What if you can’t pay the IRS?

Your tax return is done, but you realize you don’t have enough cash to pay Uncle Sam. Don’t worry: You’re not alone, and you won’t go to jail. The IRS has some options, as well as some more forms for you.

[Related content: taxes, tax penalties, IRS, tax laws, Jeff Schnepper]

By Jeff Schnepper

MSN Money

It’s getting on April 15. You’ve finished your return, and you’re still in shock. You made a lot of money and paid a lot of bills. But now you’re looking at a tax bill that you just can’t afford to pay.

Relax. You’re not alone, and your plight is not unusual. Moreover, you’re not going to jail. There are criminal penalties if the Internal Revenue Service can prove (the burden of proof is on the agency) that you intentionally didn’t pay your taxes, but we’ll assume that’s not the case here. You just ran low on cash, and nobody goes to jail just because they owe money — even to the IRS.

Unemployed? Help is available

Your return is done — that’s how you know the magnitude of your debt. Send it in. Don’t hold it just because you owe money that you can’t pay.

You can’t go to jail because you don’t have the money to pay your tax bill, but you can go to jail for not filing. It’s a criminal act, and you’re not a criminal, so get that return in the mail.

If you file and don’t pay in full, IRS computers will automatically send you a letter asking for the tax due and any interest from the due date.

There is a penalty for late filing of 5% of the tax not paid by the due date for each month, or part of a month, that your return is late. Generally, the maximum penalty is 25%. But if your return is more than 60 days late, the minimum penalty is $100 or the balance of the tax due on your return, whichever is smaller.

Begging and borrowing

Taxes 2010: Most-common mistakes

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But avoiding the late-filing penalty doesn’t get the tax paid. Consider all of the possible sources of money. Can you borrow from friends or relatives? Do you have any equity in your house? If so, a home-equity loan might help eliminate or minimize your tax liability. Moreover, the interest on the loan likely would be deductible on next year’s return.

Do you have potential cash in your credit cards? The interest wouldn’t be deductible, and it probably would be much higher than the rate the IRS would charge. Still, you might prefer to eliminate the specter of the IRS and the post-midnight nightmares that go with it. (And, you could get mileage on your credit card for a potential future vacation.)

But what if you decide to negotiate directly with the government? Understand that the government ranks at the top of the list of creditors who must get paid. Any assets (other than your home or selling your business) are potentially fair game if you owe taxes. Don’t try to hide your assets. That comes under the heading of fraud, and you can go to jail for that.

If you can’t come up with the money

What if you can’t find the cash? Remember, you’re not alone.

You can ask for a streamlined installment plan. You will need to submit an Installment Agreement Request using Form 9465 (.pdf download). The form comes with instructions. Additional information can be found at IRS Topic 202 or in Publication 17 (.pdf download). Fill the form out and send it to the IRS for review and approval.

You may qualify for a streamlined plan if you don’t owe more than $25,000. Also, you must be able to pay your tax bill off within five years. The true length of your payments is a function of both how much you owe and the interest rate charged. Since that rate changes every three months, these figures are estimates, not guaranteed maximum payments. If the interest rate goes down, you may actually pay over a shorter period of time.

The rate is calculated on the basis of the short-term federal rate plus 3 percentage points, as of the first month of each quarter. The IRS issues a news release in the last month of each quarter announcing its rates for the following quarter. (To check on current rates, check here for the applicable IRS news release.)

I should add that if you overpay, the IRS will owe you interest.

If you don’t meet the criteria for a streamlined agreement, you can compare your monthly expenses to the amounts allowed under the IRS’ Collection Financial Standards to determine an appropriate tax payment amount.

If the IRS approves your request, you will be charged a $105 fee, but you can knock it down to $52 if you set up monthly payments through electronic funds transfer. Don’t submit the fee with Form 9465; the IRS normally will deduct the fee from your first monthly payment.

Even if your Form 9465 request is approved, you still will be charged interest and may be assessed a late-payment penalty on any tax not paid by its due date. To limit interest and penalty charges, file your return on time and pay as much of the tax as you can.

Form 9465 is easy to complete. It asks for your name, address, Social Security number, the name of your bank and your employer. (Relax — based on your W-2 and the 1099 the bank sends, the IRS already has that information anyway.) It then asks how much you owe and how much you want to pay each month. You don’t need an attorney or an accountant to fill it out. Almost all requests from those who pledge to pay the outstanding liability within 12 months and to keep current with this year’s taxes are granted.

If you can’t pay what you owe within 12 months, request an installment plan that you can realistically meet. The IRS takes a harder line on longer payment periods, but the government has granted such requests after an investigation.

What if an installment plan just won’t work for you? As in the past, you have the opportunity to ask for what’s called an offer in compromise. Under this program, you pay the IRS, but less than 100% of what’s due.

In the past, there were only two situations where the IRS would consider an offer in compromise:

  • Your liability for the taxes owed was in question.
  • The IRS wasn’t sure it could collect the taxes, no matter what it did.

The IRS can now approve offers in compromise based simply on economic hardship.

You can qualify for this new provision if you have a history of filing and paying your taxes and “collection of the entire tax liability would create economic hardship, or exceptional circumstances exist where collection of the entire tax would be detrimental to voluntary compliance.”

To apply for this program, you must first submit a copy of Form 656 (.pdf file), the standard offer in compromise application. You must pay a $150 application fee with the form submission.

The IRS has cautioned that this program is designed only for taxpayers in extreme circumstances. It’s not designed for everyone with a financial problem, nor should it be viewed as an invitation to avoid paying taxes.

In making an offer in compromise, you can offer to make a lump-sum, cash payment or fixed payments over a short period. In many cases, people borrow from friends and relatives. However, these people have to know upfront, before they commit any money, that the IRS is going to accept those dollars as payment in full.

The fixed-payment option combines all debts owed under the terms of the offer into a single payment. Be warned, however, that the law still requires that interest be assessed. That means that if you default on your agreement, the entire amount of taxes owed, plus penalty and accrued interest, will then be due.

Don’t hide from the IRS

The final word on what to do when you can’t pay your taxes is communication. The IRS is a vast bureaucracy filled with people asked to do an impossible job. Talk to them; don’t hide. The sooner you approach them, and the more often you respond with changes in your situation, the more comfortable they will be in working with you.

Always get the names of the people you speak with and keep notes of what was said. Agency employees are expected to stress customer service. After all, isn’t “service” part of the agency’s name?


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About melvynburrow

Attorney and CPA services.
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