For taxpayers who owe more in taxes than they are currently able to pay, the IRS does allow you to enter into a tax payment plan. You might even think of this as a loan (with applicable penalties and interest). However, unlike other lenders, the IRS requires you to come up with the terms on how you intend to repay the outstanding balance. The IRS then decides if those terms are acceptable or not.
Basically, you can apply for a payment plan, either online, over the phone, in person at an IRS walk-in office, or by submitting Form 9465-Installment Agreement Request. However you initiate your request, you submit the terms that you believe are acceptable, and the IRS either approves or declines those terms. If your request is approved, the IRS will give you guidance on how to set up the payment plan. If your request is rejected, then you can either start over with a new request or by submitting an appeal.
There are a couple of risks involved with a taxpayer-initiated tax payment plan. Because the IRS forces you to make the first move, odds are that you will do one of two things:
You might underestimate the payment schedule that the IRS is willing to accept. In other words, you might not offer enough, which will force you to either appeal or try again. This keeps the interest and penalty clocks ticking on your outstanding balances. While first-timers might be able to abate the penalties, the interest keeps on accruing. Plus, you have to start the process over, which is frustrating in itself.
You overestimate the payment schedule. In other words, you might offer way more than the minimum that the IRS would be willing to accept. This might be preferred in some situations, particularly if you have the resources and want to put this behind you as quickly as possible. However, if you’re already financially strapped, you might not want to (or be able to) commit yourself to the payment schedule that you submit.
Given those two risks, you might say that the ‘sweet spot’ is to come up with a plan that satisfies the IRS requirements while allowing you to abide by the terms that you created. Don’t look to the IRS to help you in this department. Generally speaking, the IRS will likely discuss options that favor heavy down payments, larger monthly payments, and accelerated payment schedules. After all, they are a creditor, and they want you to pay them back.
Because there are so many factors that dictate what this ‘sweet spot’ might look like for different taxpayers (or whether such a ‘sweet spot’ even exists in some situations), this article won’t attempt to solve this problem.
Instead, below are 9 questions that you might consider when trying to figure this out.
Have I filed all of my required tax returns yet?
If the answer is no, then the IRS will not consider your payment plan request.
However, there is a point I’d like to illuminate. This applies to for people who owe back taxes and are facing their tax filing deadline, where they know that they’ll owe even more. They can do one of three things:
They can avoid filing. This is the option that it seems most people do. It’s also the option that is probably least desirable.
Where is this in the collections process?
This is probably the key determining factor in figuring out what your options are. If you just missed the most recent tax filing deadline, and are only dealing with that year’s tax bill, then you’re probably in a different category from someone who has multiple years of back taxes. The second person might have received notices, and might be going through the IRS’ Collections Process, whether they realize it or not.
To understand where you might be in that collections process, Publication 592-The IRS Collection Process, is a good place to start.
What is the outstanding balance?
Once you understand where your taxes are in the collections process, the next thing you’ll want to understand is how much your outstanding balance is. For purposes of setting up an installment plan, your outstanding balance consists of:
Your actual taxes. This could be for one tax year, or it could be for multiple tax years.
Accrued penalties. These can be one-time penalties (such as an early withdrawal from a retirement plan) or penalties that accrue over time (like late filing penalties, which accrue an additional 5% per month up to a maximum of 25% of the outstanding balance).
Accrued interest. This is interest that accrues on top of taxes, penalties and interest. This accumulates daily.
Since your interest accumulates daily, that means your balance changes daily. The IRS allows you to set up an online account on their website so you can view the most recent changes to your account balance. If you don’t want to do this, you can get the same information by calling the IRS or visiting their office.
Generally speaking, the lower your balance, the more options you have. To that end, the IRS has certain ‘tripwires’ for people establishing a payment plan. For example, individual taxpayers (meaning, not businesses) can set up their payment plan online. Here are the options:
If you want to pay in full, it doesn’t matter how much you owe. This probably is not a feasible option if you’re interested in setting up a payment plan.
If you want to set up a short-term payment plan (paying your balance in 120 days or less), then your balance has to be less than $100,000.
