How does tax relief work?

Reducing taxable income

If you’re unsure how to proceed, it’s best to consult with a qualified tax professional. In the meantime, we’ve listed a brief summary of deductions, credits and exemptions below.

Tax deduction

A tax deduction is a reduction in the amount of your income that's taxed. Common deductions include charitable donations and mortgage interest. (Note: Childcare expenses are typically covered under a tax credit, not a deduction.)

When you file taxes, you’ll choose between itemizing deductions or taking the standard deduction, which is a flat amount based on your filing status.

Here’s how tax deductions work: Say you’re a married couple earning $100,000 per year and you have itemized tax deductions that total $30,000. In this case, you'll only be taxed on $70,000. But if your tax deductions equal just $15,000, you’d be better off taking the standard deduction, which is currently $29,200 for joint filers (and $14,600 for single filers). This lets you reduce your taxable income more — and ultimately pay less in taxes.

» EXPLORE: Tax deductions for homeowners

Tax exemption

A tax exemption is similar to a tax deduction in that it reduces taxable income. A minor difference is that an exemption means a certain amount of your income will be “exempt” from taxation without respect to your expenses, Allec says. Examples of exemptions include fees for social clubs, labor organizations and Veterans’ organizations.

» RELATED: What is tax avoidance?

Tax credit

A tax credit is a dollar-for-dollar reduction in your tax liability, according to Allec. Examples of tax credits you might be eligible for include education costs, low-income credits, child credits (a credit for each child you can claim as a dependent) and investments in solar panels for a home or a car.

Here’s how tax credits work: Let's say you earn $100,000 in a year. You have $30,000 in deductions, so you’re taxed on the remaining $70,000. Assuming a 10% tax rate, your before-credit tax liability is $7,000. Now, suppose you qualify for a $1,000 credit; this would reduce the tax you owe to $6,000.

Always file on time

Even if you can’t pay the full balance of your tax liability right away, you should still file your taxes on time. Failure to do so will cause you to incur penalties, which can serve to worsen your financial situation.

» LEARN: How to file your taxes for free

Types of tax relief

If, despite the above reductions, you still have more tax than you can handle, there are a few types of tax relief to consider:

• Installment agreement: These are long-term payment options of more than 180 days. You can qualify as an individual once you’ve filed your taxes if you owe less than $50,000 in combined taxes, fees and penalties. You can apply for an installment plan on the IRS website.
• Partial pay installment agreement: This is a monthly payment plan that lets you pay what you can afford until the collection statute date expires (typically 10 years). After that, you’ll be released from the obligation of paying the remaining balance.
• Offer in compromise: One of the most well-known forms of tax relief, an offer in compromise lets you settle your tax debts for a portion of the full amount you owe. It’s most often approved when the IRS feels your offer matches what they could expect to collect from you in a reasonable amount of time.
• Currently not collectible status: If you have a severe financial hardship and you are choosing between paying your household bills or the IRS, you may qualify for currently not collectible status. “Under a CNC, you are protected from IRS collections and not required to pay the IRS anything,” Allec said. “However, this status is most often temporary.” Unfortunately, you’ll still accrue penalties and fees while on CNC status, meaning you’ll owe more when the IRS lifts your payment reprieve.
• Penalty abatement: The IRS assesses stiff penalties if you don’t file or pay your taxes in accordance with their deadlines. A penalty abatement — either a one-time or a reasonable cause abatement — allows you to request a reduction or removal of penalties associated with the debt you owe.

Eligibility for tax relief

The IRS uses your income, living expenses and equity in assets to determine if you qualify for its tax debt relief programs. You may not have to prove much information to the IRS if you’re simply requesting a few extra months for repayment. But a more formal agreement, like an offer in compromise, comes with certain eligibility requirements.

Requirements for an offer in compromise

• Not currently involved in bankruptcy proceedings
• All federal tax files have been properly filed
• All estimated tax payments have been made
• All federal tax deposits have been made (if you have employees)

Requirements for currently not collectible status

• Your monthly expenses exceed your monthly income.
• Your monthly income would not be enough to cover basic living expenses if you were making payments toward your tax debt.
• You have no income.
• You live on Social Security or other fixed income.

In addition to these eligibility requirements, you should be prepared to show proof of income, expenses, and/or equity in assets, including paystubs, bank statements, statements showing living expenses, retirement accounts, mortgage statements and/or vehicle loan documents, says Allec.

How to apply for tax relief

The process of applying for tax relief varies based on your individual situation and the type of relief you’re seeking. Requests for brief extensions to the repayment period can be done over the phone.

According to Allec, “The process will typically involve calling IRS ACS (Automated Collection System), letting them know what you need in order to repay your tax debt, and stating your financial situation over the phone. ACS may then ask for supporting documents (such as bank statements and pay stubs) and then send your case to a manager for review.” To apply for currently not collective status, simply fill out Form 433-F, Form 433-A or Form 433-B and provide proof of your financial status.

How to apply for an offer in compromise

Submitting an offer in compromise typically involves a more formal process. Working with a tax relief company is an option to make this easier for you.

1. Complete IRS Form 433-A (individual) or Form 433-B (business).
2. Collect all required documentation specified on the form.
3. Complete IRS Form 656, which lists your individual and business tax debt.
4. Pay the non-refundable $205 application fee.
5. Make an initial payment as per Form 656.
6. Mail the application to the site listed on Form 656.
7. Consult the IRS’ Offer in Compromise Booklet for step-by-step instructions.