Effective tax relief options are a win-win for the IRS and taxpayers. When applied correctly, tax relief methods increase the revenue the IRS collects and provide taxpayers with a powerful incentive to remain current with their taxes. This article will provide a summary of the nine main tax relief options available to taxpayers.
Tax Relief Options and The IRS’s Struggle
It’s not that we want you to feel bad for the IRS. The IRS isn’t the most disliked federal agency for nothing. However, understanding the challenges the IRS faces explains why it’s willing to offer tax relief in the first place.
Collecting unpaid taxes is a huge challenge for the IRS. According to the latest IRS data, 840,000 taxpayers are behind on their taxes and owe a total of $58 billion. Those figures are extremely conservative. They don’t include taxpayers who underreport their income and those who don’t file their tax returns.
The most recent estimate of the tax gap, the difference between total tax liability (including underreported income and unfiled returns) and taxes paid on time is $458 billion. About 80% of that amount is due to underreporting of income. Over the past 30 years, the tax gap has ranged between 16 and 20 percent of total tax liability. According to a report by the Taxpayer Advocate Service, the IRS has to abate (forgive) around 25% of the taxes owed by delinquent taxpayers every year. All this while the United States is buried in a $19 trillion federal debt.
So what are the options for taxpayers who want to get back on track with the IRS but can’t afford to pay their tax debt in full? The IRS recently introduced the Fresh Start Program, which expanded tax relief programs and made it easier to qualify for them.
Read on to find out more about the 9 main tax resolution options available to taxpayers. We will highlight the advantages and disadvantages of each method, and when you should consider using them.
Tax Relief Option 1: File or Amend Past Returns
An often overlooked tax relief option is to file an amended return or to file a return after the deadline. Taxpayers regularly overstate their income or don’t take advantage of all the available deductions, exemptions, and tax credits. If you “forgot” to file a return, the IRS may file one on your behalf. You can be sure the IRS will apply the minimal exemptions and deductions. A qualified CPA, tax attorney, or even an enrolled agent can help you find tax dollars you missed the first time round.
When should you file or amend a tax return?
You should always consider giving your tax returns a second, third, or tenth look when you’re facing tax debt. It is a particularly useful method for self-employed taxpayers and small business owners because they often leave hundreds if not thousands of tax dollars on the table.
Benefits of filing or amending a tax return
Directly reduces a taxpayer’s liability, as well as the penalties and interest attached to it.
Disadvantages of filing or amending a tax return
There is the issue of the statute of limitations. The IRS has 10 years to collect taxes on assessed income. When you amend a tax return you automatically extend the statute of limitations. Always consult with a tax professional before making changes to your tax returns. Click here to receive a free consultation with a senior tax professional.
Tax Relief Option 2: Payment Plans or Installment Agreements
Installment agreements are often the best tax relief option available to taxpayers. Sure, they’re not as sexy as offers in compromise, which allow you to pay pennies on the dollar of your tax debt balance. However, you are much more likely to qualify for a payment plan. The IRS considers a taxpayer in an installment agreement as tax compliant, which means you won’t have to worry about IRS letters, phone calls, and tax liens.
When should you apply for an installment agreement?
You should apply for a payment plan whenever there isn’t a better option, which is most of the time. For instance, if you can’t afford to pay your tax debt in full but you own a home, an expensive car, or have a substantial and regular income, an installment agreement is probably your best choice. On the other hand, if you have a large tax debt and your income only allows you to make minimal payments, you should look for another option.
Benefits of applying for an installment agreement or payment plan
They are easier to qualify for than other tax relief options. You don’t have to liquidate your assets. The IRS will consider you as compliant and it will protect your assets from tax liens and tax levies.
Disadvantages of applying for an installment agreement or payment plan
You have to pay the full amount (the partial payment plan is an exception). Interest on the tax debt continues to accrue. If you can’t afford to make large enough payments, you could be just paying interest and barely making a dent on the debt’s principal.
Tax Relief Option 3: Offer in Compromise
This is the rock star of tax relief options. It gets all the attention from tax relief companies and taxpayers. Can you blame them? Who wouldn’t want to negotiate a settlement where a big chunk (if not all) of a tax debt is wiped clean? As you can imagine getting the IRS to forgive part of your tax debt is not easy. To illustrate, in 2015, the IRS approved 2.99 million installment agreement but only 66,600 offers in compromise. However, if the circumstances are right, an offer in compromise can be the best option for a taxpayer with substantial tax debt.
