Not many things in life can be more stressful than owing money to the IRS, particularly if you can't easily lay your hands on it. 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.
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% of what you owe per month. It can add up eventually, and the agency will eventually run out of patience and take more serious measures, imposing levies and liens on your income and property.
Let's say you owe the IRS $30,000 for your last two years' tax returns. You consider going back and amending one or both of them to take advantage of any tax deductions you might 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 tax debt by amending your returns, but the interest and penalties assessed by the IRS 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.
Consider an Installment Agreement
In March 2020, the IRS eliminated its Expanded Installment Agreement program. In its place, however, the agency unveiled a non-streamlined installment agreement (NSIA). The NSIA allows taxpayers who owe between $50,000 and $250,000 to pay the balance owed before the collection statute expires, which is generally up to 120 months if the balance owed is for a current year. If you can’t afford the minimum payments, you can try selling assets to have cash ready, or asking for a deferment or requesting an offer in compromise from the IRS.
"Streamlined" simply means that the IRS won't investigate your current financial situation, and you'll have fewer forms to fill out.
You would qualify for a streamlined agreement in our example if you owed $30,000. You would have qualified for a guaranteed installment agreement if you owed less than $10,000.
The streamlined 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.
It's generally advisable to set up your installment agreement for the minimum amount the IRS will accept, then you can pay extra whenever you can. You're not limited to your minimum payment. You can pay more voluntarily.
What If You Can't Afford the Minimum?
You'll have to contact the IRS to work out a different payment arrangement if you simply 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 tax debt 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 a credit card or home equity loan to pay the IRS?
- How much money do you have left over each month after you pay your necessary living expenses?
Your leftover income after paying necessary living expenses 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 income 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 left over each month after paying your necessary living expenses. Suppose you earn $4,600 per month. You must spend $4,350 of that on living expenses. You have $250 left over 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 IRS Form 433-A or Form 433-F to help you make these calculations, but here's where it gets tricky because the IRS might not allow all your expenses. It can disregard certain spending because an expense isn't necessary, or because it's 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.
According to the IRS, necessary expenses are those that provide for a taxpayer's health, welfare, and/or 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
Collection Financial Standards
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.
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.
You Might Have Other Options
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 some ready cash to pay to the IRS
- Taking out a loan or using credit cards to pay the IRS
- Requesting an offer in compromise—a proposal to pay the IRS less than the full amount due
- Asking for a deferment where the IRS would agree that you don't have to make payments until your financial situation improves
The right answer is sometimes a mix of these options.