Taxes can seem like an overwhelming issue. It’s complicated and filing a return is hard work.
Plus there’s always something else you could be spending the money on. The car needs fixing, or your mortgage payment is due. Before you know it, you’re behind on your taxes, and The IRS is not happy with you.
If you should find yourself facing a significant amount of tax debt, it can feel like a huge burden. But don’t worry, there are many others in the same boat as you.
Every year thousands are scratching their heads, wondering how on earth they’re going to pay their back taxes. The important thing to remember is that there are sources of help. The IRS has tax debt relief programs which are specifically designed to get your financial affairs back in order and remove that crushing burden of being unsure of how you can repay your debts.
So, what exactly is tax debt relief?
Any form of debt relief is, in essence, any way whereby the burden of debt is lessened. This can be by extending the pay back time, reducing the amount of money owed, or any other mechanism whereby life is made easier for the debtor.
Tax debt relief is specific to those whose debt burden is comprised of unpaid taxes. Be it back taxes that they’ve been unable to pay in the past, or a present income tax bill which is too big for them to pay back.
Essentially, tax debt relief is any method whereby the IRS eases your tax burden to make sure that, in the long run, they can recover some or all of the money owed.
It’s not charity.
It’s a hard-headed response to the fact that every year billions of dollars of tax go unpaid. The IRS is aware that there is ten year statute of limitations on tax collection before the debt is effectively written off.
They’re naturally eager to get as much of that in as they can before time runs out.
Tax debt relief takes a variety of forms. But each is a compromise between the IRS and the taxpayer, where the situation is resolved to hopefully mutual satisfaction.
The IRS reasons that it’s better to get some money back than none, so tax debt relief measures are there to ensure that all that money isn’t lost forever. However, their definition of an affordable amount to repay may differ somewhat from the taxpayer’s.
Who needs it?
Tax debt relief is there to help anyone who has fallen behind on their taxes and is unable to pay it back all at once.
Each year about 7 million Americans fail to file their tax returns.
That’s about 5% of the tax-paying population.
If you know twenty taxpayers, the odds are one of them won’t have filed a tax return.
The situations can vary. It can be those who haven’t filed returns at all, those who have filed but are unable to meet their obligations, those who are just short of money this year, and those who have accumulated years of back taxes owed.
Income tax delinquency comes in all shapes and sizes, and so does the tax debt relief to assist them.
Different levels of debt qualify for various forms of tax debt relief, so when dealing with this, it’s a good idea to get some professional help, as knowing precisely which form of tax debt relief you qualify for can be an extremely complicated matter.
So, how much are we talking about here?
Tax debt is a major burden in the US.
The overall figure is closer to $458 billion.
Some have estimated the overall “tax gap”, that is to say, the difference between the amount owed to the government and that actually paid, at closer to $600 billion.
The tax gap is composed of three different elements: non-filing of tax returns, under-reporting of income, and underpayment.
If you’ve filed a comeback, but are only not paying, this comes under under-payment. By far the biggest cause of loss of revenue is under-reporting (which accounts for roughly $387 billion of the tax gap).
The closest figure for unpaid income tax that the IRS is chasing is $44 billion. I
n the year ending April 2016, the IRS clawed back $54 billion in unpaid taxes.
Whichever way you look at it, these are BIG numbers.
So, what happens if you’re delinquent on your taxes?
Paying your tax means you’re a responsible member of society. But what exactly are the concrete consequences if you don’t pay your taxes?
Right, what actually happens?
Well, there can be a number of negative outcomes if you don’t pay your tax.
These can include:
- Arrest and Prosecution
- Tax refunds being withheld
- The IRS filing your return for you
Whoa, arrest and prosecution?
Now the arrest and prosecution bit is unlikely. The IRS doesn’t tend to prosecute if you come forward voluntarily.
But you should remember that non-payment of taxes is a criminal offense. The prosecution is more likely to occur if you are deliberately not filing to avoid paying taxes (or if your income is through illegal means), particularly if you’re a serial offender in this category.
So, rest assured, if you’re just bit a bit behind, the IRS is not going to send you to jail. But if you’ve been ducking taxes for ten years, there’s a pretty good chance that they’ll try. The statute of limitations on this is six years. So if you had a couple of years where you forgot to file a few years back, they could still bust you for it.
It’s always best to come forward and own up to what you owe. That way arrest and prosecution are taken a right off the table.
