When to Settle Tax Debts For Less & When You Can’t

Every year many taxpayers fall into bad financial problems and they cannot pay the taxes that they owe.

I strongly believe that everyone should pay their fair share and in no way should they settle their taxes for less just because they do not want to pay.

However, there are times when it does make sense to allow an individual to settle tax debts for less.

The IRS system is set up to maximize tax revenue or collections because it benefits the country as a whole.

Sometimes, though, it makes financial sense to allow someone to settle their taxes for less.

I have come to the realization, in some cases, that letting a taxpayer settle for less actually results in the IRS collecting more money in the future.

If you are not in a situation where the existence of a tax settlement would benefit the country financially then you will be required to pay back your taxes in full in one way or another.

When You Can Settle For Less

You are probably wondering how the IRS benefits if they allow people to settle their taxes for less.

Sometimes individuals are in such financial straits that if the IRS were to force them to pay their taxes, using forced collection mechanisms, this would limit their ability to ever regain financial strength.

For example, say an individual owns a small business and gets behind on their taxes and in order to pay their taxes they would have to sell everything they own, including their business, which would leave them without a job or revenue-producing assets.

This person then would most likely collect unemployment, which would ultimately cost the US people more of their tax money than if they just allowed the individual to settle the taxes for less.

There are two main ways the IRS will allow individuals to settle their taxes for less under this sort of reasoning:

  • Offer in Compromise: An Offer in Compromise is a complex tax filing whereby a taxpayer will make an offer to pay the IRS less than the total amount they owe. The IRS looks at a taxpayer’s “Reasonable Collection Potential,” or RCP, which is the total value of their assets (if liquidated) plus disposable income over the next four to five years. If the IRS believes that the amount in the taxpayer’s offer is more or equal to their RCP, then the IRS will accept the offer.
  • Partial Payment Installment Agreement: A Partial Payment Installment Agreement is a payment plan that the IRS will accept in some cases if the taxpayer is under financial hardship, owes over $10k, and does not qualify for a normal Installment Agreement. Since the payments are smaller than the required payments with an installment agreement it is likely that the statute of limitations will expire before all taxes have been paid off. The typical statute of limitations on tax debt is 10 years. If the IRS does not collect the full out amount in that time period then those taxes are no longer due.

There are other mechanisms that the IRS provides that allow individuals to settle for less.

They allow individuals to remove or abate penalties through “penalty abatement” if they can show reasonable cause for not filing or paying their taxes.

You may think that this is not in the best interest of the IRS financially since they can force them to pay and get away with it, but it kind of is.

The IRS uses steep penalties in order to encourage people to file and pay their taxes.

By having more individuals stay in compliance, operating costs are minimized because the IRS does not have to go out and pursue taxpayers that have not filed or paid their taxes.

Therefore, with penalty abatement, the IRS can be forgiving because they realize that steep penalties exist and it would not be fair to charge all people.

When You Cannot Settle For Less

So if the IRS does not think a tax settlement will benefit the U.S. people financially or maximize tax revenues then it will not happen.

You can attempt to file for an Offer in Compromise, but it will be rejected leading to a waste of your time and money.

The IRS does offer alternatives for those individuals who cannot pay in full and do not qualify for settling for less. Below are two of these alternatives:

  • IRS Payment Plan (Installment Agreement): With a payment plan the IRS will allow you to make monthly payments towards the tax amount owed. The IRS has many different forms of payment plans depending upon the tax amount owed. It is in your best interest to work with the IRS on a payment plan as soon as you know you cannot pay your tax debts because it can significantly decrease penalties that the IRS will charge you.
  • Pay With Credit Card: The IRS does encourage people to put their taxes on a credit card if they cannot pay. Sometimes this can be a good idea if you know you can pay off the credit card in the near future or you have a very low-interest rate on your credit card. If your credit card does not have the limit or carries a high monthly interest rate on outstanding balances it is a good idea to enter into an IRS payment plan instead assuming you could not receive a lower rate from a financial institution.

No matter how your financial standing looks and no matter how much you owe in tax debt there is a road to compliance.

If it is logical to pursue a tax settlement for less than what is owed, you should try to pursue this option if you think it will help you financially in the future.

The IRS is willing to work with all taxpayers.

It is important to be upfront about your problem and take action towards resolving it as soon as possible.

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