Settle Your IRS Debt for Pennies on the Dollar

I dedicate this blog to the memory of my dead hamster Lulu.  Her full name was Honolulu Maui.  She was my Hawaiian fuzzy friend.  From the moment she friended me on Facebook, we felt an instant connection.  Although I never caressed her furry body in my palms, she was my soul mate.  I longed to see her nibble on a carrot.

For a few moments, like when she asked for my bank account information, I thought that maybe she didn't really exist.  When she explained how her Skype account had been cut off, I used my Paypal account to send her the necessary $10K to get it turned back on.  Her Skype never did work due to a vicious German Shepherd, who bit through the cable to her camera.

Lulu died in a tragic car accident in September.  Her Volkswagen Beetle was crushed underneath an eighteen wheeler carrying dog poop.  Even though alcohol was found in her system, I do not believe her driving was impaired.  So long and farewell Lulu.  I am sending your estate $20K for the funeral.  I won't be attending her funeral because of tax season, but she knows I'll be there in spirit.

Speaking of imaginary friends, this time of year the tax resolution firms bombard us with advertisements for  new IRS programs that offer to settle your IRS debts for pennies on the dollar.  Former TV "star", Alan Thicke, stars in one ad running now on the radio.  He tells us that a brand new IRS program now gives you the chance to eliminate up to ninety percent of old tax liabilities.  What great news!

Maybe not.  First of all, there are some relatively new IRS programs, such as the Fresh Start program, but these programs won't relieve you of taxes you legitimately owe.  How can the tax resolution firms make these outlandish claims of tax freedom?

They lie - or at least they only tell a small portion of the truth.  To find out if you "qualify" for these wonderful new programs, you'll pay a $2,500 to $5,000 retainer.  Then they'll listen to your story and explain to you that you don't really qualify for the ninety percent reduction programs. But, they can negotiate an installment agreement with the IRS so that you can pay your taxes, including interest and penalties, over time.  How can they get away with doing business this way?  For the most part they don't.  These firms are always in trouble with state authorities.  Some of the owners are doing jail time now.

The other way they claim big tax liability reductions is to cite instances where a taxpayer really didn't owe the taxes in the first place.  For example, maybe you forgot to record stock sales from your brokerage statement.  The IRS computer sees this and sends you a big tax bill.  They assume you paid nothing for these stocks.  All you have to do is amend your return for both the sales proceeds and the cost of your stock purchases, and you may owe little or nothing.  Maybe you even get a refund.  I handle these situations fifty times a year.  But, I don't claim I got rid of ninety percent of your tax liability.  I know you didn't owe the taxes in the first place.

What's the real story about settling tax debts with the IRS?  First, let's look at the regulations that govern when the IRS can accept an agreement to pay back taxes for less than the full amount.  There are three reasons the IRS can accept for paying less than your full tax liability.

First,  the IRS will settle for less than your full tax liability if there is doubt as to whether you actually owe the money.  This happens when you have been audited by the IRS, and they assess additional taxes on you based a gray area of the law.  Rather than face you in tax court and potentially lose a case that could set a precedent, they'll negotiate with you.

Second, the IRS will settle for less than your full tax liability if your tax debt is not fully collectible.  Before you break out the champagne, there is a catch.  You don't get a break because you are having a rough time financially.  Not fully collectible has a very specific definition.  It means that your income and assets, after allowed living expenses, cannot pay the debt in full within ten years.  Any amount not collectible in ten years will be written off.

"Allowed living expenses" has a very specific definition as well.  You will be given an allowance for housing, vehicle expenses, food, clothing, and some other necessary items.  The allowance for housing does not include an amount sufficient to make payments on your million dollar mortgage or the payments on your Mercedes.  You get regionally adjusted amounts from a table.  The IRS doesn't really care if you have to stiff your other creditors and file for bankruptcy to live within their allowance.

The third reason the IRS will compromise your tax liability is for efficient tax administration.  Not even the IRS knows what that means, nor do I.  I have never seen this provision used.  I suspect the IRS fears a congressional backlash if they ever use this provision.

What about this thing the tax resolution firms refer to as an offer in compromise (O.I.C.)?  Keep in mind all three rules above apply to O.I.C.'s.  So don't expect to walk away from your tax bill.  The O.I.C. form walks you through the calculation for rule two above.

Here's a sobering statistic about O.I.C.'s.  The IRS accepts less than twenty percent of O.I.C.'s.  Even that is a vast overstatement.  The overwhelming majority of people, who start the O.I.C., process, never complete the process.  I have started the process for a number of clients, but I have never submitted a completed offer.  In most cases, we come to an agreement with the IRS through other programs.  However, in some instances, our client simply stopped the process when they realized that the O.I.C. process gives the IRS complete knowledge about their income and assets.  if the IRS turned down the offer, they would have all of the client's bank account information.  The IRS would be in position to immediately seize all of my client's money.  So your odds successfully submitting an O.I.C. are slim and none.
The IRS will work with you to settle your tax liability.  In my next post, I will discuss the mechanics of reaching a real world agreement with the IRS.  Expect pain.  The basic IRS collection principle is that someone, who pays his taxes late, cannot be placed in a better position than a taxpayer, who complied with his payment obligations on a timely basis.  That is just basic fairness to all of us, who meet our obligations.  Yes, you can settle your IRS debt for pennies on the dollar - 115 pennies to the dollar just like everyone else.

Next week's Superbowl has been renamed the Psychopath Bowl.  It features the Forty-niners coach, who has turned the post game handshake into a potential UFC fighting match.  He doesn't play well in the sand box with the other NFL coach children.  The Ravens feature Ray Lewis, the would be serial killer, whose limo was found with blood stains from a murder victim prior to a Superbowl a few years back.  I have no idea who to root for.

Thanks for reading.  For real tax and accounting advice, please like the "Stitely & Karstetter" Facebook page as well as the "How To Screw Up Your Small Business" Facebook page, where I post daily business tips.  Until next time, let's do it to them before they do it to us.