When the IRS says taxpayers owe money

What are the options when taxpayers owe the IRS money? Offers in compromise, installment agreements, and changing to uncollectible status could help.

By: Carl Breedlove  /  September 16, 2019

Every year, thousands of taxpayers receive notices from the IRS saying they didn’t pay enough federal income taxes or that their return is under audit. Taxpayers who owe the IRS money they can’t pay could panic as they try to come up with what they owe to avoid even harsher penalties, refund offset and credit issues.

Fear not, taxpayers! The IRS provides several ways to minimize or eliminate an assessment with certain requirements, including installment agreements, offers in compromise and changing an account to “currently not collectible status.”

Installment agreements are usually accepted and don’t require a lump-sum payment

Installment agreements are the most widely used taxpayer remedy because they are a way for the IRS to collect the entire liability and the taxpayer isn’t required to make a lump-sum payment. Taxpayers can request an installment agreement online, under certain circumstances, or they can mail Form 9465, Installment Agreement Request.

To submit a request online, taxpayers must complete an Online Payment Agreement (OPA). For individuals, the total tax liability, penalties and interest must be $50,000 or less. If the total liability is greater than $50,000, the taxpayer must mail Form 9465 along with a completed Form 433-F, Collection Information Statement, that lays out the taxpayer’s financial situation. If a taxpayer does not abide by the installment agreement, the IRS will consider it a default on the installment agreement and may revoke it.

Once a taxpayer defaults on the installment agreement, the IRS will send a CP523 Notice giving the taxpayer a chance to make any payments and contact the IRS before a specified termination date. If the taxpayer ignores the notice, the IRS will terminate the installment agreement, and the IRS will proceed with collection actions such as levying wages and bank accounts.

Streamlined agreements don’t require financial statements and are generally approved faster than others

Streamlined agreements don’t require financial statements or managerial approval which means they tend to get approved faster. The payment duration of a streamlined agreement cannot exceed 72 months (six years) or they must be completed prior to the collection statute of limitations expiration date (normally 10 years from the assessment date), whichever is earlier. To qualify, taxpayers must owe $50,000 or less, but they can pay down their liability and then qualify. If the taxpayer owes between $25,001 and $50,000 they must enroll in either a direct debit installment agreement or a payroll deduction agreement (Form 2159, Payroll Deduction Agreement) and some financial information may be required.

Example 1: John owes $20,000 in back taxes. He has a good job and the ability to pay off the debt over time. John files Form 9465 requesting an agreement that allows him to pay $278 per month until the debt is paid off. This agreement will likely be accepted because his monthly payment is large enough to pay off the debt within the 72-month time-period. If John had asked to make payments of only $200 the agreement likely would not be accepted because it would take 100 months to eliminate the debt.

Guaranteed agreements are automatically approved if certain requirements are met

An installment agreement is automatically approved when:

  1. The amount of the tax (excluding interest, penalties, additions to the tax, and additional amounts) does not exceed $10,000;
  2. The taxpayer has filed all previous tax returns and paid any tax required (other than for the year an installment is requested), and hasn’t entered into an installment agreement for the last five years;
  3. The IRS determines that the taxpayer is financially unable to pay the tax in full based upon information provided by the taxpayer;
  4. The agreement will result in full payment of the tax within 36 months (three years); and
  5. The taxpayer agrees to file and pay all tax returns during the term of the agreement.

Guaranteed agreements allow taxpayers some certainty that an agreement will be approved, if they meet all the requirements. Note that the dollar limit for guaranteed agreements of $10,000 only applies to tax, not to penalties, interest, etc.

Although installment agreements are the most common remedy used, sometimes taxpayers cannot afford to pay the debt in full. That’s where offers in compromise and changing an account to not collectible status come in.

Offers in compromise settle tax liabilities for less than the full amount owed

In situations where an installment agreement is too onerous for a taxpayer to pay, an offer in compromise (OIC) may be the best option. An OIC is an agreement between a taxpayer and the IRS that settles a tax liability for less than the full amount owed. The IRS will evaluate the taxpayer’s specific situation based on all the facts and circumstances in relation to income, expenses and whether the taxpayer owns any assets. The IRS will authorize an OIC in three cases, when there is a:

  1. Doubt as to liability
  2. Doubt as to collectability
  3. Question of effective tax administration

Doubt as to liability only occurs when the IRS and taxpayer legitimately doubt the validity of a tax debt

Doubt as to liability exists when there is a dispute as to whether the tax liability is actually correct under the law. The taxpayer must provide a written statement explaining why the tax debt or portion of the debt is incorrect along with supporting documentation to identity the reasons the taxpayer doubts the accuracy of the tax debt. Essentially, the taxpayer is saying that they have a genuine dispute about whether they actually owe the taxes and following the normal procedures to resolve the dispute are not feasible.

Doubt as to liability is rarely approved because the IRS does not consider this a substitute for the normal procedures to determine a liability. Grounds for a compromise might exist if the IRS and taxpayer legitimately doubt the validity of a tax debt. Doubt as to liability cannot be claimed if a court has made a final determination of liability.

