Tax debt is a problem for everyone, not just the nearly 900,000 taxpayers with delinquent accounts (Source).
Americans fail to pay $458 billion a year in taxes, according to the latest tax gap estimates (source). The tax gap is the difference between what taxpayers owe in taxes and what they pay on time. These estimates also include taxes on income taxpayers don’t declare. The latest tax gap estimate is based on the 2008-2010 tax years.
Compare a tax gap of $458 billion with the federal budget deficit of 2016, which was $587 billion (Source). The U.S. government’s annual deficit could have been reduced by 78% if the IRS had collected the money it was owed. The effect of tax debt on the federal government’s bottom line was even more pronounced in 2015. Because there was a lower deficit, the tax gap could have turned a $439-billion deficit into a $19-billion surplus. (Source 1, Source 2)
The IRS tax gap estimate has grown by $8 billion since the last report was issued for the 2006 tax year (source). Meanwhile, IRS resources have dropped to pre-1998 levels due to a series of IRS budget cuts implemented by the Bush and Obama administrations (source). The trend is unlikely to change under the Trump administration. The White House budget office has recently proposed a 14.1% cut to the IRS for the 2017-2018 fiscal year (source). Despite all this pressure, the IRS has somehow managed to increase overall collection mainly due to increased use of an unlikely set of tools: tax relief programs.
How much do Americans owe in tax debt?
The largest component of tax debt is underreporting, which represents 84% ($387 billion) of the tax gap. Underreporting of taxes is hard to reduce because more than 60% is owed by businesses and self-employed workers, whose income the IRS cannot easily verify. (Source)
Underpayment of taxes is easier to quantify because it is based on audits or the self-assessments of taxpayers through their tax returns. According to IRS estimates, tax underpayment amounts to $39 billion a year. The three main components are individual income tax ($29 billion), employment tax ($6 billion), and corporate income tax ($3 billion). However, these are just estimates.
What hard data do we have on tax debt?
The IRS reports nearly 900,000 taxpayers were delinquent in 2015, owing a total of $57.5 billion. In 2015, delinquent taxpayers owed, on average, $64,000 in back taxes. This was an improvement compared to the 1.14 million delinquent taxpayers and $63.1 billion owed in 2012.
In 2015, the IRS audited 1.4 million tax returns, and an additional $25.1 billion in tax liability was assessed. That is an average of $18,300 per tax return. (Source) Still, increasing tax liability doesn’t mean the IRS can always collect the taxes it assesses. In 2014 and 2015 the IRS wrote off $14.7 billion in bad debts. Although doing away with tax debt altogether may be unrealistic, there are tools to help reduce it. Tax relief is one of them.
What is tax relief?
Tax relief includes any program or method that helps taxpayers pay off their tax debt. Some programs, such as installment agreements, give you more time to pay. Other programs reduce your debt, such as offers in compromise or the penalty abatement program.
When done well, tax relief programs are a win-win for the IRS and taxpayers. The IRS knows the longer taxpayers are behind on their taxes, the less likely they are to pay. According to a 2015 study carried out by the Taxpayers Advocate Service, the IRS collects twice as much on delinquent accounts in the first year than in the second year; and three times as much in the first year as in the third year. (Source)
Typically, the IRS has 10 years to collect taxes. As the years tick by, the IRS gradually loses the ability to collect any revenue on accounts that reach the 10-year limit. From 2003 to 2011, the IRS wrote off 19% to 28% of back taxes each year, the latest report by the Taxpayer Advocate Service says. (Source)
From 2012 to 2015 alone, the IRS wrote off $31.4 billion in tax debt.
Tax relief programs give taxpayers a way to settle delinquent tax debt and avoid the tax liens, levies and wage garnishments the IRS can impose. At the same time, tax relief programs help the IRS increase revenue.
Unfortunately for taxpayers, tax relief programs are typically hard to apply for and even more difficult to qualify for. Negotiating with the IRS is a complex and lengthy process that many taxpayers can’t manage without help. Just getting in touch with an IRS agent can be a challenge. A 2015 survey by the Taxpayer Advocate Service reported the IRS answered only 37% of taxpayers’ calls routed to customer service representatives (source).
Complexity and a lack of resources have helped create a niche for tax relief companies that provide representation to taxpayers applying for tax relief programs before the IRS.
Tax relief programs offered by the IRS include:
- Installment agreements
- Currently not collectible status
- Offer in compromise
- Bank levy release
- Tax lien release
- Penalty abatement
- Innocent spouse relief
Every year the IRS writes off billions of dollars in bad tax debt. However, that tax forgiveness is not spread evenly. Neither is it necessarily good news for taxpayers. Tax abatement typically occurs when the IRS has exhausted all other tax collection methods, such as tax liens and tax levies, which leave taxpayers with damaged credit and frozen assets. A better use of tax relief programs could help the IRS collect more revenue and reduce the hardship of tax debt on taxpayers.