When should you apply for an offer in compromise?
You should apply for an offer in compromise whenever you qualify. In other words, if you don’t have enough assets to pay the debt in full and your income is not large enough to pay the debt balance within two years, you may qualify for an offer in compromise. You must also be up-to-date with your tax returns, estimated tax payments and deposits, and you can’t be in an open bankruptcy. Read this in-depth guide to how the IRS’s assesses eligibility for an offer in compromise. You will also learn how to calculate the minimum offer an IRS agent is authorized to approve.
Benefits of applying for an offer in compromise
Reduces the amount of money you owe the IRS. Stops certain collection actions and allows you to keep some of your assets.
Disadvantages of applying for an offer in compromise
Requires taxpayers to make a large initial payment. It requires taxpayers to provide detailed financial information to the IRS. Always consult with a tax attorney before providing the IRS with sensitive financial information that could be self-incriminating. The offer in compromise is cancelled if a taxpayer is not fully compliant for five years after the offer is accepted. It usually requires the taxpayer to liquidate certain assets and can take many months to 2 years to complete. If the IRS does not respond to an offer in compromise after 2 years, it is automatically accepted.
Tax Relief 4: Penalty Abatement
There are certain circumstances where taxpayers can request the IRS for a reduction or removal of tax penalties. This can be a useful tax relief method because penalties and interest represent up to 44 percent of the initial tax liability. The problem is the IRS is in no hurry to forgive penalties. It knows that penalties work. Research by the Taxpayer Advocate Service indicates that taxpayers who are hit with a significant amount of penalties are more likely to be compliant in future years.
When should you apply for penalty abatement?
Applying for a penalty abatement is always an option. Taxpayers who have had no previous delinquencies or penalties can apply for a First Time Abatement Rule. Taxpayers can also claim “reasonable cause” for late payment. This includes reasons like death, serious illness, fire, natural disaster, undue hardship, bad advice from the IRS or a tax advisor, IRS error, or even ignorance of the law.
Advantages of applying for penalty abatement
Dollar for dollar reduction of tax liability. First-time offenders have a good chance of reducing or removing the tax penalty.
Disadvantages of applying for penalty abatement
Repeat offenders find it hard to qualify for penalty abatement. Requires a good understanding of the IRS’s Penalty Handbook. Always reference the appropriate section of the IRS Penalty Handbook when applying. IRS workers use software to determine whether they can approve a penalty abatement request. The software requires them to insert the tax rule the request is based on. Providing the correct reference will increase your chances of approval as many IRS workers don’t have the training to determine or reference reasons for reasonable cause.
Tax Relief Option 5: Currently Not Collectible
Getting the IRS to categorize you as uncollectible is a useful method to buy the time you need to get your finances in order and pay your tax debt or apply for another tax relief option. In 2015, the IRS labeled 16.3% of delinquent accounts as currently not collectible.
When should you apply for currently not collectible status?
If you agree with the IRS’s assessment of your taxes but your current financial situation doesn’t allow you to pay taxes and reasonable living expenses, the IRS may agree to give your account currently not collectible (CNC) status.
Advantages of requesting currently not collectible status
While your account is categorized as currently not collectible, the IRS will pause collection activity, such as the use of tax liens and tax levies. This gives you time to organize your affairs.
Disadvantages of requesting currently not collectible status
It is only a temporary solution. The interest and penalties on your tax debt continue to accrue. The CNC status will put a pause on the statute of limitations for your tax debt, which extends the time the IRS has to collect the tax.
Tax Relief Option 6: Innocent Spouse Relief
The innocent spouse relief offers relief when a taxpayer is assessed additional tax because of the mistakes or underreporting of a spouse or former spouse.
When should you apply for innocent spouse relief?
Apply for innocent spouse relief when you didn’t know (and had no reason to know) your spouse was under-reporting taxes on your joint return.
