What to do if you Can't Pay your Tax Bill

While tax time isn’t something most of us look forward to, some of us do anticipate a “reward” in the form of a refund check. But as of December 15th, 2006, nearly 35 million returns did not include a refund, and no doubt many of those consumers found they owed the IRS a good chunk of money.

If you can afford to pay your tax bill, it is best to just write a check and get it over with. But if you don’t have that kind of cash lying around, take a look at other options. Note that tax rules change frequently, so check with your tax preparer or the IRS for updates to this information.

Not an option

What’s not an option is not filing. If you don’t file, or if you don’t find a way to pay what you owe, taxes and penalties can accumulate quickly. If you don’t pay what you owe, a Notice of Federal Tax Lien could be filed against your property. Tax liens are reported to the major credit bureaus and they can drop your credit score significantly. They can be reported as long as any other type of negative information – seven years from the date they are paid. 

The IRS can ask you to sell or mortgage your assets or urge you to get a loan. Your tax debt may be turned over to a private collection agency. The IRS can also take more serious enforced collection action, such as taking money from your bank accounts, wages, or other income, or taking other assets. In general, they have many more options available to collect your tax debt than other companies to whom you may owe money.

Charge It!

You can use a major credit card (American Express, Discover, MasterCard, or VISA credit card) whether you file electronically or file a paper return. Credit card payments can be submitted via tax software when filing electronically. Credit card payments can also be made over the telephone and by filing on line. In 2005, about 1.5 million taxpayers paid by credit card, an increase of 54% from the previous year.

The IRS does not set or collect any type of fee for credit card payments, but the private sector companies the IRS has authorized to process these payments do impose convenience fees. The tax payment sent to the U.S. Treasury and the convenience fee are listed separately on the cardholder’s credit card statement.

For the 2006 filing season, two companies were authorized by the IRS to accept credit card charges from both electronic and paper filers. Each company offers both phone and Internet payment services and each charges a convenience fee (currently 2.49% of the amount paid) for the service. Fees are based upon the amount of the tax payment and may vary between companies. The two companies are:

Link2Gov Corporation, 1-888-PAY-1040 (1-888-729-1040). 

Official Payments Corporation, 1-800-2PAY-TAX  (1-800-272-9829)
 
The disadvantage is that you may have to pay the convenience fee and interest to your card issuer while you pay off the balance. The advantage is that you will have paid your debt to the IRS. It’s generally better to have an outstanding bill with a credit card company than with the IRS.

Last year a number of issuers encouraged consumers to pay their taxes with their credit cards with special offers that allowed consumers to reduce or waive the convenience fee and/or earn extra reward points. Visit the above links as tax time approaches to learn more about current offers. Keep in mind that the extra interest charges you pay can quickly outweigh any rewards. Do the math and choose your lowest-rate credit card to minimize the cost.

Tip: If your credit card issuer sent you promotional checks with low interest rates, you can use one of these to pay your taxes. You won’t receive bonus points or other offers, but you won’t pay a convenience fee and the interest rate may be lower than your normal interest rate for purchases. Watch out for fees associated with these checks. If there are fees, ask the issuer to waive them.

Line up a loan

Whether is a personal loan, a home equity line of credit, or a loan from your retirement account, you may want to borrow to pay off the IRS. As with any loan, the interest and fees are important to understand. But when it comes to owing the IRS or a lender, a lender almost always wins hands down. If you act quickly, you should be able to avoid a tax lien on your credit report.

Request a monthly payment plan from the IRS

If you can pay your full tax bill over time (in more than four months but less than five years, in most cases), you may want to ask the IRS for an installment agreement. In fiscal year 2006, almost 2.8 million taxpayers established installment agreements to pay their tax bills. With an installment plan, you make regular monthly payments until your tax bill is resolved. Like other options, you can only request an installment agreement if all required tax returns have been filed.

If you owe $25,000 or less in combined tax, penalties, and interest, you can use the IRS Online Payment Agreement (OPA) to request your installment agreement or call the number on the bill or notice you received. A fill-in Request for Installment Agreement, Form 9465, is available online that can be mailed to the address on the bill.

If you owe more than $25,000 in combined tax, penalties, and interest, you may still qualify for an installment agreement, but a Collection Information Statement, Form 433F, may need to be completed. Call the number on the bill or mail the Request for Installment Agreement, Form 9465 and Form 433F, to the address on the bill.

