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Owe Taxes But Can't Pay In Full? The IRS's Payment Options

Earlier this week I wrote about the fact that millions of folks could find that they unexpectedly owe taxes for 2009 as an unintended consequence of the new Making Work Pay Credit.

To avoid costly penalties and interest changes, you should always file your tax return (or an extension to file), and pay your current year's tax liability, on time. If you are short on cash read my blog for a few ideas on financing options.

But what do you do if you can't pay the full amount of what you owe and have nowhere to turn for a loan? 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 and you owe less than $25,000, you can complete and submit an Online Payment Agreement Application, or OPA, at the IRS.gov 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 they can determine your eligibility for an installment agreement, the OPA application also includes an address and a toll-free phone number so you can contact them.

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 for 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, though: you must have filed all of your prior year's tax returns and paid all previous tax debts, and pay a user fee of $105 ($52 if you have payments 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 that the proposed payment terms have either been accepted or need to be changed.

Once again, the IRS will charge 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, they 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.

The Final Option
The option of last resort is the Offer In Compromise, or OIC. This is an agreement in which the IRS and the taxpayer settle the tax liability for less than the full amount owed. In connection with an OIC, the reduced amount allowed must equal what the IRS believes they 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 (note: make sure you 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).