Internal Revenue Service (IRS) can be troublesome and frustrating to deal with. Few debts are as difficult to deal with as back taxes, so it’s sometimes surprising to learn that there are several methods available to reduce your tax liability with the IRS for less than what you owe. These tax relief options include offers in compromise, partial payment installment agreements, currently not collectible status, bankruptcy, and installment agreements. This article will explain what these options entail, how they work, and other information to help you decide if they’re options that you should consider when dealing with your tax bill.
What Can An Offer In Compromise (OIC) Do For Me?
An offer in compromise (OIC) is a special IRS program that allows taxpayers with outstanding tax bills the opportunity to pay off their tax debt for less than the full amount owed. Taxpayers must submit an OIC request to the IRS, but the IRS has full discretion when deciding whether to grant it or not.
If the IRS decides to grant an OIC, it’ll do so for one or more of the following reasons:
Doubt as to the validity of the tax debt: There might be a legal question as to whether the money the IRS claims that the taxpayer owes is a legitimate tax debt. Or, there’s no dispute that the taxpayer owes the IRS money, but there’s uncertainty as to how much this amount is.
Questions as to tax debt collectability: Everyone agrees as to the tax debt, but the taxpayer’s income and assets don’t come close to paying off what they owe the IRS.
Effective tax administration: The IRS can collect the tax debt, from both a legal and practical perspective. But doing so would result in extreme economic hardship to the taxpayer or would be unfair due to the taxpayer’s circumstances.
How To Apply For An OIC
To be eligible to file an OIC, you must meet four basic requirements:
You’re current on all your required tax returns;
You’re up to date on all estimated tax payments; and
You’re not currently in the process of filing for bankruptcy.
You have enough cash on hand to make an initial partial payment towards paying off your tax debt.
Given how much time and effort it takes to request an OIC, you’ll want to determine if you have a realistic chance of having your request approved before you commit to this plan of action. It might be a good idea to file an OIC application if you’re in the following financial situation: you couldn’t pay off your tax liability even if you sold all your assets and used all of your disposable income over the next four to five years to resolve the full outstanding balance owed.
How does the IRS decide if you’re facing this type of financial hardship? It’ll ask for information concerning your income, expenses, and assets. Providing this information takes a great deal of time and effort for most people.
The primary component of an OIC application is IRS Form 433-A. Completing this form includes not just filling it out, but providing supporting documentation, like paystubs, bank account statements, and loan statements.
You must also submit a $205 non-refundable application fee unless you meet low-income certification guidelines. To meet these guidelines, you’ll need an adjusted gross income (as determined by your most recent income tax return) that’s less than or equal to the amounts shown in the below table. This information is also available on IRS Form 656, Section 1.
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Finally, it can take a long time for the IRS to process an OIC request. You should expect the IRS to take at least 6 months before making a decision. But there may be instances where it’ll take up to 2 years. But if the IRS hasn’t decided within 2 years, the law requires the IRS to automatically accept your OIC.
Should You Hire A Tax Professional?
This is a difficult question to answer, because there are benefits and drawbacks to hiring a tax professional. They’ll have experience with helping clients file an OIC with the IRS and can help answer any questions about what to include and what to leave out. But most importantly, they’ll understand the ins and outs of dealing with the IRS. This includes anticipating what kind of offer the IRS is most likely to accept.
In contrast, hiring a tax professional can be expensive. It’s almost always better to have one help you with your OIC. But if you don’t have the money to pay your taxes, chances are good you’ll struggle to find the money to hire a tax professional. Ultimately, you should do whatever makes the most sense for your unique financial situation.
Ways To Pay An OIC
When submitting an offer to the IRS, you’ll need to include an initial payment. Besides the initial payment, you’ll choose one of the following payment options:
Lump Sum Cash: You’ll pay 20% of the total offer amount when you file your OIC. Then you’ll pay the remaining balance within five months after the IRS accepts your offer.
Periodic Payment: You’ll provide the first payment when you file your OIC. While the IRS considers your offer, you’ll continue making monthly payments over the next 6 to 24 months until the remaining balance gets paid off.
