The IRS has a bad reputation. Just as people blame the messenger for bad news, taxpayers blame the IRS for upholding the tax laws enacted by our elected representatives. Yet while the IRS has broad power to collect unpaid taxes, including the right to take part of your paycheck or put a lien on your property, it also has the ability to forgive your tax debts in certain circumstances.
One option available to taxpayers with unmanageable tax bills is an IRS program known as an offer in compromise, which may let you settle your tax liability at a reduced rate. Although you shouldn't count on the offer in compromise program to solve all your problems, it can give you a way to work through serious financial trouble.
The IRS has the power to settle federal tax liabilities by accepting less than the full amount due under certain conditions. These include situations in which there's doubt about whether the amount of tax assessed is correct, uncertainty about the taxpayer's ability to pay in full, or substantial hardship if the IRS collects the full amount.
It's important to understand, however, that offers in compromise are for extreme circumstances. Some TV commercials make it sound as if anyone can benefit from an offer in compromise, but to even have a chance of reaching that compromise, the arrangement must make sense both for the taxpayer and the government. You can read the IRS recommendations for taxpayers considering an offer in compromise on the service's website.
If you decide an offer in compromise is right for you, you must do several things. Form 656 requires most taxpayers to submit a percentage of their proposed settlement up front, along with an application fee. In addition, taxpayers must make sure that they are current on their other tax obligations; you must file any outstanding returns and pay any outstanding tax due that isn't the subject of your compromise offer. You must also stay current by making any estimated tax payments as they come due.
You'll also need to submit financial information to support your claim that you can't pay your tax in full. You'll find the correct format on Form 433-A. Depending on your resources, you can propose either making a lump-sum payment, repaying a portion of your tax liability over a 24-month period, or spreading out regular payments over a longer period.
The IRS also provides a worksheet to help you determine what an appropriate offer should be. You shouldn't expect to hold onto a bunch of assets while repaying the IRS less than the full amount of tax due, but if you really find yourself in a bind, you may be able to significantly reduce what you owe.
Don't just ignore it
The offer in compromise program is designed to encourage taxpayers to continue to follow the tax laws, even when they're having financial difficulties. By being responsible and asking for help, you can demonstrate your commitment to obeying the law and paying your fair share of taxes.
On the other hand, the worst thing you can do when facing a big tax bill is to ignore it. Even if you can't pay the full amount, filing your return and paying what you can is the best way to make the best of a difficult situation. Even though it may be tempting not to face your obligations, the consequences in the end are far worse.
Foolish tax expert Roy Lewis wrote about the various options available if you can't pay your taxes in a special article for the Fool's personal finance service, Motley Fool Green Light. You can check out Roy's article, and learn much more about how to save on taxes, by signing up for a free 30-day trial.
The IRS has a reputation for a good reason -- tax cheats are ruthless. But if you play by its rules, the IRS can sometimes do the right thing, giving you a chance to pay your tax bill on a more manageable schedule.
You can also learn more about managing your taxes in our Tax Center.