If you want to set up a long-term payment plan (more than 120 days), then you must have a balance of $50,000 or less.
Other tripwires include:
For individuals, balances over $25,000 must be paid by direct debit. Balances under $25,000 can be paid by credit or debit card (fees apply). For businesses, this amount is $10,000.
If you want to avoid a lien on your home, your balance must be less than $50,000. If there is already a lien on your home, your balance must be $25,000 or less in order for the IRS to withdraw the lien.
Many local IRS offices cannot work with taxpayers who owe more than $100,000. Balances above that threshold are often referred to a centralized collections process. While this doesn’t affect your tax liability, it does require a lot more phone calls (and waiting on hold), than being able to sit with your local IRS office. If you’re the kind of person who’d rather make an in-person appointment, you might not have that option if your balance is above this threshold.
Understanding your current balance (and what it could be, if you put a down payment) will help you understand what flexibility you might have in your payment plan.
What is my desired time horizon?
In order to answer this question, you’re going to have to have a handle on two things:
How comfortable you are owing the IRS for a period of time, knowing that penalties and interest may continue to accrue until your balance is paid off.
Do you need (or want) the longest possible payoff schedule?
If you want to (and can afford to) pay off the IRS as soon as possible, then you have a lot of options. For example, if you owe six figures of tax debt, but have a high income, you might be able to pay off the total balance in 120 days or less. If that’s the case, then a short-term payment plan would make sense. In most instances, you could probably set it up online, make a down payment to get your total balance under $100,000, then set up auto-debits for the remaining balance.
Or you might decide that you want to carry this like a normal loan. In that case, it might make sense to pay your balance down to $50,000 (the maximum amount you can still carry while initiating a long term payment plan), then propose monthly payments over a 48, 60, or even a 72 month period. A 72-month payment schedule is the longest payment schedule that I’ve seen under the IRS’ ‘streamlined process.’ However, the IRS has experimented with allowing certain taxpayers to submit plans to pay off balances as high as $100,000 over an 84-month period (subject to any applicable statutes of limitations on IRS collections).
Conversely, your focus might be on keeping monthly payments as low as possible. Depending on your balance, you might need to have a payment schedule that goes beyond a 72-month payoff period. In that case, you might not have much success applying online—you’d probably be better off trying to make an appointment or calling the IRS directly.
How much money do you need to (or can you afford to) put down?
This depends directly on the above factors. In other words, if you have a certain target balance (like $25,000 in order to be able to use direct debit and avoid high credit card fees), then you’ll need to put down the difference between your current balance and your target. You can make a direct payment to the IRS at any time before you submit a payment plan request.
Perhaps you only have a certain amount of money that you can afford to put down. In that case, you might need to see what options are available based on what you can pay up front.
What financing options do I have available?
Other than the IRS (who is essentially financing your delayed tax payments), what other options do you have? For example, you might be able to borrow against equity in your home. In fact, the IRS’ websites even state that taxpayers should consider paying their tax liability through loans or credit cards. The website goes on to say that the interest rate and applicable fees charged by your bank or credit card company might be lower than the combination of interest and penalties set by the Internal Revenue Code.
Of course, the IRS will highly emphasize any plan that involves getting them paid in full. Whether that’s in your best interest…that depends on what’s available to you. Some other ‘options’ out there (in no particular order) include:
Asking friends and family
Microlending-borrowing from sites like Lending Club or Prosper
Taking a second job, or doing a side gig
Borrowing from an employer-sponsored retirement plan, like a 401(k).
Withdrawing from an IRA or Roth IRA
While this list is not inclusive, it does consider many options that you might not consider in normal circumstances. But then, if the decision is between selling some stock or facing an IRS seizure on your primary residence, you might have to resort to some unconventional financing options.
Whatever your choice, you should evaluate your options thoroughly. If your options include borrowing, then you’ll want to compare interest rates & fees to what the IRS will charge you.
What are the prevailing interest rates?
As previously mentioned, the IRS charges interest on outstanding taxes, penalties, and interest. This compounds daily on outstanding balances until the balance is paid in full. But how does the IRS calculate which interest rates are charged?
