Comprehensive Guide to Settling IRS Tax Debts

Interview with David Bauman, EA, of JK Harris

Man on sofa examining paperwork
Chris Ryan/ OJO iMages/ Getty Images

Taxpayers have several options for resolving their federal tax debts. They can request a monthly payment plan, submit an offer in compromise, or seek bankruptcy protection. I spoke with David A. Bauman, an enrolled agent, who works for JK Harris, about the advantages and disadvantages of filing an Offer in Compromise.

The Tax Debt Basics: Offer in Compromise and Partial Pay Installment Agreements

Good afternoon, David, and thank you for taking the time to talk to me today. How do you help taxpayers solve their problems with IRS tax debts?

The tax professionals at JK Harris help individuals and businesses evaluate all their options for dealing with tax debts. We will prepare a financial statement for clients based on their unique financial situation to determine which tax debt strategies are best for each client.

What are the options for dealing with tax debts?

Taxpayers have five alternatives for resolving IRS Collections activity: setting up an installment agreement, setting up a partial-pay installment agreement, submitting an offer in compromise, filing for bankruptcy, or being declared not currently collectible by the IRS.

How do you know if a particular debt strategy is appropriate for a client? Everything depends on the client’s unique financial situation. We examine the client’s ability to pay. If the client cannot afford to pay his tax debts in full, the offer in compromise program may be a good option.

In particular, we examine the client’s monthly disposable income.

If there’s sufficient disposable income, we generally recommend that the client set up an installment agreement or a partial-pay installment agreement. If the client is making enough income to cover expenses and is more or less breaking even, then we may recommend an offer in compromise. However, if the client spends a lot of money on expenses, which the IRS will disallow, we may recommend that the client considers bankruptcy as an alternative.

What’s the biggest factors in determining whether an Offer in Compromise will be successful?

The taxpayer must be in compliance and must have the ability to pay and to borrow. The IRS will not approve an Offer in Compromise if the taxpayer is not in compliance with the tax laws. For example, the taxpayer must be current on estimated tax payments or federal income tax withholding, must be making payroll tax deposits on time, and must have filed all tax returns. The ability to pay and to borrow is measured by the Reasonable Collection Potential.

Which tax debt strategy do you prefer?

Generally, we prefer that a client set up an installment agreement or an offer in compromise. Installment agreements and offers in compromise are contracts between the taxpayer and the IRS. As long as the terms of the contracts are being fulfilled, the IRS won’t bother the taxpayer.

What about partial-pay installment agreements, where the taxpayer makes monthly payments but ends up paying less than the full amount owed?

Partial-pay installment agreements can be easier to get than an offer in compromise. However, unlike an offer or a full-pay installment agreement, the IRS can re-evaluate the terms of a partial-pay installment agreement every two years.

For example, if the IRS thinks the taxpayer can afford to make bigger payments, then the partial-pay installment agreement might have to be re-negotiated. The taxpayer can request re-evaluation at any time should his circumstances change to such a degree that the agreed upon payment can no longer be made.

How does a taxpayer request a partial-pay installment agreement? Taxpayers should submit a written request for a partial-pay installment agreement to the IRS Revenue Officer assigned to their case or to the Automated Collection System unit handling their account. If the taxpayer wishes to set up a partial-pay installment agreement before either of the two IRS interactions cited above, a written request may be submitted to the Service Center where the taxpayer files his tax return.

A Collection Information Statement (IRS Form 433A) also needs to be submitted, just like an offer in compromise.

So does this mean the taxpayer needs all the same documentation as an Offer in Compromise, such as three months of bank statements, and so forth?

Yes, the taxpayer will need to submit documentation to support the information on the Collection Information Statement.

No Documentation, Effective Tax Administration, and Paying an Offer in Compromise

What about taxpayers who have little or no documentation? Can they still request an Offer in Compromise?

The IRS expects documentation to accompany the Collection Information Statement (Form 433A). However, some clients do not keep their bank statements and paystubs. I tell them that “I’ll do the best I can for you, based on the documentation you provide.” Typically the IRS wants the backup documentation or else they will disallow the expenses being claimed. However, in some cases, the IRS will accept written projections of a client’s income when there’s little documentation to go on. For example, a taxpayer starting a new business may need to estimate his future income and expenses. Such income projections need to be reasonable.

Speaking of new businesses, a problem I see over and over again is small businesses falling behind on their payroll taxes. Can payroll taxes and trust fund recovery fees be settled through an Offer in Compromise?

Yes, a business owner can try to settle payroll taxes and penalties through an offer in compromise. If neither the business nor the business owners have the ability to pay the taxes in full, the IRS may accept an offer in compromise.

A taxpayer may request an Offer in Compromise based on doubt as to collectibility, doubt as to liability, and effective tax administration. Very few offers based on effective tax administration have ever been approved. Have you ever seen the IRS approve an effective tax administration offer in compromise?

Yes, I have seen the IRS approve an offer in compromise based on effective tax administration. They are rare, however. Basically, the taxpayer needs to demonstrate that he or she is suffering an extraordinary hardship, such that collecting the tax would be inequitable and not fair. I can think of a case where the taxpayer was suffering a significant medical hardship, and it was uncertain whether he would even live long enough to pay off his tax debts.

In submitting an offer based on effective tax administration, the taxpayer needs to provide an extensive narrative of the special and extraordinary circumstances along with the rest of the offer in compromise documentation. Right now, extraordinary circumstances would mean some sort of life and death situation, such as a serious medical condition.

