Tax delinquencies and the economic downturn

The Internal Revenue Service’s Offers in Compromise program — in which taxpayers negotiate down the tax debts that they owe — has a long and tumultuous history. Critics have long complained about the complexity of the program, and the low rate of accepted offers, which amounted to just 24 percent between fiscal 1996 and 2005, according to the Treasury Inspector General for Tax Administration.

In testimony before the Senate on complexity and the tax gap, National Taxpayer Advocate Nina Olson showed that the result of trying to collect from delinquent taxpayers during the economic downturn was what you might expect — a long line of taxpayers waiting for resolution.

More than 5.5 million unresolved IRS collections were unpaid at the end of fiscal 2010, and were classified as delinquent. At that time, some 3.3 million of these accounts, involving $46.2 billion in unpaid taxes, were assigned to the collection queue.

“These cases tend to sit for years in the queue, accruing interest and penalties, and therefore becoming more difficult to resolve and for the IRS to collect,” Olson testified. At the end of fiscal 2010, approximately 80 percent of the IRS’s inventory of unresolved delinquent accounts involved the 2007 tax year or earlier.

As with any delinquency (note what’s happened with unpaid mortgage debts), the longer the amount of time that passes, the tougher it is to resolve, even when it’s in the interest of both sides to find their way to an agreement. A 2009 TAS Research study of taxpayers who failed to pay in 2002, following a previous recession, found that the IRS overestimated the ability of those who had declared bankruptcy to pay off their tax debts.

Yet in fiscal 2010, despite the economic slump, the IRS accepted only 13,886 offers in compromise and 40,461 partial payment installation agreements. Meanwhile, the IRS accepted just 95,000 installment agreements on business-related tax delinquencies, which typically involve small-business taxpayers. And less than 4 percent of the delinquent accounts were reported as uncollectible due to economic hardship.

While this is a side note for the hearings — which Senate Finance Committee Chairman Max Baucus is holding as Congress mulls a broader overhaul of the tax system, which was last revamped in 1987 — it’s an important issue for many individual taxpayers who’ve run into tough times and are faced with sizeable tax debts that they will never be able to pay.

Will the IRS and delinquent taxpayers be able to reach more agreements on these debts going forward? As Olson testified, the IRS has publicly announced its intention to be more flexible with taxpayers resolving outstanding tax debts, and has been working to improve various aspects of its collection programs. It is on track to increase accepted compromise offers by some 59 percent in fiscal 2011. As Olson testified: “The government needs to offer a taxpayer who cannot pay in full realistic options to pay what he or she can, so that voluntary compliance is practical.

If you are among the delinquent taxpayers hoping to negotiate down your debts to the government through the Offers in Compromise, it’s worth hiring a reputable lawyer, accountant or enrolled agent to help you. But beware of offers of help that sound too good to be true, as this is an area that’s rife with them.