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Guide to Tax Debt and Relief

Here’s a guide to the basics of tax debt, and how to get back on track if you owe the IRS money.

Every year, hundreds of thousands of Americans end up in debt to the IRS because of underreporting or underpaying their taxes, whether by mistake or on purpose. Owing the IRS can be stressful and worrisome, especially if they place a lien or levy on your assets or property. But you’re not alone – there are tax debt resolution services that can help you.

What is Tax Debt?

When you forget to pay or file your taxes, there is a mistake on your taxes, or the IRS wants to change your taxes, and the IRS says you owe money as a result, you’ve incurred tax debt.

If you have tax debt and you’re worried about owing money to the IRS, you’re not alone. In 2017, 859,745 American taxpayers had delinquent accounts. Fortunately, the IRS provides options for taxpayers to resolve their debt. There are many options to help reduce, and in some cases eliminate, tax arrears, ranging from filing or correcting a tax return to arrangements like penalty abatement, installment agreements, or offers in compromise.

Tax Debt Key Terms Glossary

Collection Statute Expiration Date

The date on which the IRS has to forgo a taxpayer’s debt, 10 years from when the penalty was assessed.

First-time abatement

An abatement of tax-related penalties for one tax period, for taxpayers who have incurred tax debt for the first time.

Injured spouse

Someone whose spouse has past-due tax debt, who feels their spouse should be wholly financially responsible for this debt.

Innocent spouse

Someone whose spouse or former spouse has made an error on their jointly filed return, who feels their spouse should be financially responsible for the debt.

Installment agreement

A payment plan made with the IRS by which the taxpayer agrees to pay off debt in installments.

Read more about installment agreements.

Lien

The IRS can file a lien against a taxpayer’s property or assets, giving them the right to claim any income generated from these things as a means of settling the taxpayer’s debt.

Read more about Lien

Levy

A direct seizure of property, assets, or income by the IRS. This can affect a taxpayer’s home, car, bank account, retirement funds, wages, and more.

Read more about Levy

Offer in compromise

An agreement with the IRS to pay less than what is owed, because a taxpayer cannot pay the full amount due to financial hardship.

Read more about Offer in compromise

Penalty abatement

A delay in the collection of tax debt due to a taxpayer’s personal and financial circumstances.

Do you owe the IRS money?  Here are some things you need to know:

Owing the government tax money can be a daunting prospect, but understanding the basics is one way to make the process a little easier. The IRS has many options to help you pay your tax debt, including reducing the debt through filing, or correcting, an already filed tax return. If it becomes too much, don’t hesitate to get help from a professional.

Does tax debt have a statute of limitations?

Income tax debt does have a statute of limitations for when the IRS can collect on the unpaid debt. The total time for the statue is 10 years from when the penalty was assessed – this is known as a Collection Statute Expiration Date (CSED). Generally, this means that once that date is passed, the IRS has no choice but to forgo that debt.

Keep in mind that the CSED can be extended through various means, such as entering into an installment agreement, submitting an offer in compromise, having property seized, or entering in a period of non-collectability. However, if you are nearing the CSED date, it would be a stronger argument to have your debt partially absolved by submitting an offer in compromise.

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Did you get a letter from the IRS? – 

Getting a letter from the IRS can be a disconcerting experience, because the IRS only sends letters if there’s some sort of issue with your return or tax status. You might have a balance due; maybe there was a mistake with the size of your refund; there might be a question as to your identity. Sometimes, a letter from the IRS isn’t as serious as you might think: The IRS might have a simple question about your tax return, or they need to notify you about a delay in processing it.

In all cases, you should take the time to carefully read the letter and figure out what the problem is. You’ll also want to respond as soon as possible, which means you’ll likely have a decision to make: Is this something you can solve yourself, or do you think you might need help? If you need help responding to a letter from the IRS, consider contacting a tax professional – but don’t let a letter from the IRS go unanswered.

What are the IRS penalties for underpayment?

If you didn’t pay your taxes, or if something went wrong with your return, you may have outstanding debt. There are two types of underpayment penalties. The first comes with the filing of your tax return because you did not prepay enough taxes through withholding or estimated tax payments. This penalty is determined by the federal treasury rate each quarter during the tax year. The second, and largest, type of underpayment penalty is due when you don’t pay your taxes by the due date of your tax return. This penalty can be as much as 25 percent of the taxes owed, and is compounded immediately and assessed regularly until you pay the debt. The IRS can take your tax refund each year to help pay the debt, and they might issue claims on your property and/or assets, or even take money directly from your paycheck, which can be a stressful experience.

