Tax returns filed by Americans every year serve as the income of the nation. Taxes paid by each of us are our contribution to this revenue. The Internal Revenue Service (IRS) is the office charged with all tax issues, including tax debt.
If you owe Uncle Sam back taxes, you’re certainly not alone. There’s a significant gross tax gap; this refers to the difference between the total tax owed and paid.
In this article, we’ll dig into what tax debt is and how to get out of tax debt, laying out your options and solutions for squaring things up with the IRS.
How does the IRS tax debt collection work?
Says tax expert Susan Aki-Sanford, “The IRS can be brutal and has a wider latitude and more resources to collect than normal debt collectors. IRS collectors aggressively pursue taxes owed. Debt to [Uncle Sam] takes precedence over other types of debt.”
According to the IRS, if you owe taxes and don’t respond to the first bill, they’ll send you at least one more. The second bill will include accrued interest and penalties. If you still don’t respond, they’ll begin collection actions.
These actions range from applying your future tax refunds toward your debt to taking your property and assets. If you cooperate rather than ignore the issue, the IRS can help you find a reasonable solution.
Says Aki-Sanford, “It’s important to be proactive and deal with the tax situation head-on. I often see people ignore their mail or hide from phone calls. Avoidance only makes things much worse.”
What to do about tax debt?
Take urgent action. Tax debt can quickly get out of hand if you procrastinate about dealing with it. The IRS will tack on penalties and interest to your outstanding balance beginning at 0.5 percent of what you owe per month. It can add up significantly over time, and the agency will eventually run out of patience and take more serious collection actions, imposing levies and liens on your bank accounts and property.
Let’s say you owe $30,000 for your last two years’ returns. You consider going back and amending one or both of them to take advantage of any tax deductions you may have overlooked. That’s a good first step, but late penalties and interest will continue to pile on while you debate this option and finally get around to filing two new returns.
You might shave a little off that debt by amending your tax return, but the interest and penalties assessed can offset any savings you might realize. It might benefit you more to address the debt first. Your balance owed can be adjusted later if it turns out you don’t owe that much.
Explore our guide on how to deal with the IRS on debt.
While it’s important to act on your back taxes, it’s equally important to work out the reasons why you have tax debt. Did you underpay? Is there a mistake on your return? Call the number on your notice or letter and get more information if you don’t fully understand the situation.
Doing this can help you in a few ways. If you notice any mistakes, you can get them corrected. You can also hopefully learn from your experience and get better results in the future. For example, when you’re doing your taxes, maybe you need to claim different deductions or tax credits you might have qualified for or review your filing status. Once you have a better grasp of the issue, you can move forward with settling your debt.
Why is the collection statute expiration date important?
In general, the IRS has 10 years to collect unpaid taxes. After that, the debt is wiped clean from its books and written off. The IRS can only collect any tax debt until its Collection Statute Expiration Date (CSED), which is 10 years from the penalty assessment date. There are ways that the CSED can be extended, but once it expires, the IRS has to stop trying to collect what is owed.
It is not in the financial interest of the IRS to make this program widely known. Therefore, many taxpayers with unpaid bills are unaware this program exists. Like most other tax rules, the nuances of the program can be complex and difficult to understand.
How to pay off tax debt that the IRS won’t forgive
Complete debt forgiveness, or getting your tax debt down to zero without paying it, is very rare. However, there are several ways to pay off the tax debt.
There are many debt relief programs available to pay off your back taxes and negotiate with the IRS if they don’t consider tax forgiveness. Says Aki-Sanford, “There are many creative ways to settle tax debts that people may not know about.”
The method you choose depends on your financial situation and how much you owe. Here are some payment options to consider:
Pay with an installment agreement payment plan
One option is to pay your tax debt with a payment plan. There are a few different options for an installment agreement (also referred to as a payment plan).
For example, suppose you qualify for a streamlined installment agreement, which means you owe $100,000 or less. The IRS won’t require verification of your financial situation. This kind of agreement gives you up to six years to complete your payments rather than trying to pay a lump sum.
However, if you owe $10,000 or less and meet other criteria, you qualify for a guaranteed installment agreement, which gives you up to three years to settle what you owe. Besides, the IRS won’t file tax liens or levies against you for outstanding taxes due.
|Plans||Setup Fee||Maximum Debt|
|Short-term payment plan (180 days or less)||Pay by automatic withdrawals from your checking account or by check, money order, or debit/credit card||$100,000 in combined tax, penalties, and interest|
|Long-term payment plan (120 days or more) also known as an installment agreement||If you pay with another method: $149 to apply online; $225 to apply by phone, mail, or in-person. (Fees are reduced to $43 for low-income applicants and may be reimbursed in certain circumstances.)||$50,000|
The most important part about installment agreements is that you must always make your minimum payments. For streamlined installment agreements, your minimum can’t be less than your total debt divided by 72 months (so, if you owe $36,000, that means a minimum of $500/month). You can always pay more than this amount if you want to, but you certainly don’t have to.
