8 Ways to Get Tax Debt ReliefTax Relief
Tax debt relief is a term used to describe the various programs and methods that taxpayers and tax professionals utilize in order to reduce a taxpayer’s tax debt with the IRS or state revenue agency or at least get more time for the taxpayer to pay their tax debt.
Here are the eight primary ways to get tax debt relief:
- Offer in Compromise
- Currently Not Collectible Status
- Penalty Abatement
- Innocent Spouse Relief
- Partial-Payment Installment Agreement
- Full-Payment Installment Agreement
- Contesting the Liability
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Table of Contents
1. Offer in Compromise
An offer in compromise is an agreement with the IRS or your state to pay less than you owe on your tax debt with any excess debt being written off.
How Does an Offer in Compromise Work?
And the beauty of it that it doesn’t matter so much what you owe; it matters what you can pay based on the IRS’s math.
So even if you owe the IRS $1,000,000, if we can show the IRS that by their own math — by their own methodologies laid out in the Internal Revenue Manual for calculating how much equity you have in assets and what your monthly expenses are — your reasonable collection potential is only $100, the IRS should accept that $100 as your offer in compromise and write off the remaining $999,900.
This sounds great, right?
That’s because it is — offers in compromise are, essentially, the “holy grail” of tax debt relief options.
Offer in Compromise Acceptance Rate
The bad news, however, is that the IRS rejects the majority of offers in compromise it receives — 56% to be exact.
And of the offers it accepts, many are not only for $100 — it’s not uncommon for accepted offers in compromise to be for some higher amount; it all depends on the financial analysis.
And while the states don’t publish their offer in compromise acceptance and rejection rates, in my experience, I would estimate the offer in compromise rejection rate at the state level to be even higher than that 56% figure at the IRS level.
How to Maximize Your Offer in Compromise Chances
But there are some things you can do to maximize your chances of getting your offer in compromise approved, including making sure that you:
- Actually qualify for the type of offer in compromise you are submitting
- Have filed all required tax returns for the past six years
- Correctly complete all required forms correctly such as the Form 656 and the Form 433-A (OIC)
- Include the correct documentation and payments with your offer in compromise
- Mail your offer to the right place
For more information about maximizing your chances of getting your offer in compromise approved, check out the video below.
2. Currently Not Collectible (CNC) Status
Currently not collectible (CNC) status is a special hardship status with the IRS that allows you to owe the IRS but not have to pay off your debt as long as you remain in CNC status.
That’s right — no payments.
The Best Thing About CNC Status
And probably the best part about CNC status is that while you are in this special status, the IRS’s 10-year clock that it has to collect your debt that begins on the date your tax is assessed keeps ticking.
So theoretically, if you are able to remain in CNC status throughout that entire 10-year period — and keep in mind that that 10-year period can be extended for other things like bankruptcy or submitting an offer in compromise or an installment agreement request — then your tax debt will simply drop off without you paying the government a dime.
How to Get CNC Status
Before you get too excited, however, understand that eligibility for CNC status can be quite difficult to get; you basically have to show the IRS that you have no disposable income by the IRS’s math using the IRS standards and have no or almost no accessible equity in assets.
So for example, if you have equity in your home, the IRS will often ask for loan denial letters from lenders to show that you can’t access the equity in your home. Now, if you otherwise qualify for CNC status, meaning that you have no disposable income, most mortgage lenders would deny you for a loan to take cash out of your home anyway.
Does CNC Status Protect You From Liens?
Another thing to know about CNC status is that it does not lien proof you; the government may still file a Notice of Federal Tax Lien against you in state and county records to protect its interests informing other creditors of the IRS’s claim such that if you were to, say, sell a property you own, the IRS would be paid the lien amount before you get any of the proceeds.
Many clients are disappointed when I tell them this, but if you think about it, this makes sense. If the government is letting you not pay your tax debt right now while you’re in CNC status, it stands to reason that it would want to protect its interests if you were to, say, sell a property and have hundreds of thousands of dollars wired to your bank account from escrow.