Here’s what owing the IRS could mean for you:

  • The bill keeps growing since penalties are assessed each month and interest is compounded daily.
  • If you are not working on a resolution and on a timely payment plan, your security clearance and/or your job can be jeopardized.
  • IRS can take your tax refund and apply it to your outstanding debt.
  • In the most delinquent cases, IRS can assess a levy on your paycheck and take a portion of it each payday.

The IRS’ goal is to work with you to resolve your debt before taking collection actions. Most taxpayer penalties for not paying a debt are monetary and do not include any criminal penalties. Jail time is typically reserved for taxpayers convicted of tax fraud.

What is a first-time abatement?

If this is the first time you’ve owed the IRS money, you can request a first-time abatement (FTA). If you prove to the IRS this is the first time you have been in a non-payment status on taxes, you can request an abatement of tax-related penalties for one tax period. You must show you previously didn’t have to file a return, or you filed and paid your previous taxes and have a three-year history of no penalties. To demonstrate filing compliance, you must have filed, or filed an extension for, all of your tax returns; you can’t have an outstanding request from the IRS for a return you didn’t file. The same goes for payment compliance: You must have paid, or made arrangements to pay, any tax you owe. You can be on a current installment agreement with the IRS, meaning your payments are up-to-date. Keep in mind that first-time abatement is a one-time offer. If you’ve already used FTA, then you would need to look toward a reasonable cause penalty abatement.

What is reasonable cause for penalty abatement?

There are many reasons to abate penalty, in addition to the first-time penalty abatement. Some examples include:

  • Fire, casualty, or natural disaster
  • Death, serious illness, or unavoidable absence
  • Inability to get records
  • Erroneous IRS advice

This list is not exhaustive, as reasonable-cause abatement considers the facts and circumstances in your situation. Ultimately in order to successfully argue for a reasonable cause abatement, there must be extenuating circumstances which, if the full amount of penalties were assessed, would lead to either your financial hardship or egregious overextension of penalties through no fault of your own.

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How can I settle my tax debt?

Four common “reasonable collection alternatives” are recognized by courts: payment in full, an installment agreement, an offer in compromise, and a temporary delay of collection.
Payment in full means exactly what it sounds like, while installment agreements and offers in compromise (OIC) are ways of paying down your tax debt.

If you are current on all your tax returns and your debt is manageable – but you just need a little more time to pay it off – you can request an installment agreement. With this method, you can make payments each month until your debt has been satisfied. However, you will have to pay a fee to set up the plan, and you will also have to pay interest and a late penalty.

Will the IRS ever forgive or negotiate tax debt?

It is within the IRS’ best interests to efficiently collect tax on behalf of the government, encourage voluntary compliance, and promote reasonable fairness and consistency. To that end, the IRS does allow certain taxpayers to negotiate their debt to mutually benefit the IRS’ collection goals and the taxpayer’s reasonable ability to pay. While the IRS will not traditionally forgive debt, they are willing to negotiate. Because of that fact, debt settlement and resolution remain important assets for taxpayers looking for much needed relief for their situation. 

What is an offer in compromise?

An OIC represents an agreement between you and the IRS, and it means you can settle your debt for less than you originally owed, so long as you meet certain requirements:

  • Paying your tax debt would create an economic hardship.
  • You have unusual expenses due to catastrophic issues such as a seriously ill family member, you live in a disaster area, etc.
  • Your income has dropped substantially due to unforeseen circumstances.
  • You have little or no assets, or your assets have little or no equity.

Before the IRS can consider your offer, you must have filed all required tax returns. You are not eligible if you are in an open bankruptcy proceeding.

In addition to the traditional OIC, there is an OIC for doubt as to liability. This may apply when you dispute the existence or amount of a tax debt.  If the existence or amount of the debt has already been established by a final court decision, or is based on current law, doubt as to liability cannot be considered.

What is an “innocent spouse?”

You may be an innocent spouse if your spouse, or former spouse, made an error on your joint return that causes your tax liability to be understated. If you believe your spouse should be the only one responsible for paying all or part of the tax owed, you can apply for relief from these unpaid taxes by filing Form 8857, Request for Innocent Spouse Relief. However, there is no guarantee of tax relief for innocent spouses.

What is an “injured spouse”?

Like an innocent spouse, an injured spouse can request relief from some liability of the other spouse. In either case, there isn’t a guarantee the IRS will agree to assign the responsibilities of the debt to the other spouse.

