I Owe the IRS. What’s Next?

What happens if you owe the IRS back taxes?

If you will owe taxes to the IRS and can’t pay the balance, this is the most important thing: You should still file your tax return. If your tax return won’t be ready before Tax Day, you should at least file for an automatic six-month extension.

It’s important to complete one of these steps to avoid the failure to file penalty. The penalty is equal to 5% of the unpaid balance, per month or part of a month, up to a maximum of 25% of unpaid tax.

(Note: The 5% per month penalty increases to 15% per month if the failure to file is due to fraud. For returns filed more than 60 days after the due date or extended due date, the minimum penalty is equal to the lesser of $205 or 100% of the unpaid tax.)

If you can’t afford to pay all the taxes you owe, you should know your options. It’s important to come up with a plan. Otherwise, you may be hit with significant penalties and interest accruals over time. Here are some of the most common options for people who owe and can’t pay.

1. Set up an installment agreement with the IRS.

Taxpayers can set up IRS payment plans, called installment agreements. The type of agreement you can get depends on your situation, including how much you owe and how soon you can pay the balance. You shouldn’t set up an installment agreement if you can pay the balance within 120 days (see #5 below).

Fees or cost: Application fee of $120, or $52 if payments are made electronically. $43 for low-income taxpayers. To apply for lower application fee, submit Form 13844.

Action required: Complete an online payment agreement or Form 9465. You won’t need to submit a financial statement for installment agreements of $50,000 or less. You can also get an expert to evaluate your situation and identify your best solution.

Advantages or disadvantages: If you set up an installment agreement, the penalty on your unpaid balance reduces to 0.25% per month, until you pay the full balance on schedule. Interest is charged at the short-term federal rate plus 3% (interest may change each quarter).

Generally, the IRS can void agreements if you don’t pay on schedule.

Forms: Form 433-A or Form 433-F is required if the balance is more than $50,000. You can pay through payroll deductions (Form 2159, Payroll Deduction Agreement).

2. Request a short-term extension to pay the full balance.

The IRS will provide up to 120 days to taxpayers to pay their full tax balance.

Fees or cost: There’s no fee to request the extension. There is a penalty of 0.5% per month on the unpaid balance.

Action required: Call the IRS at (800) 829-1040 or get an expert to handle it for you.

Advantages or disadvantages: This option is convenient for taxpayers who need a short time to pay their full tax bill. The IRS will charge interest at the short-term federal rate plus 3% (interest may change each quarter). With short-term extensions, you avoid the installment payment application fee (see #1), but not late-payment penalties and interest.

3. Apply for hardship extension to pay taxes.

The IRS offers options for people in hardship situations, including currently not collectible status and the offer in compromise. For an extension based on hardship, you’ll qualify only if you can prove that paying the tax you owe would cause financial hardship, based on IRS financial standards.

Fees or cost: There’s no cost to apply. There are no penalties, but interest is calculated at the short-term federal rate plus 3% (interest may change each quarter).

Action required: File IRS Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship. You must include a statement of your assets and liabilities.

4. Get a personal loan.

You could ask a personal contact – maybe a friend or family member – to loan you the money. Fees and cost will vary widely depending on the source. This could be an inexpensive option, but use your best judgement.

5. Borrow from your 401(k).

If your 401(k) plan allows for this type of loan, you are generally limited to 50%, with a $50,000 maximum, and you must repay the money within five years.

Fee or cost: There is a possible minimal fee. The plan must also charge interest.

Action required: Check with your plan administrator for details.

Advantages or disadvantages: If it’s allowed, a loan from your 401(k) plan can be a ready and inexpensive source of cash. However, taking a loan could negatively impact your future retirement savings if you don’t repay it. The loan is treated as a taxable distribution if you leave your company or your plan terminates.

6. Use a debit/credit card.

Various service providers are available for this option.

Fees or cost: Varies; generally about $2.49 to $3.95 (debit card) or 1.87% to 2.35% of the tax balance due (credit card)

Action required: Check with the IRS for a list of service providers.

Advantages or disadvantages: This type of payment is convenient and gives taxpayers greater control and flexibility for making payments. They may also earn points, miles, or other credit card rewards. However, higher credit card balances could negatively impact your credit score, and paying with credit may not be appropriate for people with unmanageable credit card debt.

Learn all the steps to take when you can’t pay your taxes. Or, make an appointment for a free consultation with a local tax professional by calling 855-536-6504.

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