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Updated on Tuesday, April 11, 2017
Owing a debt you can’t pay is a situation nobody wants to find themselves in, and it can be especially stressful when that debt is owed to the IRS. Many people fear the IRS and not without reason.
The IRS has collection powers that many creditors don’t have, including garnishing wages, seizing bank accounts, and even putting liens on property. Yet many people occasionally face a situation where they have a tax debt they just can’t pay. There are many options for dealing with tax debt, but ignoring it and hoping it goes away is not one of them. If you find yourself in this unfortunate situation, check out these tips for facing tax debts.
Filing for a filing extension will not give you more time to pay back the debt
Some people mistakenly believe that if they extend their tax return, they’ll have additional time to pay the amount due with their return. But an extension is just an extension of time to file, not to pay. You are still obligated to calculate the amount you’ll owe and pay that by April 15, even if you’re not yet ready to file.
Pay as much of the debt as possible by the filing deadline
When you file an extension but don’t pay 90% of the tax you owe for that year, the IRS will charge a failure-to-pay penalty. The penalty is generally 0.5% per month on the balance of your unpaid balance, and it starts accruing the day after taxes are due. It can grow to as much as 25% of your unpaid taxes.
In addition, interest will accrue on any unpaid tax from the due date of the return until you pay your balance in full. The interest rate is determined quarterly and is the federal short-term rate plus 3%.
If you can’t pay the amount you owe, filing your return without making a payment won’t avoid penalties and interest, but it’s important to know that filing an extension won’t help you avoid them either. Just file on time and pay as much as you can to reduce penalty and interest charges.
Now that you’ve filed your return and know how much tax you owe, it’s time to consider your options for paying the balance due.
How to pay your tax debt
By credit card
If you don’t have the money to pay the amount due immediately, the IRS does accept credit cards, but be wary of paying your tax debt with plastic. Although the IRS doesn’t charge a fee to pay by credit card, the company that processes your payment will charge a fee ranging from 1.87% to 2.00% of the payment amount. Plus, you’ll need to consider the interest your credit card company will charge until you pay off the balance.
The IRS will charge a far lower interest rate than your credit card, which means you can pay off the debt much quicker.
Enroll in an IRS repayment plan
Paying a tax debt via credit card may not be an option if the amount due exceeds your credit limit, or it may not be the best choice if your credit card has a high interest rate. In that case, you may be able to work out a payment arrangement with the IRS. Just be aware that your account will continue to accrue penalties and interest until the balance is paid in full.
Here are three types of IRS repayment plans:
Short-term extension to pay
If the amount you owe is relatively small and you believe you can pay it off within 120 days, call the IRS and ask for a short-term extension of time to pay. This is not a formal payment plan. The IRS will just make a note on your account that you’ve been granted additional time to pay the full amount. During this period, they will not take any collection action against you.
If you aren’t able to pay your debt in full within 120 days, Scott Taylor, a CPA with Piercy Bowler Taylor & Kern in Las Vegas, Nev., recommends that you contact the IRS to arrange an installment agreement. An installment agreement is basically a monthly payment plan. You can apply online for an installment agreement if you owe $50,000 or less in combined tax, penalties, and interest. For balances over that amount, you will need to complete Form 9465 and Form 433-F and send them in by mail.
With an installment agreement, you decide how much money you will pay each month and on what date you’ll make the payment. As long as your debt will be paid off within three years and you owe less than $10,000, the IRS has to accept your payment plan.
Keep in mind that the IRS also charges user fees for installment agreements. “Unfortunately for taxpayers, the fees have gone up as of January 2017,” Taylor says. The cost to set up an installment agreement is $225. If you apply online and choose to have the monthly payments directly debited from a bank account, the fee drops to $31.
If your ability to pay the agreed upon amount changes later on, you’ll need to call the IRS immediately. When you miss a payment, your agreement goes into default and the IRS can start taking collection action. For example, if your agreement calls for a $300 payment and you lose your job and aren’t able to make the payment, call the IRS before you miss a payment. They may be able to reduce your monthly payment amount to reflect your current financial situation.
Partial payment installment agreement
What if you owe so much that you can’t pay it off in a reasonable period of time? In that case, you may be eligible for a partial payment installment agreement. Like a regular installment agreement, you will make regular, agreed upon payments for a set period of time. However, the payments will not pay off the entire debt. After the agreement period ends, the remaining debt will be forgiven.