Installment agreements don’t reduce the amount of money taxpayers owe. Instead, they provide a payment plan that allows them to pay their debt over time. In recent years, the IRS has expanded the criteria for streamlined processing of installment agreements. As of February 2016, about 90% of people who owe money on their taxes qualify for an online payment agreement (source). To qualify, taxpayers must owe $50,000 or less and be up to date with their tax returns.
In 2015, the IRS approved 2.99 million installment agreements, which have been an effective tool for the IRS. According to a 2013 report by the Department of Treasury, the default rate of streamlined installment agreements is 44 percent lower than overall default rate.
Offer in Compromise
The Offer in Compromise Program (OIC) is a flexible tax relief initiative that reduces the tax liability of people who can’t afford to pay their tax balance. In exchange, taxpayers agree to pay a discounted amount of their tax debt within a certain time period. This is a win for the IRS, which gets money it would not have otherwise collected, and taxpayers who see their tax debt reduced.
There is a strong incentive to remain current on monthly payments because the initial debt is reinstated if you default.
Currently Not Collectible
The IRS assigns the “currently not collectible,” or CNC, status to taxpayers who agree they owe money to the IRS but whose current financial situation doesn’t allow them to qualify for a payment plan. The idea is to give people time to get their finances in order. In most cases, the IRS will not try to levy the assets or income of taxpayers with CNC status. However, the IRS will withhold their tax refunds to offset their debt.
In 2015, 16.3 percent of tax delinquent accounts were categorized as Currently Not Collectible (source).
Bank Levy Release
The IRS has the authority to seize the property or assets of delinquent taxpayers when they are behind on their taxes and don’t respond to notices. That includes bank accounts. The IRS can make a one-time withdrawal of whatever money is in the bank account or file a continuous levy that takes a percentage of the taxpayer’s salary until the debt is paid. However, the IRS can release a bank levy when:
- taxpayers have already paid what they owe
- taxpayers have entered an installment agreement
- the levy creates an economic hardship
- taxpayers can prove that doing so would help them pay their taxes.
In 2015, the IRS placed over 1.6 million levies on delinquent taxpayers.
Tax Lien Release
The IRS can place a lien, or claim, on the property and assets of a delinquent taxpayer. A tax lien is different from a levy. Instead of seizing assets, a lien signals to other creditors the IRS has a legal right to a taxpayer’s property. If there is a lien on a home, for instance, the owner will not be able to sell it until the debt is paid or the IRS agrees to a lien release. The IRS will sometimes grant a tax lien release to taxpayers that are still behind on their taxes if it helps them pay their tax debt.
In 2015, the IRS filed over 515,000 tax liens.
Penalties for late filing or payment quickly add up when taxpayers are behind on their taxes. The combined penalties of failing to pay and failing to file can add up to 5% of the unpaid taxes a month. The IRS’ penalty abatement programs can reduce or even remove tax penalties for a variety of reasons, such as first-time penalty abatement or penalty relief because of reasonable cause.
In 2015, the IRS assessed $24.1 billion in penalties and abated (or canceled) $8.88 billion in penalties.
Innocent spouse relief
The innocent spouse relief program allows taxpayers to avoid the responsibility of paying tax, interest, and penalties caused by a spouse or former spouse who improperly reported items on a joint tax return.
In 2015, the IRS received 42,400 requests for innocent spouse relief. However, there were only 140 employees working on these cases in 2015. It can take up to eight months to receive a determination (source).
IRS Collection Process
The IRS uses a ‘carrot and stick’ approach with delinquent taxpayers. Audits, tax liens, tax levies, and criminal prosecution act as a persuasive deterrent.
Despite a 17 percent budget reduction since 2010, the IRS remains a formidable adversary. A $900 million reduction in its budget may have reduced the number of tax audits the IRS can perform a year, but its conviction rate for tax investigations is impressive.
The Carrot: Benefits of Tax Relief Programs
Tax relief programs such as installment agreements, offers in compromise, and penalty abatement are the “carrot” in the IRS’ approach. They provide taxpayers with an incentive for staying on track.
The IRS’ data indicate tax resolution programs have been much more efficient as revenue collecting methods than tax liens and levies. The graphs below compare the number of levies issued and liens filed to the delinquent taxes the IRS managed to collect. Despite a large reduction in levies and liens filed (down 45% and 51%, respectively), the delinquent taxes the IRS was able to collect increased by 14% (1.7% if you adjust for inflation) from 2010 to 2014.
