Maybe you adjusted your withholding too high, or had some self-employment income you spent without setting aside money for the taxes. Maybe you sold some valuable property, or went through a divorce that messed up your finances. Or maybe you paid what you thought you owed, but the IRS sent you a bill because of an adjustment or an error on your return.
Whatever the reason, you owe the Internal Revenue Service and you don’t have the money to pay. What are your options? Well, you can:
A: Ignore the situation and hope the IRS doesn’t catch up to you.
B: Borrow the money to pay the IRS.
C: Work out a payment arrangement with the IRS to pay over time.
D: Find a way to reduce or eliminate what you owe.
Some of these options are better than others. Ignoring the whole problem and hoping it will go away, for example, is the worst option since the IRS has many ways to get you to pay.
In this publication, I’ll describe what you can do if you can’t pay your tax bill, and provide other resources that you’ll find helpful. This publication explains what to do if you can’t pay your federal income taxes. Contact your state government to see what options you have for state taxes.
Finally, before you do anything else, adjust your withholding immediately so this won’t happen again! Your withholding may be adjusted by completing Form W-4, the Employee’s Withholding Allowance Certificate. See your employer for a copy.
You determine the amount of Federal taxes withheld from your paycheck by completing the number of allowances claimed. On Form W-4, a Personal Allowance Worksheet is provided to assist you in determining a recommended number of allowances. Use the Deductions and Adjustments Worksheet if you plan to itemize or claim adjustments to income.
Completing of one or both of these worksheets will yield a recommended number of allowances. Of course, you may claim fewer, or even zero, allowances if you wish to increase tax withholding. However, if you overstate your allowances during the year, you may owe taxes when you file your return.
You may also request an additional dollar amount in Federal taxes be withheld from each paycheck. A Two-Earner Job Worksheet is provided to assist you in determining if additional withholding is recommended.
Once you have completed the form, sign and date it, then return it to your employer. Your employer takes it from there.
Option A: Ignoring Your Tax Bill
Just because you can’t pay your taxes doesn’t mean you shouldn’t file. If your tax return is not filed on time, you may have to pay a “failure-to-file” penalty, in addition to a
“failure-to-pay” penalty, plus interest. There’s even the possibility — though remote — that you will face criminal charges for not filing.
And forget about hiding. Chances are that sooner or later, the IRS will find you, and the price you’ll pay for dodging your taxes for so long may be steep.
So consider sending in a tax return even if you don’t have the money to pay. You can use one of the options that follow to pay off the bill eventually.
Option B: Borrow the Money to Pay
You can apply for a bank loan, a credit card or ask a relative to help out. Whatever way you choose, try to pay back the loan as soon as possible. Taxes are expensive enough without paying interest on them, too!
The advantage of using borrowed money to pay off your debts is that you no longer have to worry about IRS collectors. When it comes to collecting a debt, the IRS has more options than lenders. These options include seizing your bank account, levying your wages or taking other income or assets without having to take you to court first.
If you can’t pay a loan or your credit card bill, on the other hand, the account will normally be sent to a collection agency, which will try to collect the debt before taking more serious action. Unlike the IRS, the creditor or collection agency generally cannot touch your assets without first taking you to court and getting a judgment.
In 1998, the IRS gave taxpayers the option of paying their taxes with most major credit cards. Under this program you use your major credit card to charge your taxes through a processing firm which charges a fee of approximately 2 percent to 3 percent of the amount you charge.
To decide whether to charge your taxes, you have to compare that option with your other alternatives, such as borrowing the money from a bank or using an IRS repayment plan. Charging your taxes will usually be more expensive than working out a payment plan with the IRS — but not always.
To establish a repayment plan through the IRS, you’ll pay a setup fee, plus interest. For example, if you wished to set up a payment plan in October, 2010, you would pay a $43 set-up fee and 8 percent interest, adjustable quarterly, plus a penalty of 0.25 percent per month (or 3 percent per year) on the unpaid balance (up to 25 percent). Compare that to paying interest on your credit card and the processing fee of about 2 percent to 3 percent that will be assessed by the company that processes payments.
You might consider using a credit card to pay taxes owed if:
The tax amount is less than $1,399.99 and you charge it to a low-rate credit card.
In that case, the processing fee assessed on your credit card should be less than the fee charged by the IRS to set up a payment plan. If the interest rate on the card is less than 12 percent, it should be competitive with the IRS’s, plus the penalty.
You aren’t certain you can keep up with a payment plan set up by the IRS.
If you are late on your payments to the IRS, it may immediately begin collection activity against you. Because the IRS has greater powers in collecting a debt than credit card companies, it might be smarter to owe a credit card company if you run into financial difficulties.
You will be able to pay off the debt quickly and you charge it to a card with a low rate.
If you know you will be able to pay the debt within a few months by selling something or earning extra money, for example, you may want to use a card with a low rate and pay the bill. In that case, the fee may be outweighed by the interest savings.
Don’t charge taxes on your credit card just to earn frequent flier miles or other perks! Generally, the fee for using the credit card will be close to the value of the miles so, when you add interest, you don’t end up ahead. A frequent flier mile is considered to be worth two cents and most programs give one mile for each dollar charged. That means that if you charged $2,000 dollars of taxes on your card, the processing fee will be $68, while the miles will be worth $40. When you add interest on the balance, the cost will clearly outweigh the benefit.