One thing to keep in mind is that if you meet low-income certification guidelines, you won’t need to include the initial payment when you file your OIC or make monthly payments under the Periodic Payment option while the IRS decides whether to accept your offer.
Other Things To Consider When Applying For An OIC
If the IRS accepts your OIC application, you must fully comply with the OIC payment plan as well as obey all tax laws (like continuing to file tax returns) for the next five years. Failure to do so could result in a default.
If there is an OIC default, the IRS may immediately demand the entire remaining balance of the OIC. Alternatively, the IRS may ask you to pay the original tax liability, less any payments you have made so far. Additionally, the IRS will reinstate any waived penalties or interest. Finally, the IRS could place a lien or levy on your property.
Don’t forget that filing an OIC with the IRS requires you to reveal a significant amount of financial information. If the IRS rejects your OIC, the IRS can still make use of the information you gave them, such as adjusting or speeding up their collection efforts against you.
Payment Arrangements That Allow The IRS To Change The Terms Of The Agreement Under Certain Conditions
If you already have a payment arrangement with the IRS, changes to your financial situation may make it possible for you or the IRS to make changes to your payment arrangements. Sometimes the payments will go up and sometimes they’ll go down. But in some cases, the overall amount you pay will be less.
Partial Payment Installment Agreement
A partial payment installment agreement (PPIA) requires you to make monthly payments to the IRS for a period of time. After the time period ends, the IRS forgives any remaining balance.
A PPIA is similar to an OIC in that you can settle a tax debt for less than what you owe. The PPIA and OIC options are also similar in terms of how you apply. For example, you have to complete IRS Form 433-A and provide the supporting documentation for both. But, there are a few major differences between an OIC and PPIA.
First, you have more time to pay off your tax debt with a PPIA. This can result in smaller payments. In some cases, you can have as many as 72 months to make monthly payments.
Second, with a PPIA, you must update the IRS every two years as to what you can pay. If this update shows that you’re earning more money, the IRS is free to increase the size of your monthly payments. But if your income drops, you can ask the IRS to lower your monthly payments.
Third, it’s easier to apply for a PPIA and faster, too.
Based on these differences, the PPIA could be a better option for you over the OIC, especially given the opportunity to have the IRS lower your payments. There’s also more time to make payments. Depending on the size of your tax debt, this can make the monthly payments easier to manage.
Currently Not Collectible Status
Your tax account could go into Currently Not Collectible (CNC) status if the IRS has temporarily suspended its collections activities against you. The IRS might do this because of your challenging financial situation. Despite pausing its collection efforts, the IRS may still:
Continue to accrue interest and late penalties against you.
Garnish your wages.
Levy your bank accounts.
Withhold any tax refunds and apply them to your tax debt.
Require you to pay off your entire tax debt.
To apply for CNC status, you’ll need to complete IRS Form 433-A. If this form and your supporting documentation show that you have almost no money left over after paying for basic living necessities, the IRS may grant you CNC status. Also, before granting CNC status, the IRS may require you to file any past due tax returns.
If your income increases or you acquire significant assets, the IRS may remove the CNC status from your account and you must resume making payments or pay off the remainder of what you owe.
Can Bankruptcy Reduce My Tax Debt?
Depending on the nature of your IRS tax debt, it may be possible to use bankruptcy to eliminate it or significantly reduce it. The special nature of bankruptcy proceedings means that your attorney could negotiate with the U.S Department of Justice to reduce your taxes. The exact tax reduction process will rely on whether you choose to file for Chapter 7 or Chapter 13 bankruptcy.
How a Chapter 7 Bankruptcy Can Reduce Your Tax Debts
One of the most important characteristics of Chapter 7 bankruptcy is that it allows filers to discharge or erase certain types of debts, such as credit card debt, car loans, payday loans, and medical bills. But not all tax debts are dischargeable in Chapter 7 bankruptcy.