If tax liens and levies are not responsible for the increase, what is? As indicated by the graph below, installment agreements, refund offsets and the use of regular collection notices have been the primary reasons for the increase.
- Source: Taxpayer Advocate Service
The bottom line is that despite being underused, tax relief programs have increased revenue collection for the IRS and outperformed tax levies and liens.
Tax relief programs not only improve the IRS’ ability to collect revenue but also provide delinquent taxpayers with the incentive to change their long-term behavior, so they stay out of debt.
A 2012 study by the Taxpayer Advocate Services looked at taxpayers who held “not collectible” status, a label used for taxpayers who are temporarily unable to pay their tax debt. The study then compared taxpayers in this status who were offered an offer in compromise to those who hadn’t. By the end of the study, 80% of the taxpayers who had an offer in compromise had no tax liability, as opposed to only 20% of the taxpayers without an offer in compromise.
Brief history of tax relief programs
IRS tax relief programs have been around in some form or another for decades. For example, Congress passed the Innocent Spouse Act in 1971. However, it was the IRS Restructuring and Reform Act of 1998 (RRA 98) that set out the structure and policies that regulate tax relief programs as we know them today. The goal of the act was to improve customer service, expand taxpayer rights and simplify tax relief programs. Although there were improvements, tax relief is anything but simple.
One of the ideas that came out of RRA 98 was the IRS should adopt a “liberal acceptance policy” of offers in compromise to give delinquent taxpayers an incentive to continue filing tax returns and pay their taxes. As mentioned above, the offer in compromise (OIC) has an impressive compliance rate. Unfortunately, a lack of staffing has limited the benefits of the OIC program (source).
The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA 2005) clarified the rules that regulate the offer in compromise and installment agreements programs. For instance, taxpayers had to make a good faith 20% lump-sum payment of delinquent taxes owed for the IRS to consider their application.
In 2012, and again in 2014, the IRS’ “Fresh Start Initiative” expanded its tax relief programs. These changes made it more likely the IRS would consider and accept tax relief settlements from taxpayers.
What is the Tax Relief Sector?
The tax relief sector is made up of companies that provide advice and representation to taxpayers who want to settle their tax debt with the IRS and state tax agencies. Many taxpayers struggle to understand the eligibility criteria and complete the necessary application forms of such programs.
Tax relief companies help taxpayers determine what programs they qualify for and assist with the application and negotiating process. Some have tax lawyers, enrolled agents and certified public accountants on staff. Certain law and accounting firms also have tax relief departments that help clients facing audits and tax debt problems.
What is the size of the tax relief industry?
The tax relief companies currently operating are all private entities that do not publicly disclose their revenue, number of clients or their clients’ cumulative tax debt. This makes tax relief industry statistics difficult to obtain. However, most tax relief companies will only deal with the cases of taxpayers who owe $5,000 or more to the IRS. Every year, the IRS has about 1.2 million cases in which a taxpayer owes $5,000 or more; those cases total $35.2 billion of tax debt (source).
Should taxpayers hire a tax relief company?
Tax relief companies are a convenience service. They are not cheap, but they provide representation to taxpayers who don’t have the know-how or time to negotiate with the IRS.
“There are two conditions that would allow someone to benefit from tax resolution services,” says Phil Hwang, a tax attorney working for Optima Tax Relief. “They have to owe enough to justify hiring a tax relief company. And they must lack the time and/or expertise to navigate the IRS and its codes and regulations to take care of the issues themselves.”
The complexity of the tax code and IRS budget cuts are helping the tax resolution industry. The IRS has 13,000 fewer employees now than in 2010, and yet they have 9 million more individual tax returns to process (source).
In theory, all taxpayers should be able to negotiate directly with the IRS. Unfortunately, tax regulations are too complicated for most people. “We have people who come for help that shouldn’t have to,” says Bob Wheeler, a CEO of an accounting firm in Santa Monica who is also a CPA. “They should be able to do it by themselves. But a couple of details will complicate their entire case to the point they can’t go forward without professional help.”
Tax debt resolution experts also help taxpayers know when to apply for tax relief programs.
Say, for example, a delinquent taxpayer is considering applying for an offer in compromise. This can provide a fresh start to a taxpayer who fits the IRS’ eligibility criteria. To qualify, the taxpayer has to submit a comprehensive list of assets, including bank accounts, retirement funds, cars, real estate and other valuables. The IRS also wants to know where the taxpayer works. This information can be used to garnish wages, levy bank accounts, and file tax liens if the application is denied. It can take up to six months to get a reply on an OIC application, and the IRS hits the pause button on the 10-year statute of limitations during that six-month period. If a taxpayer is close to the end of the 10-year statute, an offer in compromise may not be his or her best option.