What If You Can’t Afford the Minimum?
You’ll have to contact the IRS to work out a different payment arrangement if you can’t afford to pay the minimum. You must submit Form 9465 rather than apply online, and a thorough financial analysis will be required. The IRS will want to know:
- How much money could you come up with to pay your back taxes if you were to sell your assets? Measure the current value of your assets and subtract any loans against those assets.
- Do you have available credit? Could you borrow money through credit cards or a home equity loan to pay the debt?
- How much money do you have leftover each month after you pay your necessary living expenses?
After paying necessary living expenses, your leftover income is how much the IRS will expect you to pay every month if you can’t manage the minimum payment.
The IRS will review your financial documents including bank statements, pay stubs, and other documents to verify your finances and spending if you can’t commit to paying your entire balance off in 72 months.
Not every expense will count
The critical question is how much money you have leftover each month after paying your necessary living expenses. Let’s say you earn $4,600 per month, and you spend $4,350 of that on living expenses. You have $250 leftover each month.
This net difference between your monthly income and your monthly expenses is what the IRS would look for in a payment plan. You can complete Form 433-A or Form 433-F to help you make these calculations.
But here’s where it gets tricky: the IRS might not allow all your expenses. It can disregard certain spending because an expense may be considered unnecessary or higher than average. This might be the case if you spend $250 a month on the best available cable or streaming package. Is this a necessity? The IRS would most likely say no. You could live a perfectly reasonable lifestyle with basic cable; that $250 or more likely $150 of that $250 because paying for some form of cable is acceptable could go to the IRS instead.
Necessary expenses provide for taxpayers’ health, welfare, and/or production of income and their families. They include:
- Food, groceries, clothing, housekeeping, and personal care items
- Housing and utilities including rent, mortgage payments, property tax, and homeowner’s or renter’s insurance, telephone service, trash, water, gas, electric, propane, some cable television, and internet service
- Transportation including car payments, gasoline, oil changes, maintenance and repairs, auto insurance, and public transportation such as bus passes, train, and other mass transit fares
- Health insurance premiums and out-of-pocket medical expenses
- Child care
- Term life insurance premiums
- Estimated tax payments and withholding for the current tax year
- Installment payments for past-due state and local taxes
- Any other expenses if they are necessary for health, welfare, or the production of income.
Collection financial standards
The IRS will compare your actual spending to averages that vary by region, considering areas with higher living costs than others. These expense averages are called collection financial standards.
The IRS will assume that you need to spend only up to the amount specified by collecting financial standards. Anything over and above that amount is discretionary rather than necessary.
Your mortgage might be $3,000 a month, but the IRS will most likely add $1,500 back to your disposable income if the standard in your area is $1,500.
Pay the IRS with alternative funds
You may find that using an alternative source of payment is better than owing the IRS.
If you can’t afford the minimum payment, you can request a partial payment installment agreement (PPIA). The IRS will want to know the state of your finances, and they may require you to use the equity in assets to help make your payments. This kind of agreement isn’t permanent, and it allows your finances to be reviewed and potentially modified by the IRS every two years.
If you have a home or own real estate, consider using a HELOC to pay your tax debt. Generally, you can access about 85 percent of your home’s equity. That amount may be enough to settle your overdue taxes and get the IRS off your back. HELOCs also feature low-interest rates.
Another option for paying your tax bill is to get a personal loan. Some people find that it’s less stressful to use a personal loan to pay the debt. If you have good credit (700+), you can get a favorable interest rate. Getting a loan with a low-interest rate can be more manageable than an IRS agreement, which compounds interest daily.
It’s normally never recommended adding to your credit card debt, but a balance transfer credit card with a zero percent APR offer might help buy you some time and save you some interest.
Consider an offer in compromise
An offer in compromise (OIC) enables you to settle your tax liability for less than the total amount owed. This route may work if you can show that paying off the entire bill would create a true financial hardship.
An OIC is more permanent than a partial payment installment agreement (PPIA) once you and the IRS agree on how much you’re going to pay and settle the matter, regardless of what happens in the future.
However, it’s much harder to be approved for an OIC, making it less appealing to some people. You may still want to try if you think it would work for you.
The IRS settles for the total amount they think they can collect from each taxpayer. To determine if you qualify for an OIC, the IRS looks at several factors, including your ability to pay, income, expenses, and asset equity.
Taxpayers aren’t eligible for an OIC if they’re in the middle of a bankruptcy proceeding. You must also have filed all required tax returns, made all estimated tax payments for the current year, and all required federal tax deposits for the current quarter.
You can see if you qualify for an OIC here.
The Fresh Start Initiative, introduced in 2012, made the restrictions for an offer in compromise eligibility more flexible. Thanks to the initiative, you now have a better chance of getting an offer in compromise.
