Tax evasion leads to criminal charges, which can be severe. However, when you pay taxes, honesty is the best policy. Sometimes mistakes happen, and tax settlements can allow you to rectify them.
Tax settlements can give you a fresh start if you have made a mistake and underpaid taxes on a settlement. But how do you qualify for them?
We’ll tell you all you need to know here.
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What are the Types of Tax Settlements?
There are several types of tax settlements, each designed to address specific circumstances and help taxpayers resolve their tax debts with authorities. Here are some common types of tax settlement:
Offer in Compromise (OIC)
An Offer in Compromise is one of the most well-known ways to settle a tax bill. It lets people pay less than the total amount owed to settle their tax bills.
To get an OIC, you must show that paying the total amount would be hard on your finances or that you have a lot of doubt about your ability to pay. To determine a fair settlement amount, the IRS looks at your finances and how likely you will pay.
Installment Agreement
With an installment agreement, you can pay off your tax bill in monthly installments over time. Even though the overall debt doesn’t go down, this method makes paying it off easier by spreading it out over a set time.
Penalties and interest keep adding up until the debt is paid in full. Depending on how much money you have, you may be able to get a simple installment agreement or a more organized agreement with clear payment terms.
Penalty Abatement
Penalties can be a big part of the total amount of tax debt. In some situations, you might be able to get a penalty abatement. This is when the tax agency agrees to lower or eliminate penalties on your tax bill. Common reasons for reducing a penalty are good reasons, it being the first time or an administrative mistake.
Innocent Spouse Relief
If you filed a joint tax return with your spouse or former spouse and were unaware of errors, omissions, or underreporting of income, you might be eligible for innocent spouse relief. This relief can protect you from being held responsible for your spouse’s tax liabilities.
Currently Not Collectible (CNC)
If you’re facing financial hardship and can’t afford to pay your tax debt, the tax authority might classify your account as “currently not collectible.” This doesn’t eliminate the debt but temporarily suspends collection efforts until your financial situation improves. If you’re interested in learning more, you can view here for more information on CNCs and their implications.
Statute of Limitations Expiration
The tax office only has a certain amount of time to collect tax debts. The debt may be canceled if the debt collection deadline has passed and the tax agency hasn’t gotten the money yet. This doesn’t involve negotiating but rather a waiting time.
Compromise with State or Local Tax Authorities
Even though the IRS is in charge of federal taxes, state and local tax agencies also have settlement choices similar to the Offer in Compromise. Taxpayers can settle state or local tax debts for less than the total amount due if they meet specific financial requirements and follow the rules of the relevant jurisdiction.
How Do IRS Tax Settlements Work?
Tax settlements are agreements between the Internal Revenue Service (IRS) and a taxpayer that resolve unpaid taxes or tax liabilities. Here’s how IRS tax settlements work:
Submission of Offer
If you meet the eligibility criteria, you can initiate the process by submitting an Offer in Compromise to the IRS. This involves completing Form 656, which includes detailed information about your financial status and the proposed settlement amount. Along with the application, you’ll need to pay an application fee unless you qualify for a waiver due to low income.
Documentation
Accurate and comprehensive documentation is crucial for a successful Offer in Compromise. You’ll need to provide a thorough overview of your financial situation, including details about your income sources, monthly expenses, asset values, bank statements, investment accounts, real estate holdings, and other relevant financial information. Special circumstances that impact your ability to pay, such as medical conditions or other hardships, should also be documented.
Evaluation
The IRS will review your submitted Offer in Compromise and the supporting documentation. They will assess whether your proposed settlement amount accurately reflects your realistic ability to pay off the tax debt. The IRS uses specific guidelines and formulas to calculate the reasonable collection potential (RCP), which estimates the maximum amount they can expect to collect from you.
Reasonable Collection Potential
The reasonable collection potential (RCP) is a key factor in determining the offer amount. The IRS calculates this based on your future earning potential, asset values, and anticipated disposable income. They consider various elements, such as your income, expenses, equity in assets, and the number of months left in the statute of limitations for collecting the debt.
Acceptance, Rejection, or Negotiation
After the IRS reviews your Offer in Compromise, they will either accept it, reject it or make you a counteroffer. If the IRS accepts your offer, you must follow their rules, which usually include paying the agreed-upon settlement amount by a certain date. If your request is turned down, you can review the decision or give more evidence to support your case.
Payment of Accepted Offer
If the IRS accepts your offer, you must fulfill the payment terms outlined in the agreement. Depending on the terms negotiated, you may need to make a lump sum or a series of periodic payments. It’s essential to make payments on time and by the agreed-upon schedule.
Completion of Settlement
The IRS will consider your tax debt settled once you have met all of the terms of the settlement deal. Any balance still owed is canceled, and the IRS releases any liens put on the bill. To ensure the settlement is still legal, you must keep up with your tax obligations for a certain time after the payment.
How Do You Qualify For Tax Settlements?
Qualifying for a tax settlement typically involves meeting certain criteria and going through a formal process. Here’s a general overview of how you might qualify for a tax settlement:
Financial Hardship
The government knows that unexpected financial problems can arise, making it hard for people to pay their taxes. To be eligible for a tax settlement based on financial hardship, you must show proof of your finances. This can include recent pay stubs, bank statement, information about outstanding debts, medical bills, and any other evidence that shows you can’t pay the entire tax debt without putting too much stress on your finances.
Inability to Pay
To qualify, you must show that you can’t pay the full amount of your tax bill. This could mean a big drop in your income because you lost your job, had to cut back on your hours, or your business went bankrupt.
You will probably have to show that your financial situation has changed a lot since the tax bill was made. This proof could include tax returns from previous years that offer a drop in income, recent financial statements, and any other paperwork that backs up your claim of financial hardship.
Doubt of Liability
If you think the tax assessment is wrong or you don’t agree with the amount of tax you owe, you might be able to get a settlement based on “doubt of liability.”
Usually, this means giving the tax authority detailed evidence that disagrees with their assessment. This could include receipts, bills, contracts, and other documents showing the exact income amount, deductions, or credits.
Compliance
Tax authorities are more likely to consider your request for a settlement if you comply with your tax obligations for subsequent years. Being current with your tax filings and payments demonstrates your commitment to fulfilling your responsibilities. This can positively influence the tax authority’s decision regarding your settlement request.
Evidence and Documentation
When filing for a tax settlement, it is vital to have complete and correct paperwork. Your financial information should be easy to find and backed up by legal documents.
For example, if you have a heavy financial need, you might need to show recent pay stubs, bank statements, utility bills, and any other documents that show your financial position. You can make a strong case for your settlement request with the help of detailed papers.
Negotiation
Successfully navigating the tax settlement process often involves negotiation with the tax authority. This is where having a tax professional on your side can be invaluable. They can help you formulate a strong case, present your financial information persuasively, and negotiate with the tax authority to reach a favorable settlement agreement.
Unlock Freedom with Tax Settlements
Tax settlements are valuable tools for those facing financial constraints. On the one hand, they can provide relief from the burden of hefty taxes. Conversely, the resulting taxes owed and new payment conditions must be acknowledged.
To further understand the impact of tax settlement services and any applicable payment options, seek advice from a qualified financial professional.
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