Tax debts are dischargeable under Chapter 7 bankruptcy, but only if they meet all of the following conditions:
The tax liabilities come from unpaid income taxes;
The tax debt is at least three years old;
The tax debt relates to a tax return filed at least three years ago;
The IRS assessed the income tax debt at least 240 days before the individual filed for bankruptcy; and
The IRS hasn’t placed a federal tax lien to secure the tax debt.
How A Chapter 13 Bankruptcy Can Reduce Your Tax Debts
Chapter 7 bankruptcy is popular because of the ability to eliminate many types of debts within the span of a few months. Yet, many individuals aren’t eligible to file for Chapter 7 bankruptcy because they make too much money and can’t pass the Chapter 7 Means Test. Instead, they must file for bankruptcy under Chapter 13 of the U.S. Bankruptcy Code.
A prominent feature of Chapter 13 bankruptcy is that it involves the creation of a 3 to 5-year payment plan that only requires the filer to pay as much as they can afford. And at the end of this period, as long as the filer meets all other Chapter 13 requirements, any remaining balances get wiped out. So even though Chapter 13 bankruptcy may not fully discharge a tax debt, it’s still possible to pay off an eligible tax debt for pennies on the dollar.
Another benefit of the Chapter 13 bankruptcy process is that filers can use it to satisfy an IRS tax lien. This is especially handy when the equity in the filer’s assets isn’t enough to secure the entirety of the filer’s tax liability. This can occur because bankruptcy exemptions don’t count when calculating how much equity the filer has to satisfy an IRS lien.
Whether filing for bankruptcy under Chapter 7 or 13, remember that usually only tax debts more than 3 years old will be dischargeable.
What Do I Need To Do To Get An Installment Agreement?
An installment agreement allows you to pay your tax debt over time, although penalties and interest will continue to accrue while you’re making payments. You may end up paying more money in the end, but the payments are small enough to be manageable.
You can apply for an installment agreement online if you meet the following eligibility requirements:
For a short-term installment agreement, you must owe less than $100,000 in combined taxes, penalties, & interest.
For a long-term installment agreement, you must owe less than $50,000 in combined taxes, penalties, & interest.
If you’re unable to apply for an installment agreement online, you can use Form 9465 instead.
Short-Term Installment Agreements
Individuals with short-term installment agreements must pay it off within 120 days while businesses have up to 180 days.
There is no fee to set up a short-term installment agreement. If you’re not eligible to apply online, you can apply by telephone, mail, or in-person.
Once set up, you can pay directly from a bank account, through the Electronic Federal Tax Payment System, by check, with a money order, or using a credit/debit card. There’s an additional fee when paying by credit or debit card, though.
Long-Term Installment Agreements
Long-term installment agreements provide you with up to 72 months to pay off your tax debt, with payments made each month. There is a set-up fee, but the amount depends on several factors.
If paying through Direct Debit Installment Agreement (DDIA) wherein the money automatically comes out of your checking account, the online set-up fee is $31. Using any other method of setting up the long-term installment agreement with a DDIA is $107.
There is no set-up fee for low-income applicants. The IRS will consider a filer as low-income if they have an adjusted gross income at or below 250% of the applicable federal poverty level.
If setting up a long-term installment agreement that doesn’t involve the DDIA payment method, then the set-up fees are as follows:
$149 for an online application
$225 when applying by phone, mail, or in-person
$43 for a low-income filer
The IRS will reimburse low-income filers the $43 set-up fee after they pay off the installment agreement.
The IRS is among the best creditors when it comes to collecting debts. So, it’s understandable that you may feel resigned to your financial fate if you receive an IRS collection notice about a tax liability. Thankfully, there are multiple options available to not only make it easier to help you pay off your tax debt, but pay it off for less than the original amount. They include:
Offer in compromise
Partial payment installment agreement
Currently not collectible status
Chapter 7 or 13 bankruptcy
None of these options require the use of a bankruptcy lawyer or other tax professional. But working with these professionals can make the process easier and improve your chances of the IRS accepting your request.
If you’d prefer to handle things on your own, but want to learn more about what to do, you can check out the Upsolve Learning Center. Here, you can find more detailed information about many of the topics mentioned in this article.