Paying Off a Tax Debt Just Got Much, Much Easier

by Gerri Detweiler

NEW YORK ( -- 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 guidelines issued recently 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. 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 "five-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."

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