Fees for installment agreements increased in 2007. The fee for new direct debit installment agreements, where payments are deducted directly from a taxpayer’s bank account, went up from $43 to $52. The fee for other new installment agreements went from $43 to $105.

When you file your request for an installment agreement, you will have to pay what you can afford immediately and pay the rest over a reasonable period of time. You will have to specify the amount you can pay and the day you wish to make your payment each month. Online requests are usually confirmed in ten days, while written requests may take longer. The IRS will respond to let you know if your request is approved, denied, or if additional information is needed.

Here is the good news: If your tax debt is less than $10,000, your request will automatically be approved as long as you have filed all of your tax returns on time for the last five years and have paid the tax due without using an installment agreement; the IRS has determined you cannot pay the full amount you owe immediately (and you have given them the information they need to determine that); and you agree to pay your tax bill in full within three years and comply with all tax laws. 

Here is the bad news: Even if your installment agreement is accepted and you make the proposed payments on time, the IRS may still file a Notice of Federal Tax Lien to secure the government’s interest in your property against other creditors.  A notice of federal tax lien attaches to your personal or real property until final payment is made and, as we mentioned above, it will have a negative impact on your credit score.

In addition to the upfront fee, you will also pay interest – currently figured at around 8% per year, compounded daily – plus a late payment penalty. This penalty, usually 0.5% of the balance due per month, drops to 0.25% when the IRS approves the agreement for an individual taxpayer who filed the return on time and did not receive a levy notice.

Request a short-term extension

If you cannot pay in full immediately due to a hardship but you can pay within the next four months, you may be eligible for a short-term extension of time to pay of up to 120 days. (An extension to pay is not the same as an extension to file.) There is no fee for an extension to pay. You can file a completed Form 1127 along with a statement explaining why paying now would be a financial hardship for you.

Tax attorney Scott Estill, author of Tax This: An Insider’s Guide to Standing Up to the IRS, warns that the IRS does not approve the majority of these requests. Looking at the form with it’s warnings and requirements, including a detailed list of your assets and itemized spending and income for the past for the last three months, is enough to scare most taxpayers off! Most taxpayers will instead request either an installment agreement or an offer in compromise, or find another way to pay.

Request an offer in compromise

An Offer in Compromise (OIC) is an agreement between a taxpayer and the IRS that resolves the taxpayer's tax debt. The IRS has the authority to settle or "compromise" federal tax liabilities by accepting less than full payment under certain circumstances. These include doubt that the assessed tax is correct and doubt that you could ever pay the full amount owed. But it’s not an easy way to pay less than you owe. In fact, the IRS says it resolves less than 1% of all balance due accounts through the OIC program.

When you see ads claiming you can “settle your tax bill for less than you owe,” they are usually referring to an offer in compromise. Be careful, however, of promises to settle your tax bill for pennies on the dollar. The IRS warns that some companies are collecting excessive fees from consumers who will never qualify for these programs. You can complete all the paperwork on your own by following the instructions found at the IRS website.

Like most tax issues, the rules for offers in compromise have become more complicated. With the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), significant changes were made to the IRS Offer in Compromise (OIC) program. These changes went into effect on July 16, 2006.

As a result, it may make sense to get help from a tax professional to help you evaluate your options and prepare your offer in compromise. The IRS generally has 24 months to accept or reject your offer or negotiate a further compromise.

One of the main changes in the law requires that offers submitted after July 16, 2006, must be accompanied by a $150 application fee, and partial payments of the proposed offer amount. The form of these partial payments depends upon the taxpayer’s proposed offer and its terms. (There are exceptions to this requirement for low-income taxpayers, or offers filed when there is doubt as to liability only. See more information below.)

When you file your offer (excluding doubt as to liability offers) you must specify whether you are filing a lump sum or periodic payment offer. In the case of a “lump sum” (which means five or fewer installments), you must pay 20 percent of the offer amount with the application.

If you file a “periodic payment offer” (which means six or more installments), you must pay the first proposed installment payment with the application and pay additional installments while the IRS is evaluating the offer.

If you are a low-income taxpayer, or you are filing a doubt as to liability offer only, the $150 application fee is waived and you do not need to make a partial payment. A low-income taxpayer is an individual whose income falls at or below poverty levels based on guidelines established by the U.S. Department of Health and Human Services (HHS). Additional paperwork is required.

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