What To Do if You Can't Pay Your Taxes

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With the end of tax season just around the corner, millions may be cringing over income tax bills they simply can't afford to pay. Ignoring payment is not an option, but there are alternatives that taxpayers facing this situation should know about, according to CCH, a Wolters Kluwer business and a global provider of tax, accounting, and audit information as well as software and services.

"If you can't pay what you owe all at once, you should still file your tax return and make payment arrangements with the IRS", said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA. "If you don't file because you can't pay, you're immediately facing a failure-to-file penalty as well as interest, additional costs, and potentially a tax lien or levy down the road."

Last year, the IRS issued new rules to help soften the blow for taxpayers who can't afford to pay their taxes when owed, including increasing the threshold at which the IRS files a tax lien as well as expanding the installment and offers in compromise programs to allow more taxpayers to qualify. Despite the changes, however, taxpayers can still face a host of issues for not paying taxes when owed, and they need to understand the options available to address their tax debt. The IRS also followed up this year with some expanded penalty relief.

Newly Expanded "Fresh Start" Initiative

To better help those who may be struggling to pay their taxes, the IRS has expanded its Fresh Start initiative. To take advantage of the initiative, taxpayers may fill out a new Form 1127A to request the 2011 penalty relief if they're in one of these two categories:

  • Wage earners who have been unemployed at least thirty consecutive days during 2011 or in 2012 up to this year's April 17 tax deadline; or
  • Self-employed individuals who experienced a 25 percent or greater reduction in business income in 2011 due to the economy.

To qualify for this penalty relief, the taxpayer's adjusted gross income (AGI) must not exceed $200,000 if married filing jointly; or $100,000 if filing status is single, married filing separately, head of household, or qualifying widower. However, a taxpayer's 2011 balance due can't exceed $50,000. The penalty relief only extends to October 15, 2012, and interest continues to accrue during that period.

Penalties for Ignoring Tax Deadlines 

If a taxpayer doesn't file a return and pay the taxes owed when due, the IRS can take several steps, including:

  • Failure-to-file penalty - The taxpayer faces a penalty of 5 percent of the tax due for every month, or any fraction of a month, that the return is overdue, capped at 25 percent;
  • Substitute tax return - The IRS can file a substitute tax return for the taxpayer based on information it has from other sources; and
  • Levies and liens - The IRS may start a collection process that can include a tax levy or tax lien against the taxpayer's property, bank account, or wages. Tax liens can impact credit ratings and make it difficult to buy and sell property and even get a job.

However, there are options taxpayers can look into. Luscombe has a short video ‒ Options if You Can't Pay Your Taxes ‒ that discusses these options. 

Three other options available to taxpayers include: 

1. Borrow, liquidate assets, or charge it 

Taxpayers who owe and can't pay their entire tax bill when it's due, but can pay the full amount within 120 days, can ask the IRS for a short-term administrative extension.

Those who need more time have just a few options: They can try to secure a bank loan, such as a home equity loan; they can cash out a retirement account; or they can use a credit card. 

While going into debt to pay off a debt may not seem the best option, the interest rate and fees assessed by a bank or credit card issuer may be lower than the interest and penalties assessed by the IRS. Credit card payments must be made electronically, through personal tax software, a paid tax preparer, or through credit card service payment providers.

2. Enter into an installment agreement with the IRS

The IRS is required to accept installment payments if a taxpayer has a good filing and payment record over the past five years, if the amount owed is not more than $10,000, and if the amount owed can be paid in full within three years. 

Small businesses may enter into "streamlined" installment agreements if their debt is below $25,000 and they agree to pay it off in twenty-four months. This option is available to small businesses that file as an individual or as a business. 

3. Reach an offer in compromise with the IRS 

In some instances, the IRS may accept less than the full amount due. This typically occurs if the taxpayer can show that the full tax debt could never be collected, or the taxpayer has a dispute with the IRS as to how much is owed and neither party wants to enter into a legal battle to resolve the issue.

Under the new rules issued in February, more people may be eligible to participate in offers in compromise. Taxpayers with incomes of up to $100,000 (up from $50,000) and who have a tax debt below $50,000 (up from $25,000) can now request an offer in compromise from the IRS.

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