Without going into too much detail, the Internal Revenue Code directs the IRS to calculate the interest rates on outstanding tax debt (as well as money that the IRS owes to taxpayers), as an adjustment to interest rates that the IRS uses for other purposes. This interest rate is known as the federal short-term rate (not to be confused with the federal funds rate, calculated by the Federal Reserve Board).
For individual taxpayers, the interest rate is 3 percentage points higher than the federal short-term rate for both underpayments and overpayments. The IRS updates this interest rate quarterly, in the form of revenue rulings. However, probably the most user-friendly way to quickly access the latest information is to browse the IRS’ Newsroom for the most recent update.
When you compare interest rates, you should also factor in the associated penalties that might apply if you continue to carry an outstanding balance. While you might be able to eventually abate those penalties, the IRS forces you to include the penalties in your payment plan, THEN apply for the abatement after you’ve been approved.
What does my cash flow look like?
Let’s assume that you get a plan in place. If it’s not very sustainable, then you probably won’t be able to see it through. Before you try to commit yourself to a payment plan, you should probably run the numbers against your current finances. This is the time where, if things look doubtful, you might want to start trimming fat from your expenses. Because if you don’t, the IRS definitely will. Then they’ll start cutting away muscle, and down to the bone. More than just skipping your lattes, you may need to look at making serious life changes. That is, if you’re also interested in keeping your credit history as clean as possible.
How can I do this while keeping my credit history as high as possible?
Technically, tax liens do not appear directly on your credit reports any more. In 2017, the three credit bureaus (Experian, TransUnion, and Equifax), eliminated civil judgment records and tax liens from consumer credit history. This is primarily because the Consumer Financial Protection Bureau found many issues with the way this information was being reported.
However, many collection efforts, such as liens, become public record when they are filed. So even though your credit score might not reflect your tax lien, your lender will probably still find it when doing a public records search.
However, just owing taxes does not necessarily damage your credit, any more than owing a balance on your credit card (notwithstanding the impact of high utilization rates on your credit score). The true impact to your credit happens when the IRS starts taking collections actions, if you submit an offer in compromise, or if you have to discharge your debt through bankruptcy. Below are a couple of things to keep in mind:
Offer in compromise (OIC): An OIC is an offer from you, the taxpayer, to the IRS, in which you will pay less money than you owe, in exchange for the IRS wiping the slate clean. You can think of this as a short sale for your taxes, instead of your house. You can find out more about OICs in Form 656-B-Offer in Compromise Booklet.
Lien: After issuing notices, this is usually the first collection effort that would be public information. A lien simply is the government’s legal claim against your property if you’re behind on your taxes. A lien can be placed on your real estate (including your house), personal property, and financial assets. While there are multiple ways to get rid of a lien, if you ask the IRS, the best way is to pay the taxes off in full. The other methods pretty much exist only if it’s in the IRS’ best interest--good luck trying to figure out whether that works in your situation.
Levy: If you think of a lien as a warning, the levy is the next step for the IRS. A levy actually takes property away from you to start paying down your taxes. This could happen to virtually anything worth collecting, from your paycheck to bank accounts, to your real estate and personal property. However, there are limitations, and there is certain property that cannot be seized, such as worker’s compensation, child support payments. A comprehensive list can be found on page 6 of Publication 594-The IRS Collection Process.
However, there are MANY things that can be levied, that you wouldn’t think of. Federal & state tax refunds—forget about them.
Bankruptcy: Despite what you may think, it is possible to discharge some types of tax-related debt through bankruptcy. In most cases, this should probably be considered as a last resort. However, if this is a possible option, you should probably review your rights under Publication 908-Bankruptcy Tax Guide, and consult a bankruptcy attorney in your state.
Hopefully, if you owe back taxes, you’re in a position where you can pay them off quickly. However, if you owe significant amounts of taxes, you might have to set up a tax payment plan. Throughout this process, understand that you are not alone. The IRS’ Taxpayer Advocate Service helps people through this (and other tax issues) on a routine basis. For free.
After you’ve gotten a handle on your tax situation, it might be worth looking at the rest of your finances. If you think you might need help moving forward financially, contact us. We can schedule a no-cost consultation to see how we might be of service to you.