Options When You Can't Pay Your Income Tax Bill
What now?
You find yourself in the unenviable position of owing money to the IRS, but
you don't have the cash to pay what you owe. What are you going to do? Perhaps
the worst thing you can do is nothing. As much as you might hope, the amount
that you owe isn't going to just go away. In fact, the amount you owe will
increase significantly over time, since the IRS charges interest and penalties
on overdue unpaid balances. If you ignore the problem long enough, the IRS will
initiate enforcement and collection procedures that may include the placement of
liens on your property or the seizure of your assets. Moreover, if you try to
evade the IRS or conceal assets, you could be subject to criminal penalties.
Caution: One of the biggest mistakes people make is not filing a federal income tax return by
the due date because they owe taxes, can't afford to pay the amount owed, and want to postpone the billing and collection process. This is a very bad decision for a number of reasons. By not filing your federal income tax return on time, you're subject to a failure-to-file penalty in addition to interest and penalties on any taxes due. The failure-to-file penalty is generally 5 percent of the amount of unpaid taxes as of the due date, per month (or part of a month) that the return is late, up to a maximum penalty of 25 percent. By the time you finally do file your return (and if you don't, the IRS will eventually file one for you), the amount of accrued interest and penalties can be staggering. You're much better off filing your return and choosing one of the tax payment options available to you.
You should always pay as much of your tax liability as possible, whether at the time you file your return or in response to an IRS bill for an unpaid tax balance. Whatever you pay will reduce the balance that the IRS uses to compute interest and penalty charges, so you'll save money in the long term. If you're short on cash and can't pay the entire amount due, consider paying some or all of the taxes due by credit card. If necessary, try to borrow the funds, either from a financial institution, or from a relative or friend. If those options aren't feasible, you can request an installment payment agreement from the IRS. Finally, if your financial situation demands it, you may consider more drastic options such as proposing an offer in compromise, or (in very limited circumstances) filing for bankruptcy.
Paying by credit card
The IRS allows taxpayers to pay their taxes by credit card or debit card.
You can make credit card payments through certain tax software programs or
through an authorized service provider. For more information, see Paying the
IRS. If you wish, you can split payments between two different credit cards, but
only certain cards will be accepted. You'll probably want to pay the tax bill
with the credit card (or cards) carrying the lowest interest rate.
Caution:
If you pay your income taxes by credit card, the service provider will charge you a fee.
The fee varies with the amount of taxes that are charged, and is in addition to any interest charged by your credit card company.
Paying by credit card offers certain advantages. Because you're paying your taxes in full, you'll avoid future IRS penalties and interest charges. In addition, you may earn airline miles or other rewards from your credit card issuer for using your card. Of course, unless you payoff the balance each month, there's a finance charge associated with amounts charged to a credit card. In fact, the credit card issuer's finance charge may be higher than what the IRS charges on late payments.
Loans
You may want to consider borrowing the funds to pay your federal income tax.
If you can borrow money from a relative or friend to pay your tax bill in full,
you won't incur any future IRS penalties and interest charges, and you may have
to pay little or no interest on the personal loan.
Caution:
If you borrow more than $10,000 from a friend or relative and the terms of the loan
are more favorable than current market conditions, the below market-interest loan rules may trigger certain tax consequences.
You might also consider paying your tax bill with an unsecured bank loan or funds drawn from a home equity line of credit. While the interest you pay on either of these loans may be higher than what you'd pay on a loan from a family member or a friend, it may still be less than the interest and penalty charges you'd have to pay the IRS. In addition, the interest you pay on a home equity line of credit is generally deductible on your federal income tax return if you itemize your deductions.
Installment payment agreement
An installment payment agreement is a monthly payment plan that you arrange with
the IRS. The amount of your payment is based on how much you owe in unpaid tax
and your ability to pay that amount within the time available to the IRS to
collect the debt. Although your plan may be for a shorter length of time, you
generally may be allowed up to 60 months to pay.
To enter into an installment agreement, contact the IRS by mail, or telephone the agency at (800) 829-1040. You'll be sent Form 9465, Installment Agreement Request. If you owe more than $25,000 in tax (not including interest, penalties, and other additions) you may also have to complete a Collection Information Sheet (Form 433-A or 433-8) detailing your assets and expenses. If your tax liability is under $10,000 and you agree to pay the full amount you owe within three years (and you meet certain other agreement requirements), your request for an installment agreement must be accepted by the IRS. You'll be charged a $43 fee to set up the agreement.
You'll generally be expected to pay the maximum monthly installment amount that you're able to make. You may make your payments by check, payroll deduction, or direct debit from your bank account. You won't avoid interest and penalty charges with this payment method, but you will avoid more severe collection action as long as you make your payments on time.
Caution: Taxpayers who are unable to pay their full tax liability within the installment period may request a partial payment installment agreement (PPIA). PPIAs are subject to additional substantiation requirements and review criteria. Installment payments under a PPIA will likely need to be paid under a direct debit arrangement.
Offer in compromise
An offer in compromise is
a negotiated settlement between you and the IRS that resolves your tax
liability. If your offer is accepted, the IRS agrees to settle your unpaid tax
obligation (including any interest, penalties, or other additions) for an amount
that's less than the total you owe.
To apply for an offer in compromise, you must either disagree with the IRS
determination of the amount you owe, doubt you can fully pay what you
acknowledge to be your tax liability, or demonstrate that collecting it would
either create an undue economic hardship or be unfair and inequitable. You must
complete Form 656, Offer in Compromise. You may also be required to fill out a
Collection Information Sheet (Form 433-A or 433 8) and you'll need to provide
documents (such as financial statements, pay stubs, and bank records) verifying
your assertions.
How much you'll need to offer in compromise depends on both the basis on which you are applying and what payment terms you request. Generally speaking, the longer the payment term you request, the more you'll have to offer to secure acceptance by the IRS. While submitting an offer in compromise can be a complicated process, an accepted offer may substantially lower your tax obligation and help you avoid more severe collection actions.
Bankruptcy
Generally, taxes cannot be avoided in bankruptcy. Additionally, bankruptcy can
have significant long-term consequences. That said, bankruptcy could help you
manage your tax debts. If you can reduce your debt burden by eliminating or
reorganizing other unsecured debts (such as credit card balances) in bankruptcy,
then you may have more money available to pay the IRS. Additionally, in a
Chapter 13 or Chapter 11 bankruptcy case, you may be able to gain court approval
of a plan to repay the IRS over a period of up to 60 months. While your case is
pending, collection activities will stop (although refunds may be seized to
offset your tax debts), and interest and penalties will cease to accrue.
Tip: The grounds for discharge of taxes in bankruptcy are very narrow. Consult an experienced
bankruptcy or tax attorney for more information.
Prepared By: Suzanne M. Darnall