In an ideal world, everyone would be able to pay their taxes in full and on time, but sometimes it just isn’t possible. If difficult circumstances mean that you are coming up short this tax season, it is probably the source of a lot of stress and anxiety.
The instinct to avoid the issue may be strong, but it can cause your problems to multiply exponentially. Interest, penalties, and other severe consequences can begin to build up. The most important thing for anyone struggling with their taxes to know is this: the IRS can usually work with you, but only if you work with them.
A quick introduction to installment agreements
Put simply, an installment agreement is a payment plan which allows you to pay what you owe over time, in smaller payments. Depending on how much you owe, you may be able to get on an installment plan just by asking. Being proactive with the IRS can save you a lot of trouble down the line.
Owing the IRS: First Steps
If you have a balance due, you will receive a notice or letter from the IRS stating the amount owed and requesting you to take action by a certain date. Responding within the listed time frame is important because it can:
- Minimize additional interest and penalty charges.
- Preserve your appeal rights if you want to contest the contents of the letter.
You should keep a copy of this letter, and to pay attention to the notice or letter number in the upper right hand corner: you should be able to reference this number in future communication or correspondence with the IRS.
Even if you know you won’t be able to pay your taxes, make sure to file. The sooner you file, the better. You must be current on filing your tax returns up to the current year before you can request an installment agreement or other relief from the IRS. In addition, failure to file fees are steep and continue to accrue until your return is filed, which can make your situation worse.
What happens if you can’t pay in full?
Penalty fees: Aside from the possible late filing fee, there are penalty fees for late payment. They are charged at ½ of 1 percent of your unpaid tax balance. The penalty will apply for each month or part of a month after the due date and starts accruing the day after the tax-filing due date.
It may be possible to avoid paying penalty fees if you can prove that you have a reasonable cause for filing and/or paying late. The exact criteria for reasonable cause are generally determined on a case by case basis. Serious illness, death of a close family member, unavoidable absences, and disasters may all qualify.
If you fail to pay your tax liability in a timely manner, the IRS may issue a Federal Tax Lien. The IRS will issue a public document called a Notice of Federal Tax Lien, which lets creditors know that the government has a right to your property. A lien is a very serious consequence which can have devastating effects on your reputation and your business. You may have problems accessing credit, and the IRS could seize your property. Avoiding a tax lien should be your first priority.
Fresh Start Program:
The recent IRS Fresh Start Program was designed to make it easier for individuals and small businesses to pay back their tax debts and avoid federal tax liens. You can read the full details on the IRS website, but in short, The Fresh Start initiative:
- Increased the amount that a taxpayer can owe before the IRS will usually file a tax lien up to $10,000. (Though a lien may still be filed on amounts under $10,000 in some cases.)
- Expanded and streamlined access to Installment Agreements.
- Expanded and streamlined the process for Offers in Compromise.
Payment options: how to make it right
You have four basic options when it comes to paying your tax debt:
- Pay the full amount: If you can free up some capital to pay your federal tax liability in full, this is usually the best option.
- Loans: Between penalties and interest rates, owing money to the IRS is very expensive. If you can get a loan or even use a credit card, you may get a better deal.
- Offer in compromise: An offer in compromise is a negotiated deal with the IRS where you agree to pay a sum which is less than your total tax debt. It is usually tied to financial hardship and is accepted by the IRS when they determine that it is the most money they are likely to be able to collect in a reasonable amount of time.
- Installment agreements: A payment plan, usually arranged for a period of up to 72 months (6 years).
Installment agreements in-depth:
Understanding how IRS installment agreements work will help you decide if they are the right option for you and your business. Here is what you should know.
The amount owed matters
Under the Fresh Start Initiative, if you owe less than $50,000 total in back taxes, penalties, and fees you should qualify for a 72 month Installment Agreement without needing to undergo an in-depth financial disclosure. The IRS may request some financial information, but generally installment agreements of this type are approved easily.
If you owe more than $50,000 total in back taxes, penalties, and fees, or if you will need more than 72 months to clear your balance, you will need to submit a detailed financial statement with your application. Depending on the contents of this statement, you may be required to sell some assets to pay some or all of your liability.
- You can probably apply online. The IRS has an online Payment Agreement Tool which allows you to submit your application and get notice of approval instantly. If you do not qualify for the Online Payment, you can still pay in installments: you’ll just have to contact the IRS by phone, mail, or in person to apply.
- You may have to pay a small fee. There is a fee charged when you apply for an Installment Agreement. The amount of the fee depends on how you will pay your installments (direct debit will earn you a discount) and if you think you can clear your balance with 180 days, the fee may be waived.
- You have some control over your minimum monthly payment. The IRS will ask you how much you think you can pay each month. The more you can afford to pay off each month, the less you will ultimately end up paying in penalties and interests, but you do not want to stretch so far that you put yourself at risk of defaulting. It is generally wise to keep the minimum payment low but make periodic large payments whenever possible.
- You have choices about how to pay your installments. When you set up your installment agreement you will be asked to choose a payment option.
- The minimum monthly amount will be automatically withheld from your paycheck.
- You authorise the IRS to withdraw your minimum monthly payment automatically from your bank account.
- This one isn’t a choice: any future tax refunds will be applied to your debt until the balance is cleared.
- Defaulting on the installment agreement is never a good idea. Default will open you up to a serious enforced collection actions. The IRS may file a Notice of Levy on salary, income, bank accounts, or property, and you could lose your assets, business, or even your home. If you think you may be unable to keep up your minimum monthly payments, you must get in touch with the IRS. They may be able to help, and good communication can fend off collection action as you work together to find a solution.
How to avoid future tax debts
Staying on top of your taxes is the best way to save yourself the strain and overwhelm of late payments. You should check your withholding amount regularly: the IRS has a useful calculator to help you estimate how much you (or your employer) should be setting aside each month for taxes. If you are self employed, have multiple jobs, or an otherwise complex income situation, you may want to consider a consultation with a tax professional to establish a reasonable withholding rate so that you will not face a nasty surprise next tax season.