How to Settle IRS Debt
For most people, a letter from the IRS or the state tax department is one of the scariest things they can get in the mail. And every year, the IRS finds billions of dollars of unpaid taxes. If you’ve underpaid your taxes, you’ll receive a notice saying that you still owe the IRS money.
Owing money to the IRS or the state can feel like a death sentence, but there are plenty of repayment and settlement options.
If you have tax debt, keep reading to understand how it works, how to resolve it and if you can pay less than you owe.
What is Tax Debt?
Just like the name suggests, tax debt means owing the IRS or state money for unpaid taxes. This generally occurs after you have filed your taxes and the IRS (or state) determines you still owe them.
Many people file their taxes and discover that they are owed a tax refund from the IRS, which means they have overpaid their taxes. But if you miscalculate your taxes, you may receive a letter saying that you actually owe the IRS money.
Self-employed individuals, freelancers, contractors and small business owners often have to file estimated quarterly taxes based on their income and expenses from the past quarter. During tax time, you will then find out if you paid enough in taxes or if you owe money to the IRS.
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Unpaid tax debt will usually come with interest. The interest rate varies over time and is generally the federal funds short-term interest rate plus 3%. In January 2024, the rate will be 8%.
What Situations Can Cause Tax Debt?
Having tax debt means that you owe the IRS (or state) money, from either underpaying your taxes, not filing your taxes on-time or some other combination of reasons.
If you don’t file your taxes or don’t file on time or don’t pay your tax bill by the due date (April 15 for most individuals), then you may owe a penalty worth .5% for each month that you fail to pay the complete amount.
Unpaid tax debt will usually come with interest. The interest rate varies over time and is generally the federal funds short-term interest rate plus 3%. In January 2024, the rate will be 8%.
Help With Your Debt
Steps to Take to Resolve Tax Debt
Confirm That You Owe
First, you should make sure that you actually owe the IRS (or state) money. You can contact them directly, even if you receive a notice in the mail or get a phone call from what seems to be an official number.
There are many scammers who pretend to be from the IRS, so you should always call the official hotline at 800-829-1040, available from 7 a.m. to 7 p.m (or your state tax franchise board).
Contact the IRS
Even though the IRS seems like a glum set of individuals, they can be reasonable to work with if you reach out.
Remember, avoiding the IRS will only cause you to rack up more fees. Ask them what your repayment options are and confirm what the fees are.
Find Out if You Can Pay Less Than You Owe
If you genuinely can’t afford to pay your back taxes, then you can try to settle the balance with the IRS. If you want to go this route, Logan Allec, CPA and owner of tax relief company Choice Tax Relief says you may have to file several forms depending on which type of settlement you’re looking for.
“Even if you don’t qualify for an offer in compromise, you may still be able to convince the IRS to knock some penalties off your account if can prove that you didn’t pay your taxes on time due to a really good reason — known as ‘reasonable cause’ — or if you’ve been perfectly compliant on your taxes for the past few years,” Allec said.
The IRS offers three different ways to settle your debt, also known as an offer in compromise.
There are three types of offers in compromise:
- Doubt As to Collectibility
- Doubt As to Liability
- Effective Tax Administration
In general, Allec says it’s hard to get your debt reduced unless you can provide strong evidence that you can’t afford to pay it back.
“If I have $100,000 in a savings account or taxable brokerage account and I owe the IRS $30,000, I’m probably not going to qualify for an offer in compromise,” he said.
What Happens if I Don’t Pay my Tax Debt?
While most lenders have to take you to court to garnish your wages, the IRS does not. If they issue a levy, they can garnish your wages automatically.
That means that they can contact your employer and start receiving a percentage of your paycheck to repay your balance. Not only can this affect your standing at work, it can also be much more costly than if you had set up a repayment plan in the beginning.
Wage garnishment is only one of the enforcement actions they can take. The IRS can also place a lien on your property or levy your bank accounts.
Be Diligent on Who You Work With
If you’re overwhelmed and don’t know how to manage your IRS debt, there are professional firms you can turn to, ranging from tax relief companies to tax attorneys. If you already have an accountant you use, ask them if they can help or provide a recommendation.
“Look for firms that are owned by attorneys, CPAs or enrolled agents (EA),” Allec said. “They’re often held to a higher ethical standard.”
Try to avoid tax relief companies that promise they can erase your debt if you just pay them a small fee. If it sounds too good to be true, it probably is.
“There’s more leeway than what the average person would think, but not as much as what a tax relief company will promise,” he said.