Tax resolution experts have the experience and software to evaluate the merits of a case and determine whether the IRS is likely to accept an OIC. They understand the eligibility criteria of tax relief programs and don’t have their clients go through the time and effort of applying unless they have a good chance of acceptance. That is why leading tax relief companies have an acceptance rate for offers in compromise of more than 90%; the IRS’ average acceptance rate is only 40.3% (source)
How does the United States tax system compare to other countries?
We love to hate paying taxes. A 2016 Gallup survey found 57% of Americans say the federal income tax is too high. The truth, however, is taxes in the United States are low when compared to other developed countries.
According to the Organization for Economic Co-Operation and Development (OECD), the U.S. tax revenue as a percentage of gross domestic product (GDP) in 2015 was 26.4%. Calculating tax rates as a percentage of GDP is a useful measure of the overall tax burden of government on a country. Only four countries, South Korea, Ireland, Chile and Mexico, had lower rates than the United States. However, this is partly because the U.S. has one of the lowest corporate tax rates in the developed world. If you look at the average tax burden per person instead of the percentage of GDP, the United States is closer to the middle of the pack.
The bad news is the U.S. tax system is also incredibly complex and difficult to navigate.
You would need to read 70,000 pages – two full sets of the Encyclopaedia Britannica – to get through the entire tax code (source). Americans spend 6.1 billion hours and $168 million a year on tax compliance, according to the IRS’ Taxpayer Advocate Service. That is the equivalent of 2.9 million people (the population of Utah) working 40 hours a week for an entire year.
The privatization of IRS collections
The incentives are all wrong. Collecting taxes is one of the few jobs you want the government working on instead of the private sector.
Bob Wheeler, CPA
The IRS is painfully aware of the complexity of the tax code, not to mention the restrictions imposed by budget cuts. It has a plan, called the IRS “Future State”.
It’s hard to argue with the goals of this plan. It includes streamlining the federal tax system and making it easier for taxpayers to interact with the IRS online, much as they do now with their banks. The IRS is also looking for ways to fight noncompliance, identity theft, and fraud.
However, tax relief experts are concerned with some of the IRS’ methods to achieve those goals. In 2017, the IRS started a program that privatizes the debt collection of certain accounts as a way to offset its lack of resources. These private companies are assigned overdue tax accounts the IRS has shelved as bad debt.
“It’s insane,” Wheeler said of private collection agencies. “The incentives are all wrong. Collecting taxes is one of the few jobs you want the government working on instead of the private sector.”
Private collection agencies are compensated based on how much they collect, not on the quality of their service. At times, the incentives will work against treating people fairly and helping taxpayers who are going through financial hardship qualify for tax relief programs. The practice of rewarding employees based on how much they collect in overdue taxes was the method of operation before the IRS Restructuring and Reform Act of 1998. A series of scandals caused by overzealous agents pushed Congress to reassess these methods, which is why the IRRA specifically states in Section 1204 that the “Internal Revenue Service shall not use records of tax enforcement results to evaluate employees; or to impose or suggest production quotas or goals.” The IRS sidesteps this law by hiring private collection agencies to act in a way IRS employees are not allowed to operate.
There is also concern about scam artists taking advantage of changes in the way the IRS communicates with taxpayers. As Wheeler points out: “We have always told our clients they will never get a phone call from the IRS, that if they do, it’s a scam, and they can hang up. Not anymore.”
“I think private collection agencies are a terrible idea for several reasons,” said Hwang, the tax lawyer from Optima Tax.“The trust factor is the biggest one. People need to trust the IRS. The IRS has made a huge push toward customer services as opposed to only focusing on collections. Having private collection agencies dealing directly with taxpayers will only generate confusion and mistrust.”
It is unclear how the IRS’ “Future State” changes will pan out, but what does seem clear is that tax relief companies will be a part of that future. As long as the tax code requires professionals to understand it, and the IRS doesn’t have the resources to give taxpayers the help they need, there will be a place for companies that provide tax resolution services.
If you are having tax problems, tax relief companies that have tax lawyers, enrolled agents or certified public accountants on their staff can provide assistance. However, not all tax relief companies have the expertise or experience to provide effective help. The Federal Trade Commission warns about tax relief companies that promise they can provide relief from tax liabilities or misrepresent how long it will take to process debt relief application.
SuperMoney provides expert reviews and consumer comments on leading tax relief companies to help taxpayers do their due diligence before they commit to a company, product or service.