Tax Debt Settlement FAQ

If you’re looking to settle your tax debt, here’s what you need to know.

This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.

Can you really settle your IRS debt for pennies on the dollar?

You’ll frequently see advertisements saying that you can settle your tax debt for pennies on the dollar. There’s truth to these statements, but you have to understand what they mean.

Settling a tax debt isn’t like settling a court case or credit card debt.

In a court case, settlements are negotiable because you never know for sure who will win or close. Credit card companies also negotiate settlements because of legal costs, the possibility of losing in court, and uncertainty about how much you’ll pay if they wait.

With the IRS, you generally have to pay what you owe.

Tax debt is only negotiable when there’s doubt as to collectability. That usually means you have a complicated tax return where the tax law is uncertain. In those cases, the IRS knows it might lose if it goes to court.

For most tax debt, there is no doubt about what you owe. The IRS also has huge power as a debt collector. That’s why they don’t usually negotiate.

What most people are referring to when they say settle your tax debt is an offer in compromise.

What is an offer in compromise?

An offer in compromise is when you settle your tax debt, but it’s based on what you can pay. Offers go by strict math formulas not by negotiation.

When you make an offer in compromise, the IRS will make you give up most of your savings and assets. There are some exceptions, like for a modest car and home.

You’ll also need to give up virtually all of your disposable income.

Once the IRS confirms what you can pay, you can pay that amount. The compromise is that the IRS will wipe out the rest of your tax debt.

You can use the IRS Offer in Compromise Pre-Qualifier to see if you qualify.

Does bankruptcy work for tax debt?

You may be able to discharge your tax debt in bankruptcy. If you only have tax debt, it often won’t be your best option.

Bankruptcy is very expensive and causes a major drop in your credit score. IRS tax settlement options don’t go on your credit report.

Bankruptcy also has similar results to IRS options. Just like an offer in compromise, you pay what you can, and the rest gets wiped out.

If you do have the resources to pay in the near future, just not now, an IRS payment plan will often be cheaper and have less financial consequences than filing for bankruptcy.

What happens if I don’t take care of my tax debt?

If you don’t take care of your tax debt, things can usually only get worse.

Interest and penalties keep getting added on until you pay it. The IRS could also place a lien on your home or start garnishing your wages.

Working with the IRS will almost always lower your costs and keep worse things from happening.

How much will the IRS settle for?

There is no fixed amount that the IRS will or won’t settle for. They look at your current financial situation and the chances that it will improve in the future.

If you were a high earner and lost your job, the IRS might think you can find another good job in the near future. If you can no longer work because of a disability, the IRS will take that into consideration.

Of course, the larger the tax debt, the closer a look the IRS will take at your finances before approving anything.

What is the minimum payment the IRS will accept?

There is also no fixed minimum payment that the IRS will accept. It’s based on your financial resources.

If you can convince them you can only pay a penny, they will take your penny (or determine that you can’t pay at all).

The only true minimum is that if you want to do a payment plan, it usually can’t last longer than six years.

Can I settle with the IRS myself?

You can technically settle with the IRS yourself. There are two reasons you may not want to.

First, they can only give you general information. They can’t give you advice on what the best option is for you. So they can’t tell you if you should do an offer in compromise, payment plan, currently not collectible status, bankruptcy, or something else.

Second, the application process can be difficult. You have to provide a lot of documentation, and IRS agents sometimes try to deny your settlement even when they shouldn’t.

Working with a tax lawyer or Enrolled Agent gives you the benefit of having an experienced tax professional to guide you through the process and fight the IRS if needed.

If you can’t afford to hire a tax pro, you may qualify for a Low Income Taxpayer Clinic.

How likely is the IRS to accept an offer in compromise?

According to IRS data, the IRS accepts just over one out of three offer in compromise applications.

While some of the denials are taxpayers who didn’t qualify, many are because of mistakes in filling out the application or not providing enough documentation. Those are the kinds of things a tax expert can help you avoid.

Do I have to pay taxes on debt settlement?

When you settle most debts, you have to pay taxes on the amount of the debt you don’t have to pay. The theory is that not having to pay is income because you receive a benefit when you’re told you don’t have to pay.

When you settle an IRS debt, you generally don’t have to pay taxes. You’ve already proven that you can’t pay more in taxes.

Is there a one-time tax forgiveness?

There is no one-time forgiveness that wipes out the taxes that you owe.

There is a first-time penalty relief program that lets you have your penalties removed or reduced. To qualify, you can’t have had certain other tax issues in the recent past, such as late payments or unfiled taxes.

There is also a Fresh Start Initiative for people with first-time tax issues. This isn’t really a separate set of options but an effort by the IRS to be nicer to and make things easier for people who haven’t had tax trouble before. This includes making the application easier and being slightly less strict on some of the requirements.

Does IRS forgive tax debt after 10 years?

The IRS generally has ten years to collect most tax debts. This is known as the statute of limitations.

If you have a very old tax debt, it sometimes makes sense to not pay it because the IRS won’t be able to collect it if you wait. However, the IRS often takes extra steps to collect before the statute of limitations expires.

You may be more likely to have your wages garnished or receive a notice of intent to levy.

There are also certain situations where the IRS can extend or ignore the statute of limitations.

If you’re considering not paying an old tax debt, talk to an Enrolled Agent, CPA, or tax attorney.

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