In an effort to collect much-needed revenue during lean economic times, the Internal Revenue Service (IRS) has stepped up efforts to collect unpaid back taxes from individuals and businesses that have outstanding balances due. Those who are unable to pay their back taxes can face severe penalties by the IRS, including the eventual seizure of personal or business assets in some cases. In the wake of this dilemma, a new type of business has sprung up to help delinquent taxpayers cope with their tax debts. Known commonly as tax settlement firms, these legal agencies claim that they can either drastically reduce or completely eliminate whatever the client owes the IRS.
TUTORIAL: Personal Income Tax Guide

But can these firms really deliver what they promise? This article examines how these firms work and their success rate. (The auditor's review isn't always the last word. Many taxpayers who are audited can successfully appeal their audits and save thousands of dollars. Check out How To Appeal Your IRS Audit.)

What Are Tax Settlement Firms?
The tax settlement industry mirrors other debt settlement firms in some respects. Most firms that specialize in tax settlements claim to have a litany of tax experts available who are former IRS employees who can go to bat for clients. In reality, this may be a substantial misrepresentation - at least in some cases. Although there may be a few lawyers and a handful of people in the company who worked for the IRS at some point, the majority of employees probably haven't. In fact, the majority of employees may be little more than minimum-wage customer service representatives. (Learn more about debt settlement in A Guide To Debt Settlement.)

What They Offer
Most tax settlement firms promise to send their experts to the IRS to negotiate on behalf of the client, where they can presumably persuade the IRS to accept a much smaller amount, such as for pennies on the dollar. In reality, this is virtually impossible to do, and the IRS very, very seldom accepts any real reduction in the amount of tax owed unless the taxpayer is near death or totally unable to obtain any type of gainful employment and has absolutely no assets whatsoever that could be used in a meaningful way to cover the required tax liabilities. The best that everyone else can hope for is perhaps an extension of time to pay their taxes. (For more insight on getting an extension, see When You Can't Pay Uncle Sam.)

Tax settlement firms use an accepted procedure known as an "offer in compromise" in an effort to reduce their clients' tax bills. This is a special agreement that some taxpayers can make with the IRS to settle their tax debts for a lesser amount than what is owed. The taxpayer must supply substantial information to the IRS about his or her current assets and liabilities as well as projected future income.

However, the number of offer-in-compromise applications that get approved is generally very low. In order to have such a reduction approved, taxpayers must prove that the total amount owed is incorrect, the probability of being able to pay back the full amount is very low or paying back the full amount will result in tremendous financial hardship. Qualifying for one of these offers may be more difficult than qualifying for Medicaid, and no spend-down strategy is available for this. Offers-in-compromise also typically take at least several months to complete.

The Price Tag
The majority of tax settlement companies will charge their clients an initial fee that can easily run anywhere from $3,000 to $6,000, depending upon the size of the tax bill and proposed settlement. In most cases, this fee is completely nonrefundable - and therefore outrageous. (This fee quite often mysteriously mirrors the amount of "free cash" that the client has available.)

Clients have also complained to the Better Business Bureau that some of these firms have not produced any of the promised results and in fact the organization was a scam. Many firms also materially misrepresent their fees to clients, perhaps charging them a lower amount to begin with and then coming back for more once they are deeply involved in the process.

Their Success Rate
As stated previously, the IRS rejects the majority of offers-in-compromise that it receives each year. Therefore, the number of clients who get satisfaction from tax settlement companies is probably somewhere below 10% - and most of them are virtually destitute financially. The vast majority of potential settlement clients need to work out payment plans with the IRS that will allow them to clear out their tax balances over time while keeping their assets - and dignity.

Who's For Real?
There are several red flags that prospective customers should look for when it comes to choosing a tax settlement firm. Any firm that promises a drastic reduction of a customer's taxes without first getting a detailed financial background on that person is likely going to end up being a scam. Any tax agent that does not ask a customer why he or she owes the IRS money is not conducting the full due diligence process that would be required for a proper appeal.

Any reputable firm will first obtain the necessary financial data from its customers and then give them a realistic assessment of what they can do for them for a reasonable fixed fee. Prospective clients would be wise to find a local firm that's been in business for several years and has a presence in the community.

Warnings from the IRS
The IRS is probably the most difficult of all creditors for many taxpayers to deal with. They have the legal power to seize assets and to push forward with extreme collections measures, and therefore many delinquent taxpayers find them much more intimidating than private debt collectors or credit card companies. Tax preparation firms play heavily upon this fear, promising a lifeline of professional help that can make their problems go away. Don't be fooled by misleading claims from these outfits that first require substantial up-front payments. The IRS itself previously issued warnings to the public about fraudulent firms, citing many of the problems listed here. (If you can't pay your taxes, know that the IRS has many avenues for collecting what you owe. To learn more, see IRS Asset Seizures: Could It Happen To You?)

The Bottom Line
The tax settlement business is fraught with peril at every turn. Those seeking assistance with their unpaid tax balances should have their tax or financial advisor refer them to a qualified tax attorney who has years of experience dealing with this issue. They should also be prepared to undergo an extensive financial analysis and bureaucratic process that may stretch out for months. Most of all, they should be prepared to hear the word "no" from the IRS in the end.

Related Articles
  1. Taxes

    Why People Renounce Their U.S Citizenship

    This year, the highest number of Americans ever took the irrevocable step of giving up their citizenship. Here's why.
  2. Economics

    Understanding Cost-Volume Profit Analysis

    Business managers use cost-volume profit analysis to gauge the profitability of their company’s products or services.
  3. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  4. Taxes

    Taxes: H&R Block Vs. TurboTax Vs. Jackson Hewitt

    There are more and more tax services to help ease the pain of filing income taxes. Here's our take on three of the biggest.
  5. Taxes

    Confused About Estimated Tax Deadlines for 2016?

    If you run a business or have investment income, pay attention to this year's estimated tax deadlines. Here are the details, and what's new for 2016.
  6. Investing Basics

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
  7. Professionals

    A Day In The Life Of A Public Accountant

    Here's an inside look at the workdays of two experienced CPAs, to give you an idea of what it might be like to pursue a career as a public accountant.
  8. Professionals

    A Day in the Life of a Public Accountant

    There’s no typical day in the life of a public accountant, but one accountant’s experience may shed some light on what the career entails.
  9. Investing Basics

    Analyze Cash Flow The Easy Way

    Cash flow statements reveal how a company spends its money and where that money comes from.
  10. Economics

    What is a Trade Credit?

    Trade credit means that a customer purchases goods from a seller who allows the purchaser to pay for those goods at a later time.
  1. How do I file taxes for income from foreign sources?

    If you are a U.S. citizen or resident alien, your income (except for amounts exempt under federal law), including that which ... Read Full Answer >>
  2. How Long Should I Keep My Tax Records?

    The Internal Revenue Service (IRS) has some hard and fast rules regarding how long taxpayers should keep their tax records. As ... Read Full Answer >>
  3. Can working capital be depreciated?

    Working capital as current assets cannot be depreciated the way long-term, fixed assets are. In accounting, depreciation ... Read Full Answer >>
  4. Do working capital funds expire?

    While working capital funds do not expire, the working capital figure does change over time. This is because it is calculated ... Read Full Answer >>
  5. Does the IRS charge interest on penalties?

    The Internal Revenue Service (IRS) charges interest on any overdue taxes owed, but it does not charge interest on penalties. ... Read Full Answer >>
  6. Are tax shelters legal in Canada?

    Most tax shelters are legal in Canada. However, there have been illegal tax shelter scams that the Canada Revenue Agency ... Read Full Answer >>
Trading Center