How to Settle IRS Debt: A Complete Step-by-Step Guide for Business Owners

Receiving a letter from the IRS can trigger immediate panic. The envelope sits unopened on your desk while you convince yourself that ignoring it will somehow make the problem disappear. According to IRS data, the agency accepted just 12,711 offers in compromise out of 30,163 proposals in fiscal year 2023—a 42% acceptance rate. Understanding your options and approaching the process strategically can mean the difference between years of financial stress and a fresh start.

Whether you owe $5,000 or $50,000, the IRS offers legitimate paths to resolve your debt. This guide walks you through every option available, the requirements for each, and the specific steps to take based on your situation.

Why Ignoring IRS Debt Is the Costliest Mistake

Before exploring solutions, understand what happens when tax debt goes unaddressed. The IRS has collection powers that no ordinary creditor possesses:

Failure-to-pay penalty: The IRS charges 0.5% of your unpaid taxes for each month (or partial month) the balance remains outstanding, capping at 25% of the original amount.

Compounding interest: Interest accrues daily on both the original debt and any penalties, creating a snowball effect that can double your balance within a few years.

Enforced collection actions: The IRS can file tax liens against your property, levy your bank accounts, garnish your wages, and even seize business assets—all without a court order.

For business owners, payroll tax debt carries an additional risk. If you fail to pay withheld employee taxes to the IRS, you can be held personally liable through the Trust Fund Recovery Penalty. The IRS can pierce the corporate veil and pursue your personal assets—your home, vehicles, and savings—to satisfy this debt.

Step 1: File All Required Tax Returns

Before the IRS will consider any resolution option, you must be current on all filing requirements. This applies even if you cannot pay the amounts owed.

For individuals: Ensure all personal income tax returns are filed for at least the past six years.

For business owners with employees: Confirm all quarterly payroll tax returns (Form 941) are filed, and all required federal tax deposits have been made for the current quarter and the two preceding quarters.

For self-employed individuals: File all required Schedule C returns and ensure estimated tax payments are current for the present year.

Filing delinquent returns actually helps your case. It demonstrates good faith and gives the IRS a complete picture of your financial situation, which is essential for negotiating any settlement.

Step 2: Determine Your Total Liability

Request a complete account transcript from the IRS to understand exactly what you owe. You can:

• Create an account at IRS.gov to view your balance online
• Call the IRS directly at 1-800-829-1040
• Mail Form 4506-T to request transcripts by mail

Your transcript shows:

• Original tax amounts owed
• Penalties assessed
• Interest accrued
• Any payments credited
• The Collection Statute Expiration Date (CSED)

The CSED is particularly important. The IRS has 10 years from the date of assessment to collect your debt. Once this date passes, the remaining balance becomes legally uncollectible. Knowing your CSED helps you evaluate whether certain resolution options make strategic sense.

Step 3: Evaluate Your Resolution Options

The IRS offers several programs depending on your ability to pay. Understanding which option fits your situation saves time and positions you for success.

Option A: Short-Term Payment Plan (180 Days or Less)

Best for: Taxpayers who can pay the full balance within six months.

Requirements:

• Owe less than $100,000 in combined tax, penalties, and interest
• Can pay full balance within 180 days

Advantages:

• No setup fee
• No financial disclosure required
• Can be arranged quickly online at IRS.gov

Considerations:

• Interest and the late-payment penalty continue until paid
• Must pay the entire balance within the timeframe

Option B: Installment Agreement (Long-Term Payment Plan)

Best for: Taxpayers who need more than 180 days to pay but can eventually pay in full.

Requirements for streamlined approval (individuals):

• Owe $50,000 or less in combined tax, penalties, and interest
• Can pay within 72 months
• All required returns filed

Requirements for streamlined approval (businesses):

• Owe $25,000 or less
• Can pay within 24 months
• All required returns filed

Advantages:

• Penalty rate drops to 0.25% per month while agreement is active
• Stops most collection actions
• Guaranteed approval if you meet the criteria for a guaranteed installment agreement

Setup fees:

• $22-$225 depending on setup method and income level
• Low-income taxpayers may qualify for fee waivers

Guaranteed Installment Agreement: If you owe $10,000 or less (excluding penalties and interest), have filed all returns on time for the past five years, and can pay within three years, the IRS must approve your request.

Option C: Partial Payment Installment Agreement

Best for: Taxpayers who cannot afford full payment but don't qualify for an Offer in Compromise.

This option allows you to make reduced monthly payments based on what you can actually afford. If the 10-year collection statute expires while you're making payments, the remaining balance may be written off.

Requirements:

• Submit Form 9465 with a Collection Information Statement (Form 433-A or 433-B)
• Demonstrate that full payment within the collection period isn't feasible

Option D: Offer in Compromise (OIC)

Best for: Taxpayers who genuinely cannot pay their full liability and can prove it.

An Offer in Compromise allows you to settle your tax debt for less than you owe—sometimes significantly less. In 2017, the IRS accepted offers averaging $10,234 to settle larger debts.

Eligibility requirements:

• All required tax returns filed
• All required estimated tax payments made for the current year
• Not in an open bankruptcy proceeding
• Received a bill for at least one tax debt included in the offer

How the IRS evaluates your offer: The IRS calculates your Reasonable Collection Potential (RCP) using this formula:

RCP = Net Quick-Sale Asset Value + (Monthly Disposable Income × Multiplier)

The multiplier is 12 for lump-sum offers or 24 for periodic payment offers. Your offer must generally meet or exceed your RCP to be accepted.

