We get asked this question a lot – can I offer the IRS an amount and they’ll just cut out the penalties and interest? Unfortunately, no – there is no mechanism or process in place to just call the IRS, offer a large payment, and get everything reduced. Many people think just offering a large lump sum will
Don’t understand this wrong – you CAN get a settlement, but it’s not in the informal way that most people think is possible. There are three major ways to reduce your prior taxes (already assessed) with the IRS.
Offer in Compromise – Doubt as to Collectability
This program deserves its entire article of its own. This is the closest thing to what people may think of when it comes down to settling the IRS a lump sum of money for a settlement. However, there are a lot of conditions to this program – if you have a large amount of assets or too high of income, you will not qualify.
If you do qualify, there are many different strategies to be able to have a successful Offer in Compromise. What is an Offer in Compromise? This is a formal process, through a Form 433-A (OIC) and Form 656, where you list all your assets, income, liabilities, and expenses and show the IRS that you will never be able to pay them back within the 10-year collection statute (the IRS has 10 years to collect on a debt once it’s been assessed).
If you have any back taxes which need to be filed, you may need to get caught up on those unfiled years (unless an ‘substitute for return’ has been filed) before you are able to file for an Offer in Compromise. Assuming you have filed all back taxes, and your income/assets are low enough, you could save a major percentage of what you owe – the IRS would rather get something than nothing at all or to risk losing out in periods where you can never pay them back.
Penalty Abatement
Another way to lower your tax liability is through a penalty abatement. In some cases, a first-time penalty abatement can be obtained without compiling large amounts of documentation, support, and arguing for a reasonable cause abatement. However, if you have had repeated penalties in multiple years, you may not be able to get a first-time penalty abatement unless it is for the oldest year in question.
A penalty abatement based on reasonable cause is more difficult to obtain but it can done. The IRS has guidelines on what is necessary to obtain penalty relief. The best resource, in our opinion, is reading from the IRS handbook directly (called the Internal Revenue Manual) and then trying to use their own guidelines to obtain the necessary reasonable cause penalty abatement. Reasonable cause can be granted for death, serious illness, unavoidable absence, natural disasters, inability to obtain records, mistakes/errors, erroneous advice from a professional; it is more difficult or unlikely to obtain reasonable cause for ignorance of the law or forgetfulness.
Filing a Replacement to a Substitute for Return
In some cases, the a taxpayer may avoid filing a certain year. The IRS uses available information to file on that taxpayer’s behalf. This is called a substitute for return. Authority for this is granted to the IRS by Internal Revenue Code 6020(b). This usually results in the worst possible tax filing for a Taxpayer – they will be given a default filing status of Single (even if married or if they have dependents); will not be granted any deductions, no expenses will be provided for business income, and you can be left with the highest possible tax.
We file tax returns in many cases for our clients to replace a Substitute for Return (also known as a “SFR”). This can significantly reduce taxes owed by a significant sum – commonly for older tax years, we reduce tax balances by thousands of tens of thousands of dollars. In one case, we reduced a Taxpayer’s balance from over $2 million dollars to less than $75,000 due to multiple years of SFRs replaced by actual tax filings (they were trading stocks – SFRs make it so the IRS assumes you have zero cost in selling a stock).
Conclusion
These are just some of the ways you can reduce your tax liability – but not conclusive of every possible way to reduce a tax liability. There are other programs such as an Offer in Compromise, Doubt as to Liability or even by, in some cases, waiting out the clock (due to a ten-year statute of limitations for the IRS to collect on a debt).