TIP: While you don’t want to pay late, you don’t want to pay unnecessarily early either! The IRS reports that most taxpayers who charge their taxes did so in January, rather than waiting until the April 15th deadline. Those early chargers had interest accruing up earlier than it should have.
If there’s no valid reason for you to pay early (you’re not making estimated tax payments, for example), wait until close to April 15th to get a loan or pay by credit card. Of course, you’ll want to leave enough time to make sure you’ll have the money by the date you need it.
Charging a tax payment isn’t the only way to pay by credit card. You can also write a “convenience check” — those checks that card companies send periodically — to the Internal Revenue Service. Just be careful: these checks can carry high rates and fees. Sometimes, though, they can offer very attractive interest rates and may be even cheaper than a personal loan or an installment plan with the IRS.
Option C: Work With the IRS to Pay Over Time
You can request an installment plan from the IRS if you can’t pay your tax bill in full. This allows you to pay the IRS over time. If the IRS approves your request for a repayment plan, it will charge you a setup fee, plus interest, plus a penalty per month on the unpaid balance. If you decide to go this route, file your tax return on time and attach to the front of your return either a completed Form 9465, Installment Agreement Request, or your own written request for a payment plan. (Specify the amount you can pay and the day you wish to make your payment each month.)
You should pay as much as you can when you file your return to lower your interest and penalty charges.
If you’ve already filed your return and have received a notice or bill requesting payment, you may attach a completed Form 9465 or your own request to the notice and mail it in the envelope provided. The IRS will let you know, usually within 30 days, whether your request is approved, denied or if additional information is needed.
Repayment agreements are usually approved, but the IRS will generally want you to pay the back taxes within three to six years.
Option D: Find a Way to Reduce or Eliminate What You Owe
This ain’t easy, folks. But in some cases, you may be able to work out an arrangement where you pay less than the total tax bill to settle the debt. This is called an “offer in compromise.”
Offers In Compromise
The IRS says it will accept an offer in compromise to settle unpaid accounts for less than the amount owed when there is a doubt about whether or not you owe the tax, or doubt that the tax can be collected in full and the amount you offer reasonably reflects your potential ability to pay.
If you are making the offer because there is a doubt that you owe the liability — for example, a disputed assessment — you must provide a written statement of supporting evidence. The IRS can’t accept an offer in compromise if you are in the middle of filing for bankruptcy or if you haven’t filed all of your tax returns.
To submit an offer-in-compromise you must complete a Form 656 (instructions are provided on the form). If the basis of the offer is doubt that the liability can be collected in full, you must submit Form 433A, Collection Information Statement for Individuals, or Form 433B, Collection Information Statement for Businesses. These forms provide a statement of your income, expenses, assets and liabilities.
The amount of the offer should at least equal or exceed your equity in all assets. When reviewing an offer, the IRS considers three factors:
1. The amount collectible from your assets
2. The amount collectible from present and future income
3. The amount that can be collected from third parties
It’s your responsibility to show how acceptance of the offer would be in the best interest of the government.
Generally, the IRS will not accept an offer unless it is clear that you have complied with all current filing and paying requirements. The acceptance of an offer by the IRS creates a “fresh start;” therefore, you must meet all tax filing and paying requirements for a period of five years. If you do not abide by all the terms of the offer, including the compliance requirement, the IRS may reinstate the entire tax liability.
You may be able to wipe out some or all federal (and even state) income taxes by filing for bankruptcy. On the plus side, filing will stop IRS collection action while your bankruptcy is sorted out. On the negative side, bankruptcy is a very serious step — one that should never be taken lightly (or in a panic).
There are two main types of consumer bankruptcy: Chapter 7 (where you wipe out all or most of your unsecured debt) and Chapter 13 (where you pay back some of your debt under a court-ordered plan). Either may help with a tax liability, as long as you meet certain requirements and the bankruptcy judge approves it.
According to attorney Frederick Daily in Stand Up to the IRS (Nolo Press), you may be able to reduce or eliminate income taxes by including them in bankruptcy if there was no fraud involved, the taxes were due at least three years before you filed, and you actually did file the return at least two years before filing for bankruptcy, plus other conditions. You should be aware that if you used your credit card to pay your federal taxes, you cannot discharge that debt on your credit card in bankruptcy.
Additional information about the Offer-in- Compromise can be found on Form 656 and in Publication 594, Understanding the Collection Process.
If you would like printed IRS information on your rights as a taxpayer, making arrangements to pay your bill, installment agreements and what happens when you take no action to pay, download Publication 1, Your Rights As a Taxpayer, and Publication 594, Understanding the Collection Process. You also can get the current rate that the IRS charges on installment plans.
Publications and forms may be downloaded from irs.gov. They may also be ordered by calling 1-800-829-3676.
Stand Up to the IRS by Attorney Frederick Daily (Nolo Press) is an excellent, comprehensive book which will guide you through all of your options if you owe the IRS or encounter any other kind of problem (even an audit).
The fee schedule for charging taxes on a credit card is available at officialpayments.com.