One of the very first things that any individual or business with a tax liability should consider is whether it is possible to settle that tax liability for less than the amount owed. Although it is not easy to reach a tax settlement agreement (aka Offer in Compromise or “OIC”) with the IRS—or a state taxing authority–many taxpayers do, in fact, qualify for a settlement. Some even qualify for a “screaming deal” where their entire tax liability is settled for a tiny fraction of the amount owed.
Sound too good to be true? It isn’t. However, beware. Unfortunately, there are a handful of unscrupulous tax relief service providers who advertise and promise to reach some mind-blowing settlement to taxpayers who clearly don’t qualify. Falling for such false promises is a time-consuming and expensive mistake. Worse yet, a failed settlement attempt can easily take a year, during which the penalties and interest continue to pile, and you wind up worse shape than you were to begin with. Consequently, it is imperative not to get duped.
This mistrust can lead some tax debtors to try to settle with the IRS (or state) without the assistance of an experienced tax professional. This may also prove to be a huge mistake. The vast majority of tax settlement proposals fail, and the chances of success increase significantly with the aid of an ethical and experienced tax resolution professional—one who has been down the tax settlement road many times and who knows exactly when and how to stand up to the IRS (or state) and fight for their client. Success very often depends on choosing battles wisely. Simply put, a do-it-yourselfer who has never been down this road can’t be expected to choose these battles wisely or even have any clue about when it is time to stand up and fight.
So, what is one to do? The answer is surprisingly straightforward. First, arm yourself with some basic knowledge about whether you have a decent chance of qualifying for a settlement. Second, find a tax resolution professional who is knowledgeable, talented, experienced, and ethical. I’m going to explain in simple terms how to do these two things now.
Do I Qualify for a Tax Settlement?
The first step is to learn the basics so that you will know that you at least stand a chance of being a good tax settlement candidate. Here are the basics.
The IRS has three types of Offers in Compromise (tax settlements):
- Doubt as to Collectability (I can’t afford to repay the whole amount);
- Doubt as to Liability (I shouldn’t owe this or it is doubtful that I should owe this); and
- Exceptional Circumstances (aka Effective Tax Administration): I owe it, I am able to pay it, but doing so would create a hardship or there are compelling public policy/equity considerations which would justify settling for less than the full amount.
Understand that for any IRS tax settlement proposal to be considered, the taxpayer must be in compliance, meaning that all required tax returns have been filed, and the taxpayer has made all required tax deposits for the current tax period (individuals who are required to make estimated 1040 income tax deposits must have made the required deposits for the current year; businesses who make federal 941 employer withholding tax deposits must have made all deposits for the current quarter).
Doubt as to Collectability
The Doubt as to Collectability (“DATC”) Offer in Compromise is by far the most common type. In order to prevail with a DATC settlement, the taxpayer must demonstrate that they:
- Do not have the income to repay the tax liability back over time while still meeting their necessary expenses;
- Do not have assets which could reasonably be liquidated or borrowed against to pay the liability off; and
Do not have a combination of income and assets (#1 & #2 above) that could be utilized to pay off the tax liability in full within a reasonable period of time.
For individuals (not businesses), the IRS will look at the household’s income minus allowable expenses and derive an amount that the individual (or individuals in the case of a joint income tax liability) could pay each month towards the tax liability. The IRS will also look at the equity in the taxpayer’s assets. They use a mathematical formula, which is beyond the scope of this article, to determine an acceptable settlement amount. If the amount they determine to be an acceptable amount exceeds the tax liability, they will decline to settle.
With regard to real estate (and some other non-liquid assets), the IRS will generally take the quick sale value of the real estate (80% typically) and subtract encumbrances (e.g. mortgages and judgments) that are senior to the tax lien to determine the “net realizable equity” (“NRE”). To determine your ability to pay, they look at the NRE, not the total equity. Thus, even if you could theoretically sell your home and full pay the IRS with the proceeds, you may still be a strong candidate for an OIC if there isn’t a lot of NRE.
The IRS uses a system of tables and charts that determine what they consider to be “allowable expenses.” Getting into the details of this is also beyond the scope of this article. However, suffice it to say, that if you are living a relatively modest lifestyle and there is little to nothing left over each month after you pay for your household’s necessary expenses, you likely have very little or no excess income left over that could be paid towards your tax debt.