See the IRS Form 656-L, Offer in Compromise (Doubt as to Liability), for more information.

Doubt as to collectability balances feasibility of payment while paying basic living expenses

This is, by far, the most common reason OICs are accepted by the IRS. The IRS will determine the “reasonable collection potential” of the tax debt which balances the amount the taxpayer can feasibly pay while still paying their basic living expenses. Taxpayers use national and local guidelines, published annually, when determining their living expenses. To make this determination the taxpayer must file Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals, in conjunction with Form 656, Offer in Compromise. Typically, a taxpayer must make an offer equal to the full amount that could be collected from the taxpayer’s future income and assets, but special circumstances may exist to allow for a lesser amount.

Example 2: Continuing the above example, John lost his job and now cannot afford to make monthly payments, but he does have two cars that he no longer drives daily. The cars have a combined value of $18,000. John decides to sell the cars and make an offer to the IRS to pay the $18,000 he receives from selling the cars at auction. This agreement has a good chance of being accepted, if the IRS determines John’s future earning potential and other assets create doubt as to collectability. If accepted, John would be relieved of the debt owed without having to make a long-term commitment—unlike an installment agreement. If John got a new job making roughly the same amount as the position in Example 1, the offer would likely be rejected because there would be no doubt as to collectability since he could make payments.

Effective tax administration (ETA) can help taxpayers who can’t afford to pay due to economic hardship or when equitable considerations are present

This type of offer in compromise can be similar to doubt as to collectability in that one of the acceptable reasons is that a taxpayer may have sufficient income or assets to pay their liability but paying would create an economic hardship. This occurs where the taxpayer may not be able to earn a living going forward due to long-term illness and selling all their assets would make them unable to pay living expenses, or the taxpayer cannot use their assets as security to acquire funds and seizing the assets would have adverse consequences.

Another acceptable reason for accepting an OIC based on ETA occurs when the taxpayer can demonstrate a compelling public policy or equitable considerations against collecting the full liability. The taxpayer must demonstrate that collection of the full liability would undermine public confidence that the tax laws are not being administered in a fair and equitable manner.

The IRS has accepted offers based on the following situations:

  • The liability was directly caused by a processing error by the IRS;
  • The taxpayer incurred the liability due to erroneous advice or instructions by the IRS;
  • Action or inaction by the IRS unreasonably delayed resolution of the taxpayer's case and interest or penalty abatement is not available;
  • The criminal or fraudulent act of a third party is directly responsible for the liability;
  • Pursuing collection of the liability would have a significant negative impact on the community where the taxpayer lives or does business; and
  • The taxpayer was incapacitated and unable to comply with the tax laws.

Taxpayers may submit an offer based on doubt as to collectability and ETA on the same Form 656, allowing the IRS to determine if either reason is grounds to accept the offer. Taxpayers may not include doubt as to liability and doubt as to collectability on the same form.

Currently Not Collectible status allows taxpayers to pause collection

If a taxpayer cannot pay an assessment due to a financial hardship, he or she may have the option to place their account in Currently Not Collectible (CNC) status. Other situations may also allow for CNC status. If a taxpayer qualifies, all collection activities by the IRS, such as levying the taxpayer’s income, will be suspended and no payments are due.

Typically, the IRS will exhaust all available methods to collect a past due tax liability before deeming the account uncollectible. In this situation, a financial hardship occurs when collecting the liability would create an undue hardship for the taxpayer by leaving them unable to pay their necessary living expenses.

The taxpayer must file a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, to demonstrate a financial hardship, and this form is valid for a period of less than 12 months. This form provides the IRS with the taxpayer’s employment status, whether the taxpayer has liquid assets or real property, and the taxpayer’s monthly income and expense statement. In addition, the taxpayer must file delinquent returns and satisfy any other requests made by the IRS to qualify for CNC status.

Unlike the other remedies discussed, CNC status does not resolve the taxpayer’s case because it will remain open for the remainder of the statute of limitations for collections (typically 10 years from the assessment date). This means that penalties and interest still accrue, and the IRS may apply any future refund to the debt owed. Lastly, the IRS will review the taxpayer’s income annually to ensure the financial hardship still exists. These additional considerations mean taxpayers should evaluate if any other remedy exists before attempting CNC status.

Example 3: John hasn’t had a job in over five years, and he has no major assets. After the IRS goes through all the normal collection methods, John requests that his account be granted CNC status. Here, there is a good chance his request would be accepted because there is not an avenue at this time for the IRS to collect the debt. If after two years John gets a job, and the statute of limitations has not run out, John will likely lose CNC status and be required to pay the debt.

No matter why taxpayers owe back taxes, they should respond when they receive a notice from the IRS and set up an appointment with one of our experts to see if any of these remedies can help.

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Carl Breedlove

Carl Breedlove is a tax research analyst at The Tax Institute. Carl works with a research team focused on tax law and policy, including analysis of the Tax Cuts & Jobs Act, state law updates and IRS materials.

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