If you find yourself with a tax bill you can’t pay on time, your mind may be reeling with the worst-case scenarios. While it is important to confront the problem head-on, you don’t need to stress too much. In recent years, the IRS has become more flexible with delinquent taxpayers as long as they are making efforts to settle the debt (source). Here, we will take a closer look at what you need to know about tax debt.
What is tax debt?
Tax debt occurs when a taxpayer does not pay their full tax liability by the due date (April 15th for most people). According to the latest estimates, the gross average tax gap in the U.S. is $441 billion (source). That is a lot of money. Particularly when you compare it to the federal deficit. If the tax debt estimate is accurate, the federal government could have cut its deficit by 45% if taxpayers had paid their taxes. About 84% of taxes are paid voluntarily and on-time, while the remaining 16% become tax debt.
What happens when you have an overdue tax debt?
If you have a tax debt that is past due, the IRS will demand payment and begin to charge interest and penalties on the past due amount.
- Late penalties: Late payment penalties are generally 0.5% per month until the full amount is paid, with no cap.
- Interest: Interest compounds daily on the tax debt from the original due date until the date it’s paid in full. The IRS publishes the interest rate every three months which is equal to the federal short-term interest rate plus 3%.
If you believe you have a valid reason for not paying taxes, you can request an abatement of penalty and the IRS may reduce the penalties you owe. However, they will not reduce or remove the interest accrued. In addition to assessing penalties and interest, the IRS will also make collection attempts.
The IRS tax debt collection process
Not paying your taxes on time begins the collection process and it doesn’t end until your account is settled. The IRS communicates its intentions through letters. The first letter you will receive will explain how much is due and will demand full payment. If you can’t pay in full, you may be able to work out another payment arrangement with the IRS. If no arrangement is made, the IRS can take collection actions including:
- Serving a notice of levy which allows the seizure of property, refunds, wages, bank accounts, retirement income, and/or social security benefits.
- Filing a notice of federal tax lien which is a legal claim to your property or any property you may acquire in the future.
The good news is the IRS has increased its efforts to offer taxpayers tax relief programs. As the graphs above show, this has reduced the need for resorting to levies and liens. If you owe taxes, it’s best to contact the IRS and work out a plan to prevent the seizure of your property and/or money. What kind of arrangements are available?
IRS tax relief programs
The IRS offers various tax relief programs. Here are the main options:
Installment plans enable you to pay your balance over time through monthly payments. There are two categories of plans; short and long-term. If you can pay off your balance in less than 120 days, opt for a short-term payment plan as it’s free. Otherwise, a long-term plan will be better which will cost between $43 and $105 to set up.
If you choose a long-term installment plan, the amount you owe will impact it as follows:
$0 – $10,000
Installment plans for balances under $10,000 are usually automatically approved. As long as you agree to pay off your balance within three years, you can choose your payment amount (no minimum requirements).
For balances between $10,001 and $25,000, you can qualify for a streamlined installment plan which usually doesn’t require you to submit additional financial information. This plan gives you 72 months to pay and has a minimum payment requirement of your balance divided by 72.
Plans for balances between $25,001 and $50,000 require you to submit Form 9465-FS which asks for information on your income and expenses. Again, the minimum payment must be equal to your balance divided by 72.
Balances over $50,000 require a detailed review of your situation. The IRS will request information about your bank accounts, income, investments, and assets. You may have to liquidate assets to pay down your balance and the minimum payment will be unique to your situation.
Installment agreements can stop collection attempts by the IRS, however, interest charges and penalties will continue to accrue until the debt is paid in full. Setup fees may also apply. Many taxpayers will be able to apply for an installment plan online and most can get approved. In fact, as of January 2018, 90% of people who owe tax debt qualify for an installment plan.
Offer in compromise (OIC)
An accepted offer in compromise (OIC) is an agreement with the IRS which allows you to settle your tax liability for less than the full amount due. There are three types of OICs:
- Doubt as to liability because of an examination issue.
- Doubt as to collectibility which is the most common.
- Promotion of effective tax administration, which only happens under special circumstances.
The OIC must be equal to or more than the reasonable collection potential (RCP). RCP is evaluated by looking at a taxpayer’s assets, future income, and basic living expenses. In 2017, about 40% of OICs were accepted. To qualify, you must have filed all required returns and made all estimated tax payments for the current year.
Currently not collectible (CNC) status
Currently not collectible (CNC) status is a determination made by the IRS when a taxpayer’s situation does not allow them to qualify for a payment plan. This gives them time to get their finances in order without the stress of further IRS collections efforts. However, qualifying does require a complex application process. This is an often-overlooked solution as, in 2016, 300,000 taxpayers who could’ve qualified for CNC status, signed up for installment agreements.
These tax relief programs tend to be a win-win for the IRS and taxpayers.
Between 2004 and 2014, the amount of tax debt collected through the use of levies and liens decreased by 45% and 51%, respectively. However, the amount collected through installment agreements increased by 25%, through notices by 33%, and through refund offsets by 6%.
Overall, the IRS saw the total collection yield increase by 14% which showed that these tax relief programs are improving the IRS’s ability to collect on tax debt. Conveniently, they also provide taxpayers with a less stressful way to settle their accounts. It’s important to know all of your tax relief options to ensure you find the best solution for your unique situation.
Tax debt: Frequently asked questions
Does the IRS settle tax debt? How can I get my tax debt forgiven?
The IRS does settle tax debt but only in circumstances when you can prove you don’t have the money or assets to pay, and won’t have them for the foreseeable future. The process to pursue a settlement is explained above under offer in compromise.
Is there a statute of limitations on tax debt?
There is a ten-year statute of limitations on IRS collections. The period begins when taxes are assessed and you receive a demand for payment. After the ten years, the IRS can no longer attempt to collect that debt.
However, there are circumstances under which the period can be extended. Some examples include if you request to extend it, if the IRS is legally barred from collecting from you for a period of time during those ten years, or due to certain installment agreements.
Does overdue tax hurt your credit?
Tax debt does not show up on your credit report. If you are late on payments, it will not be reported by the credit bureaus. But what if your debt results in a tax lien?
As of 2018, all tax liens were removed from credit reports by the three main credit bureaus (Experian, TransUnion, and Equifax) and are no longer reported.
What if you owe taxes and don’t file your return?
If you owe taxes and don’t file your return, the IRS can file a substitute return for you. When it does so, it will not factor in any credits or deductions you may qualify for. That means you will probably owe way more than you should. Plus, you will be charged a late filing penalty equal to 5% of the tax due for each month you are late, up to 25%.
Once your tax liability is determined, you will receive an IRS notice demanding payment. If a full payment or payment arrangement is not made, collection proceedings will follow. Note, if the IRS files a return for you, you can still file your own tax return after the fact. It is usually best to do so with the help of a tax professional.
Get expert help to settle your tax debt
If you are facing tax debt, it’s a good idea to speak with a tax relief professional. Tax laws are complicated and most people are at a great disadvantage when facing the IRS alone. Any advice or information you get from the IRS is likely to be biased as its number one goal is to recover the tax debt as soon as possible.
A trained professional can inform you of all of the options available and advise you which one best suits your situation. That way you can settle the debt and move on with minimal disruptions to your daily life. Below, find a curated list of industry-leading tax relief firms, complete with real-user reviews. Compare them side-by-side to find the right fit for your needs.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.