If you have little or no excess income (relative to the amount you owe) and the net realizable equity in your assets is small relative to the size of your tax liability, you may be a good candidate for a tax settlement. If that’s the case, I strongly recommend that you consult with a knowledgeable, talented, experienced, and ethical tax resolution pro so that you can explore further whether moving towards a tax settlement is the right move for you (see below).
For businesses, the analysis as to whether the business is a good candidate for a DATC tax settlement is similar to that for an individual. The IRS will look at the business’s excess income, they will look at the business’s equity in assets, and they will use a mathematical formula to derive a settlement amount. There are two main differences, however.
First, when it comes to a business, all expenses of the business are generally deemed “allowable.” Only on very rare occasions might the IRS disallow a business expense in the context of evaluating a settlement proposal. For example, if your business is shelling out $90,000 per year for a luxury suite for your local NFL team and you don’t have the type of business where it is really necessary to have this suite for the purpose of schmoozing clients, the IRS could “disallow” this expense and claim that you could, instead, give that $90,000 each year to the IRS to be applied to your tax liability.
The second major difference when evaluating a business DATC settlement proposal is that assets of the business that are necessary for the production of income will generally not be considered in the determination of whether the business has the ability to pay off the tax liability. For example, a trucking company could have $250,000 worth of trucks, all of which are needed for business operations. The IRS generally will not include that $250,000 into the business’s “ability to pay.”
Aside from cash reserves, most small to medium sized businesses don’t have assets that aren’t necessary for the production of income. Thus, in many cases, a business is a good candidate for a DATC tax settlement if its cash flow isn’t sufficient to full pay the tax debt over a reasonable period of time. If that’s the case, get with a knowledgeable, talented, experienced, and ethical tax pro to explore your settlement options.
Doubt as to Liability
Both individuals and businesses may settle an IRS tax liability by submitting a successful Offer in Compromise based on Doubt as to Liability (“DATL”). With this type of tax settlement, the applicant demonstrates that the taxes really should not be owed or that there is legitimate doubt as to whether the taxes should be owed. If this is demonstrated, then the IRS may be willing to settle for less than the full amount owed. Keep in mind that there may be other methods that are more effective than a DATL tax settlement to resolve a tax liability that really shouldn’t be owed. Thus, if you are in this situation, it is especially important to consult with a knowledgeable, experienced, and ethical tax professional.
Exceptional Circumstances (Effective Tax Administration)
This type of tax settlement is possible when:
- The taxpayer has the ability to pay the tax liability in full, and
- The IRS determines that the taxpayer does not qualify for a DATC or DATL settlement (above), and
- There are economic (e.g. hardship) or public policy/equity circumstances that would justify settling for less than the full amount owed.
Demonstrating “economic or public policy/equity circumstances” (#3 above) boils down to either proving that paying the full amount due would result in an economic hardship for the taxpayer or that, due to exceptional circumstances, collection in full would undermine public confidence that the tax laws are being administered in a fair and equitable manner. Only individuals can qualify for this type of tax settlement based on economic hardship, while both individuals and businesses can qualify by demonstrating sufficient public policy/equity considerations.
I’m reluctant to elaborate too much on what might constitute “economic hardship” or “public policy/equity” circumstances because there is no set definition, and this is something that would be far better suited for a discussion with a tax resolution pro. To give you a taste of some factors that might support a case for economic hardship (individuals only), think along the lines of old age, few years left in the workforce, disability of the taxpayer or the taxpayer’s dependent, anticipated medical expenses, and such.
A taste of factors that could support a case for settlement based on public policy/equity concerns include a liability stemming from an IRS error, a liability stemming from the criminal or fraudulent acts of a third party, a situation where requiring full payment of the tax liability could result in adverse effects to the taxpayer’s community, and the like. Again, this is just a taste of what might work. There’s no set rule, so those who think they might be able to make a public policy or equity case would be well advised to talk it through with an experienced tax resolution professional.
I’ll mention briefly that there is also a sort of hybrid DATL/Exceptional Circumstances settlement type (called Doubt as to Liability with Special Circumstances). With this kind of settlement, the taxpayer could qualify for a DATC settlement, but can get a lower settlement due to the “special circumstances.”
