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.
EconomicsA company’s days working capital ratio shows how many days it takes to convert working capital into revenue.
ProfessionalsLearn about the differences between controllers and accountants, how the two are related and which is the best career choice for aspiring bookkeepers.
ProfessionalsCash basis accounting recognizes revenues and expenses at the time cash is paid or received.
EntrepreneurshipHow to determine if the amount you clear dovetails with the competition.
EconomicsFair market value is the price at which a buyer and seller are willing to exchange a good.
EconomicsCommon examples of explicit costs include wages, utilities, rent, raw materials, and other direct expenses companies pay to conduct business.
ProfessionalsLearn the nuances that separate the similar careers of accounting and bookkeeping, and identify which is better for you based on your skills and career goals.
InvestingFATCA regulations have cast a wide net on offshore banking activities, and many innocent account holders might get caught in its tangle.
EconomicsVarious states have been trying to figure out how to tax cloud-based services, but they just might be opening an economic and legal Pandora's box.
ProfessionalsRead about what life is like as an actuary or as an accountant, how the two careers are different and how to decide which is best for you.
Financial advisors engage in a wide variety of financial areas, including tax return preparation and tax planning for their ... Read Full Answer >>
A profit and loss (P&L) statement, or balance sheet, is essentially a snapshot of a company's financial activity for ... Read Full Answer >>
Dividends paid in cash affect a company's balance sheet by decreasing the company's cash account on the asset side and decreasing ... Read Full Answer >>
Cash or stock dividends distributed to shareholders are not considered an expense on a company's income statement. Stock ... Read Full Answer >>
The only account recorded on the balance sheet, when dividends are declared and before they are paid out to a company's shareholders, ... Read Full Answer >>
In accounting, general and administrative expenses represent the necessary costs to maintain a company's daily operations ... Read Full Answer >>