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Negotiating With the IRS Just Got a Bit Easier

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If you owe the federal government a tax debt, it may be easier to strike a deal to settle your debt for less than the full balance through an Offer in Compromise, thanks to new guidelines recently issued by the Internal Revenue Service. Larry Heinkel, a Florida tax problem resolution lawyer says this change is “gigantic.”

Heinkel describes the changes:

When considering a taxpayer’s proposed Offer in Compromise to settle a tax debt, the IRS looks at (i) the taxpayer’s total equity in assets that it could seize for payment, plus (ii) the present value of the amount it believes the taxpayer can pay each month toward the outstanding balance.

While the rules about calculating the first part of the equation have not changed, the IRS has made a significant and favorable change to how it calculates the “present value” of a taxpayer’s ability to pay monthly. Previously, the monthly ability to pay was multiplied by 48; now it is only multiplied by 12.

As an illustration, let’s say your income is $4,000 a month, and your allowable expenses (explained below) are $3,000 monthly. That means the IRS will assume you can pay $,1000 a month toward the debt you owe them. Under the old OIC formula, the IRS would multiply that $1,000 a month by 48 to arrive at the present value of that income stream, and insist that the taxpayer come up with at least $48,000 to settle the debt (plus equity in assets).

But under the new rules, they will multiply that amount by 12 months. So in the example above, the taxpayer would only have to come up with $12,000 to settle the debt, rather than $48,000 (plus equity in assets).

Clearly it would be a lot easier for someone with few assets to, say, borrow $12,000 from a relative to resolve the debt than it would be to get their hands on $48,000.

Heinkel points out, however, that the IRS will not allow all of the taxpayer’s living expenses in determining the ability to make monthly payments. Rather, only “necessary” living expenses are allowed, based on state and national “standards.” If your actual monthly expenses are higher, too bad. (And for the self-employed, the IRS will look at the last six months of income and expenses to get an average monthly income figure).

Does that mean this program is a slam dunk for taxpayers who can find the money to settle? Unfortunately, no. The IRS may refuse to accept an Offer In Compromise if it believes the taxpayer has other assets it can seize to pay the debt. (And a lot of things are fair game, including IRAs or home equity.) Nor will the OIC likely be accepted if the taxpayer transferred assets into someone else’s name, or if it would be against public policy — such as settling a tax debt after they convicted the taxpayer of fraud.

And to even apply for an OIC, you must pay a $150 nonrefundable application fee and include 20% of the amount you are proposing to settle with upfront. If the application is not approved, that payment will go to the tax debt.

If the offer is approved, you’ll have to pay the agreed upon amount in no more than five payments over five months. If you need a longer installment plan, you’ll have to multiply the amount you have available monthly to pay the IRS by 24 instead of 12, and pay the compromised amount over those 24 months.

“I still think bankruptcy is better than OIC in many cases, but if you have certain civil penalties (such as being responsible for unpaid payroll taxes that can’t be discharged), maybe the OIC is good,” Heinkel advises.

Finally, if you do pay off your tax debt through an Offer in Compromise, you’ll be on what he refers to as “5-year probation.” He warns: “For the next five years you must file your taxes on time and pay in full. If you don’t, then the deal is off. The IRS keeps all the money you gave and you owe the rest of what you owed, plus whatever you now owe as a result of the new problem.”

Image: Aidan Jones, via Flickr

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  • Dona Collins

    This is a bit scary, but I guess it’s scary to owe thousands upon thousands to the IRS. My fiance and I are both self-employed, but he owes a bit more than I do. Still, we both make monthly payments so we’re not exactly hiding or off the radar. It’s still a bit unnerving to owe the government money, though, especially since I rather enjoyed seeing a refund (I know it’s not found money, but still) as opposed to a bill each year. I wouldn’t give up freelancing for anything, though.

    The quote at the end talks about bankruptcy. I didn’t think there were any taxes that were dischargeable. Is this not true?

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  • Angelo Petrakis

    I lived in Florida from 2003 to 2009 and during the wilma hurricane I had $70,000 damage. I apply for fima but could not get anything. However they offer me a SBA loan for $38,000 to do the repairs. In 2008 my adjustable loan interest wen to 11% could not make the payments because it double the bank forclose on me. I got a Lawer to stop the forclosure, and I also got another Lawer to try nagotiate me loa for lower interest and was denied as well. The bank took my house the loan amount was $233,000 they gave me a 1099 for that amount and they claimed the house is worth $45,000 and a month later was sold for $85,000.
    Now I am paying for the SBA loan. What can I do.

    • Gerri Detweiler

      I wish I could tell you exactly what to do Angelo, but this sounds to me like a situation where you need to get help from a tax professional with experience in these forms…

    • James

      There are a few things you can do. I’m sorry you just saw this. 1stly, declare bankruptcy. 2ndly, or try to settle the debt, you have to stop paying first. They will usually accept 10 percent. Get a letter in writing that the debt has been settled for whatever amount from the creditor. That would require a lump sum payment. If you have a deficiency with your bank and they try to come after you later (meaning you didn’t have the attorney during the foreclosure), They can’t come after your 401K or IRA. Thirdly, hire a lawyer to negotiate it for you if you are trying to avoid a deficiency judgment. Good luck.

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  • http://www.credit.com/ Credit.com Credit Experts

    Matt – This is disheartening to hear, especially with it being such a significant dollar amount. By filing for bankruptcy your mother and brother were able to discharge the debt and essentially avoid the collection headaches that you’re now having to deal with. Unfortunately, with cosigners, if the primary borrower defaults (or files bankruptcy), the cosigner is liable for any outstanding amount on the loan. The only way to resolve the debt on your own would be to pay it, or negotiate a settlement. To negotiate a settlement, you typically need a large lump sum before the bank or collector will agree to negotiate. If this is an option, here’s a great resources that can explain how to deal with collectors so that you know what to expect as you work through resolving the debt: Seven Ways to Defend a Debt Collection Lawsuit

    In the end, filing bankruptcy should always be a last resort, but before you make any hard and fast decisions, it may be worth at least consulting with bankruptcy attorney so that you know your options in the event it comes to that.

  • http://www.Credit.com/ Gerri Detweiler

    You are going to need to consult a tax professional.

  • PurpleReign

    You won’t pay early withdrawal penalties when the IRS takes the money out. Read about exceptions to the 59 1/2 withdrawal rules.

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