Economic hardship in the tax context refers to a situation where a taxpayer cannot pay their tax debt without sacrificing essential living expenses such as food, housing, medical care, and utilities. The IRS uses specific national and local standards to evaluate whether your income and resources are insufficient to meet these basic needs once your tax obligations are considered.
How the IRS Defines Economic Hardship
The IRS defines economic hardship based on whether collection actions would leave you unable to afford basic necessities. This is more than short-term money troubles; it reflects a serious financial condition, often caused by unexpected events like job loss, serious illness, or natural disasters.
Relief Options Available for Economic Hardship
The IRS offers several tools to help taxpayers facing economic hardship:
1. Currently Not Collectible (CNC) Status
When taxpayers cannot pay their tax debt without experiencing severe financial difficulty, the IRS may place their account in CNC status. This temporarily halts collection activities such as levies, garnishments, and letters, though penalties and interest continue to accrue.
To qualify, you must provide detailed financial information to prove your inability to pay based on IRS financial standards. The IRS reviews your status periodically (usually yearly) to see if your financial situation has improved. The IRS typically has 10 years from assessment to collect taxes, so time continues to run during CNC status unless your situation remains unchanged until the statute expires.
2. Offer in Compromise (OIC)
An Offer in Compromise allows taxpayers to settle their tax debt for less than the full amount owed if they can demonstrate that full payment is not possible or would cause undue economic hardship.
The IRS considers:
- Doubt as to Collectibility: You truly can’t pay the full amount.
- Effective Tax Administration: Paying the full amount would cause financial hardship or be unfair.
Acceptance of an OIC requires comprehensive financial disclosure and is subject to stringent IRS review. Upon acceptance, the agreed-upon amount must be paid, and the remaining debt is forgiven.
Real-Life Situations Leading to Economic Hardship
Common circumstances include:
- Sudden unemployment or reduced income
- Serious health issues or disability
- Natural disasters destroying property
- Death of primary income earners
- Divorce or separation disrupting finances
- Caring for seriously ill family members
Eligibility and Requirements
Eligibility typically requires you to:
- Demonstrate inability to pay without sacrificing basic living expenses
- Be current with required tax filings
- Prove no reasonable assets or borrowing opportunities exist to pay the debt
The IRS evaluates allowable living expenses using standardized figures covering essentials and compares them against your reported income.
Tips for Managing Tax Debt During Economic Hardship
- Communicate promptly and honestly with the IRS
- Organize thorough financial documentation
- Explore relief options: CNC, OIC, or installment agreements
- Consider professional tax help from an Enrolled Agent or tax attorney
- Prioritize essential expenses like housing, food, and medical care
Other IRS Collection Alternatives
| Collection Alternative | Description | Key Points | Tax Forgiveness? | Duration |
|---|---|---|---|---|
| Currently Not Collectible | Temporary suspension of collection actions when you can’t pay without severe hardship. Interest and penalties accrue; reviewed periodically. | Requires detailed financial proof; pauses active collection. | No | Continues until circumstances change or 10-year statute expires |
| Offer in Compromise | Settles tax debt for less than owed based on inability to pay or hardship. Requires extensive financial disclosure and IRS approval. | Can significantly reduce debt; requires compliance for 5 years after acceptance. | Yes | One-time resolution |
| Installment Agreement | Allows payment over up to 72 months, making debt more manageable though interest continues to accrue. | Easier to qualify than OIC; keeps collection at bay during payments. | No | Up to 6 years; can be renegotiated |
Common Myths Clarified
- Ignoring tax debt worsens penalties and collection, it doesn’t make it disappear.
- Economic hardship doesn’t erase debt but may delay or reduce it.
- IRS requires proof; hardship claims without documentation are rejected.
- Offers in Compromise are difficult to obtain and require strong cases.
- Bankruptcy might discharge some tax debt but isn’t a guaranteed solution.
FAQs
Q: How does the IRS determine basic living expenses?
The IRS uses national and local standards for food, housing, utilities, transportation, and more. These are published on the IRS website and guide what expenses are considered “necessary.”
Q: Will my tax refund be applied to debt if I’m in CNC status?
Yes. Refunds are typically applied to outstanding tax debt even while in CNC status since this status pauses collections but does not forgive debt.
Q: Does economic hardship apply to state taxes?
Many states have their own provisions similar to the IRS for hardship relief. Check with your state’s tax agency for details.
Q: How long does it take to get CNC status or an OIC approved?
CNC can be granted relatively quickly if your financial situation is clear. OIC approvals are more complex and may take several months or longer.
For more detailed IRS guidelines on economic hardship and relief programs, see IRS Collection Financial Standards and IRS Offer in Compromise.