Finding an Experienced, Talented, Knowledgeable, and Ethical Tax Resolution Pro
There is a lot more to negotiating a successful tax settlement than you might imagine, so finding the right person to do this on your behalf can make a HUGE difference. An ethical pro will tell you up front if you have a crummy case, and will save you the time, expense, and aggravation of pursuing a settlement that is destined for failure. A good pro can very easily mean the difference between acceptance and rejection. A good pro may also finalize a settlement amount that is tens of thousands of dollars less than that which would have been negotiated by a do-it-yourselfer or a bad tax pro. Consequently, it pays big time to find the right pro.
Finding a Pro who is Knowledgeable, Talented, and Experienced
When it comes to choosing a tax pro for a settlement agreement, it is critically important to understand the difference between a tax pro and a tax resolution pro. Tax is a big, broad field, and there are tons of tax pros out there who have very little experience negotiating tax settlements. In fact, the vast majority of tax pros have little or no experience in this realm.
To give you a feel for this, understand that a lot of accountants (CPAs and Enrolled Agents) do not ever try to negotiate tax settlements or they may try their hand at just one or two per year. They keep busy all year preparing tax returns and advising their clients how to minimize their tax burdens. Very few of their clients wind up with a big tax debt. Those that do rarely qualify for a settlement. So, most accountants simply don’t have many opportunities to try to settle tax debts and, therefore, lack experience.
At the other end of the spectrum, there are professionals who exclusively or almost exclusively represent taxpayers who are in collections with the IRS or with a state. So, rather than having just a few clients with tax debts, all of their clients have tax debts, and all these pros do every day is work on resolving those tax debts. These professionals are tax resolution pros, and they can easily work towards 10 or more tax settlements in any given year.
So, how much experience is enough? Generally, I would say the more the better. To break it down to a number, I would say that someone who has actually negotiated at least 40 tax settlements has had enough experience. Someone with that much experience settling tax debts could be a good choice if they are talented and ethical.
Unless you happen to be a tax pro, attempting to determine whether a given tax resolution pro is talented is tricky. You want someone who is smart, tactful, and persuasive. I suggest talking to the pro and doing some basic research into the pro’s reputation.
You will also increase your chances of finding someone with the right kind of talent by choosing an attorney rather than an accountant. For one thing, becoming an attorney is a far more daunting task than becoming, say, and enrolled agent. Almost any attorney has the intellect to become an enrolled agent while the reverse is far from true.
Keep in mind, too, that negotiating a tax settlement rarely has much to do with accounting. Rather, it requires the ability to build and persuasively present a strong case—things that attorneys are, by their nature, supposed to do better than anyone else.
Finding a Pro who is Ethical
When determining whether a tax pro or a tax pro’s firm is ethical, pay close attention to the kinds of questions they ask you when they are initially evaluating your case. You’ve already armed yourself with some basic knowledge (above). Are they asking you the kind of questions that need to be asked in order for them to have any clue as to whether you are a good settlement candidate? If not, then run for the hills! In the tax resolution industry, we call these scammers “offer mills.” They don’t care whether you qualify for a tax settlement, but they have no hesitation promising you some pie-in-the-sky settlement in exchange for a hefty fee.
I also consider it an absolute must for you to do some basic homework to determine whether the tax pro or the tax pro’s firm is reputable. Check them out with the Better Business Bureau. Are they a member in good standing with the BBB? Does that BBB give them an A or an A+?
Spend a little time surfing the internet. Are their online reviews overwhelmingly positive? Are there a lot of complaints or negative reviews? Are there any legal proceedings or governmental inquiries? Have their professionals faced disciplinary action for misconduct?
If you are considering a tax resolution (aka tax relief) firm, understand that most firms are reluctant to let you speak with the professional who will actually be handling your case until you’ve signed a binding contract. This kind of structure incentivizes the tax relief firm to spend a disproportionate amount of their overhead on their salespeople while they skimp on the pros who actually do the work. Worse yet, you’re already obligated by the time you have a chance to form an opinion of your tax pro. If you don’t like the pro they assign, tough luck.
At Fortress, we have a unique intake process that allows new clients to have an in-depth conversation with the attorney who will be handling their case before they commit to a binding contract. If you’re curious, give us a call. We have knowledgeable, talented, experienced, and ethical professionals on staff who would be happy to help evaluate your options for you at no charge.