Nevertheless, an offer in compromise isn’t an answer for everyone. The IRS determines if you have a good reason for not paying such as lack of funds or serious illness. The IRS only accepts about 40 percent of the offers and will thoroughly check the information you submit.
To determine whether you qualify for tax relief via an offer in compromise, the IRS considers your ability to pay, your income and expenses, and how much you have in assets.
Applying for an offer in compromise
The materials and instructions for submitting an offer in compromise are in Form 656-B. Here are a few things to know:
- There’s a $205 fee, and it’s nonrefundable (low-income taxpayers can get a waiver).
- You’ll also need to make an initial payment, and it’s nonrefundable as well.
- You have to be current on all your tax returns. If you haven’t filed a tax return in a while, you may not qualify.
- The IRS can file or keep tax liens in place until it accepts your offer and you’ve fulfilled your end of the deal.
- You don’t qualify if you are in an open bankruptcy proceeding.
- You can hire a qualified tax professional to help you do the paperwork, but it’s not required.
- Once you file your application, the IRS suspends collection activities.
If the IRS accepts your offer
- Your initial payment has to be either 20 percent of what you’re offering to pay (if you’re paying in five or fewer installments) or your first monthly installment (if you’re paying in six or more monthly installments).
- Be aware that some of the information about your offer in compromise could be made public. The IRS public inspection files on offers in compromise include the taxpayer’s name, city, state, ZIP code, liability amount, and offer terms.
- Any federal tax liens the IRS has filed against you don’t go away until you’ve fulfilled your end of the deal.
If the IRS rejects your offer, you can appeal within 30 days. The agency has an online self-help tool to walk you through that.
If you’ve been a compliant taxpayer until now, a first-time abatement (FTA) can save you from your first penalty for not filing for a tax season, not paying on time, or not depositing your money correctly (and these penalties can be steep). Though it won’t completely clear up your tax debt, you may qualify for a reduction in penalties. Just remember that you’ll need to show proof of the following:
- You’ve filed all your returns.
- You’ve never paid the penalty before.
- You’ve paid all your taxes or you have a plan in place to do so.
You must prove that you weren’t able to pay your taxes on time because of circumstances beyond your control. If any penalties are reduced, that will also reduce related interest expenses.
Reasonable cause penalty abatement
A penalty abatement for a reasonable cause can help if you’re experiencing a specific type of difficulty. With this kind of abatement, the IRS might agree to remove a tax penalty if you can show that you had a good reason for earning that penalty. For example:
- You couldn’t access records, and that stopped you from being able to file.
- A natural disaster made it impossible for you to pay what you owed.
If your situation sounds similar to any of these, you might want to talk to a tax adviser to determine if you qualify for penalty abatement.
Defer tax payment
When you can’t pay off any part of your tax debt, you can ask the IRS to delay collection temporarily. The debt doesn’t disappear; it will increase due to penalties and interest. And when your financial situation is better, you’ll need to make payments. But a deferment might be enough to get you back on your feet before you handle your tax debt.
Before approving your request to delay collection, IRS may ask you to complete a Collection Information Statement (Form 433-F PDF, Form 433-A PDF, or Form 433-B PDF) and provide proof of your financial status. This may include information about your assets and your monthly income and expenses. During this temporary delay, the IRS will again review your ability to pay. The IRS may also file a Notice of Federal Tax Lien to protect the government’s interest in your assets.
File for bankruptcy
For income taxes to be discharged in bankruptcy:
- The taxes must have been due more than three years before filing bankruptcy.
- You must have filed your return more than two years before filing bankruptcy.
- The taxes must have been assessed at least 240 days prior to filing bankruptcy.
Note that all of these elements must be satisfied.
Think carefully before filing for bankruptcy to get tax debt forgiveness. The negative consequences of bankruptcy are many including significantly lowering your credit score.
If your tax debt is several years old, it makes more sense not to file bankruptcy. Generally, there is a 10-year statute of limitations on debt collections. That means you get tax debt forgiveness after 10 years.
Do I need a tax relief company?
Still feeling a little lost on what path might be best for you? Consider hiring a tax relief company to help you figure out the best way to deal with your tax debt.
If you’re facing tax debt that you can’t afford to pay off and you’re wondering how to negotiate with the IRS, it’s time to call a tax expert.
Quality tax relief companies have experts who will ensure you pay the least amount necessary. The best firms have dedicated tax relief professionals assigned to your case. Tax relief professionals are experts and fiduciaries — financial experts with legal obligations to act in your best interests.
Says Aki-Sanford, “Unless you’re knowledgeable about the tax code, it’s probably better to get professional help with tax. It’s really like speaking another language. The IRS is slow, but when they move, they tend to move quickly.”
Julie Bawden-Davis is a widely published journalist specializing in personal finance and small business. She has written 10 books and more than 2,500 articles for a wide variety of national and international publications, including Parade.com, where she has a weekly column. In addition to contributing to SuperMoney, her work has appeared in publications such as American Express OPEN Forum, The Hartford and Forbes.