Application requirements:

• $205 application fee (waived for low-income taxpayers)
• Initial payment with your application:
  • Lump-sum offer: 20% of total offer amount
  • Periodic payment offer: First proposed monthly payment

Processing time: 6-12 months typically, though offers are automatically accepted if the IRS doesn't decide within two years.

Success tip: Use the IRS Offer in Compromise Pre-Qualifier tool online before applying. This free tool helps you determine if you're a viable candidate before investing time and the application fee.

Option E: Currently Not Collectible (CNC) Status

Best for: Taxpayers in genuine financial hardship who cannot afford any payment.

If paying your tax debt would prevent you from meeting basic living expenses—rent, food, utilities, medical care—you may qualify for CNC status.

What CNC provides:

• Temporary pause on all collection activity
• No wage garnishments or bank levies
• No required monthly payments

What CNC does not do:

• Forgive your debt (it remains on your account)
• Stop interest and penalties from accruing
• Prevent tax refund seizure
• Stop the IRS from filing a tax lien (typically filed if you owe over $10,000)

Requirements:

• Submit a Collection Information Statement (Form 433-F, 433-A, or 433-B)
• Provide documentation of income, expenses, assets, and liabilities
• Demonstrate that payment would cause genuine hardship
• Be compliant with current year tax obligations

Important consideration: The IRS reviews CNC accounts annually. If your income improves, they may require you to begin payments. However, if your circumstances don't improve and the 10-year collection statute expires, the debt is written off.

Option F: Penalty Abatement

Best for: Taxpayers with otherwise clean compliance history who experienced unusual circumstances.

First-Time Abatement: If you've been compliant for the past three years (filed all returns and paid all taxes on time), the IRS may remove failure-to-file or failure-to-pay penalties for a single tax period.

Reasonable Cause Abatement: If you can demonstrate that circumstances beyond your control prevented timely payment—serious illness, natural disaster, death of immediate family—the IRS may remove penalties.

Note: The IRS almost never abates interest charges, even when penalties are removed.

Step 4: Gather Required Documentation

Regardless of which resolution you pursue, prepare these documents:

For all options:

• Prior three years of filed tax returns
• Most recent pay stubs or proof of income
• Bank statements for all accounts (last three months)
• Documentation of monthly expenses

For installment agreements and OIC:

• Form 433-A (individuals) or Form 433-B (businesses)
• Asset valuations (vehicles, real estate, investments)
• Loan statements and proof of liabilities
• Business financial statements if applicable

For penalty abatement:

• Written explanation of circumstances
• Supporting documentation (medical records, insurance claims, etc.)

Step 5: Submit Your Request and Follow Through

Online submissions: Short-term and streamlined installment agreements can be set up at IRS.gov/OPA (Online Payment Agreement).

Mail submissions: Offers in Compromise require Form 656 and Form 433-A OIC, mailed to the appropriate IRS address for your state.

After submission:

• Respond promptly to any IRS requests for additional information
• Continue filing all returns on time
• Make any agreed-upon payments by the deadline
• Keep copies of all correspondence

Common Mistakes That Derail IRS Debt Resolution

Using payroll tax funds for operations: If cash flow is tight, many business owners "borrow" from withheld employee taxes. This creates personal liability and is nearly impossible to discharge.

Treating the IRS like any other creditor: The IRS has unique collection powers. Prioritize payroll tax deposits above other expenses, always.

Applying for an OIC without meeting requirements: The $205 application fee is non-refundable. Ensure you qualify before applying.

Missing payments on an installment agreement: One missed payment can void your agreement, reinstate full collection activity, and make future agreements harder to obtain.

Failing to adjust withholding: If you're in an installment agreement or CNC status but still under-withholding from your paycheck, the IRS may reject or revoke your arrangement.

When to Seek Professional Help

Consider working with a tax professional if:

• You owe more than $25,000
• You have unfiled returns spanning multiple years
• You're facing an active levy or lien
• Your situation involves payroll tax debt
• You're self-employed with complex income sources
• You've been rejected for an OIC previously

Enrolled Agents, CPAs, and tax attorneys can represent you before the IRS and often negotiate more favorable terms than taxpayers achieve on their own.

The Path Forward

IRS debt feels overwhelming, but it's rarely insurmountable. Millions of taxpayers successfully resolve their obligations each year through the programs described above. The key is taking action before the IRS takes action against you.

Start by requesting your account transcript to understand your complete liability. Then honestly assess your ability to pay and match yourself to the appropriate resolution option. File any missing returns immediately—they're required for every option and demonstrate good faith.

The 10-year collection statute works in your favor if you engage proactively. Whether you negotiate a reduced settlement through an Offer in Compromise or simply need time through an installment agreement, the IRS provides legitimate paths to resolution.

Keep Your Finances Organized Moving Forward

Resolving IRS debt is only the first step—staying compliant prevents future problems. Clear, accurate bookkeeping throughout the year makes tax filing straightforward and ensures you're never surprised by what you owe. Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data. Track income and expenses in real time, generate reports when you need them, and maintain the organized records that make tax resolution—if you ever need it again—far simpler. Get started free and take control of your financial future.