Advantages of applying for innocent spouse relief
Applying for innocent spouse relief can completely remove your tax liability. If you live in a community property state and you didn’t file jointly, applying for innocent spouse relief may protect you from the operation of community property law (i.e. 50/50 division of property) for the payment of back taxes.
Disadvantages of applying for innocent spouse relief
The rules determining eligibility are complex and it can be hard to prove you didn’t have knowledge of what your spouse was doing.
Tax Relief Option 7: Statute of Limitations
The IRS has – in most cases – up to 10 years to collect on assessed taxes. After the 10-year window expires, the IRS loses its right to collect back taxes. The clock only starts once you file a tax return, so not filing and hoping the IRS won’t notice is not a good strategy. As discussed above, certain tax relief options, such as offers in compromise and CNC status, can extend the 10-year statute of limitations.
When should you use the statute of limitations?
Use the statute of limitations to your benefit when you have no property or income and your situation is unlikely to change before the statute of limitations ends.
Advantages of waiting for the statute of limitations to run out
You don’t have to pay the tax debt. Enough said.
Disadvantages of waiting for the statute of limitations to run out
The IRS can sell your property, levy your assets, garnish your wages and place notices of tax liens on your credit report. You will most likely lose all your assets and your credit score will be toast.
Tax Relief Option 8: Remove a Federal Tax Lien Notice from Your Credit Report
This is a recent tax relief. Until recently, the best the IRS could do was place a notice saying the tax lien had been removed but it wasn’t removed from your credit history. A federal tax notice of lien on your credit report will stay there for up to 7 years. It tells other creditors that you owe the taxman $10,000 or more; that the IRS has dibs on your property; and could, at any moment, take possession of it. As you might have guessed this is not good news for your credit score. Removing a tax lien notice from your credit report will not only improve your credit score. It can also help you refinance a loan, get a new loan, or even sell some of your property.
When should you apply for the removal of a federal notice of tax lien?
Apply for the removal of a tax lien as soon as you qualify. The IRS will consider removing your tax lien notice if you pay your tax debt in full, have an installment agreement and you are current with your payments, or if you can convince it that doing so will improve your chances of repaying your tax debt.
Advantages of removing a federal tax lien notice from your credit report
Removing a federal tax lien notice from your credit report will improve your credit score and makes it easier to sell property used as a security on a loan, apply for new loans, and refinancing existing loans.
Disadvantages of removing a federal tax lien notice from your credit report
There are no disadvantages. The challenge is to get the IRS to agree to it, but it’s certainly worth trying.
Tax Relief Option 9: Bankruptcy
Bankruptcy is not a fix-all solution for tax debt. Only income-tax debt can be discharged through bankruptcy. Other types of taxes, such as employment taxes and property taxes are unaffected by bankruptcy. Having said that, if you meet the requirements, bankruptcy can remove your entire income-tax debt. Bankruptcy law is extremely complex. Don’t even think about trying it without a bankruptcy attorney that specializes in tax law.
When should you file for bankruptcy?
There are two main rules tax debt must meet to get discharged: the three-year rule and the 240-day rule. Only tax debt that was due three or more years ago and was assessed by the IRS at least 240-days before filing for bankruptcy qualifies.
Advantages of filing for bankruptcy
It can completely remove your tax liability. Enough said.
Disadvantages of filing for bankruptcy
Bankruptcies stay on your credit report for at least 10 years and you can’t remove them. It will destroy your credit and could even affect your chances of getting a job that requires you to deal with money, such as accounting, payroll, and banking.
What Should You Do Next?
Now you have a better idea of the tax relief options available to you, you are ready to discuss your situation with a tax professional. Compare it to researching your symptoms before visiting a doctor. Even if you have an idea of what your diagnosis and treatment may be, you wouldn’t dream of self-medicating or performing your own surgery. You want to be an informed taxpayer but you still need professional help when dealing with the largest debt collecting machine in history. This is particularly important if you owe $10,000 or more in debt or you are at risk of facing an IRS audit. The right to hire a licensed tax professional to represent you before the IRS is part of the Taxpayers’ Bill of Rights for a reason. Use it.
Even if you are planning to roll the dice and do it yourself, invest in at least one session with a tax attorney or CPA. It doesn’t have to cost you a penny. Get a free consultation with a senior tax professional and see if you qualify for tax relief.