Can You Negotiate Your Tax Debt Down? Yes, but It's Complicated

If you filed your tax return and were expecting a refund but found out that you owe money instead, your first instinct may have been to scream, curse, or cry just a little. And while you may be resigned to having to empty your savings account (assuming you even have the money), you may be wondering if it's possible to get the IRS to forgive your debt or accept a reduced amount.

Well, in some cases, yes. Under rare circumstances, the IRS will accept what's known as an offer in compromise, which is an agreement that settles a tax bill for less than the full amount owed.

To be clear, for most people, an offer in compromise won't work. But here are the three scenarios in which an offer in compromise might fly.

1. There's doubt as to whether you owe the tax

If there's a big question as to whether you really owe the tax the IRS says you do, then you might get away with an offer in compromise. Usually, there needs to be a thorough investigation into the matter before the IRS is willing to go this route. And much of the time, there's really not a question -- either you owe money to the IRS or you don't.

2. The tax debt isn't payable

The IRS may agree to an offer in compromise if you're not able to pay the tax debt it's looking to recoup. Let's say you've sustained an injury that may not allow you to return to a job for many years, if at all. In a situation like that, it can be argued that it's not reasonable to ask you to pay that tax debt, so the IRS might write it off or agree to less.

3. Payment of the tax will constitute a major and unfair hardship

The final scenario where an offer in compromise might work is if you can prove (based on your financial circumstances) that having to pay your tax debt will cause an undue burden on you. But to be clear, the IRS says that for it to accept an offer in compromise, it needs to be that "requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances."

What to do if you owe the IRS money and can't pay

If you file your tax return and discover you owe the IRS money, don't assume that you'll be able to negotiate your tax debt down. That rarely works. Instead, if you don't have the savings to pay in full, sign up for an installment agreement that has you paying off your tax bill over time.

It's really important to sign up for one of these rather than simply send the IRS money at random when you can. If you're on a payment plan and you make your scheduled payments, you'll be considered current, which will generally stop the IRS from going after your wages to get repaid. If you don't take that step, the IRS might think you're blowing off your tax bill, and seek to garnish your wages instead.

If you are thinking of doing an offer in compromise to deal with a big tax bill, talk to a tax professional before you start spinning your wheels. They may be in a good position to know whether you should bother going this route or not.