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When you owe taxes to the Internal Revenue Service (IRS), the IRS will not ignore this debt, but instead, the IRS will press collection and seek penalties and interest. Outstanding federal taxes may be collected for ten years from the date assessed—a debt to the IRS can have a long life. The IRS also has far reaching authority to collect taxes—it can place a lien on property and levy (seize) property including bank accounts, wages, Social Security, and even pension payments.
File the Return on Time Even if You Do Not Pay the Taxes Owed
One of the worst things you can do if you cannot afford to pay your taxes is to not file your tax return. You must file an income tax return, in general, if you are a U.S. citizen or resident alien, and your taxable income exceeds certain amounts.
April 15th is the deadline for most people to file individual income tax returns and pay any taxes owed. Filing extensions are available, but this does not extend your time to pay.
If you fail to file either an extension or your tax returns by April 15, and you owe taxes, the IRS will prepare a proposed tax return, called a “substitute for return,” which shows how much the IRS thinks you owe. You can dispute that determination by responding to the letter or filing a late return.
If you file late, the IRS will assess a late-filing penalty. If you owe taxes and are late in filing by sixty days, the penalty for late-filing is 5% of the taxes owed for each month or part of a month that your return is late, with a maximum penalty of up to 25% of the taxes owed. Totally separate from any fee for filing late is the late-payment penalty. If you pay late, the IRS will assess a late-payment penalty. The penalty for late-payment is only a fraction of the larger penalty for not filing a return—it starts at only one half of 1% of the tax owed for each month late, up to a maximum of 25% of the taxes owed. You will also be assessed interest on the unpaid tax and penalty.
Getting an extension to file is also not the solution it might seem to be. Although the IRS will automatically give you a six-month extension if you request it with payment of the taxes you are likely to owe, keep in mind that this is only an extension of time to file. It does not give you more time to pay the taxes you owe, and you will be charged both interest and probably a late-payment penalty during the time of the extension if you have not paid in full by April 15. As noted above, if you can’t pay the taxes due, it is a better idea to file the return, pay as much as you can, if anything, and then consider negotiating a payment option with the IRS (discussed below).
Options for Paying Tax Debt
When you file a return but cannot afford to pay the taxes due, you will generally have three options in dealing with the IRS:
· • Enter into a monthly installment agreement;
· • Negotiate for a smaller tax bill by seeking an “offer-in-compromise”; or
· • Request a hardship determination, called “currently not collectible” status.
All of these options require IRS approval. If IRS does not grant approval for any one of the three options, you then have the right to seek an appeal or ask for a review of your case.
The Installment Agreement. The IRS allows you to pay taxes you owe in monthly installments over a period of up to six years. Penalties and interest will continue to accrue until the balance is paid in full. The interest rate will be the federal short-term rate (presently a little over 1%) plus 3%, which is a lower rate than most rates for unsecured loans and credit cards. If you have an installment plan, the penalty for late payment is only one-quarter of 1% for each month. The IRS will waive penalties if you qualify under its First Time Penalty Abatement policy, or if you have a valid reason for your late payment or late filing.
Offer-in-Compromise. The IRS may accept payment for less than what you actually owe through its “offer-in-compromise” program. Reduced payment is permitted when the IRS determines that, under established financial guidelines, the taxpayer cannot afford to pay the full amount of taxes owed or where an exceptional circumstance exists such that collection of the tax would create an economic hardship or would be unfair and inequitable, (i.e., the assets that could be used to pay the tax debt are needed to pay for the long-term care of a seriously ill person).
There are special IRS forms you must fill out to request an “offer-in-compromise” (Form 656 and Form 433-A). You will also need to pay an application or “user” fee (presently $186) plus make a first payment of 20% of your offer amount (or the first payment of a proposed payment plan), unless your income is below a certain amount and you complete Form 656-A. Generally, an offer will only be accepted when the amount offered equals or exceeds your net equity in assets, plus your ability to make installment payments from future income.
It takes about six to twelve months for the IRS to review an offer-in-compromise. During that period, you may not be expected to make any payments on your tax debt. However, interest and penalties will continue to add up, so if your offer-in-compromise is rejected, your tax bill will grow during the time the IRS has your offer-in-compromise under review.
Non-Collectible Status. You may be eligible for a temporary hardship determination from the IRS, called “currently not collectible” (CNC) status. The IRS will only grant you this status if you do not have any assets you could use to pay your tax debt and you do not have any income left after “allowable expenses.”
Allowable expense are listed on the IRS website (use the search box to find, “Collection Financial Standards”) and are used by the IRS to determine allowable monthly living expenses. If your monthly income is less than the allowable living expenses, you will be eligible for the non-collectible status and the IRS will put your account on hold.
CNC status is not permanent, and does not mean the tax debt is forgiven or reduced. This status can change if your financial circumstances improve, if you file another return with a balance due, or if you do not file a tax return when you are required to do so. The IRS will monitor your tax returns and remove the hardship status if your returns suggest a significant financial improvement. Also, interest and penalties will continue to add up during this time.
In certain limited cases, your responsibility to pay a tax may be cancelled when the tax is owed entirely by your spouse or ex-spouse. This cancellation may be available when your spouse or ex-spouse was solely responsible for failure to pay the taxes, the taxes are entirely attributable to your spouse’s separate business, or if you were the victim of domestic abuse. This is true even if you filed a joint return.
Steps the IRS Can Take to Force Payment
If you do not set up a payment plan, negotiate an offer-of-compromise, or secure “currently not collectible status,” the IRS can force payment. Before the IRS actually forces payment, it will generally send you a series of threatening letters, for instance a Notice of Tax Due and Demand for Payment or Final Notice of Intent to Levy.
These notices inform you that the IRS intends to seize or “levy” your property. The IRS can take any or all of your property, such as bank accounts, paychecks, and even homes, with the exception of certain exempt types of income and possessions.
The IRS can also recover past-due taxes by seizing certain federal benefits and other payments, including Social Security payments (but not Supplemental Security Income payments). The IRS can levy 15% of your entire Social Security benefit. Unlike other forms of federal government seizures of benefit payments, the first $750 of your monthly income is not protected. In some cases, the IRS will levy even more than 15% of Social Security benefits.
When you receive a notice that your property is being levied or a lien is being placed on it, you can request a review of your case called a “Collection Due Process” hearing on Form 12153. You have thirty days from the date of the notice to request a hearing. The hearing request will result in a suspension of collection activities, including any levy, during the appeals process. During the hearing, you can request one of the payment options discussed above. In certain situations, you can dispute that you owe the tax.