Having a large debt balance is never good but it can be incredibly nerve-wracking when your creditor is the Internal Revenue Service (IRS). Luckily, you may be able to reach a tax debt settlement with the IRS, depending on your personal situation. If you’re able to get your agreement, called an “offer in compromise,” approved, you may be able to settle your tax debt for less than the full amount you owe. Consider working with a financial advisor as you file your taxes and, if needed, respond to an IRS audit as they can help you navigate the whole process.
How Tax Debt Settlements Work
Tax debt settlements are agreements between the IRS and someone who holds a tax debt. Tax debts can occur if you’re behind on paying your taxes, improperly filed your taxes, or have previously committed fraud. The best way to resolve a tax debt is by not getting one in the first place. Work with a well-qualified tax professional who can help ensure that you don’t miss anything or improperly claim deductions that will cause problems later after an audit.
If you’re audited and errors are found, you’ll be responsible for what you owe and any interest that’s accrued over time, which could add up to a significant liability. If you don’t make arrangements to pay your debt, the IRS can garnish your wages, withhold future tax returns and even seize your assets.
A tax debt settlement can reduce the amount you owe to the IRS. The IRS can agree to your offer and come to a settlement with you if they determine that the amount you offer is the most they can expect to collect within a reasonable amount of time. The IRS recommends that you pursue all other payment options before trying to submit an offer in compromise seeking a tax debt settlement.
How to Qualify for a Tax Debt Settlement
The IRS has explicit, rigid guidelines for who can and cannot qualify for an offer in compromise and has a pre-qualification tool you can use to check your eligibility on their website. You’re eligible to apply for an offer in compromise if you:
- Filed all required tax returns and made all required estimated payments
- Aren’t currently in an open bankruptcy proceeding
- Have a valid extension for a current year tax return (if you’re applying for a settlement for the current year)
If you’re an employer seeking a tax debt settlement, you’ll need to have made tax deposits for the current and past two financial quarters before you can apply for an offer in compromise. There are also things that you shouldn’t do if you owe the IRS, such as ignore their communications.
How to Apply for a Tax Debt Settlement
You can submit an Offer in Compromise yourself, but it’s a good idea to work with a qualified tax professional and even a tax attorney. The process is complicated and if you’ve already made errors with the IRS that got you into this mess, it’s a good idea to have your work reviewed by someone who knows what they’re doing. The IRS considers your ability to pay, income, expenses and asset balances when considering your offer. To apply you’ll need to:
- Complete Form 433-A if you’re an individual or 433-B if you’re a business, along with all required documentation listed on the forms
- Complete Form 656 (you’ll need to complete multiple if you have individual and business tax debt)
- Submit a non-refundable $205 application fee
- Submit your initial non-refundable payment for each Form 656
Choosing a Payment Option
You’ll need to choose a payment option for your offer. You can go with a lump-sum cash offer, in which case you’ll submit an initial payment of 20% of your total offer amount when you send in your application. You’ll have to pay the remaining balance in five installments or less if your offer is accepted.
If you go with periodic payments, you’ll pay monthly installments of an amount you choose, sending in your first payment with your application and continuing to pay monthly until you hear a decision on your offer. If the IRS accepts your offer, you’ll continue to pay that monthly amount until your debt is paid off.
Determining what amount to offer and which payment plan is right for you can be difficult. Even if you don’t hire an attorney or tax advisor to submit your offer, it’s a good idea to consult with one so you know what offer is most likely to be approved.
What Happens If You Can, or Can’t, Get a Tax Debt Settlement
If you’re approved for a tax debt settlement, you must make payments to the IRS following the terms of your offer. Any tax lien will remain until your offer terms are satisfied and your debt is paid in full according to the terms you and the IRS reached.
If you aren’t approved for a tax debt settlement, and your offer in compromise is rejected, you’ll have 30 days to appeal your offer using IRS Form 13711. If you didn’t work with an attorney on your first offer, it’s a good idea to work with one for your appeal. If you don’t choose to appeal their rejection, you’ll owe the full balance of the tax debt and must make payments accordingly.
The Bottom line
The IRS has strict requirements for who can and can’t settle tax debt and how to apply for your own potential settlement. Working with a professional can greatly increase your odds of doing it right and having your offer approved. If you are able to reach a tax debt settlement, you can reduce the amount you owe and get the IRS off your back sooner. This could help you get your finances on track and avoid more serious penalties.
Tips for Managing Tax Debt
- Tax debt can be stressful and confusing, which is why it makes good sense to work with a financial advisor. If you don’t currently have a financial advisor, finding the right one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use our no-cost income tax calculator to get a quick estimate of what you owe the federal government. This can help you get ahead of any debt you may have incurred so that you can pay it off faster.
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