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Tax Settlement: How to Settle Your IRS Tax Debt

July 1, 2024

Paying your taxes on time is critical for any taxpayer earning money in the United States. Yet, special circumstances may arise that leave you unable to pay taxes owed by the deadline. The IRS understands this, which is why they give taxpayers the option to settle their taxes.

It is critical that you contact the IRS to make arrangements if you are unable to pay. Otherwise, the agency may take collection actions (issuing a federal tax lien against your property or wage garnishments).

The IRS offers installment agreements (payment plans) requiring periodic payments until the tax liability is paid in full.

In some cases, you can reduce your total tax liability instead of simply delaying payment. As you might expect, this option is tempting to those who may want to abuse it. For that reason, the IRS requires strict processes and certain qualifications for you to be eligible for tax settlement options.

Key Takeaways

You may settle your tax if certain circumstances render you unable to pay on time due to financial hardship.
The IRS will consider your income, ability to pay, expenses, and asset equity to determine if you’re eligible.
Unpaid taxes may be paid in a reduced sum or over time through monthly payments.
Most taxpayers do not need to seek legal action to receive a tax settlement, you simply need to fill out the right IRS forms.
Form 656-B, Offer in Compromise Booklet that provides step-by-step instructions, is available on the IRS website.
Along with the application, you must pay a non-refundable fee of $205 (certain low-income taxpayers may be exempt).
You cannot receive tax settlement if you are applying for bankruptcy or have a history of unfiled and unpaid returns.
A business owner must be current with their payroll tax deposits to be eligible for a tax settlement.
You may negotiate your settlement options with the IRS independently or with the assistance of a tax professional.
Tax settlement companies are available specifically to help people negotiate settlements.

Table of Contents

What Is a Tax Settlement?
Benefits of an IRS Tax Settlement
Types of Tax Settlement
How Does Tax Settlement Work?
Who Is Eligible for Tax Settlement?
Freshbooks Simplifies Tax Preparation
Frequently Asked Questions

What Is a Tax Settlement?

An IRS tax settlement, called an offer in compromise, allows a taxpayer to pay a reduced amount of tax in either a lump sum (all at once) or short-term installments. To qualify for this agreement, taxpayers must prove to the IRS that they truly cannot afford their originally owed amount by their tax deadline.

Installment plans are typically delivered in monthly payments until the amount owed is met. An installment agreement is more difficult to qualify for compared to paying a reduced amount as a lump sum. To qualify for an installment agreement, a taxpayer must:

Be able to make enough money each month to satisfy your monthly payment plan
Be up-to-date in your tax returns
Have already paid off most of your state taxes and late fees

Benefits of an IRS Tax Settlement

Tax debt forgiveness is incredible news for many people who have fallen into financial hardship. Better yet, the IRS usually freezes penalties and interest once your tax settlement is approved. As a result, you can avoid wage garnishments.

Once approved, your tax liability will decrease almost immediately. This makes it much easier for you to quickly budget your path to financial stability. It’s also simply a stress-saver. Reducing the amount of tax owed gives you more breathing room to pay off other liabilities and basic living expenses.

Types of Tax Settlement

People seek settlement for different reasons, so the IRS offers different settlement options. Various options are available as a means to ensure fairness and that taxpayers in any situation have a feasible way to resolve their tax debts.

Offer in Compromise (OIC)

An offer in compromise (OIC) is the tax settlement option that allows taxpayers to pay less than what they originally owed. Bear in mind that only about 50% of OIC applications are accepted per year. You truly do need to prove that you are very much in need of tax relief to qualify for this option. Specifically, taxpayers who owe more money than they could ever reasonably pay all at once qualify for OIC.

Currently Non-Collectible (CNC)

Currently, Non-Collectible (CNC) is an account status option that states that a taxpayer’s gross monthly income is lower than their allowable expenses under National Standards. If you qualify for this status, the IRS will delay the collection process until you can pay. However, your tax debt will still grow because of interest and late penalties.

Installment Agreement (IA)

Installment agreements may not reduce your total tax liability, but they will allow you to pay what you owe over an extended period of time. Generally, installment agreement money is collected in a monthly payment plan that may last up to 6 years. Your taxes must be filed to qualify, but other than that, there are no other qualifications required for IA.

