What If You Can't Pay Your Taxes?

You have options but file your return even if you can't pay your taxes.

What should you do if you can’t pay the income taxes you owe? You have several options.

File your Tax Return

First and foremost, even if you can’t pay, you should file your tax return on time. The penalties for not filing a return are severe: 5% per month on the amount you owe, to a maximum of 25% reached after five months. This is in addition to the interest the IRS charges for paying your taxes late. Filing your return--even if you can’t pay what you owe--will at least avoid this penalty.

Borrow the Money

The interest rate on a loan or credit card may be lower than the combination of penalties and interest imposed by the IRS. As a result, it could be cheaper to borrow money or use your credit card to pay what you owe. You could try borrowing the money from a friend or relative, obtain a personal loan from a bank, or take out a home equity loan (assuming you have a home with equity). Using credit cards to pay should be a last resort since the interest is usually high.

If you can’t get together enough money to pay all you owe, at least make a partial payment. The penalty for not paying your taxes on time, even though you filed a return, is smaller than that for not filing at all, but it’s still not negligible. The IRS will charge you 0.5% per month on the amount you owe, to a maximum of 25% reached after fifty months. You’ll avoid at least a part of this penalty by making a partial payment when you file.

Request an Installment Agreement

Consider asking the IRS to permit you to pay what you owe over time in installments. If you owe $50,000 or less in combined taxes, penalties, and interest, you should be able to get an installment payment plan for up to 72 months just by asking for it. You can apply online at the IRS website. However, if IRS computers show that you haven't filed all past due tax returns, you will not be eligible for an installment plan. Likewise, if you are self-employed, you must be current on your quarterly estimated tax payments for the current year.

If you owe more than $50,000, you will have to negotiate with the IRS to get an installment plan. You may also have to submit a financial statement.

Unfortunately, interest and penalties continue to accrue on your unpaid balance while you make your installment payments.

Seek an Undue Hardship Extension

You can get an extra six months to pay the amount you owe by obtaining an undue hardship extension from the IRS. During this time the IRS won’t charge you any penalties, but you’ll still have to pay interest on the amount you owe.

You can get this extension only if you convince the IRS that paying your taxes on time will result in “undue hardship.” Undue hardship means more than an inconvenience. You must show that you will have a substantial financial loss--for example, you’ll have to sell property at a sacrifice price.

If you have assets, you’ll be required to provide security for your tax debt--for example, a bond, deed of trust, notice of lien, or personal guarantee.

To obtain a hardship extension, you must file IRS Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship, and provide detailed financial information.

Make an Offer In Compromise

If you have already filed your return, but are unable to pay your taxes, you have another option: making an offer-in-compromise (OIC). The IRS, like most creditors, would rather get something than nothing. With an OIC, you may be able to convince the IRS to wipe our your entire tax debt if you pay a part of what you owe. Generally, an OIC won't be accepted if the IRS believes you can pay the liability in full or through a payment agreement. 

The IRS will accept your OIC only if you convince it that:

  • you aren't able to pay the full amount,
  • there is doubt as to the amount of your tax liability (unusual), or
  • due to exceptional circumstances, payment in full would cause an "economic hardship" or be "unfair" or "inequitable”-- for example, you can’t work due to health problems, or you’d be left with no money to pay your basic living expenses if you sold your assets to pay your tax bill in full.

The amount of your offer must be equal to the "realizable value" of your assets plus the amount of money the IRS could take from your future income. For example, if your assets are worth $20,000 and the amount of your future income that's available to the IRS is $10,000, your minimum offer must be $30,000 multiplied by 12 or 24, depending on the repayment period you choose (five months or two years). You must follow the instructions on Form 656, Offer in Compromise, to show how you arrived at your minimum offer amount. Under its 2012 Fresh Start program, the IRS relaxed the standards for OICs and the acceptance rate has gone up to 40% from the 25% to 30% range where it had been in prior years.

To begin the OIC process, you must file IRS Form 656, Offer in Compromise and pay a $186 application fee. You must also make detailed disclosures about your finances on IRS Form 433-A, Collection Information Statement. See the IRS Form 656 Booklet and the IRS website for details.

 

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