How to Get Out of Tax Debt

The IRS is usually willing to work with you

young man paying bills at table
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Few things in life can be more stressful than owing money to the Internal Revenue Service (IRS). This becomes extra hard to deal with if your tax bill is more than the cash you have on hand. Fortunately, you have a few options to pay off your tax debt, depending on your personal situation. The IRS offers a variety of payment options.

Key Takeaways

  • File and pay on time whenever possible to avoid having penalties and interest added to your tax debt.
  • You can apply for an installment agreement or short-term payment plan if you cannot pay your tax bill all at once.
  • An installment agreement with the IRS will require you to make minimum monthly payments until your tax debt is fully paid.
  • If you cannot make your monthly payments, you may be able to request an offer in compromise or a deferment until a later date.

Address Your Tax Situation on Time

Tax debt can quickly get out of hand if you put off dealing with it. If you fail to pay on time, the IRS will tack on penalties and interest to your outstanding balance. The monthly interest is equal to the federal short-term rate plus 3%. The monthly penalty for not paying on time begins at 0.5% of your tax debt. Other penalties can be added at an even higher rate, especially if you also fail to file your taxes at all.

These amounts can add up quickly, adding a large extra burden onto the taxes you already owe. If you leave your taxes unpaid for too long, the IRS can impose levies and liens on your income and property.

Set Up an Installment Agreement

If you owe less than $50,000 in taxes, you can contact the IRS to set up an installment agreement. This allows you to make monthly payments until your taxes are paid without accruing extra penalties. An installment agreement can give you up to 72 months to pay your tax debt. Set-up costs are associated with a payment plan, though these are often waived for low-income taxpayers.

The IRS may explore other options before approving your installment agreement, such as selling or borrowing against other assets. But if you owe less than $10,000 and have not failed to pay your taxes in a previous year, you can often qualify for a guaranteed installment agreement. If you owe a little more than you can pay, you can also set up a short-term payment plan. This gives you 180 days to pay your taxes.

If you set up either an installment agreement or a short-term payment plan, you will still have to pay monthly interest until the debt is paid in full. But you will have fewer penalties added to your total. You will also owe less in interest than you otherwise would because you will be paying off part of the balance every month.

Making Minimum Payments

The installment agreement depends upon you being able to pay a minimum monthly payment equal to your total tax debt divided by 72 months. You can always pay more in a given month, but you can never pay less than the amount you agree to. The IRS will send you a notice each month with the payment you owe, as well as the date it is due. You can also set up a direct debit from a bank account, in which case the amount will be deducted automatically, and you won't receive a notice.

Set up your installment agreement for the minimum amount the IRS will accept. Then, if you have extra, you can always pay more some months and resolve your tax debt more quickly.

If you can't afford to pay the minimum, you'll have to contact the IRS to work out a different payment arrangement. You must submit Form 9465 rather than apply online. The IRS will look into your finances to make a decision about whether to modify your agreement, including:

  • How much money could you come up with to pay your tax debt if you were to sell your assets?
  • Do you have available credit?
  • Could you borrow money through a credit card or home equity loan to pay the IRS?
  • How much money do you have each month after paying your necessary living expenses?

Your leftover income after paying necessary living expenses is how much the IRS will expect you to pay every month. You can complete IRS Form 433-A or Form 433-F to make these calculations, but the IRS might not allow all your expenses. It can disregard an expense that is unnecessary or higher than average.

According to the IRS, necessary expenses are those that provide for a taxpayer's health, welfare, and production of income, and that of their families. They include:

  • Food, groceries, clothing, housekeeping, and personal care items
  • Housing and utilities, including rent, mortgage payments, property taxes, 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 can be shown to be necessary for health, welfare, or the production of income

The IRS will review your financial documents, including bank statements, pay stubs, and other documents, to verify your income and spending if you can't commit to paying your entire balance off in 72 months.

Determining Collection Financial Standards

Your leftover income after paying necessary living expenses is how much the IRS will expect you to pay every month. You can complete IRS Form 433-A or Form 433-F to make these calculations, but the IRS might not allow all your expenses. It can disregard an expense that is unnecessary or higher than average.

The IRS will compare your actual spending to averages that vary by region to take into account that some areas have higher costs of living 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 the collection financial standards. Anything over and above that amount is considered to be discretionary rather than necessary.

For example, your mortgage might be $3,000 a month. But if the standard in your area is only $1,500, the IRS will most likely add $1,500 back to its calculation of your monthly disposable income.

Other Options for Paying Your Tax Debt

You might have a few other options if the IRS isn't willing to accept the amount you think you can comfortably pay. You might want to consider:

  • Selling assets to generate cash for tax payments.
  • Requesting an offer in compromise, a proposal to pay the IRS less than the full amount due.
  • Asking for a deferment so that you don't have to make payments until your financial situation improves.

The right answer is sometimes a mix of these options. In many cases, if you request an installment agreement from the IRS, the tax officer assigned to your account will go through these options with you.

Article Sources

  1. Internal Revenue Service. "Quarterly Interest Rates for Underpayment and Overpayment of Tax."

  2. Internal Revenue Service. "Failure to Pay Penalty."

  3. Internal Revenue Service. "Penalties."

  4. Internal Revenue Service. "Additional Information of Payment Plans."

  5. Internal Revenue Service. "5.14.5 Streamlined, Guaranteed and In-Business Trust Fund Express Installment Agreements."

  6. Internal Revenue Service. "Instructions for Form 9465 (10/2020)."

  7. Internal Revenue Service. "Collection Financial Standards."