If you can show hardship, the government is willing to lend you a break from payments, but if you get some massive windfall like that, you’re going to have to pay the piper if in fact a Notice of Federal Tax Lien was filed against you.
You Can Get Kicked Out of CNC Status
And I want to stress this point — as great as CNC status can be, it does not provide the finality that an offer in compromise provides unless you remain in CNC status until the IRS’s time limit to collect your debt expires.
And this is easier said than done because the IRS can remove you from CNC status if it believes that your financial circumstances have changed — for example, if you file a tax return indicating that you’re making a lot more money now than you were when you entered into CNC status.
Now, you can be placed back into CNC status in this circumstance — maybe your income went up but your allowable expenses went up as well — but you would have to submit a new set of financials to the IRS and basically go through that process all over again.
For more information about CNC status, check out the video below.
3. Partial-Payment Installment Agreement (PPIA)
A partial-payment installment agreement (PPIA) is an agreement with the IRS to pay them less than you owe in an installment agreement.
You see, sometimes clients we work with don’t qualify for an offer in compromise because perhaps they have too much equity in their home or other assets nor do they qualify for CNC status because they have some disposable income every month that precludes them from being deemed noncollectible by the IRS.
But here’s the deal. As long as you can show — similar to CNC status — that you don’t have any accessible equity in assets, the only thing the IRS can ask you to pay is the amount of your monthly disposable income calculated according to the IRS’s own methodology for calculating monthly disposable income.
So let’s say you owe the IRS $100,000 for tax year 2015. Oftentimes our clients owe for multiple tax years, but just for the sake of example, let’s make it easy and say that a taxpayer owes $100,000 for tax year 2015.
And let’s say the assessment date for this debt was some time in October 2016 shortly after they filed their tax return that was on extension. So the IRS has 10 years — so until October 2026 — to collect this $100,000 debt. And yes, there’s penalties and interest and all that, but we’re going to ignore that just for sake of an easy example here.
So let’s say the current date — to make things easy — is in October 2023 and the IRS’s 10-year statute to collect has not been extended so the IRS’s deadline to collect is still in October 2026.
October 2026 is three years from October 2023 — 36 months to be exact.
So let’s say that we make a case to the IRS that based on the IRS’s own methodologies a client has no accessible equity in assets and only has a disposable income of $500 per month.
In this case, we’d get the client in an installment agreement of that $500 per month. And how long would they be paying $500 per month? They would be paying $500 per month only for the next 36 months because that’s when their tax debt drops off.
So what’s $500 times 36? It’s $18,000. That’s not a bad deal on a $100,000 tax debt.
And that’s why this is called a partial-payment installment agreement because it’s only going to partially pay off the balance in an installment agreement.
And if we can argue that the taxpayer has even less disposable income — which could very well be possible — to the tune of only $100 per month, they’d only end up paying the IRS $100 times 36 or $3,600 on their $100,000 tax debt — an even better deal on a PPIA.
Does a PPIA Protect You From Liens?
Now, similar to CNC status, a PPIA does not lien proof you; the IRS may still file a Notice of Federal Tax Lien against you.
The IRS Can Review Your PPIA Every Two Years
Also, the IRS has the right to review PPIAs every two years — and in fact this is not mere IRS policy; this is statutory; it is federal law. Internal Revenue Code Section 6159(d) says, “In the case of an agreement entered into by the Secretary [meaning the Secretary of the Treasury and by extension the IRS] under subsection (a) for partial collection of a tax liability [that’s a partial-payment installment agreement], the Secretary shall review the agreement at least once every 2 years.”
So if you’re making more money when the IRS reviews your PPIA, they may want to revisit it and potentially move you to a full-payment IA, which I’ll discuss next.
So that’s how partial payment installment agreements work.
And you’ll notice a theme with all of these options is that what you qualify for really depends on what your financials look like.
And I’m not talking about your actual financials and cash flow — I’m talking about your financials as calculated by IRS methodologies and standards using forms like the 433-A, the 433-F, the 433-A (OIC) for an offer in compromise, etc.
