Tax Settlements: What You Need to Know

In the world of tax settlements, businesses and individuals alike may find themselves caught up in a whirlwind of calculations, paperwork, and talks with tax authorities.

For most people, thinking about taxes is enough to bring about feelings of bewilderment, anxiety, and dread. And sometimes, the tax debt burden proves unbearable, and many are forced to seek a tax settlement, which can be a lifeboat to financial security.

But what are tax settlements, and how do they work? In this voyage of discovery, we will delve into the intricacies of tax settlements, from the various sorts of settlements accessible to techniques for reaching the best possible settlement, tax consequences of debt settlements, and more. So, buckle up, and let’s jump right into it.

What Is a Tax Settlement?

In its most basic definition, a tax settlement is an agreement between a taxpayer and the IRS or other tax authorities, allowing the taxpayer to resolve a tax liability for less than the amount initially owed. It enables taxpayers to repay their unpaid tax debt from a more bearable position than settling the entire amount owed.

This process aims to establish a mutually beneficial arrangement that meets the needs of both sides. However, not every circumstance warrants leveraging a tax settlement. The IRS and other tax authorities can only grant this option to taxpayers facing mitigating circumstances that hinder them from honoring their initial debt obligation.

Individuals that often find themselves in tax debt situations may discover that tax authorities are sometimes inclined to analyze their situations to assess whether a debt settlement is possible. This is usually based on the taxpayer’s circumstances and current tax regulations.

How Tax Settlement Works

A debt settlement can go two ways – the taxpayer can arrange with the IRS to settle the outstanding taxes over time or reach a tax settlement for less than the outstanding amount. Either way, the taxpayer must be eligible for one of the IRS’s tax settlement programs.

Before making a decision, the taxpayer must first identify their preferred type of tax settlement and submit the necessary documents to the IRS for evaluation. They may opt to fill out the information themselves or have it filed on their behalf by a certified tax professional.

Typically, the tax settlement is negotiated between the taxpayer and the IRS or other tax authorities. And in some instances, particularly when an individual seeks expert tax settlement assistance, a third party may also be present. Ideally, the arrangement requires you to clear the total tax settlement amount over a specified period, and no tax interest or late taxes are levied on the balance during that period.

On the contrary, taxpayers have an alternative option that entails paying the entire settlement amount at once. If that’s unattainable, the involved tax authority may establish a payment schedule that falls within the taxpayer’s means. For this case, the final payment should correspond with the last date agreed in the tax settlement offer.

As soon as all parties reach an agreement, the taxpayer will be on good terms with the IRS for the period stipulated in the agreement unless they fail to meet all the settlement provisions or default.

Types of Tax Settlements

There are different types of tax options that taxpayers can leverage. They include:

• Offer in Compromise (OIC)

This is a tax settlement in which an individual proposes to pay less tax debt than they owe. It is an option that the IRS will only consider if the taxpayer can demonstrate that they cannot pay the entire amount due in taxes and that adopting the OIC is in both the government’s and the taxpayer’s best interest.

The IRS will assess the person’s financial circumstances and may grant an OIC if it acknowledges that the proposed amount is the utmost it can anticipate recovering from the individual.

• Installment Agreement

An installment agreement is a type of tax option that allows the taxpayer to clear the entire amount of unpaid tax over time, typically in monthly installments.

The taxpayer must apply to the IRS for this arrangement and might be obligated to pay penalties and interest on the tax owed. In this case, the IRS may issue a federal tax lien to defend its interests.

• Penalty Abatement

A taxpayer may be entitled to seek a penalty abatement if they can provide a justifiable explanation for failing to file their tax return or pay their taxes on time.  A justifiable cause may include a death in the family, a severe sickness, or a natural disaster, and the taxpayer must provide the IRS with proof of their reasonable cause.

•  Currently Not Collectible (CNC)

If a person cannot settle their tax burden and doesn’t seem to have the capacity to meet the payments, the IRS may categorize them as “currently not collectible.”