Penalty Abatement

Penalty abatement is for a taxpayer who genuinely attempted to pay what they owe in time but couldn’t due to an unexpected financial situation. To qualify, you must demonstrate that you exercised care in your attempt to pay on time but were simply unable to due to extenuating circumstances. You also must have no IRS penalties for 3 years prior to the tax year you requested penalty abatement.

Needing a tax settlement is never pleasant, but you can make the process a bit easier with FreshBooks. Watch the video to see how FreshBooks takes some of the pain out of tax preparation.

How Does Tax Settlement Work?

In most cases, there’s no need for a tax attorney to apply for a tax settlement. Instead, you will need to fill out several forms to begin your application process. How you apply depends on what IRS settlement option you select.

Offer in Compromise: Form 656
Installment Agreement: Online or Form 9465 and a Collection Information Statement
Currently Not Collectible Status: Must call IRS directly at 800-829-1040
Penalty Abatement: Form 843

You may negotiate your options with the IRS. This discussion is usually between you and the agency. However, you may hire professional help to join the discussions. Some companies offer tax settlement services specifically for these negotiations.

Who Is Eligible for Tax Settlement?

A taxpayer is only eligible for tax settlement if they can prove that they are unable to pay their tax in full due to a situation that is out of their control. They also cannot have a history of missing tax returns.

If the taxpayer is a business owner with employees, they must be current with all payroll tax deposits and filings. A taxpayer also cannot receive a tax settlement if they are in the midst of bankruptcy proceedings.

Special circumstances like natural disasters or falling victim to identity theft may provide somewhat more leniency surrounding these requirements.

FreshBooks Simplifies Tax Preparation

Negotiating your tax debt settlement is challenging. You need to be able to prove your financial situation in order to reduce your tax liabilities. One important way to do that is to show the IRS your regular expenses compared to your monthly income.

FreshBooks is an excellent accounting software tool to use for this purpose. You can use our easy-to-read, easy-to-track reports to demonstrate that you do not receive sufficient income. This can help expedite your tax settlement acceptance so you can spend less time negotiating and more time on your financial recovery.

Try FreshBooks free to see how well it can work for you.

FAQs About Tax Settlement

Tax debts are stressful, so no doubt you have a lot of questions about how you can reduce your tax liability. Please consult professional help about your specific situation and see if any of our FAQs may be of assistance.

How much will the IRS usually settle for?

The IRS usually settles for whatever amount they claim you can reasonably pay. To determine this, they consider your total assets (e.g., house and car), your income, and your monthly expenses. You can estimate how much you may receive as a tax settlement by using FreshBooks to compare these same factors.

How long does a tax settlement take?

A tax settlement can take anywhere from a few weeks to 12 months, depending on your negotiations. Changes to your account are quick once accepted. However, negotiations may take time, depending on your financial situation. You can use FreshBooks accounting software to keep track of all the financial details that could help you come to an agreement sooner.

Does the IRS ever settle for less than the amount owed?

The IRS may settle for less than your original taxes owed if you are eligible for an offer in compromise (OIC). You must prove that your taxes owed are more than what you can reasonably pay alongside your basic living expenses. Tracking your expenses using expense tracking software FreshBooks could be a great way to provide the IRS with data-based records that verify your claim.

Does the IRS ever negotiate settlements?

You always have the right to negotiate a back tax settlement with the IRS. You have the right to represent yourself or hire a professional as you see fit. You may negotiate your payment options or your adjusted amount based on your financial details and circumstances. It’s important to understand tax law throughout the tax settlement process, especially if you choose to self-represent.

Does a tax settlement affect your credit?

A tax settlement will not affect your credit. The IRS cannot share your personal identifying information, so credit bureaus will not detect your payment plans. However, filing a Notice of Federal Tax Lien may affect your ability to obtain credit. Keeping track of your credit using FreshBooks is an excellent way to gain visibility into your financial health as you settle your tax debt.

Do you need a lawyer to negotiate with the IRS?

You don’t need a lawyer to negotiate a tax settlement. However, they can be helpful. If it’s within your means to hire one, a tax lawyer can significantly increase your odds of being accepted for a tax settlement. Many taxpayers find that other forms of help, such as tax accountants, can also provide this same benefit.

More Useful Resources

Sandra Habiger, CPA

About the author

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.