In the U.S., there are strict deadlines for filing and paying your taxes, and penalties are imposed if you fail to comply with tax requirements. That’s why it’s so frightening if you can’t pay your tax debt. After all, no one wants to end up owing a fortune in extra costs on top of their taxes — and dealing with collections activity from the IRS is definitely scary.
The good news is, you have a number of possible options available to you if you can’t pay what you owe. You just need to understand which options to pursue under what circumstances — including how to settle tax debt and when it’s an appropriate course of action.
This guide will help you understand all of the different approaches you could take when you owe money to the IRS so you can decide what course of action is best for your situation.
Always file your taxes on time — no matter what
Even if you can’t pay your tax bill, you still need to file your tax paperwork every year. While you may be reluctant to submit returns and alert the IRS to the fact that you owe a payment you can’t afford, filing is essential; the penalties for not filing are worse than what you’ll face for not paying.
If you fail to file your taxes on time, penalties start accruing right away. For each partial month your return is late, you will owe a 5% failure-to-file penalty. That’s 5% of the unpaid tax balance due. The maximum penalty for failing to file is 25% of the unpaid tax balance, but there’s also a minimum penalty once you’re at least 60 days late with filing. The minimum penalty is the lesser of 100% of whatever tax debt you owe or $210.
You can avoid a failure-to-file penalty if you submit a request for a tax extension by the April tax deadline — this will give you until October to file your returns. Your returns will be due October 15 or the next business day if the 15th falls on a holiday or weekend.
Missing the October deadline, however, will start the clock on that 5% failure-to-file penalty. And unfortunately, requesting an extension only gives you more time to file — you still have to pay by the April deadline or will start accruing the smaller failure-to-pay penalty.
If you file but do not pay what you owe, you’ll also owe a penalty immediately — but a far lower one. The penalty for failing to pay is 0.05% per partial month your payment is late. Again, this is a percentage of the unpaid tax balance, and the maximum penalty you could end up owing is 25% of the unpaid balance due.
The penalty does increase if the IRS issues a notice of intent to levy property and you still don’t pay — 10 days after the levy, it goes up to 1%. But, this is still below the failure-to-file penalty.
A failure-to-pay penalty can be avoided by paying 90% of what’s owed by the April deadline and paying the rest by the October deadline. It can also be reduced down to 0.025% if you file your tax return by the date it’s due and request to make payments on an installment agreement.
In addition to penalties when you don’t pay taxes on time, you’ll also owe interest charges on your unpaid tax balance.
The interest rate you’ll pay is determined on a quarterly basis and equals the federal short-term interest rate plus three percentage points. You can find the current rates on the IRS website.
4 steps to settle tax debt
While submitting tax returns on time will limit the penalties you face even if you can’t pay your tax debt, you’re still going to need a way to deal with the outstanding balance.
Fortunately, there are a number of different steps you can take depending on how much you owe, when you can pay, and how much you can pay. Here are some of your key options for how to settle IRS debt or arrange to make IRS payments on a schedule you can afford.
1. Research IRS payment plans
If you can pay your tax debt with a little more time, IRS payment plans could be the answer. There are a number of different payment plans available, including the following:
- Short-term payment plan: This plan requires you to pay the amount owed by check, automatic payment, money order, debit card, or credit card within 120 days or less. There’s no fee if you apply online, by phone, via mail, or in person — but you must pay any accrued penalties and interest until the balance is fully paid. You will also incur additional fees if you pay by credit card.
- Long-term payment plan with automatic withdrawals: This plan is available to taxpayers who will take more than 120 days to pay their taxes off but will pay what they owe via automatic payments debited out of a checking account. There’s a $31 setup fee if you apply online or a $107 fee if you apply by phone, mail, or in person. Fees can be waived or reduced for low-income taxpayers.
