Tax Problem Solving: A Step-by-Step Process

Tax problem solving is the process of identifying and resolving issues with federal or state tax authorities. A notice from a tax agency signals the start of a resolution process that requires a proactive approach. Navigating the tax system involves diagnosing the specific problem, gathering the necessary information, and executing a targeted solution.

Diagnosing Your Specific Tax Issue

Resolving a tax problem begins with diagnosing the issue from the correspondence sent by the IRS. These official notices explain the nature of the problem and the agency’s position. Understanding each notice is necessary to determine the correct course of action, as each points to a different type of underlying issue.

A CP2000, “Proposed Changes to Your Tax Return,” is an alert that information the IRS has from third parties, such as employers or financial institutions, does not match your tax return. This notice is not a bill but will detail the discrepancies and propose a new tax calculation. You have 30 days to respond by either agreeing with the changes or disputing the findings with supporting documentation.

The CP14, “First Notice of Balance Due,” is the initial bill from the IRS stating that you owe taxes. Review the notice to confirm the amount is accurate. If you agree, pay promptly to avoid further penalties and interest.

More serious notices indicate the IRS is moving toward collection. A CP504, “Final Notice Before Levy,” warns that the agency intends to seize your assets if a tax debt is not paid. This notice is a final opportunity to resolve the issue before the IRS begins levying property, such as state tax refunds, and requires immediate attention.

The most severe notices relate to liens and levies. A Letter 3172, “Notice of Federal Tax Lien Filing,” informs you the IRS has filed a public document giving it a legal claim to your property, including real estate and personal property, as security for a tax debt, which can affect your credit. Following a lien, you might receive a Letter 1058 or LT11, a “Final Notice of Intent to Levy,” which is the last warning before the IRS can seize property like wages and bank accounts.

Preparing Your Resolution Case File

After diagnosing the tax issue, assemble a case file with all necessary documents. The specific documents needed will vary depending on whether the issue relates to unpaid taxes, unfiled returns, or inaccuracies on a filed return. This preparation allows you to respond effectively and complete required forms accurately.

For unpaid tax debt, you must provide a detailed financial picture. You will need to gather several documents, including all IRS notices, copies of tax returns for the years involved, recent pay stubs, and bank statements. You must also create a detailed list of monthly living expenses, as this information is used to determine your ability to pay.

The IRS uses Form 433-F, Collection Information Statement, to structure this financial disclosure. To seek a formal resolution, you will need other specific forms. For an Installment Agreement, you need Form 9465, Installment Agreement Request, and for an Offer in Compromise (OIC), you need the Form 656, Offer in Compromise package.

If your problem is unfiled or inaccurate returns, gather all W-2s, 1099s, and records of deductions or credits for the missing years. For inaccurate returns, you will also need a copy of the original return and documents showing the correct information to complete Form 1040-X.

Executing Solutions for Unpaid Tax Debt

The three primary resolution options for unpaid tax debt are an Installment Agreement (IA), an Offer in Compromise (OIC), and Currently Not Collectible (CNC) status. Each has a distinct submission process and set of expectations.

An Installment Agreement is for taxpayers who can pay their debt over time. The request is made by submitting Form 9465, either online through the IRS website or by mail. The IRS will notify you within 30 to 60 days if your request is approved, providing the terms of the agreement. You must adhere to the payment schedule to keep the agreement in good standing.

An Offer in Compromise is for those who cannot pay their full tax liability. The submission involves mailing a completed Form 656 package to the designated IRS processing center. A non-refundable application fee and an initial payment are required with the application. The evaluation process can take six months to a year or more, during which an IRS examiner will review your finances and may request more information. A final decision is communicated in writing.

Currently Not Collectible (CNC) status is for individuals with severe financial hardship, temporarily suspending collection efforts. To request CNC status, provide the IRS with a completed Form 433-F and supporting documents, which can be done over the phone or by mail. If granted, the IRS will stop collection actions, but the debt remains and continues to accrue penalties and interest. The IRS will periodically review your financial situation to see if payments can resume.

Addressing Inaccurate or Unfiled Returns

Tax problems can also involve returns that were never filed or were filed with errors. The resolution requires submitting past-due returns or correcting previously filed ones.

Filing delinquent returns is necessary for compliance, even if you cannot afford to pay the tax owed, as failure-to-file penalties are more severe than failure-to-pay penalties. Prepare the return for the specific year using the forms and laws in effect for that year. Mail the completed return to the designated IRS service center. After processing, the IRS will send a notice detailing any tax, penalties, and interest owed.

To correct a return with inaccurate information, file Form 1040-X, Amended U.S. Individual Income Tax Return. On the form, you must explain the changes and attach any affected schedules. For recent tax years, Form 1040-X can be filed electronically; otherwise, it must be mailed. Processing can take up to 16 weeks, and you can track its status on the IRS website.

If the amended return results in additional tax, pay it as soon as possible to minimize interest and penalties. If you are due a refund, the IRS will issue it after the return is processed.

Requesting IRS Penalty Abatement

Penalties can increase the total amount owed to the IRS, but the agency offers penalty relief, or abatement, in certain circumstances. You can request an abatement once the underlying tax issue is addressed by demonstrating a valid reason for the penalties to be removed.

One common reason for penalty relief is First-Time Abate (FTA), available to taxpayers with a clean compliance history for the past three years. Another basis is showing Reasonable Cause, which requires demonstrating you were unable to comply with tax obligations due to circumstances beyond your control, like a serious illness or natural disaster.

For straightforward cases like an FTA, a request can often be made by calling the number on your IRS notice. For more complex situations involving a Reasonable Cause argument, a written request is better. This can be a formal letter explaining your reasons and including supporting documentation, or you can submit Form 843, Claim for Refund and Request for Abatement.