If IRS is after you to collect a tax liability that's beyond your capacity to pay, you should be aware of a technique that may allow you to settle your tax debt for a fraction of its face value. It's called an offer-in-compromise.

Like any creditor, IRS prefers a partial payment to no payment at all. Thus, IRS is sometimes willing to settle a tax liability for less than the full amount if (a) the taxpayer is unable to pay the full amount, (b) there is doubt as to how much the tax liability is, (c) collection of the liability would create economic hardship for the taxpayer (such as where the taxpayer is out of work due to health problems, or where sale of assets to pay the tax would leave the taxpayer without enough money to meet basic living expenses), or (d) exceptional circumstances exist such that collection of the liability would be detrimental to voluntary compliance by taxpayers. Exceptional circumstances include situations such as reliance on erroneous advice from IRS, or a medical condition that prevents the taxpayer from managing his financial affairs.

The taxpayer starts the settlement process by making an offer-in-compromise. If the offer is grounded on any reason other than doubt as to how much the tax liability is, financial information must be submitted along with the offer. If it is grounded on doubt as to the liability, IRS is not permitted to request a financial statement.
If an offer is accepted, the taxpayer must be careful to file returns and pay taxes for five years. If these requirements are not met, the compromise terminates and IRS can seek collection of the original liability amount.

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