4. Full-Payment Installment Agreement
A full-payment installment agreement is an agreement with the IRS to pay off your entire tax debt.
So while this kind of payment arrangement does not result in a reduction of your balance, it does give you more time to pay off your tax debt and avoid forced collection activities such as wage garnishments and bank levies.
For obvious reasons, the IRS is generally much more open to this kind of tax debt relief option than the others I spoke about previously, and in some cases, we can get the IRS to avoid filing a Notice of Federal Tax Lien if a taxpayer agrees to a full-payment installment agreement over 72 months.
With CNC status or a partial-payment installment agreement, there is no lien proofing option there.
And quite frankly some people just are in too good a financial position to really qualify for anything other than a full-payment installment agreement.
For more information about IRS installment agreements, check out the video below.
5. Penalty Abatement
If you owe the IRS money, they will charge you penalties as a result.
Common IRS Penalties
The most common IRS penalty is the failure-to-pay penalty, which the IRS charges at 0.5% of your unpaid balance every month or part of a month with a maximum penalty of 25% of your balance.
The failure-to-file penalty is another common IRS penalty. This penalty is equal to 5% of your unpaid balance for every month or part of a month that your tax return is late with a maximum penalty of 25% of your balance.
Now, if you are unlucky enough to be subject to both the failure-to-pay penalty and the failure-to-file penalty, the failure-to-file penalty is reduced by the failure-to-pay penalty for the five months during which the failure-to-file penalty kicks in.
So because of that, the maximum combined failure-to-file penalty and failure-to-file penalty amount you can be hit with is 47.5% of your balance.
There are many other penalties as well that the IRS can accrue and assess, but these are the major ones.
How to Get Your IRS Penalties Forgiven
The good news, though, is that you can get some abatement — that is, forgiveness — of your tax penalties.
If you’ve been a good taxpayer historically and just got behind for a year or something like that, we can generally get the IRS to waive these penalties.
But if you have a pretty spotty compliance history recently, we’d need to make a case based on reasonable cause for why the IRS should remove your penalties for that year or those years.
And it’s not as easy as saying, “Oh, I was sick, and that’s why I couldn’t file my taxes,” or, “Oh, a close relative passed away, and that’s why I couldn’t pay.”
There has to be a strong link between the life circumstance or whatever it is that you are claiming as your reasonable cause and your lack of compliance. You have to spell everything out and connect the dots for the IRS in a logical way, or they will not grant penalty abatement for reasonable cause.
They will also consider other factors. For example, if you’re claiming that an illness prevented you from filing your taxes, they may say, “Well, look — you were able to take care of other obligations when you were sick such as your business obligations or your employment obligations. Why didn’t your illness hinder you from taking care of these things but it did hinder you from taking care of your taxes?”
That’s the mentality the IRS has when it comes to penalties. That said, I do recommend at least looking into penalty abatement for yourself as a form of tax debt relief.
6. Innocent Spouse Relief
Innocent spouse relief is a form of tax debt relief where your spouse or ex-spouse made some mistakes on a married filing jointly tax return that you were on as well.
Examples of these mistakes could be underreporting income or taking tax deductions or credits they shouldn’t have.
Joint and Several Liability
Now, because that was a married filing jointly return you filed with your spouse, you’re generally on the hook just as much as your spouse is for that tax debt.
It doesn’t matter if he or she earned all the income and he or she was the one who actually filled out the return — by signing that married filing jointly return as the spouse, you are affirming under penalty of perjury — to quote the language on the Form 1040 itself — that you have “examined [the] return and accompanying schedules and statements and to the best of [your] knowledge and belief, they are true, correct, and complete.”
And both of you — you and your spouse or ex-spouse for that tax year — are just as liable as the other for the tax debt for that year; that is called joint and several liability.
So that’s the general rule.
How Innocent Spouse Relief Works
But if you qualify for and obtain innocent spouse relief, you are not on the hook for the taxes, penalties, and interest attributable to your spouse’s or ex-spouse’s shenanigans.
