I am asked so often whether it's true that the IRS will actually settle tax debt…I find myself thinking about it even when I don't want to be. It's like a song that you can't get out of your head. Don't Stop Believing. So in another effort to answer this question yet again…and to help clear my head for the weekend, here is a quick review:
YES! THE IRS WILL SETTLE TAX DEBT FOR LESS THAN WHAT IS OWED
The IRS settles tax debt formally and they do it all the time. The “program” that is used to tell the IRS whether it should settle, is call the “Offer in Compromise” program (“OIC”).
AGAIN, IT'S FORMAL
The OIC program process isn't one that is based on some phone calls and some wheeling and dealing. It is formal. The Taxpayer has to prove that the facts and circumstances qualify him or her for settlement.
“Hey – do you think you'd take 10%?”, doesn't work.
FIRST REQUIREMENT TO SETTLE
The first “hoop” that needs to be jumped through, is proving to the IRS you can't afford to pay all of the tax debt before the 10 year date on the IRS' ability to collect runs out. This date is commonly known as the Collection Statute Expiration Date or CSED.
This first and for many…the most difficult hoop to jump through.
WHY IS THE FIRST REQUIREMENT SO DIFFICULT TO SATISFY
Reason One – CSED Length
The CSED is 10 years long plus anytime the taxpayer did anything to stop it like file an appeal, request a payment plan, file a bankruptcy, or leave the country.
Reason Two – Most Recent Date Used
The most recent tax year is the year used to calculate the CSED. If the taxpayer owes for five years from 2013 to 2017…the 2017 CSED is used to determine the 10 year + CSED.
Reason Three – Budget set by the IRS
The IRS looks very closely at three things when you request a settlement. Your income, assets, and budget. It will try to use the largest income amount it can prove. It will give a discounted value on assets, but…it will count their remaining value.
But the most common problem is that it limits the budget to one that is based on what it thinks the average household spends – not necessarily what the taxpayer spends. (IRS Collection Standards)
Tax debt $50,000.00
Asset Value $8,000.00
Avg. Income $4,500.00 per month
Avg. Budget $4,500.00 per month
CSED 80 remaining months
Given the above…you'd think the IRS Settlement should be $8000.00.
But look at what happens when the IRS uses it's budget.
Assuming that budget includes $250.00 more per month than what the IRS thinks the average car payment is, and $300.00 in minimum credit card payments above their standard amount for miscellaneous expenses…it will see an ability to pay $550.00 per month toward the debt.
Given 80 months remaining on the CSED, the amount the IRS believes the taxpayer could afford toward the debt will be:
$8,000.00 plus $44,000.00 or $52,000.00. Rejection.
Yes, the IRS will actually reject the offer if the numbers show an ability to pay before the CSED.
WHAT IF THE FIRST “HOOP” IS SATISFIED – WILL THE IRS SETTLE?
If the first rule is met, the IRS is supposed to multiply the excess number by 12 and add the value of your assets (some at a discounted amount) and allow the taxpayer to pay that amount over several payments.
In the example above – assuming that excess car payment amount were $150.00 and not $250.00, the excess income would be $450.00, not $550.00.
$450.00 x 80 is $36,000.00 plus $8,000.00 = $42,000.00 – LESS than the debt so:
$450.00 x 12 + $8,000.00 is $13,400.00.
$13,400.00 should be the settlement amount.
BUT HOW DOES THE SETTLEMENT AMOUNT GET PAID?
Using the 12 month multiplier example above…the taxpayer would have had to pay 20% with the OIC filing and the rest in 5 installments after acceptance.
There is another way to skin the “payment cat” that has to do with using a larger multiplier and longer pay-back period.
THE SECOND BIG HOOP – NOT ABLE TO PAY THE SETTLEMENT AMOUNT
The second big problem that we see is that even when a taxpayer makes the numbers work, they have no way to pay the settlement amount. This happens because the asset value is usually tied up in a home or other difficult to sell asset and/or the excess income number was created using a fictional budget…the taxpayer doesn't actually have the excess and hasn't been able to save it.
HOW TO JUMP THROUGH THIS SECOND HOOP
If the taxpayer plans ahead and creates a “tight” situation with this potential problem in mind, he or she might be able to pay the settlement amount. Even then…a third party often has to get involved to help the taxpayer come up with the money.
WHAT DO I DO
If you have a large IRS debt, start the process of determining whether an OIC might work by doing the following:
- Become an expert on the issue of your average income and budget
- Become an expert on the value of your assets
- Provide your expert analysis to me
- Allow me to review your analysis and the IRS' history re: your IRS debt and apply the facts to the rules
If you'll provide the numbers and other valuable information about yourself, I do the evaluation for free. Once we know what's going on, we can discuss whether you can make an offer work, either now or in the future. We'll also discuss your other options.