Individuals and businesses with outstanding tax balances due can face severe penalties from the Internal Revenue Service (IRS), including the eventual seizure of personal or business assets in some cases. To handle this dilemma—which can trigger a significant financial crisis—a new type of business has sprung up to help delinquent taxpayers cope with their tax debts.
Known as tax settlement firms, these entities claim they can drastically reduce or eliminate whatever the client owes the IRS. But can these firms really deliver what they promise, or is it buyer beware?
- Tax settlement firms claim to have a litany of experts such as former IRS employees who can go to bat for their clients.
- Promises by tax settlement agencies are virtually impossible to fulfill because the IRS rarely accepts any proposal to reduce the amount of tax owed.
- Qualifying for offers-in-compromise is difficult and typically takes at least several months to complete.
- Most tax settlement companies charge high fees.
What Are Tax Settlement Firms?
You've probably seen the advertisements on television. Desperate people who owe tens of thousands of dollars to the IRS and have no one to help them out. Cue the tax settlement firm, which steps in and leaves the worried client amazing messages that say their tax liability is miraculously reduced by hundreds or thousands of dollars. Clients are elated, being left more than satisfied. But that's television (or radio or social media), and things don't necessarily work that way in reality.
If you're confused about the tax settlement industry and what it does, think of the debt settlement business. The two work in the same way to some degree. Most firms that specialize in tax settlements claim to have a battery of tax experts at their disposal who are former IRS employees who can go to bat for their 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 did work for the IRS at some point, the majority of employees probably haven't. In fact, most employees may be little more than minimum-wage customer service representatives.
What Tax Settlement Firms 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 agency to accept a much smaller amount—often pennies on the dollar. In reality, this is virtually impossible to do, and the IRS rarely accepts any real reduction in the amount of tax owed. There are, of course, several very extenuating circumstances under which Uncle Sam will accept a deal for repayment of back taxes, including:
- If the taxpayer is experiencing an exceptional circumstance and the amount due would cause an economic hardship or would be unjust (this would have to be an extraordinary situation)
- If the debtor is unable to obtain any type of gainful employment with sufficient income to repay the amount, such as in the instance of a long-term illness or disability
- If the person owing taxes has absolutely no assets whatsoever that could be used in a meaningful way (via asset seizure) to cover the required tax liability
The best everyone else can hope for is perhaps an extension of time to pay off their tax debts, which typically includes additional interest and penalties as well.
Offer in Compromise
Tax settlement firms use an accepted IRS procedure known as an offer in compromise 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 their current assets and liabilities as well as projected future income.
Offers in compromise also typically take at least several months to complete, and qualifying for one of these offers may be more difficult than qualifying for Medicaid. There is no spend-down strategy available for this avenue.
The number of offer-in-compromise applications that are actually approved is generally very low. 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.
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.
According to IRS Form 656, the exceptional circumstance leading to a financial hardship would have to be along the lines of "unplanned events or special circumstances, such as serious illness, where paying the full amount or the minimum offer amount might impair your ability to provide for yourself and your family."
Tax Settlement Firm Price Tag
Most tax settlement companies charge their clients an initial fee that can easily run anywhere between $3,000 and $6,000, depending on the size of the tax bill and proposed settlement. In most cases, the fee is non-refundable and quite often mysteriously mirrors the amount of free cash the client has available. This is generally the amount of money the company says it will save the client in tax payments.
The IRS Office of Professional Responsibility targets questionable practices in the tax debt resolution industry. You can report problems to the IRS on Form 14157, Complaint: Tax Return Preparer.
Clients have complained to the Better Business Bureau (BBB) and the Federal Trade Commission (FTC) 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 initially charging them a lower fee before coming back for more once they are deeply involved in the process.
Tax Settlement Firm Success Rates
As stated previously, the IRS rejects most offers in compromise it receives each year. The number of clients who get satisfaction from tax settlement companies is negligible, and most are virtually destitute financially. The vast majority of potential settlement clients need to work out payment plans with the IRS that allow them to clear out their tax balances over time while keeping their assets—and dignity.
You can find more information about payment plans on the IRS website.
Finding a Legitimate Tax Relief Firm
Several red flags should warn any prospective customers who are considering hiring 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 who does not ask a customer why the client owes the IRS money is not conducting the full due diligence process that would be required for a proper appeal.
Any reputable tax relief firm will first obtain key financial data from its customers before giving them a realistic assessment of what they can do for a reasonable fixed fee. Prospective clients would be wise to find a local firm that has been in business for several years and has a presence in the community.
Tax Settlement Warnings From the IRS
The IRS is probably the most difficult of all creditors with whom many taxpayers have to deal. It has the legal power to seize assets and push forward with extreme collection measures. Therefore, many delinquent taxpayers find the agency 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 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.
Publication 594: The IRS Collection Process offers a detailed description of the Offer in Compromise process and a description of the collections process. Compare that information to anything a tax settlement firm tells you to ensure you have been given correct information before you decide whether or not to retain the firm.
Do Tax Relief Companies Really Work?
That depends. Unfortunately, the industry is rife with scams and poor business practices. Disreputable companies lure customers with false promises while charging high fees. Still, legitimate tax settlement firms do exist. These companies are honest about whether you can benefit from their services and charge reasonable fees that are disclosed upfront.
Are Tax Settlement Companies Worth It?
Again, that depends. Disreputable companies may collect hundreds or thousands of dollars in fees without providing the outcome you seek. On the other hand, good companies charge reasonable, transparent fees and have proven track records. Some companies charge a flat percentage of the amount owed to the IRS, such as 10%. Others charge an hourly rate that might range between $275 and $1,000. Some companies will not accept clients with a tax debt of less than $10,000.
What Does Tax Settlement or Tax Relief Include?
The tax settlement process generally begins with a free consultation. A case manager will review your current tax debt and other financial details and provide an estimate for their services. If you continue, the case manager will perform an in-depth investigation into your taxes, develop a plan of action, and negotiate with the IRS.
The Bottom Line
The tax settlement business is fraught with peril at every turn. Those who seek assistance with their unpaid tax balances are generally better off having their tax or financial advisor refer them to a qualified tax attorney with years of experience dealing with this issue. They should also be prepared to undergo extensive financial analysis and a bureaucratic process that may stretch out for months. Above all, they should be prepared to hear the word "no" from the IRS in the end.