Now, to get innocent spouse relief, the burden is on you to show that you did not know and had no reason to know that the tax return that you signed was incorrect leading to the tax balance and that it would be unfair for you to have to pay these back taxes. They also consider things like whether or not your spouse or ex-spouse abandoned you as well as if you personally received a “significant benefit” from the error on the return.
So there are hoops to jump through; ignorance of what your spouse or ex-spouse did is necessary but not sufficient — yes, you had to be ignorant of what your spouse or ex-spouse did, but it’s not enough to make an innocent spouse claim on that basis alone; you must also have had no reason to know that they were being shady and that holding you liable would be unfair. And like I mentioned, there are other things the IRS looks at as well when evaluating innocent spouse claims.
There’s a lot of facts and circumstances involved here to make an innocent spouse claim, but the general rule is that the more distance between you and whatever errors or misstatements your spouse or ex-spouse made on your and their tax return, the better.
Good Fact Pattern for Innocent Spouse Relief
A good example of an innocent spouse claim is where your spouse runs a business that you are not involved in whatsoever because you have your own business or employment or you are providing childcare to your children while your spouse is working on their business and while you know that they incur a lot of travel expenses for their business you don’t really know exactly how much.
So if in reality they only had $50,000 of justifiable travel expenses during the year but they reported $75,000 of travel expenses during the year and the IRS caught this in an audit, you may have grounds to claim that you had no reason to know exactly how much your spouse spent on travel for their business.
Bad Fact Pattern for Innocent Spouse Relief
But if the return had an extremely obvious error in it — for example, if your tax return indicated a deduction or credit for tuition expenses but you know that neither you nor your spouse nor any of your dependents are going to college right now — that’s not a very good fact pattern.
The more obvious the error and the easier it is to catch and the simpler it is to understand, the weaker your claim.
But innocent spouse relief can be an excellent way to get tax debt relief in the right circumstances because it results in all that tax debt attributable to one’s spouse’s or ex-spouse’s errors on a joint tax return being removed from your account with the IRS.
Just as a pointer there — always review your tax returns and don’t just blindly trust your spouse with financial and tax matters.
Bankruptcy is a legal process through which debtors can obtain relief from their debt, tax debt or otherwise.
Now, there are definitely some drawbacks to filing for bankruptcy, but if you have significant unsecured non-tax debt such as medical debt or credit card debt in addition to your tax debt, bankruptcy could make sense for you.
Now one thing to know about taxes and bankruptcy is that generally only income taxes are something that can be discharged in bankruptcy. So if you run a business and you withheld FICA taxes from your employee’s paychecks that you did not remit to the government — those trust fund taxes are not dischargeable in bankruptcy.
So I’m talking about personal income taxes here.
And when we’re talking about discharging or reorganizing personal income tax debt in bankruptcy we’re typically talking about Chapter 7 or Chapter 13 bankruptcy.
There are other kinds of bankruptcy filings available to individual debtors, but by far Chapter 7 and Chapter 13 are the most common.
Chapter 7 (Liquidation)
In a Chapter 7 bankruptcy, the bankruptcy trustee will liquidate your assets except for certain exempt assets that are protected from liquidation and use the proceeds of these assets to pay off your debts that qualify for discharge in bankruptcy.
Now, not all tax debts are dischargeable in a Chapter 7. In order for your individual income tax debt to be discharged in a Chapter 7, you and your debt must meet these requirements:
- The tax must have been due at least three years before you file for Chapter 7. The due date for these purposes include extensions.
- You must have filed the tax return for the tax debt in question at least two years before you file for Chapter 7.
- The tax must have been assessed at least 240 days before you file for Chapter 7.
Taxpayers often owe tax debt for multiple years, so a taxpayer’s tax debt for years that meet these requirements may be dischargeable in Chapter 7, while a taxpayer’s tax debt for years that don’t meet these requirements wouldn’t.