As you can imagine, the IRS doesn’t take debt forgiveness lightly, so applying for a partial payment installment agreement is more complicated than applying for a regular installment agreement. Instead of letting you decide how much you can afford to pay each month, the IRS will calculate your monthly payment by taking into account your outstanding balance, the remaining statute of limitations for collecting the debt, and the reasonable potential of collection.
To request a partial payment installment agreement, it’s best to consult a tax professional with experience handling tax debts. Before the IRS approves a partial payment installment agreement, you will need to have filed all of your tax returns and be current on your income tax withholding or estimated payments.
How to settle your tax debt (offer in compromise)
You’ve probably heard the television commercials promising to help you “settle your tax debt for pennies on the dollar.” These ads refer to an offer in compromise (OIC), and they’re not as easy to get as those ads would have you believe.
With an OIC, you agree to a lump-sum or short-term payment plan to pay off a portion of your debt in exchange for the IRS forgiving the remainder of the debt.
To qualify, you must prove that you are unable to pay off the entire debt through an installment agreement or other means. It can be difficult to meet the income and asset guidelines to qualify for an OIC, so it’s best suited for taxpayers with low income and very few assets.
You can check to see if you are eligible for an OIC by using the IRS’s pre-qualifier tool. To apply, you’ll need to complete Form 656 and Form 433-A and submit them along with an application fee of $186. You’ll also be asked to provide documentation to support the financial information provided in the forms.
Again, it’s a good idea to get help from a tax professional with experience working with OICs to help you complete the forms and walk you through the complex process. Be wary of tax resolution firms making promises that sound too good to be true. Check with the Better Business Bureau and the state attorney general’s office for complaints before you pay a retainer.
Tax debt discharge
There is a 10-year statute of limitations on tax debt collection, so if you are having serious financial issues and can’t pay at all, letting that statute run out may be an option. To do this, you’ll need to get your tax debt in currently-not-collectible (CNC) status by demonstrating that you cannot pay both reasonable living expenses and your tax debt.
To request CNC status, the IRS will ask you to provide financial information on Form 433-A or Form 433-F and provide documentation to support amounts listed on the statement. If you have any assets that the IRS believes could be sold to pay your debt, they may not grant CNC status.
While your account is in CNC status, the IRS will not pursue collection, but if you are owed any tax refunds on returns filed while your account is in CNC status, the IRS may keep your refunds and apply them to your debt. They may also file a Notice of Federal Tax Lien, which can affect your credit score and your ability to sell your property.
The IRS will review your income annually to see if your situation has improved. If you maintain CNC status until the 10-year statute of limitations runs out, you may no longer be required to make payments, regardless of whether your financial situation improves later on.
What if you don’t agree with the amount due?
If you owe a lot more than you expected, take a moment to review your completed return carefully to look for errors. Make sure you didn’t accidentally enter the same income twice or forget an important deduction, and make sure you answered all of the questions correctly. One missed question or checkbox can cause you to miss out on valuable tax benefits. Also, compare this year’s return to last year. If your tax bill went up drastically even though your situation hasn’t really changed, find out why.
Occasionally, taxpayers receive notices from the IRS indicating an amount due that they don’t agree with. Don’t feel like you have to pay an amount you don’t believe you owe just because it comes on IRS letterhead. Taylor says each notice will include a section detailing how to respond.
“The IRS may have made an error in matching up 1099s or W-2s, and the amount owed needs to be adjusted,” he says, and he recommends that you send a letter via certified mail in response, with a full explanation. “A CPA can help you with this letter, but if you follow the guidelines provided by the IRS, you should be able to respond appropriately and have the fees resolved or adjusted.”
IRS collection enforcement
If your taxes are not paid on time and you do not communicate with the IRS, they can issue a Notice of Levy. An IRS levy permits the legal seizure of your property. They may garnish your wages or seize your bank account, vehicles, real estate, or other personal property to satisfy the debt.
Taylor says IRS notices will only come via U.S. mail, so be sure you check your mail and read all IRS notices. “It seems like a simple thing,” Taylor says, “but with many financial and personal transactions occurring online, many people ignore their mailbox for long periods of time.”
Whatever your situation, Taylor says it’s important to remain in contact with the IRS to show your intent is to pay your debt. “Don’t ever ignore IRS notices,” Taylor says. “The IRS is willing to coordinate payment plans, and the consequences of ignoring them are always difficult to adjust.”