Many of us end up owing the IRS additional taxes at some point in our lives. Being notified that you owe the taxman is never a welcome experience and can send you into a downright panic if the dollar figure is significantly more than you can afford. There are significant benefits to paying all that you owe on time, since that way you will avoid penalties and interest. But even if you can't pay your whole bill, all is not lost. Though the IRS certainly prefers to get paid immediately, it provides taxpayers with options to pay off back taxes over time.
Why Do I Owe the IRS in the First Place?
People end up owing money on April 15 for a variety of reasons. The most common and obvious is that you didn’t withhold enough taxes from your paycheck during the year. With the advent of direct deposit, many of us don’t scrutinize the breakdown on our paystub like we used to. If you owe one year and you don’t make any changes in your deductions and your income stays the same, it’s a good bet you will owe the next year too. Accurately following the instructions on the W-4 (single, married, number of dependents, etc.) will usually have you covered, but there are more accurate ways of calculating withholding for those willing to put in the effort.
Another common reason for owing the IRS has to do with side income. Let’s say you do freelance work. If a company pays you more than $600 for the year, it must submit a 1099. That means the federal government will have a record of the income and it will therefore be subject to tax. One way of offsetting this is to have extra money withheld from your regular paycheck (if you have one). Additionally, those who have significant and continuous freelance income must make quarterly payments to the IRS during the year. It's common to miscalculate these payments and not send enough.
What Are My Payment Options?
As noted, the IRS has programs to help taxpayers deal with tax bills that are too large for them to handle. The most common--and attractive--option is to negotiate payment on an installment plan. With installment plans, you will be paying the entirety of your bill over time. Fees and interest charges are dependent on the time frame. To apply you can fill out and mail a Form 9465, apply online, or call the IRS Individual Assistance line at 1-800-829-1040.
Individual Installment Agreements
For those who owe $50,000 or less in taxes and penalties.
Short-Term – This is the one plan that has no set-up fees. If you can manage to take care of your balance within 120 days, you will pay what you owe plus the accrued penalties and interest for the time period, which can be negligible. This plan accepts automatic payments from your checking account or check/money order. There are additional fees, however, if you opt to use your credit or debit card.
Long-term – This plan is for individuals who need more than 120 days to pay off their balance. If you set up direct automatic debits to your checking account, you will incur smaller fees than otherwise. The plan includes a $31 setup fee if you apply online, and a $107 setup fee if you sign up by phone, mail, or in person. As with the short-term plan, you will be liable for penalties and interest for the installment time period.
Long-term with other payment methods – This plan has the most significant fees. Payment can be made through direct pay with credit card, debit card, or other electronic method. Checks and money orders are also accepted. Online application costs $149 phone, while applying by mail or in person costs $225. As always, interest and penalties are compounded for the life of the installment and fees may apply when paying by card.
Offers in Compromise
In certain circumstances, the IRS will allow you to actually settle your tax bill for less than the total amount you owe. This is called an Offer in Compromise. In theory, an Offer in Compromise is similar to negotiating a debt settlement plan with credit cards you cannot pay off. When the creditor becomes certain there is no way you can possibly pay the full amount, and that you are close to choosing the nuclear option of bankruptcy, only then will they agree to take less money because it is better than nothing. However, unlike debt settlement, an Offer in Compromise will NOT affect your credit score. The IRS does not report the fact you are seeking relief to the credit bureaus.
Qualifying for an Offer in Compromise
The IRS will use Form 433-A to determine your ability to pay. Put simply, they will look at your income, expenses, and asset equity. Only after they get an accurate picture of your full financial situation can they make a decision regarding whether or not they can feasibly get the full amount out of you. Caution should be used in applying for an OIC, as you will be disclosing an enormous amount of personal information to the IRS. This includes:
- All accounts, savings, checking, online, etc.
- Available credit card credit
- Investments, including mutual funds and 401k
- Gross salary
- Value of total assets
- Real estate, vehicles, or significant assets you can sell
Approval of offers in Compromise are far from a sure thing. It is estimated that the IRS only approves around 17%-18% of applicants. The requirements are very strict. Often, your best bet is to go with a tax relief professional who can get your documentation in order for the greatest chance of success.
Currently Not Collectible (CNC) Status
The IRS can only approve you for an Offer in Compromise if you are left with reasonable living expenses (the cost of food, clothing, housing, utilities, transportation, healthcare, etc.) after the payments are made. If there is simply no way you could afford to make payments against you tax bill while paying reasonable living expenses, the tax officials may put your account into CNC status.
If your account is put into CNC status, the IRS will suspend attempts to collect from you. They will not garnish your wages or levy against your assets. However, they will still charge interest and penalties and send you an annual bill. What’s more, if you receive refunds in the future, they will keep those to pay off the balance.
You Have Options
Although they are tough, the IRS will work with you. The most important advice we can give is to BE PROACTIVE. Regardless of how daunting the sum you owe is, be fully transparent and immediately open up lines of communication with the IRS so they are aware of your situation. They have enormous power to collect the money they are owed and will not stop. If you ignore notices, they can garnish your wages, freeze your bank account, take your home, or shut down your business.
Tax relief companies employ CPAs, tax attorneys, and enrolled agents (EAs) who are certified by the IRS itself. They have daily experience helping taxpayers navigate the complexities of installment plans, offers in compromise, and other options that may be available. If you find yourself in a tight spot this tax season, check out our top ten tax relief companies.