IRS & Refunds

what if I owe taxes?

I Owe the IRS. What’s Next?

April 11, 2016 : Mike Slack - The Tax Institute

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Monday-Mishap_finalWhat happens if you owe the IRS back taxes?

If you will owe taxes to the IRS and can’t pay the balance, this is the most important thing: you should still file your tax return. If your tax return will not be ready before Tax Day, deadline you should at least file for an automatic six-month extension.

The reason why it is important to complete one of these steps is that you want to avoid the failure to file penalty. The penalty is equal to 5% of the unpaid balance, per month or part of a month, up to a maximum of 25% of unpaid tax

(Note: The 5% per month penalty increases to 15% per month if the failure to file is due to fraud. For returns filed more than 60 days after the due date or extended due date the minimum penalty is equal to the lesser of $205 or 100% of the unpaid tax.)

If you can’t afford to pay the amount of taxes that you owe for 2015, you should know your options. Some of the options include a short-term extension and an installment agreement, among other things. It’s important to come up with a plan. Otherwise, you may be hit with significant penalties and interest accruals over time.

1. Installment Agreement with the IRS

Use the Online Payment Agreement (OPA) or Form 9465 for mailed-in application.

Online installment agreements are available to taxpayers who owe $50,000 or less in combined tax, penalties, and interest. If you owe more than $50,000, you will need to mail in your application and have it approved by the IRS. Installment agreement repayment period is up to 72 months. Installment agreement should not be set up if balance can be paid within 120 days (see item #5 below).

Fees or Cost Taxpayer Action Required Advantages or Disadvantages
Application fee of $120, or $52 if payments are made electronically. $43 for low income taxpayer. Complete an online payment agreement (OPA) or Form 9465 if balance due not more than $50,000. Application is accepted automatically if balance due is no more than $10,000, returns for past 5 years have been timely filed, IRS determines that taxpayer cannot pay tax owed when due, and taxpayer agrees to pay full amount within three years.
Penalty on unpaid balance of 0.25% per month until fully paid if payments are made on schedule (a reduction from the 0.5% per month “failure to pay” penalty rate without an installment agreement). Form(s) and Form 433-A or Form 433-F required if balance exceeds $50,000 Payroll deductions may be used for payments (Form 2159, Payroll Deduction Agreement)
Interest at short term federal rate plus 3% (interest may change each quarter). To apply for lower application fee, submit Form 13844. No financial statements needed for installment agreements of $50,000 or less. Generally, IRS can void agreement if payments are not made on schedule; however IRS will show leniency during financial hardship period such as unemployment.
Small business Direct Debit Installment Agreement available to taxpayers who file either as an individual or as a business.

2. File an extension

File an “extension to file” with Form 4868 by April 18, 2016, and pay balance due by the extension due date of October 17, 2016. Note that 90% of tax liability must have been paid by April 15 to avoid late payment penalty.

Fees or Cost Taxpayer Action Required Advantages or Disadvantages
No late payment penalty if 90% of tax liability was paid by April 18, 2016 Make sure at least 90% of tax liability paid by April 18, 2016, either through withholding or estimated tax payments. Relatively easy and convenient. Can file return any time until extended due date (October 17, 2016)
Interest applies until the balance is fully paid. Interest is short term federal rate plus 3% (interest may change each quarter). See IR-2013-96 for 1st quarter 2016 rates. File Form 4868 Avoids late filing penalty. However, 90% of tax liability must have been paid by April 18, 2016, to avoid late payment penalty (therefore, tax liability must be calculated by that date).
Must file return, or an extension to file, by April 18, 2016. See failure to file and pay penalties. File income tax return by October 17, 2016 Interest rate applies.

3. Apply for hardship extension  to pay tax due

Fees or Cost Taxpayer Action Required Advantages or Disadvantages
No penalties, but interest calculated at short term federal rate plus 3% (interest may change each quarter) File IRS Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship There's no cost to apply, but it can be filed only if payment of tax would cause financial hardship. Taxpayer must include statement of assets and liabilities.

4. Short-term extension

This provides up to 120 days to pay the balance due.

Fees or Cost Taxpayer Action Required Advantages or Disadvantages
No fee. Penalty of 0.5% per month on unpaid balance. Call IRS (1-800-829-1040) Convenient for taxpayers who need a short time to pay balance due
Interest at short term federal rate plus 3% (interest may change each quarter) Taxpayer avoids installment payment application fee (see #1) but does not avoid late payment penalty and interest.

5. Personal loan

You could ask a personal contact – maybe a friend or family member – to loan you the money. Fees and cost will vary widely depending on the source. This could be an inexpensive option, but use your best judgement.

6. Borrow from 401(k)

If your 401(k) plan allows for this, you can borrow money from it. Generally, it is limited to 50% with $50,000 maximum and must be repaid within five years.

Fees or Cost Taxpayer Action Required Advantages or Disadvantages
Possible minimal fee but plan must charge interest Check with plan administrator If plan allows, a loan could be a ready and inexpensive source of cash
Negative impact on future retirement savings if loan not repaid
The loan is treated as taxable distribution if taxpayer leaves company or plan terminates.

7. Online debit/credit card

Various service providers are available for this option. Check with the IRS for a list.

Fees or Cost Taxpayer Action Required Advantages or Disadvantages
Varies Contact IRS Convenient; gives taxpayer greater control and flexibility for making payments
Approximately $2.49 to $3.95 (debit card) or 1.87% to 2.35% of tax balance due (credit card)
Credit card: 888-872-9829 or 888-729-1040 Taxpayer may earn points, miles, or other credit card rewards
Debit card: 866-472-9829 Credit card fees to pay balance due are deductible as itemized deductions (subject to 2% of AGI)
Higher credit card balance could negatively impact credit score; may not be appropriate for taxpayer who already has unmanageable credit card debt

Hopefully this post offered more insight into what happens if you owe the IRS. You definitely don’t want the extreme to happen: heading to jail due to tax evasion.

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Mike Slack - The Tax Institute

Mike Slack - The Tax Institute

The Tax Institute

Mike Slack, JD, EA, is a senior tax research analyst at The Tax Institute. Mike leads research teams focused on business and investment tax issues.

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