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, around 858,000 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
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 starts at .5% of the unpaid taxes, and increases each month to no more than 25% of the taxes owed. Penalties are assessed monthly and interest is compounded daily 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.
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.
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