Mandatory filing
Irrespective of the size of the tax liability and the taxpayer’s ability to cover it, a tax return has to be filed by April 15th. Not filing the mandatory tax return will not make the tax liability disappear and failure to file is against the law. The IRS allows taxpayers to request an extension for filing. Extension requests have to include an estimated tax liability (or refund) and if the extension shows that money is owed, it has to be paid by Tax Day.
Options to Delay Payment
The Internal Revenue Service offers a number of options to tax-payers who cannot cover their upcoming tax obligations as they become due for structuring a series of manageable payments. The tax agency’s goal is collection of all outstanding debt, if necessary over a longer period of time. Reducing, let alone forgiving the liability is contemplated in extremely rare exceptions. All of the available IRS options require extra paperwork and more intense scrutiny of financial date by the IRS. All options carry additional costs for processing fees, late payment penalties and interest charged on the amount owed.
Before turning to the IRS options
The IRS prefers that taxpayers with insufficient funds use other options to raise the necessary funds to cover outstanding liabilities before choosing the IRS-provided routes for the installment or negotiated settlement of taxes owed. Securing the necessary funds from a loan or a home-equity line are the options that taxpayers should consider first. If the IRS initiates a collection process, the agency itself will examine if the taxpayer in debt has these alternatives available and considers them the preferred options over approving installment plants, let alone compromise offers. Using an available home-equity line to cover the tax liability may be preferable to they taxpayer, as well, as the interest paid on the home-equity loan may be lower and tax-deductible for the upcoming tax year.
Covering the obligation with credit cards or money borrowed from friends and family is also a viable alternative. Swapping the tax debt with credit card debt is typically an expensive proposition as the interest rate charged by credit card companies is typically considerably higher than the IRS-levied financing charge. However, the IRS may push the taxpayer to rely on credit card debt to settle the tax liability immediately.
IRS payment installment plan
However, if the taxpayer does not have the ability to raise the money they owe, the IRS is willing to work out a solution. There are three available options: payment installment plan to pay off all outstanding debt over an extended period of time, compromise offer to pay a reduced liability as a lump sum or in installments and bankruptcy. The agency will guide taxpayers towards the options in the order they are listed as their primary objective is to recover all of the outstanding debt and the installment plan is designed to ensure this. A compromise allows the IRS to collect some of the debt and gives them a more active part in negotiating the size of the recovered tax, while in bankruptcy both the actual recovery and its extent will be highly uncertain.
Installment plans
Installment plans are designed to allow taxpayers to pay the liability over an extended period of time. Setting up an installment plan can be relatively straightforward or a bit more involved depending on the amount owed and the length of the proposed plan. An installment plan request should be filed as soon as possible once the taxpayer confirms their inability to pay their taxes fully on their due date. If the taxpayer can propose a plan that helps them to pay the tax debt in full within 120 days, no special forms need to be filed and the IRS prefers to negotiate the proposal with the client .
A simplified streamlined installment plan is available for tax debts under $25,000. It can be requested by filing a simple, one page Installment Agreement Request, Form 4965 with the IRS. The form can be filed using the IRS’s Online Payment Agreement process if the request is initiated after the taxpayer has filed their tax return – which is mandatory – but the IRS has not issued a collection letter yet.
Form 9465 requires the tax payer to propose a payment plan by specifying the amount of monthly payments offered. The guidelines offer by the IRS on calculating the monthly installment amounts state that it should be chosen to maximize the monthly amount to minimize the length of the payment period and interests and fees.
The IRS will typically accept the proposed installment plan as long as the length of the plan is no longer than 12 months. Payment plans for taxes owed below $15,000 are automatically approved if the 12-month condition is met. The IRS will evaluate installment plans requesting longer repayment periods against their Collection Financial Standards to determine if they are acceptable.
Tax debts over $25,000 do not qualify for a streamlined installment plan and require the filing of additional paperwork, Form 433-F, which collects detailed information relating to assets, liabilities and expenses. The IRS will scrutinize these requests more thoroughly and often taxpayers in this situation engage the services of tax accountants or attorneys to help them navigate the IRS negotiation process.
Payments specified in approved installment plans can be made via automatic payroll deductions, automated fund transfers from bank accounts or by check, money order or credit card. Tax liabilities enrolled in installment plans will accrue interest and late charges. The IRS sets the applicable interest rates at a quarterly basis, typically at a rate 3% above the short-term federal rate. A fee of $105 is charged for installment plan requests. If the installments are paid with electronic fund transfer, the fee is dropped to $52.
Compromise
If the taxpayer cannot work out an acceptable installment plan due to their inability to obtain the money to fund it, they may request the IRS to contemplate a compromise offer.
Compromise is meant to be a rarely used, exceptional process. The IRS cautions taxpayers that they consider such offers in rare circumstances when either the amount owed is highly doubtful or the collection of the entire tax amount would cause ‘extreme economic hardship’ and is deemed unfeasible considering the taxpayer’s available assets and potential future earnings.
Taxpayers claiming extreme economic hardship are scrutinized extensively and a compromise is approved only if the IRS determines that the taxpayer truly has no feasible option to pay in the foreseeable future. Unemployment and the loss of savings are typically considered a temporary hardship and are not sufficient to request a compromised.
A request for compromise needs to be filed on Form 656, with the requester specifying the details of the proposed compromise, which can be structured as a one-time payment or a series of installment payments over a fixed period of time to cover the proposed compromise amount. Interest payments are applicable, meaning that if the taxpayer defaults on the accepted compromise, they will be liable for the outstanding amount still owed under the plan plus interest and late charges.
Bankruptcy
If the taxpayer is unable to negotiate an installment plan for the full amount of taxes owed and a compromise is not an option in the absence of real economic hardship, bankruptcy is the only available option. For understanding the implications of bankruptcy forced by unpaid tax liability and for the optimal management of the process, taxpayers should engage the services of expert attorneys in the field.
Importance of continuous communication with the IRS
The IRS has wide-ranging authority and powers to enforce compliance with tax laws. Failure to file the returns is a crime, but inability to pay taxes owed is not punishable by law. However, it remains a liability and the IRS has the means to enforce its fullest possible payment. It is in the best interest of taxpayers to seek early cooperation with the tax agency to avoid the worst scenarios of mounting interest and penalties or bankruptcy.