So, something in life or business didn’t go according to plan, and now you’re faced with an IRS tax liability. While few people relish being a collection target of America’s most formidable creditor, there may be a silver lining. You may have options which could significantly reduce the amount that you have to pay the IRS in order to resolve your tax debt. In fact, depending upon your circumstances, it may be possible to resolve your tax issue without having to pay the IRS a single penny. This article will explore the top 5 ways in which you may be able to reduce, or even eliminate, your tax liability.
Best Ways to Reduce Your IRS Tax Liability
For the purposes of this article, I am going to assume that your tax liability is accurate. In other words, you filed accurate returns or were assessed with an audit liability which you cannot successfully dispute. If that is not the case, then you may be able to reduce your liability simply by amending and filing accurate returns or by appealing the findings of an audit. If neither of those situations apply, then you may be a candidate for one of my top 5.
1. Offer in Compromise: Doubt as to Collectability
Have you ever heard a radio or TV commercial where the advertiser states that it can settle your tax liability for “pennies on the dollar?” Well, an Offer in Compromise (OIC) based on Doubt as to Collectability (DATC) is likely what the advertiser is pitching. With a DATC OIC, a case is made that you do not have the financial ability to repay your tax liability. While most taxpayers do not qualify for this type of settlement, the ones who do may be eligible for a tremendous reduction in their tax bills. The IRS uses a mathematical formula to determine an appropriate settlement amount. If you don’t have a lot of equity in assets relative to the size of your tax bill, you live a relatively modest lifestyle, and there isn’t much money left over each month after you pay for your necessary living and/or business expenses, you could be a candidate for this type of settlement. Both business and individual taxpayers may be eligible for this type of OIC.
Example: We had a client who owed about $107,000 in unpaid income taxes. He didn’t have much equity in assets. Although his income was close to $100,000 per year, we were able to demonstrate that his income was barely enough to cover his necessary expenses. We convinced the IRS to accept $3,390 as settlement in full.
2. Offer in Compromise: Doubt as to Liability and Effective Tax Administration
While the vast majority of accepted OICs are based on Doubt as to Collectability (see above), there are a couple other types of OICs worth considering, even if you have the financial wherewithal to pay off your tax debt. One is an OIC based on Doubt as to Liability (DATL) in which you build a case calling into question the legitimacy of your tax liability. Here, you would offer to settle it for a smaller amount based on the argument that you legitimately should not owe some or all of your tax debt. The other is called an OIC based on Effective Tax Administration (ETA). With an ETA OIC, you demonstrate that paying the tax liability back would cause a hardship. Note that with either a DATL or an ETA OIC, you need not prove an inability to pay back your tax debt.
Example: A client of ours owed about $30,000 in combined 1040 income taxes and 941 employer withholding taxes. The client was elderly and suffered from several serious health issues. Although our client had the ability to fully repay the $30,000 that he owed by way of monthly installments, we were able to convince the IRS that doing so would have caused him a significant hardship. Since the income tax liability was a joint liability with our client’s spouse and the 941 liability was not, we actually had to negotiate two separate settlements. The bottom line is that we got the IRS to take a total of $500 to settle all of it via an Effective Tax Administration Offer in Compromise.
3. Penalty Abatement
If you can prove to the IRS that you had “reasonable cause” for non-payment or late filing, it may be possible to eliminate some or all of your penalties plus associated interest. You have to have a good reason for failing to meet your tax obligations. Examples of a “good reason” include death or serious illness of the taxpayer or someone in the taxpayer’s immediate family, unavoidable absence of the taxpayer, fire, casualty or natural disaster. There is also a catch-all provision that allows the IRS to abate penalties if the taxpayer can demonstrate that she acted with reasonable business care and prudence, but was nevertheless unable to meet her tax obligations. Note that there is also a First Time Abate program that is available to taxpayers who have a good track record of compliance and who meet basic criteria.
Example: I had a case where a business was owned by 4 brothers. One of the brothers suffered a serious injury, which caused a ripple effect of problems within the business. Since there were 4 owners, the serious injury of one of them, in and of itself, might not have been enough to establish reasonable cause. The business also experienced several financial problems that were beyond the control of the owners and officers. I submitted a multi-page persuasive brief requesting abatement of penalties on the basis that the taxpayer exercised ordinary business care and prudence, but was nevertheless unable to comply with its tax obligations, and succeeded in getting approximately $76,000 in penalties abated.
4. Partial Payment Installment Agreement (PPIA)
With a PPIA, you make monthly payments towards your tax liability, but the payments are too small to pay off the debt within the 10 year collection statute of limitations. While technically this does not actually reduce the amount you owe, the effect can be the same—you only repay a portion. You may be a good candidate for a PPIA if you don’t have a lot of equity in assets relative to the size of your tax debt, you live relatively modestly, and you don’t have much left over after you pay your necessary expenses. Another important characteristic of a PPIA is that the IRS will likely require you to submit updated financial information every two years or so. If your income goes up or your expenses go down, they may want to increase the amount of your monthly payments.
Example: We represented a business with a tax liability of about $769,000. We demonstrated that the business did not have significant equity in assets and that it did not have the ability to fully pay off the liability within the collection statute of limitations. The IRS approved a PPIA with monthly payments of $2,500. Assuming that there were 60 months remaining in this client’s collection statute of limitation when the PPIA was initiated, this client may be able to escape a $769,000 tax liability in exchange for payments totaling $150,000.
5. Currently Not Collectable (CNC)
With this strategy, you prove to the IRS that you have minimal equity in assets and that you are unable to afford any monthly payment towards your back tax liability. If approved, you won’t be required to pay…anything, at least for the time being. CNC, also known within the IRS as “Status 53,” is like a PPIA in that it does not technically reduce the amount that you owe, and the IRS will likely require you to submit updated financials every couple of years or so. If your financial circumstances improve, you may be required to start making payments at some future date. However, some taxpayers are able to remain in CNC for the entire collection statute of limitations (generally 10 years from the date of assessment) without having to pay the IRS anything.
Example: We had a client who owed about $150,000 to the IRS. We were able to demonstrate that the client had minimal equity in assets and an inability to make any payments towards the back taxes. Initially, we had to submit updated financials every two years or so proving that our client should remain in CNC. Eventually, we convinced the IRS to refrain from further financial review so long as our client’s adjusted gross income did not rise to an agreed-upon dollar amount. Adjusted gross income did not increase to the agreed-upon amount, the statute of limitation expired, and our client was ultimately absolved of a $150,000 tax liability without having to pay the IRS a single penny!