What to do if You Can’t Pay Your Income Taxes

The following is a post by MPFJ staff writer, Kevin Mercadante, who is a freelance professional personal finance blogger for hire, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.

It can be a real panic situation if you can’t pay your income taxes. But even if you can’t, panic is an emotion that you need to resist. The IRS offers a number of ways to pay your income taxes, so the best strategy is always to take positive action.

File Your Income Tax Return By the Due Date

If you can’t pay your income tax bill, at least make sure that you file your income tax return when it is due. This will start the process that will enable you to make a payment arrangement with the IRS.

It will also reduce the amount of penalties and interest that you will ultimately have to pay. That’s important, because the penalties for late filing your tax return – or not filing it at all – can actually be more severe than what they are for late payment of income tax.

File for an Extension of Time to Pay Your Tax Bill

If you have ever filed an extension to file your income tax, you may be surprised to learn that there is also an extension available to pay your income taxes, if the non-payment is due to temporary factors. If you don’t have the money to pay now, but you expect that you will a few weeks or months, this is a good strategy.

The extension to pay will get you up to 120 days to make a full payment. Just remember that you must file your income tax on time in order to begin this process.

You can make the request for an extension of time to pay by calling the IRS directly at 800–829–1040 (there are no forms for you to complete). Using this payment option you will not have to pay any type of upfront fee, but interest and penalties will be assessed on the unpaid tax balance until it is fully paid.

Set Up an Installment Agreement

If you have a larger tax liability, one that you will be unable to pay within 120 days, you can set up an installment agreement. The IRS will allow you to set up a payment agreement that will extend as long as 72 months (6 years), and require equal monthly payments until the liability is completely paid. Penalties and interest are added to the amount of your tax liability due and there is a small setup fee ($50 to $120) to initiate the process.

You can use this method for a tax liability up to $50,000, however you may be required to submit personal financial statements in the event that the balance due is higher than $25,000.

There are three ways that you can set up an installment agreement:

1. Contact the IRS by phone, again at 800-829-1040, or by calling 800-829-4933 if the liability is for a business tax return
2. Complete an Online Payment Agreement Application, or by filing IRS Form 9465 and file it with your income tax return
3. Complete an Installment Agreement Request, and mail it in to the IRS

Here’s the general sequence involved in requesting an installment plan:

• You can complete and file Form 9465, or a written request for a payment plan (include all details of the plan, including the monthly payment amount and due date) and attach either form to the front of your return.
• If you have filed your tax return, and the IRS hasn’t contacted you with a bill, you can request a pre-assessment installment agreement on current tax liabilities.
• If you received a bill from the IRS you can request an installment agreement using the Online Payment Agreement Application, or you can submit Form 9465 or attach a written request for a payment plan to the front of your tax bill and return it to the IRS.
• You can also request an installment agreement by calling the toll-free number on your bill or if you do not have a bill, call the IRS at the phone numbers listed above.

Your installment agreement request will generally be processed within 30 days of your application or phone call.

The IRS provides several payment methods, including:

• Direct debit from your bank account;
• Payroll deduction from your employer;
• Payment via check or money order;
• Payment by Electronic Federal Tax Payment System (EFTPS);
• Payment by credit card via phone or Internet; or
• Payment by Online Payment Agreement (OPA).

The IRS usually charges a $120 fee to set up a payment plan, but if you make your payments by direct debit, the fee is only $52. The fee for a request to restructure or reinstate an existing installment agreement is $50.

The amount of your monthly payments should be an amount that you are able to pay comfortably. If you can’t, you may be setting yourself up to default on the installment agreement, which will bring a host of complications. The IRS will allow you to request a specific monthly payment amount, as long as it is sufficient to satisfy your liability within 72 months.

There is also flexibility in regard to the date of the monthly payment. The IRS will allow you to choose a due date between the first and the 28th of each month. If you plan to submit payments by mail, it is recommended that you send them at least 10 days before the due date, that way they will arrive on time.

You can also use payroll deductions to make your monthly installment payments. This can be done by completing and submitting IRS Form 2159, Payroll Deduction Agreement. The form must be completed by your employer since it is an agreement between you and your employer.

Offer In Compromise

So far we’ve been talking about what to do when you actually have the ability to make installment payments. But what happens you can’t do that either?

The IRS offers a solution. It’s referred to as an offer in compromise, or OIC.

You can apply for an OIC if your inability to pay your tax liability is due to permanent financial difficulties, such as a business failure or job loss. The IRS doesn’t completely waive your tax liability, but they may agree to accept a reduced amount as full payment of the debt.

To receive consideration for an OIC you must make sure that all returns have been filed and that previous year’s tax liabilities have been paid. It’s important to understand however that you will not be eligible for an OIC if you’re in bankruptcy proceedings.

You can determine in advance if you are eligible for an OIC by checking out the IRS’s
Offer In Compromise Pre-Qualifier. That won’t represent a formal request for an OIC, but it will help you to know if it is worth pursuing.

Be aware however that applying for an OIC can be a complicated process. You will almost certainly be better off hiring a CPA or tax attorney to handle the process for you, particularly if you have a substantial tax liability.

Using Non-IRS Sources

Applying for what are essentially debt arrangements with the IRS can be a complicated and intimidating process, particularly if you’ve never done it before. For that reason, you might be better off trying to cover your tax liability using other resources. You’ll still be in debt as a result, but at least you won’t be in debt to the IRS.

Sources you might consider to satisfy your tax liability include:

• Credit cards
• Home equity line of credit
• Personal loans
• Family sources
• Selling a major asset or a group of assets

One common source of funds you may want to avoid is liquidating funds from retirement accounts. That may get you the funds you need to satisfy your tax liability, but it will generally result in additional taxes (and often penalties) due as a result of liquidating a tax-sheltered savings plan.

If you owe the IRS money that you can’t afford to pay right now, arrange to satisfy the debt either through an IRS plan, or through alternative resources. The worst strategy is to do nothing. Not only will that make the debt go even higher, but it could result in ugly collection efforts by the IRS that will hurt your credit and disrupt your income. Being proactive is always the best strategy with the IRS!

How about you all? Have you or someone you know ever been in a situation where you couldn’t pay your income taxes? How did you handle it?

Share your experiences by commenting below!

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