Note that if a notice of tax lien has been filed against you, and you retain the property in bankruptcy — which can happen if the bankruptcy trustee believes that selling the property would not result in any proceeds to pay off other creditors — the tax lien will survive your Chapter 7 bankruptcy.
Chapter 13 (Reorganization)
In a Chapter 13 bankruptcy, your debts are reorganized to allow you to pay them off in a three-to-five-year payment plan. And whether your plan is three years or five years depends largely on your income.
In a Chapter 13, your tax debt is categorized as either secured or unsecured and then your unsecured tax debt is categorized as either priority or nonpriority.
Secured Tax Debt in Chapter 13
So with respect to a tax debt, if a notice of tax lien has been filed against the taxpayer, the tax debt contained in that lien is considered to be secured, and you will have to pay it off in full in your three-to-five-year repayment plan.
Now, keep in mind that the IRS isn’t continually filing Notices of Federal Tax Lien, so it’s possible that you may have a lien against you for older tax debt but not some newer tax debt.
So the secured tax debt must be paid in full in the repayment plan.
Unsecured Tax Debt in Chapter 13
What about the unsecured tax debt — tax debt for which no notice of tax lien has been filed?
Unsecured tax debt is categorized into either priority or nonpriority debt.
And if a tax debt for a particular year is categorized as priority, you will have to pay it off in full in the three-to-five-year payment plan that’s arranged through the bankruptcy.
But any of your tax debt that is classified as nonpriority is paid out of your remaining discretionary monthly income, which all your other creditors get a piece of as well. So it’s possible that you may not have to pay all of your nonpriority tax debt in the payment plan.
So this distinction between priority tax debt and nonpriority tax debt is very important.
So what makes a personal income tax debt nonpriority? Well, the rules are similar to the rules for the kind of personal income tax debt that would be discharged in a Chapter 7 bankruptcy. Here are the requirements for a personal income tax debt to be considered nonpriority in a Chapter 13 bankruptcy:
- The tax must have been due at least three years before you file for Chapter 13. The due date for these purposes include extensions.
- You must have filed the tax return for the tax debt in question at least two years before you file for Chapter 13.
- The tax must have been assessed at least 240 days before you file for Chapter 13.
These are the basic rules concerning the discharge and reorganization of tax debt in bankruptcy. Obviously bankruptcy is a significant decision, and you have to qualify for it as well.
8. Contesting the Liability
Now, there are instances where you can get tax debt relief simply by proving to the IRS that you don’t actually owe the debt or at least that you do not owe all of it.
There are a few ways to go about this. One way is to amend your tax return for the year in question if your originally filed tax return was erroneous and that error (or those errors) on your original return gave rise to your tax debt or a portion of it.
To submit an amended return, you simply prepare your return over again with any corrections you’re making so this time it’s accurate and you send that to the IRS with Form 1040X and a copy of your original return as well.
Of course, if you’re looking to get a refund or a credit for a particular tax year, you only have three years from the date you filed your return — and if you filed it before the original due date the IRS generally considers you to have filed it on the original due date — to get a refund or credit for that year.
But if you paid tax on a return later than that date, you actually have two years from the date you paid tax to get that tax refunded with an amended return.
Another way to contest your liability with the IRS is to file a doubt as to liability offer in compromise.
You file this kind of offer in compromise using Form 656-L and in Section 5 of this form you must explain why you believe the amount of tax you’re contesting is incorrect. You should also attach any documentation supporting your explanation to the Form 656-L as well.
Tax Debt Relief FAQs
Here are some commonly asked questions about tax debt relief.
Can I get state tax debt relief?
Yes, you can get state tax debt relief.
Now, just to be clear, in this article, I covered the federal (IRS) forms of tax debt relief for money owed to the IRS.
If you owe your state, your state probably has similar tax relief options — though not necessarily all the ones offered at the federal level — and even if, for example, your state does have an offer in compromise program, it will likely have different rules and procedures than the federal offer in compromise program.
But the similarities should be greater than the differences, and by giving you an overview of the federal tax debt relief programs, it should give you some context for your state tax debt as well.
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.