Americans fail to pay $441 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 2011, 2012, and 2013 tax years.
Compare a tax gap of $441 billion with the federal budget deficit of 2019, which was $984 billion (Source). The U.S. government’s annual deficit could have been reduced by 45% if the IRS had collected the money it was owed.
While the tax gap continues to grow, IRS resources have dropped to pre-1998 levels due to a series of IRS budget cuts implemented by the Bush, Obama, and Trump administrations (source). The President’s Fiscal Year 2018 Budget cuts IRS funding to $11.0 billion (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% 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 taxes ($29 billion), employment taxes ($6 billion), and corporate income taxes ($3 billion). However, these are just estimates.
What hard data do we have on tax debt?
As mentioned above, the Treasury’s latest compliance report put the number of taxpayer delinquent accounts in 2017 at 859,745. This is a significant drop from the 937,514 of 2016, but still higher than the 848,000 delinquent taxpayers of 2012 (source).
The total tax debt also dropped to $44.7 billion. That represents a 20% reduction from $55.8 billion in 2016.
In 2017, delinquent taxpayers owed, on average, $51,992 in back taxes. The IRS audited 1.06 million tax returns. That sounds like a lot, but it only represents 0.5 percent of tax returns. However, the audits assessed an additional $28.99 billion in tax liability. The chances of being audited by the IRS are low but if the IRS does disagree with your tax return the average tax liability increase is $89,534 (source). Still, increasing tax liability doesn’t mean the IRS can always collect the taxes it assesses.
In 2017, IRS wrote off $19 billion in bad debts. That is a 129% increase from 2016. One of the reasons for this is the IRS is relying more heavily on its Automated Collection System (or ACS), which in turn is much more liberal when it comes to shelving taxpayer delinquent taxes. In 2017, the number of delinquent accounts that were assigned to the ACS increased by 13%. The ACS shelved or abated 470% more delinquent accounts in 2017 (1.8 million) than it did in 2016 (320,000), which amounted to nearly $4 billion more in abated taxes (source)
IRS and private collection agencies
These numbers can be misleading. Not all of it is forgiven debt. A big chunk of the increase in case closures is due to the IRS’s efforts to provide private collection agencies (PCAs) with inventory. As of May 2018, the IRS assigned nearly 432,000 delinquent tax accounts with a total balance of $3.6 billion to PCAs (source). See below for more information on how private collection agencies work.
Although doing away with tax debt altogether may be unrealistic, there are tools to help reduce it. Tax relief is one of them.
Tax due by state and zip code
According to the latest IRS statistics available (FY 2015), the states with the largest tax due (on average) at the time of filing are North Dakota, South Dakota, and New Jersey.
At the zip code level, Fisher Island (Miami-Dade County), Butte City, California, and Keene, North Dakota, had the most tax due at time of filing taxes for the 2015 financial year.
Search the map below to find out the average in your zip code.
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 2017, the IRS wrote off $57.8 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 January 2018, approximately 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 2016, the IRS approved over three million installment agreements (source). Installment agreements have been an effective tax collection 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 the 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.
In 2017, 40.32 percent of offers in compromise — 24,000 out of 62,000 — were accepted by the IRS.
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.Currently Not Collectible applications are more complex than offers in compromise, which is probably why they are so underused. In 2016, nearly 300,000 taxpayers who should have qualified for CNC status entered into an installment agreement instead. Hiring a reputable tax relief firm can help taxpayers navigate the bureaucracy and qualify for CNC status. (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.
IRS agents are realizing that other tax collection methods are more effective than. So, they are starting to shy away from the use of levies.In 2016, the IRS reduced its use of levies by 41 percent: from 1.46 million to 869,000 (source).
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 2017, the IRS filed 446,378 tax liens, which is a significant drop from the 470,602 of 2016 and the 515,247 in 2015.
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 2017, the IRS assessed 26.5 billion in penalties. An improvement from 2016, which had $27.3 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 21 percent budget reduction since 2010, the IRS remains a formidable adversary. A $3 billion 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 31,402 fewer employees in 2017 (76,219) than in 2010 (107,621), and yet they have 9 million more individual tax returns to process (source, 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.”
Benefits of using a tax relief firm
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)
If you owe a lot of money to the IRS, it can help to have a tax relief company on your side. The best tax relief companies have tax lawyers and enrolled agents on staff, provide a money-back guarantee and charge competitive rates. Check out which tax relief company is the best fit for you.
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.
Concerns with the private collection agencies
However, tax relief experts are concerned with some of the IRS’ methods to achieve those goals. In April of 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. As mention above, the latest figures put the number of delinquent tax accounts assigned to private collection agencies at 432,000 with a total value of $3.6 billion (source).
Private collection agencies are compensated based on how much they collect, not on the quality of their service. They receive 25% of whatever they collect. 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.
For example, private collection agencies offer installment agreements that last up to 7 years, but the law that authorizes the IRS to hire private agencies (26 U.S. Code 6306) sets a limit of 5 years.
The other concern is the language collectors use when talking to taxpayers. Internal documents show PCAs instructing employees to suggest taxpayers use their 401(k) funds, get a second mortgage or use credit cards to pay their balance.
“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.”
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.”
The IRS has tried using private debt collectors in the past
Every one of those experiments failed. The incentives for these private contractors are poorly implemented and even if all these private collectors acted reasonably and ethically – a big “if” considering their track record – they are set up for failure because they don’t possess the resources and expertise available to the IRS.”
Harry Langenberg, founder of Optima Tax Relief
“Versions of the current private collection plan were tried out in the 1990s and 2000s,” says Harry Langenberg, founder of Optima Tax Relief. “Every one of those experiments failed. The incentives for these private contractors are poorly implemented and even if all these private collectors acted reasonably and ethically – a big “if” considering their track record – they are set up for failure because they don’t possess the resources and expertise available to the IRS.”
Senators and National Taxpayer Advocate claim private debt collectors are breaking the law
At least four senators feel contractors are in clear violation of the tax code. In a letter to Pioneer Credit Recovery, Sherrod Brown, Jeff Merkley, Benjamin Cardin and Elizabeth Warren, stated “we are concerned that Pioneer may be (1) failing to adequately protect taxpayers from criminals posing as IRS agents; (2) pressuring taxpayers into risky financial transactions; (3) violating the Fair Debt Collection Practices Act (FDCP A) and provisions of the Internal Revenue Code; and (4) violating IRS guidelines and provisions of Pioneer’s IRS contract. We urge you to remedy these matters and to end potential taxpayer abuse immediately.”
The National Taxpayer Advocate also questions the legality of private debt collectors
The National Taxpayer Advocate has also expressed concern about the practices and legality of private collection agencies. In its latest report to Congress, the National Taxpayer Advocate reported that “the IRS is implementing a PDC [Private Debt Collection] program in a manner that is arguably inconsistent with the law and that unnecessarily burdens taxpayers, especially those experiencing economic hardship (source).
What are the concerns with private debt collectors?
There are two main violations.
First, all four private contractors are offering taxpayers installment agreements that last up to seven years. The code that authorizes the IRS (26 U.S. Code 6306) to hire private tax collectors specifies a maximum of five years.
The other concern is the language collectors use when talking to taxpayers. The senators’ letter singled out the scripts used by one of the private contractors, Pioneer Credit Recovery. These scripts instruct employees to suggest taxpayers use their 401(k) funds, get a second mortgage, or use credit cards to pay their balance.
For more details on credit card debt and the consumer credit card industry read this report.
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.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.