Need Tax Debt Settlement? Avoid This Scam

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If the promise of settling tax debt for pennies on the dollar sounds too good to be true, your instincts are right on the money, say a number of lawyers and accountants who routinely represent clients before the IRS.

While thousands of professionals regularly advocate for lower tax bills on behalf of their clients, a breed of settlement firms has cropped up with ads that promise aggressive representation and pie-in-the-sky results.

Although the ads may promise access to seasoned professionals capable of bringing an array of legal and financial tools to bear, most firms claiming the title of "tax settlement specialist" are really one-trick ponies, says Leslie E. Linfield, executive director of the Institute for Financial Literacy, a Maine-based nonprofit that counsels consumers on a range of financial issues.

"What they're selling is an offer in compromise (OIC)," Linfield says. "But the reality is that an OIC is a real long shot."

What is an OIC?
Simply put, an OIC is a settlement agreement between a taxpayer and the IRS. Like any creditor, the IRS recognizes that not all accounts will be paid. Rather than letting a debt become uncollectable, the IRS opts to accept less money than is owed in certain circumstances.

According to the IRS, an offer in compromise will be accepted if the amount offered by the taxpayer is equal to or greater than the reasonable collection potential.

That means the taxpayer will have to present a complete financial picture to the IRS, detailing everything from assets and liabilities, to income and expenses. While the IRS may accept an offer in compromise after looking at the taxpayer's total ability to pay, successful offers will likely only go to those in dire financial straits, says Walter Pagano, a 10-year veteran of the IRS and now a partner at Eisner LLP, an accounting firm.

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"For all intents and purposes, (a successful OIC) means you're looking at a rather bleak financial picture for the taxpayer," Pagano says.

Generally speaking, a successful offer in compromise will come from a taxpayer who has liabilities in excess of his or her assets and little to no disposable monthly income after allowing for basic expenses.

The allowable expenses don't amount to much, and they don't take into account regional variations in cost of living, says Stuart B. Tash, who spent six years as a revenue agent for the IRS before opening his own accounting practice in New York.

"The IRS can afford to wait," Tash says. "In practice that means you have to be either really old or really sick, because the IRS will want proof that you will never be able to pay."

With such a narrow window for acceptance, it's little wonder that the IRS reports rejecting nearly three-quarters of the 46,000 settlement offers it received in 2007.

Will a professional increase your odds?
Outside of the specialty shops, most tax professionals tend to shy away from the offer in compromise, citing limited room to maneuver on their clients' behalf and the obvious economic reality that those who can afford to hire a lawyer or accountant aren't likely to meet the IRS' strict financial criteria for an acceptable offer.

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