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What to Do if You Can't Pay Your Tax Bill

Gerri Detweiler

While tax time isn’t something most of us look forward to, some do anticipate a “reward” in the form of a refund check. But if you discover you owe the IRS money, it’s another story.

If you find you owe taxes, and you can afford to pay the tax due, it’s 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.

What isn’t an option

Not filing is not an option. If you don’t file your return by the deadline, you might face a failure-to-file penalty. If you don’t pay by the due date, you could face a failure-to-pay penalty. It’s better to file your return and avoid the first penalty, even if you can’t pay right away.

Keep in mind that if you owe $10,000 or more and can’t pay it right away, the IRS may file a Notice of Federal Tax Lien. Tax liens are reported to the major credit bureaus, and are considered very negative information so your credit scores can drop significantly as a result.

Under the federal Fair Credit Reporting Act, tax liens can be reported longer than any other type of negative information — seven years from the date they are paid. However, under the IRS Fresh Start initiative, you may be able to get a tax lien withdrawn and removed from your credit reports once you pay it, or enter into an installment agreement, which we’ll discuss in a moment. That’s all the more reason to find a way to work with the IRS rather than avoid paying.

If you owe tax debt, the IRS can also take serious enforced collection action, such as taking money from your bank accounts, wages, or other income. In general, they have many more options available to collect your tax debt than do other companies you may owe money to.

Charge it

You can use a credit card to pay your taxes 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 online.

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 impose convenience fees. The tax payment is sent to the U. S. Treasury and the convenience fees are listed separately on the cardholder’s credit card statement.

For the 2012 filing season, five companies are 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 charges a convenience fee ranging from 1.88% to 2.36% of the amount paid.

The question is, “Should you pay your taxes with your credit card?

The disadvantage of charging your taxes is that you may have to pay the convenience fee plus interest to your card issuer while you pay off the balance. And the higher balance on your credit report can affect your credit scores. The advantage, though, is that you will have paid your debt to the IRS. Credit card issuers don’t have the same collection powers the IRS does.

Note that if your credit card issuer sends you promotional checks, you can use one of these to pay your taxes. You won’t receive bonus points or other offers, and there may be a convenience fee charged by the card issuer. But depending on the offer, the interest rate may be lower than the interest rate for purchases. If your issuer does charge a fee for one of these checks, it doesn’t hurt to ask if the fee can be waived.

Line up a loan

Whether it’s a personal loan, a home equity line of credit, or a loan from your retirement account, there are times when it makes sense to borrow to pay off the IRS. As with any loan, you want to understand the interest rate, fees and payment terms to make sure you can afford it. You may also want to keep in mind that a loan to pay taxes can affect your credit scores.

Request a monthly payment plan from the IRS

If you can pay your full tax bill over time (in six years or less in most cases), you may want to ask the IRS for an installment agreement. 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 $50,000 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 $50,000 in combined taxes, penalties, and interest you may still qualify for an installment agreement, but you may have to complete a Collection Information Statement, Form 433F. Call the number on the bill or mail the Request for Installment Agreement, Form 9465 and Form 433F to the address on the bill.

The fee for a direct debit installment agreement, where payments are deducted directly from a taxpayer’s bank account, is $52. It is $105 for a standard agreement or payroll deduction agreement and $43 if your income is below a certain level.

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 your tax returns on time for the past 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.

And installment agreements aren’t reported to credit reporting agencies.

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. And if you are due a tax refund while you are paying a tax debt on an installment plan, your tax refund will be taken (“offset”) to pay the debt more quickly.

In addition to the upfront fee for one of these plans you will also pay interest — currently figured at around three percent per year, compounded daily — plus a late payment penalty. This penalty, usually 0.5 percent of the balance due per month, drops to 0.25 percent 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 but can pay within the next four months due to a hardship, 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 its warnings and requirements, including a detailed list of your assets and itemized spending and income for the past three months, is enough to scare most taxpayers off this option. 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 2011, for example, the IRS rejected almost three times as many OIC applications as it approved.

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, though, 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 on the IRS website.

However, recently the IRS has announced new rules designed to make it easier for taxpayers to resolve their tax debt with an Offer in Compromise. That doesn’t mean it’s simple; but it will be easier for some taxpayers to settle because the IRS will accept less than before in certain cases.

When submitting an application for an OIC, the taxpayer must include a $150 application fee, along with an initial payment. There are exceptions to this requirement for low-income taxpayers, or offers filed when there is doubt as to liability only.

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 your application is declined, the IRS will keep that money and apply it to your tax debt.

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.

Look forward

In addition to taking care of previous tax liabilities, make sure you adjust your withholding or increase your estimated tax payments so you aren’t in the same situation next year.

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