Owe Taxes But Can't Pay? You Have Options

A helping hand extended by Uncle Sam has unwittingly resulted in many people owing more in taxes than they're able to pay. But, explains "Early Show" money maven Ray Martin in this column, there are steps you could take to make settling your tax debt less burdensome than you might think.

It's estimated that more than 15.4 million taxpayers could fall into that category as an untended consequence of the new Making Work Pay Credit, according to a report by the Treasury inspector General for Tax Administration.

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This is happening because last year, the government directed employers to decrease the federal income tax withheld from the paychecks of millions of workers in anticipation of those taxpayers applying for the Making Work Pay Credit on their 2009 tax return. The problem this is causing is that the decrease in tax withholding was, for many workers, more that the tax credit they are eligible for. As a result, many folks will ultimately owe taxes when filing their 2009 tax returns. If folks are not financially prepared and cannot pay, they could incur tax penalties and interest for not paying on time.

Folks most likely to fall into this trap are those who work two jobs, married couples who both work, and individuals who work and are also claimed as dependents. According to the report, the amounts owed could range from $200 to more than $1,000.

Always File On Time

Even if you cannot pay some or all of your taxes owed, you should always file your tax return (or file for an extension) on time. The penalty for filing late is a stiff 5 percent per month up to a maximum of 25 percent of the amount of tax due on the tardy return.

If you file your tax return (or an extension) on time, but you don't have enough money to pay your taxes in full, the penalty for paying late is much less onerous - half a percent per month, up to a maximum of 25 percent of the amount due on the return. Suffice is to say, filing and paying late can get expensive. But if you don't pay at all, the IRS will not go lightly on you - it will typically commence a collection action to levy your wages and place liens on your property for the amount of the unpaid taxes, penalties and interest.

When You Can't Pay All of the Taxes Due

Alternatives include seeking a loan from a bank or credit union. But if you can't afford to pay the taxes you owe, you probably are not going to be able to get a loan. You could also ask for a loan from a relative or friend. You could tap a home equity line of credit, if that is available. Current interest rates on home equity lines are low and repayment terms are flexible.

You can pay your taxes using your debit or credit card. Using this option will avoid the IRS penalties for not paying at all, but you'll pay convenience fees in the range of 2-to-4 percent of the amount charged. And if you don't pay your credit card balance in full, you could end up paying hundreds of dollars of interest on the balance you carry on your credit card at a rate that is higher than the IRS interest rate for installment payments.

IRS Payment Options

The IRS offers a few payment options for folks who can only afford to pay over time:

Installment Payments

If you are in a short-term cash squeeze or you owe less than $25,000, you can complete and submit an Online Payment Agreement Application, or OPA, at the IRS Web site. Taxpayers or their representatives can apply and receive immediate notification of approval. Because there may be situations when you need to speak with the IRS before it can determine your eligibility for an installment agreement, the OPA application also includes an address and a toll-free phone number to contact the IRS.

When submitting an Online Payment Agreement Application, there are three payment options:

• Pay in full: This avoids additional fees, penalties, and interest

• Short Term Extension: If approved, you will get an extension of up to 120 days to pay and will avoid any applicable payment fees.

• Monthly Payment Plan: If you cannot pay in full within 120 days, you may be permitted to make monthly installment payments. There are strings attached: You must have filed all of your prior year's tax returns and pay a user fee of $105 ($52 if the payments are automatically deducted from a bank account). You'll also pay the IRS interest on the unpaid balance, which is currently an annual rate of 4 percent.

When you request a Short Term Extension or Monthly Payment Plan, the IRS will send written confirmation within 10 days, so you'll know your request has been approved.

If you owe more than $25,000, you may still request and qualify for a payment plan, but the process requires filing several additional forms. You'll need to attach a completed Collection Information Statement, Form 433F and include a payment proposal on a Request for Installment Agreement, Form 9465 with your tax return. The IRS will reply with a written notification letter explaining whether the proposed payment terms have been accepted or need to be changed.

The IRS charges a user fee for setting up an installment agreement of up to $105 ($52 if payments are set up to be automatically deducted from your bank account, and even less for folks with incomes below certain levels.) You have up to five years to pay under the Installment Agreement and you'll have to pay all future taxes in full and on time.

You'll pay penalties and interest on the taxes you owe until the agreement is paid off. However, depending on your individual circumstances, the IRS could offer a payment plan at a reduced interest rate. Also, as a condition of the installment agreement, any future tax refunds will be automatically applied against the amount you owe until the balance is paid off.

If the IRS determines that you cannot pay your tax debt, it may temporarily delay collection until your financial condition improves. During the payment delay, your tax debt will continue to increase due to the penalties and accrual of interest until your balance is paid in full. The IRS may also file a Notice of Tax Lien to assert the government's interest in your assets.

Offer In Compromise

The option of last resort is the Offer In Compromise, or OIC. This is an agreement in which the IRS and taxpayer settle the tax liability for less than the full amount owed. In connection with an OIC, the reduced amount allowed to be paid must equal what the IRS believes it can reasonably collect from the sale of your assets, such as real property, automobiles, bank accounts, etc. The IRS may grant an OIC on the grounds that there is legitimate doubt that the taxpayer could ever pay the full amount of tax owed (doubt as to collectability), or there is doubt that the amount owed is correct (doubt as to liability). Also, if collection of the tax owed would create an economic hardship, the IRS may consider an OIC.

To request an OIC, you must send a completed Form 656, Offer in Compromise, and include a $150 application fee.

And don't go for those pitchmen claiming their services will settle your tax debts for "pennies on the dollar!" The IRS only accepted 21 percent of OIC applications in 2009, down from the previous two years.

The bottom line is that the IRS may offer some of the better options for folks who need to pay their tax debts over time. Making a partial payment of what you owe and filing an Online Payment Agreement Application is better than not.