With tax season winding down, millions of taxpayers may be looking at tax bills they can’t afford to pay but can’t afford to ignore either.
“If you can’t pay what you owe, still file a tax return and make payment arrangements with the IRS,” said CCH principal federal tax analyst Mark Luscombe. “Otherwise, you’re immediately facing a failure-to-file penalty as well as interest, additional costs and potentially a tax lien or levy down the road.”
In February, the IRS issued new rules to help soften the blow for taxpayers who can’t afford to pay their taxes when owed. These new rules include increasing the threshold at which the IRS files a tax lien and expanding the installment and offers in compromise programs to allow more taxpayers to qualify.
Despite the changes, taxpayers still face a host of consequences for not paying taxes when owed and need to understand the options available to address their tax debt, CCH noted.
Ramifications of Ignoring Tax Deadlines
If a taxpayer does not file a tax return and pay the taxes owed when due, the IRS can take several steps, including:
• Failure-to-file penalty. The taxpayer faces a penalty of 5 percent of the tax due for every month or any fraction of a month that the return is overdue, capped at 25 percent. Additionally, failing to file a federal tax return is a misdemeanor and carries a maximum fine of $25,000 for individuals or a one-year prison term.
• Substitute tax return. The IRS can file a substitute tax return for the taxpayer based on information it has from other sources. The substitute tax return will not include exemptions or expenses to which the taxpayer may be entitled. So, it may overstate the actual tax liability.
• Levies and liens. Next, the IRS will start a collection process. This can include a tax levy or tax lien. With a tax levy, the IRS can seize your property – for example, your house, car, bank account or wages – to pay your taxes if you failed to make arrangements to settle your debt. A tax lien is a claim used as security for a tax debt and can have a direct impact on a taxpayer’s credit rating. If a tax liability remains unpaid after the IRS issues a notice and demand for payment, a tax lien is automatically filed to record a claim by the IRS to all property owned by the taxpayer.
Under the new IRS procedures, liens will not be filed until a taxpayer owes more than $10,000 in taxes (up from $5,000). Additionally, the new rules make it easier for a taxpayer to have a tax lien withdrawn from their record after paying their tax debt. However, they need to make a formal request to the IRS for the withdrawal. Also, if the taxpayer enters into a direct debit installment agreement with the IRS, they can have the tax lien withdrawn while they are paying off the debt.
“You want to avoid having a tax lien,” Luscombe said. “It’s a costly and disruptive experience. Your credit rating will be affected, you can have difficulty buying or selling a home and it could even affect your ability to get a job.”
Three Main Tax Debt Payment Options
Steps taxpayers can take to help avoid a tax lien include either finding a way to pay the taxes owed outright or working with the IRS to arrange a payment schedule and possibly agree to reduce the amount owed.
1. Borrow, liquidate assets or charge to pay the debt. Taxpayers who owe and can’t pay their entire tax bill when it’s due, but can pay the full amount within 120 days, can ask the IRS for a short-term administrative extension.
Taxpayers who need more time have just a few options: They can try to secure a bank loan, such as a home equity loan, cash out a retirement account or use their credit card.
While going into debt to pay off a debt may not seem the best option, the interest rate and fees assessed by a bank or credit card issuer may be lower than the interest and penalties assessed by the IRS. Credit card payments must be made electronically, through personal tax software, a paid tax preparer or through credit card service payment providers.
Penalties for withdrawing from a retirement account may be more substantial. However, taxpayers may also want to explore this option with their tax advisor if other resources are unavailable.
2. Enter into an installment agreement with the IRS. The IRS is required to accept installment payments if a taxpayer has a good filing and payment record over the past five years, the amount owed is not more than $10,000 and it can be paid off in full within three years.
Under the new rules, the agency also is allowing small businesses to enter into “streamlined” installment agreements if their debt is below $25,000 (up from $10,000) and they agree to pay it off in 24 months. The new streamlined installment agreement is available to small businesses that file as an individual or as a business. To participate, the small business must enroll in a direct debit installment agreement.
3. Reach an offer in compromise with the IRS. In some instances, the IRS may accept less than the full amount due. This typically occurs if the taxpayer can show that the full tax debt could never be collected or they have a dispute with the IRS as to how much is owed, but neither party wants to enter into a legal battle to resolve the issue.
Under the new rules issued in February, more people may be eligible to participate in offers in compromise. Taxpayers with incomes of up to $100,000 (up from $50,000) and who have a tax debt below $50,000 (up from $25,000) can now request an offer in compromise from the IRS.
There’s a $150 fee charged for offers in compromise. Certain low-income individuals can ask for a waiver. Additionally, an initial non-refundable payment must be made with an offer in compromise.
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