- Long-term payment plan without automatic withdrawals: If you need more than 120 days to pay your taxes and plan to pay via any method other than direct debit, this would be the payment plan you will need. The fee to apply online is $149, and the fee to apply by phone, mail, or in person is $225. Again, fees can be reduced for low-income taxpayers.
Your payment plan must be approved by the IRS. You can apply online for a long-term plan only if you owe $50,000 or less in taxes, penalties, and fees — and only if all your outstanding tax returns have been filed. You can apply online for a short-term payment plan only if you owe less than $100,000 in combined taxes, penalties, and interest. If your unpaid tax balance is over $25,000, you must pay your balance by direct debit.
2. Pursue an offer in compromise
If you cannot pay the full amount of taxes you owe to the IRS, you may be able to settle your tax debt through an offer in compromise (OIC). With an OIC, the IRS agrees to accept less than the total balance owed on your taxes and not try to collect any additional money from you.
The IRS has discretion whether to accept an offer in compromise; if you have the ability to fully pay what you owe, the IRS usually will not agree to take less. However, if there’s a genuine dispute over what you owe or if the IRS is concerned that you won’t be able to pay what you owe, then you may be eligible for an OIC — provided you meet basic qualifying requirements, including filing all tax returns and making all required estimated tax payments for the current year.
The IRS will also typically require you to make an offer that is equal to or greater than the reasonable collection potential (RCP). RCP is based on what the IRS believes it could collect by going after your assets, including bank accounts, real property, vehicles, other valuable assets, and future income above what you need to cover basic living expenses.
3. Try the “Currently Not Collectible” route
If you can’t pay much, or anything, toward your taxes, there’s also another option: You could have your unpaid tax debt placed into Currently Not Collectible (CNC) status. This means the IRS will not take active steps to collect from you, such as levying your assets and income. But the IRS will keep your account active, continue charging interest and penalties, and might keep any future tax refunds and apply them to what you owe.
The IRS has discretion to put your account in CNC status, but you need to request this and provide financial information, including proof of income and expenses, to show you don’t have the ability to pay. If the IRS agrees that you really can’t pay what you owe, it can choose to put your account in CNC status.
The IRS can still review your account periodically to see if your financial situation has improved and can start collections efforts again if it doesn’t believe you qualify for CNC status anymore. Typically, the IRS has 10 years from the date your taxes were assessed to try to collect from you, so you would need to face financial hardship for a long time to permanently avoid collections activities.
4. Consult a tax professional
Sometimes trying to figure out the right course of action on your own is simply too complicated. After all, you may not be sure whether you should pursue an offer in compromise, try to negotiate a payment plan, or declare bankruptcy to try and get some of your tax debt forgiven.
The good news is, there’s help out there — but you need to find the right kind of assistance. Tax settlement firms are one option, and they often advertise that they can help you to settle IRS debt for far less than you owe. Unfortunately, many of these firms charge very high fees and have low success rates.
If you want to use one of these tax settlement firms, research very carefully and watch out for red flags, such as promises that you’ll be able to drastically reduce what’s owed before the firm has even reviewed your financial information. Unless the firm provides a realistic assessment after looking at your financial records and is upfront about their fees, consider steering clear.
In many cases, it can be better to talk with a tax lawyer. Attorneys have fiduciary obligations to clients and can’t make false promises or charge unreasonable fees. They could be sued for malpractice and even lose their license to practice law if they behave unethically, so you can rest assured they’ll be honest about what they can do for you.
Be proactive about dealing with your unpaid tax debt
It’s very important to figure out how to handle your unpaid tax debt so you can make the right choices when it comes to IRS payments, debt settlement, or bankruptcy. The consequences of not paying can go beyond just owing penalties and fines — you could have property taken or even be charged with a crime if you continue to shirk your obligations to the IRS.
The good news is, you now know many different options for how to reduce IRS debt, make IRS payments, or settle tax debt. You can pick an approach that works for you and hopefully start chipping away at what you owe so you’ll no longer have to worry about facing consequences from the IRS.