The main difference is that while innocent spouse relief is for something on the jointly filed return, injured spouse relief is for a past-due debt the other spouse owes. If the IRS has, or is expected to, apply the refund on the joint return to a spouse’s debt, the injured spouse may file Form 8379, Injured Spouse Allocation, to request their portion of the tax refund.

What if I can’t pay the IRS the amount that I owe?

If you owe back taxes, are experiencing economic hardship, and would have trouble paying essential living expenses if you paid off your tax debt, the IRS may consider the debt “Currently Not Collectible.” This would essentially give you some time to pay the debt, as the IRS would stop trying to collect it.

However, the debt still exists, meaning it will accrue penalties and interest. This measure also may not stop the IRS from placing a lien on your property. You will rarely see cancelation of debt or complete tax debt forgiveness from the IRS.

If you’re having problems and you need help with tax debt, consider consulting a Tax Pro, tax lawyer, or other type of tax advisor. Tax professionals can help you deal with your tax debt and set up a payment plan; they can also help you avoid tax scams and fraud. Learn more today.

What is a tax lien?

If you fail to settle your tax debt and pay the IRS what you owe, the IRS might file a Notice of Federal Tax Lien to protect its interests. A lien affects your current and future property, credit, and business assets. While it doesn’t represent an outright seizure of property or assets (like a levy does), having a lien against your property means if you sell any property or generate income from your assets, the IRS has rights to any money you might make. Note that state and local governments can also place liens on your assets, so you can have a federal tax lien or a state tax lien.

How can I get a tax lien removed?

The IRS will work with a taxpayer to ensure any tax debt is reasonably satisfied. Here are some of the ways to reduce the impact of a tax lien:

  • Payment – If you pay your tax debt in full, the IRS releases your lien within 30 days of payment.
  • Subordination – This option doesn’t remove the lien, but it does allow other creditors to move ahead of the IRS debt.
  • Withdrawal – This option removes the public notice so other creditors are not competing with the IRS for your property. You still owe the debt.
  • Discharge of Property – This option removes the lien from specific property based on the Internal Revenue Code (IRC) used to determine eligibility.
  • Certain Installment Agreements – Under this option, the public notice may be removed if you:
    • Owe $25,000 or less
    • Have a direct debit installment agreement that fully pays your tax debt by the earlier of 60 days or before the collection statute expires
    • Have made three consecutive direct debit payments
    • Have not defaulted on your current, or any past, direct debit installment agreement
    • Are fully compliant with other filing and payment requirements 

Will a tax lien affect my credit?

A tax lien can affect your ability to get credit including buying a house or car, or even getting a credit card. It may also affect you negatively with employers and landlords. Filing for bankruptcy may remove the lien notice from public record, but it does not eliminate the lien. You will still owe the money after the bankruptcy is completed.

What is a tax levy?

Unlike a tax lien, which represents a claim on your property in the event you don’t pay your tax bill, a levy is the outright seizure of your property in order to satisfy your tax debt. The IRS can place a levy on any property you’ve got interest in – this can include your home, car, bank account, retirement funds, wages, and more.

The most common form of levy is wage garnishment, when the IRS instructs your employer to use your wages to satisfy your tax debt, meaning the government will take a chunk of each paycheck you receive until your debt is paid off or you make other arrangements to pay the debt.

Another frequently used levy is that on your financial accounts – your bank accounts, investments, retirement accounts, and even your life insurance.

Less commonly, the IRS might place a levy on your property, seizing it to pay your debt. This type of levy usually includes property that isn’t your principal residence – but the IRS can seize your home in the event that they prove in court that your debt is still outstanding and there is no other alternative for collecting your debt.

And in rare cases, the IRS may place a levy on your Social Security benefits.

In all cases, a levy is a last resort when the taxpayer hasn’t responded to the IRS letters and notices.

Can I reverse or remove a tax levy?

You can contact the IRS and request a levy release. The IRS can release a levy if it is causing immediate economic hardship. The IRS will weigh all facts and circumstances to decide if a levy can be released. Often this includes setting up a payment plan for the taxes you owe. The removal of a levy doesn’t mean you don’t have to pay your tax debt. You must still make arrangements with the IRS to resolve it, or a levy may be reissued. However, if the levy is based on incorrect tax information, you may be able to reduce, even eliminate, the taxes owed. If you have unique circumstances, such as special regular medical expenses, the IRS can take that into consideration and reduce, or eliminate, the amount of the levy.

How much can the IRS take out of my paycheck?

The IRS will not take all of your pay. The amount you get to keep is based on how often you get paid, your filing status, and how many dependents you claim. The IRS is required by law to allow you to pay your household expenses. They don’t have a choice in the matter. 

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