IRS Tax Settlement Rules

N recent years, the IRS has made a concerted effort to get people back into good status by reaching deals on overdue taxes. The rules affecting this program have just changed dramatically.

The IRS used to be the terror in most people’s nightmares. Specifically, people who got behind on their taxes lived in dread of having the IRS catch up with them and freeze their bank accounts, sell off their homes, etc. The IRS instituted a program known as the offer in compromise to promote voluntary resolutions.

The offer in compromise program was designed to let taxpayers with back tax problems resolve their problems voluntarily. Instead of waiting for the IRS to catch up to them, taxpayers could come forward and essentially admit their sins. The IRS would consider reducing the amount past due, including penalties and interest, in exchange for this voluntary action. The program was a massive success.

Starting July 16, 2006, the offer in compromise program changed under a new federal law. Ironically, the small-government Republican majority in Congress pushed through this nasty legislation known as the Tax Increase Prevention and Reconciliation Act of 2005. The legislation dictates precise changes to the offer in compromise program.

The most significant change is the new 20 percent rule. Under the new legislation, a taxpayer that has problems with past taxes must send in 20 percent of the offer amount with their offer in compromise. The amount is not refundable, nor will any offer in compromise be acknowledged if the funds are not submitted. The logic behind this legislation is baffling to many.

When taxpayers get behind on tax payments, they almost always get way behind. It is rare to find someone who is only one year in arrears. Ostensibly, most people that miss one year take the head in the sand approach. Fearing all kinds of trouble, they ignore the situation. When the next year rolls around, they don’t file again because they are worried about alerting the IRS. As a result, the amount of taxes due grows, particularly when penalties and interest are added. While the offer is a small percentage of this amount, the basic idea is that you don’t have enough money to pay the bill in the first place. The 20 percent requirement seems to serve no purpose other than to give people another reason to ignore the problem.

The offer in compromise was initially designed to get people back into the system. Studies and statistics showed that the government would collect far more in revenues over the years if taxpayers were given a clean start. The new 20 percent rule conflicts with this purpose and hurts this program.