What would be the advantage of submitting an offer in compromise when the taxpayer feels he or she may die soon anyway?

If the taxpayer has any assets, his or her estate will have to pay the tax debts after the taxpayer dies. If there are no assets, the IRS will not be able to collect, and the tax debts will eventually expire. So, if the taxpayer has any assets, it may be advantageous to make an offer in compromise now to pay off the IRS.

When submitting an Offer in Compromise, the taxpayer must indicate how he or she plans to pay the offer amount. Taxpayers can choose between a lump sum cash payment or monthly payments over 24 months. Which payment plan do you generally recommend?

Generally, we recommend that taxpayers make a cash offer to pay within 90 days of notice that the IRS has accepted their offer in compromise. Cash offers get the attention of the IRS, and so the IRS sometimes processes these offers faster. Also, the IRS thinks there is less chance that the taxpayer might default on the payment arrangement.

Also, the offer amount is based on the reasonable collection potential, which includes a calculation of monthly disposable income over the next 48 or 60 months. With a cash offer, the IRS multiplies disposable income over 48 months. With a 24-month payment offer, the IRS multiplies disposable income over 60 months. So taxpayers will usually be better off with the cash offer if they can pay within the shorter time period. Otherwise, the taxpayer is better with the higher 24-month offer because there would still be a contract that can be counted on, as long as the terms are honored.

Can the taxpayer change his mind about payment arrangements?

Yes, the taxpayer can switch payment plans at any time prior to acceptance or rejection by the IRS. However, typically, it is not changed until the IRS comes back with a counter-offer. Switching payment plans will change the monthly income factor (the multiplier of 48 or 60). Taxpayers should be working closely with their tax professional to make sure they choose whichever payment plan is right for them.

Doing It Yourself or Hiring a Tax Professional

Speaking of working with a tax professional, an offer in compromise is a long and complex process. Should a taxpayer try to submit an offer in compromise themselves, or should they hire a tax professional?

Generally, taxpayers should seek the advice of an experienced tax professional when trying to resolve their tax debt problems. An offer in compromise may or may not be the best solution to the problem. If a taxpayer owes less than $10,000 in taxes, they can probably handle the problem themselves by calling the IRS and requesting a payment plan. If they owe between $10,000 and $25,000, they should consult with a tax professional about the options available to them. If they owe more than $25,000, taxpayers should definitely be working with an experienced tax professional.

What should a taxpayer be looking for in a tax professional to help them settle their tax debts?

Taxpayers should be looking for a tax professional with significant experience in IRS collection matters, especially experience in dealing with revenue officers, the Automated Collection Systems division, and Appeals. They should find out how many years a tax professional has been working with collections matters. Additionally, taxpayers should be looking for a professional with extensive tax knowledge, especially concerning the laws for the collection of tax debts. The professional should be admitted to practice before the IRS, such as an enrolled agent, certified public accountant, or tax attorney.

Oftentimes, a client will first seek the help of their attorney. Not all attorneys specialize in IRS collections. However, an attorney can help you evaluate potential tax professionals and make a recommendation about which tax professional seems best qualified to help.

Offer in Compromise Process, Professional Fees, 10-Year Statute

Once a taxpayer selects a tax professional to help settle their tax debts, what’s the process?

Everything depends on the taxpayer’s unique financial situation. We start by preparing a financial statement that reflects the client’s income and assets.

How long does it take to complete an offer in compromise, from start to finish?

It all depends on how fast the IRS processes the offer. I tell clients it takes anywhere from 6 months to 2 years. The fastest that I’ve seen the IRS process an offer is 4 months. The longest was 2 and a half years.

Hiring a tax professional to prepare an offer in compromise can be expensive. What should clients expect to pay?

The price for an offer in compromise and other IRS representation services will vary. The more complex the case, the higher the fee for professional help. An offer in compromise, just by itself, will cost about $2,500, more or less, depending on how complicated the case is. However, clients oftentimes need more than just an offer in compromise. They may also need to prepare back taxes. So the total cost always depends on the complexity of the case and how much help the client needs.

Overall, it seems the offer in compromise program is a good option for taxpayers who have limited ability to pay off their tax debts in full. Are there any disadvantages to filing an offer in compromise?

The offer in compromise is one tool for handling tax debts. Taxpayers should consult with a tax professional to find out if any other tax debt strategy, such as an installment agreement or bankruptcy, is right for them. The biggest disadvantage to an offer in compromise is that filing an offer, delays the 10-year statute on collecting tax debts. The IRS has ten years to collect tax debts, but the ten-year period is suspended while the IRS is processing an offer in compromise. This means the IRS may have extra time to collect on tax debts if an offer in compromise is rejected.

More About David A. Bauman and JK Harris

David A. Bauman has over 20 years of tax preparation experience, 15 years as a self-employed tax practitioner and five years as a Tax Manager for 1st Nationwide Bank. Mr. Bauman obtained his Enrolled Agent credential in July 1987 and has represented taxpayers before Federal and State Agencies for the last seven years in the area of collection representation. Assigned to the Special Assistance Group at JK Harris, Mr. Bauman represents clients involved in the high dollar and more complex individual and business issues.

JK Harris & Company, LLC, based in North Charleston, S.C., is the nation's largest tax representation firm and has served over 175,000 customers since its founding in 1997 by John K. Harris. JK Harris consultants are available to meet with consumers in over 450 locations nationwide by appointment only. The company also provides services for consumer and commercial debt, student loan debt, investment fraud, financial planning, tax return preparation, and audit representation.