How to Minimize Tax Debt

IRS payment plans and other options exist for tax debt.

Tax debt results when you fail to pay taxes to the federal or state government on your earned income. When you don’t pay your tax debt, you’ll face stiff penalties — including wage garnishment, property levies and even jail time in some circumstances.

The penalties for not paying your taxes are so harsh they’re almost worse than a tax audit. The IRS Fresh Start program provides taxpayers tax relief options to avoid a tax lien and get rid of their tax debt problems. The program increased the amount you can owe before the IRS will file a federal tax lien to $10,000.

First, learn how to lower your federal and state taxes to minimize tax debt. Next, if you do find yourself in debt with Uncle Sam, explore tax relief solutions and ways you can settle it — maybe even for less than you owe. Read on to find out ways you can minimize or settle your tax debt with IRS back tax help. Whatever you do, don’t ignore your tax debt.

Ways to Minimize Tax Debt or Settle Tax Debt

When questions like, “How much do I owe the IRS?” plague you, and you think you’re going to need debt help, it’s available. But don’t panic and start taking out loans if you can’t pay off your tax debt in one lump sum.

Instead, one easy way to minimize tax liability is to make sure you’re paying the least amount legally possible. Another is to try to settle your tax debt with the IRS. Use these eight strategies to minimize or settle your tax debt:

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1. Earn as Much Tax-Free Income as You Can

The more income you earn that’s not subject to taxes, the less likely you are to get into tax debt. Some ways to earn tax-free income include contributing to a health savings account, putting money away for your children’s education in a qualified plan, investing in municipal bonds, spending some of your earnings on out-of-pocket health costs and passing some of your investments to your children. In addition to helping you avoid tax debt, these options can help you save money for future expenses or benefit your children or family.

Use Your Head: How to Legally Cheat Your Tax Bracket

2. Claim Every Tax Credit You Can

Unlike tax deductions, tax credits reduce tax debt dollar for dollar, and new tax credits are introduced frequently. Some that are currently in place include buying a hybrid car, making certain home energy improvements, pursuing education and taking care of a child. Although you shouldn’t make purchases you don’t need just to get a tax credit, these credits are a nice benefit if you do happen to have room in your budget for a purchase.

3. Defer Your Taxes

Think of deferring your taxes as getting a government loan — for free. You can defer your taxes by investing in an IRA or another tax-deferred retirement account like a 401k and postponing your bonus from your employer.

But contribution limits apply to IRA and 401k accounts, and your employer might not agree to postpone your bonus until the following year. Also, it only makes sense to delay your bonus if you think you’ll be in the same or lower tax bracket next year. Otherwise, you risk being hit with a larger tax bill than you would if you didn’t defer.

Get the Answer: Is Taking Out Loans to Pay Off the IRS a Good Idea?

4. Take Every Tax Deduction

Simply put, the more deductions you claim, the less tax you’ll pay. Many itemized deductions are available, from business expenses to home mortgage interest, to property taxes to charitable donations.

Make sure you explore all of your options and take the deductions to which you’re entitled. A tax software program can help you determine which deductions you can take. But, for itemization to make sense, your deductions would have to exceed the standard deduction available for your tax filing status.

5. Review Your Filing Status and Exemptions

Your tax filing status affects how much you pay in taxes and which tax bracket you fall into. You can use your filing status to calculate your standard deduction, personal exemptions and income levels for phase-outs of your itemized deductions and personal exemptions.

You must know what tax exemptions you are entitled to take, too. For instance, there are personal deductions for married couples and dependent exemptions. Again, a tax software program can help you easily figure out which deductions you qualify for and which make the most sense.

6. Ask for an Offer in Compromise

An offer in compromise enables you to settle your tax debt for less than you owe. To qualify for an OIC, you must have filed all your tax returns and made your estimated tax payments for the current year. If you’re a business owner with employees, you must have made your federal tax deposits for the current quarter.

Generally, the IRS will accept an OIC if you offer an amount that’s equal to or greater than the reasonable collection potential, which is how the IRS determines your ability to pay and can include all of your assets. To apply for an OIC, you must fill out IRS Form 656 and pay a typical fee of $186.

Find Out: How to Get an IRS Payment Plan

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7. Apply for an Installment Agreement

In case you can’t pay your tax debt immediately, you can make monthly payments through an IRS payment plan, which is known as an installment agreement. Going this route will enable you to lower or eliminate any penalties or interest as long as you eventually pay off your debt in full.

Before you apply for an IRS tax payment agreement, make sure you’ve filed all your required tax returns. Follow these steps to apply for an installment agreement:

  • Complete and mail Form 9465, Installment Agreement Request and Form 433-F, Collection Information Statement.
  • Call 800-829-1040 or the phone number on your bill or notice.
  • Follow further instructions from the IRS.

8. File for Bankruptcy

You might be able to have your tax debt discharged if you file bankruptcy under Chapter 7 or 13 if you meet all requirements. Chapter 7 can enable you to fully discharge allowable debts and Chapter 13 will provide you with a payment plan to repay some of your debts. To apply for bankruptcy, contact an attorney.

Keep in mind, it might be harder to take out a loan after bankruptcy because a Chapter 13 bankruptcy is noted on your credit record for up to seven years, and a Chapter 7 bankruptcy is noted for up to 10 years. Also with a Chapter 13 bankruptcy, you’re able to keep all of your property, including non-exempt assets, but that might not be the case with a Chapter 7 bankruptcy.

Up Next: What Is a Tax Levy and How Can You Prevent It?

About the Author

Barri Segal has 20+ years of experience in the publishing and advertising industries, writing and editing for all styles, genres, mediums, and audiences. She has been writing on personal finance topics for 12 years and gains great satisfaction from making a difference in consumers’ lives.