In such a situation, the IRS won’t attempt to recover the tax owed, but interest and penalties will keep accruing. However, the taxpayer must first prove they cannot settle their tax burden because of financial difficulty.

• Innocent Spouse Relief

Innocent spouse relief is a tax settlement granted to persons who filed a shared tax return with their partner and were oblivious of any tax fraud or errors made by their partner. The taxpayer must prove that they were unaware of the fraud or mistakes and that holding them accountable for the tax bill would be unjust.

Point to Note: It is crucial to understand that not all taxpayers cut it for all the tax settlements above. Instead, the events surrounding a person’s tax burden and financial status will determine the type of tax settlement best suited to them. It is also vital for taxpayers to consult with a tax specialist to assess their qualifications for a tax settlement and to learn the possible repercussions of every type of settlement.

Benefits of a Tax Settlement

There are multiple benefits to seeking a tax settlement.

Pay Less Than Initially Owed

The most apparent advantage of negotiating a tax settlement is that the taxpayer eventually pays a significantly smaller amount to the tax department. The final payment amount can be established and presented quickly if the applicant’s situation meets specific criteria.

As soon as the owed balance is cleared as per the mutual agreement, the taxpayer’s account is deemed settled in full, implying they are no longer bound to late fees and other penalties that would otherwise be accrued.

Protection from Wage Garnishment, Levies, and Liens

Another advantage of seeking a tax settlement is that the taxpayer can avoid the imposition of a wage garnishment of their income, a bank levy on their available accounts, or tax liens on their assets.

Tax Consequences of Debt Settlement

Although debt settlement may provide borrowers with financial relief, it may also have tax implications.

In what sense? The IRS regards canceled debt as income; thus, a person may owe taxes on the canceled debt amount. However, based on the circumstances, various exclusions and exceptions could apply.

The insolvency exclusion is one of the most notable exceptions. If an individual can prove their insolvency just before the debt was canceled, the forgiven debt amount may be omitted from their taxable income. Nonetheless, the individual’s liabilities must outweigh their assets to be eligible for this exemption.

Another exemption is debt forgiven in bankruptcy. Debts discharged in a bankruptcy proceeding are not considered taxable.

Sometimes, an individual may be issued a Form 1099-C detailing the canceled debt amount. The form should be received by January 31 of the year after the debt settlement. Unless an exclusion or exception is applicable, the individual must include the forgiven debt amount on their tax return.

Given the complexity of tax consequences on debt settlements, it’s prudent that one consults with a tax professional. 

Steps Taken When Negotiating an IRS Tax Settlement

As mentioned earlier, the IRS can be open to negotiating a tax settlement in which you may be able to pay less than you owe or settle the liability over an extended time. But before you enter into negotiations with the IRS, there are steps you ought to take.

1. Submit Unfiled Taxes: If you still have outstanding returns, the IRS will not accept any settlement. So, ensure to submit any unfiled taxes promptly. Also, if the IRS issued a substitute for return (SFR) for any unfiled taxes, you must amend those.
2. Choose Your Preferred Type of Tax Settlement: You have various options for a tax settlement, including Offer in Compromise, Penalty Abatement, and others (all discussed above). Consult a tax professional to understand the best option for your situation.
3. Submit Your Application: It’s no secret that a tax settlement application process can prove daunting. You must fill out the forms, provide evidence and other supporting documentation, and pay any associated fees. And while you may handle the application yourself, we strongly advise you to involve a seasoned tax specialist with a proven track record in this field.

Seek Help From a Tax Attorney

Tax settlements can help people resolve their tax obligations with state tax authorities or the IRS. They can undoubtedly relieve one from the stress of unpaid taxes. However, they may also have negative repercussions, such as damage to an individual’s credit rating, penalties and interest, and possible legal action. 

The good news is that taxpayers can maneuver the tax settlement process and discover the best option for their situation with thorough scrutiny and help from a tax professional. 

Speaking of tax professionals, our dedicated team of tax attorneys at Cumberland Law Group is the real deal. We boast experience and an outstanding track record of helping our clients save millions in tax settlements. So, contact us today and let us help you achieve the same and address your other tax needs.