Have you ever wondered about the fairness of taxes? At the federal level we have a progressive system where the amount you pay is correlated to the amount you earn. This is why you hear about tax brackets, higher earners pay a higher percentage of income as income increases, income from capital gains and rents pay lower rates. Those who earn little at the lower end, pay the least amount of tax. In some cases, they receive tax credits which are redistributed from those who pay more in tax.
Tax relief is less progressive. As your income increases, you simply won’t qualify for most relief programs except reduction of penalties, maybe. As a matter of fact, the qualifications for tax relief programs encourage behaviors that would be considered contrary to personal finance advice as well.
It matters where you live
One of the glaring contradictions about tax relief is the impact of where you reside. In other words, in a collections context, if you are telling the IRS about your income and expenses, in the hope of qualifying for relief, the IRS takes into account the county in which you live. There’s a guidebook based on census data that the IRS uses to determine what the local cost of housing and utilities should be. If you spend more than those standards, that’s usually a problem.
My hasty analysis shows for a single person living in one of the top 50 expensive counties, you would have to earn $20-$27 per hour before you were required to repay back taxes. This wage number can be much higher if…
- you drive and have a car payment;
- are married;
- have children who live with you;
- pay for health insurance;
- pay on student loans or medical bills;
- pay child support or alimony.
Special treatments
I mentioned that my analysis was hasty because I didn’t take into account the other factors that could skew the figures. One of those factors that has an outsized effect is whether a tax debtor has financed a vehicle. In a collections context, if you are making a car payment up to $500 a month, the IRS allows it. You can have a newer (or at least, a financed) vehicle before being required to repay back tax. It seems counter-intuitive doesn’t it? Pay for your new car instead of repaying back tax.
This is where personal finance gurus flip out. Tax debtors can finance a depreciating asset in order to reduce disposable income and qualify for tax relief.
My analysis was on a single person household. Larger households get more favorable treatment – a larger allowances for food, clothing and other expenses as well as housing and utilities. The United States is unique in the world for many reasons but it is unique in the way that it taxes a family unit instead of an individual.
Exchanging collection information statement data with the IRS when you there is a stay at home parent taking care of multiple children can also yield favorable outcomes – and possibly relief.
Tax policy is used to encourage certain behaviors. I’m sure you’ve heard of “sin taxes” where higher taxes are paid on cigarettes and alcohol. Taxes for married couples who file jointly are lower than those who file separately – it nudges people to file that way. Tax policy nudges people to get married. Interestingly, the IRS won’t even allow you to amend a return from Married Filing Jointly (MFJ) to Married Filing Separately(MFS). They say they do this for public policy reasons.
Health insurance is also considered when in discussions about whether or not you can repay your tax debt. If you have health insurance, you benefit in two ways: 1) You have access to healthcare and that’s one less worry in your life. 2.) The IRS allows this expense before you have to repay tax debt. If you don’t have health insurance obviously, those two benefits do not apply.
There’s always an exception, isn’t there? The exception happens in cases of divorce. Parents who have to pay for child support and or alimony. It’s an allowable expense. It also flies in the face of the IRS’s “public policy.”
The relief everyone wants – settle my debt!
The Offer in Compromise (OIC) is the “settle your tax debt for less than you owe” relief program. Everyone (who has a tax debt) wants to do an OIC. If you have done some things right, in terms of personal finance, those good behaviors often disqualify you from the OIC program.
For most Americans, if they are able to purchase a home, it becomes the single largest store of wealth in their lives. In many real estate markets, purchasing a home might not make someone rich but it does control some cost of living and allows the homeowner to build up equity that would otherwise be lost if they were renting.
The equity one builds in the ownership of their home could be a dis-qualifier for the OIC program. If you were fortunate enough to build up enough equity in your home to match your tax debt, you may not be able to get relief through the OIC program.
Another often repeated personal finance recommendation is to leverage tax deferred/advantaged growth, if you can, by establishing a retirement savings plan. Again, for many Americans, the only retirement savings they have is a plan offered by their employers like a 401(k). Some employers even offer to match a certain percentage of the savings you make. Saving money this way over a long period of time allows the miracle of compound interest to occur.
These retirement assets factor into the qualification for the Offer in Compromise and often disqualifies them. Equity in your home, even if your can refinance or money in a retirement pan that cannot be accessed till age 59.5 make the OIC a no-go.
People who get in trouble with tax debt but who are doing their best to get ahead financially by making good decisions are being penalized. By driving cars that are already paid for, purchasing a home to keep living costs stable(and taking advantage of most American’s most important asset) and saving money for retirement – all of these things negatively affect any plan to get relief from unpaid income tax.
If you’re doing everything right from a personal finance perspective, there’s still a chance for relief. You may decide the relief plan takes too long and prevents too many future options but it’s good to know that if your disciplined behavior falters, you can may try somethings to keep the IRS away from your door.
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