As Claudia Hill, Frank Degen, and Karen Brosi write in Better Late Than Never,
“By longstanding practice, IRS has not recommended criminal prosecutions….provided they file voluntarily…..but this must happen before being notified of a criminal investigation.”
So there you have it, go to them before they go to you, and keep your liberty!
That’s a relief, what are the Penalties?
The moment that the April 15th deadline passes, penalties begin to come into effect. These start at 5% of the unpaid taxes you owe, and rise each month, before being capped at 25%.
So say you owe $5000, that increases instantly to $5500 upon not filing. Five months later, you owe $6250.
If you record over 60 days late the minimum penalty is $135.
However, if you file late and then don’t pay, that debt just keeps on growing and growing, at 5% per month.
It’s important to file on time, as tax journalism expert Tony Nitti writes,
“The April 15th deadline is not a suggestion; it is a real deadline with real consequences.”
As we see, the longer you leave it, this worse it will be for you financially.
It is important to note here that if you are due a refund, there is no penalty for late filing of a tax return.
But if you’re due a refund, and you don’t pay your taxes, that can have other consequences.
If you’ve not paid your taxes, the IRS has to go about getting their money back one way or another.
One of their methods for doing this is hanging on to your tax refund. If you didn’t pay taxes in 2011, but are due to a refund on 2016’s, you can kiss that goodbye.
The IRS will be holding onto it to help clear your debts.
Still, the IRS filing your return for you doesn’t sound too bad.
If the IRS doesn’t receive a tax return from you then they’ll file one for you.
John Gregory, tax software provider says they do so using “the worst case, which would be filing you as a single individual with one exemption.”
In other words, if the IRS files your return for you, it would be the highest amount of tax payable for someone on your income. It’s not really in their best interests to do otherwise.
There are some other downsides to not paying your taxes. Your credit rating can take a big hit. If the federal government decides to put a lien on your house, then that will show up on your credit report as an unpaid debt.
This is a somewhat apocalyptic scenario, and you’d have had to let things get appalling for this to happen. But it’s worth knowing that, if they choose to do so, the IRS can make your life tough indeed.
If you continue not to pay, they can even seize your house. Not just your house either, the federal government has the power to sell your car and take over your bank accounts if they so desire.
That these liens’, in law, take precedence over all other debts. If the IRS decides to put a lien on your house, you can forget about these student loans and store cards you were paying back; the federal tax lien comes first.
Okay, I get it…
Oh, we’re not done yet.
Other sanctions that the IRS has at their disposal are seizures of social security and other benefits. While banks and other creditors aren’t allowed to touch these funds, the IRS both can and will garnish your social security to repay debts.
They won’t take all of it, it’s capped at 15%. But that’s still a significant proportion.
Plus they’re entitled to the full 15%, regardless of how little money it leaves you.
When the IRS decide they want their money back, they have e a variety of means at their disposal.
Alright, fine, I really don’t want tax debt
All of the above is largely the Doomsday Scenario.
The fact of the matter is that the IRS is busy, there are a lot of people evading tax, and if you go to them first, the sanctions won’t be punitive.
In fact, they’ll most likely be able to do something to help.
Well, now we get to the options, and this is the good news: there are plenty. Although some are more pleasant than others:
- Installment Agreement
- Partial Payment Installment Agreement
- Offer in Compromise
- Currently not collectible
- Credit card debt settlement
- File Bankruptcy
- Penalty relief or abatement
One of the most difficult aspects of paying the tax you owe is paying it in one lump sum. Upon entering an installment agreement with the IRS, you pay your taxes back monthly, just as you would with any other debt.
If your debts are below $10,000 and you have no problem repaying over time, then it’s relatively easy to set up via the IRS website. Note that there are charges to set this up, $120 if you want to do it via payroll deduction, and much cheaper to set up a direct debit, at $52.
If you owe more, it can be a little trickier, and if you’re trying to avoid repaying the full amount, it gets trickier still. The level of detail the IRS requires here means it would be best to bring in a professional to deal with your application, which would be expensive in the short term.
The downside to installment plans is that while you’re paying them, penalties still accrue.
Think of it as interest on a loan or a credit card; they don’t let you repay without any penalty.
So you will end up paying more than you originally owed.
Partial Payment Installment Agreement
A Partial Payment Instalment Agreement is similar to a standard installment agreement; you repay the IRS in regular monthly payments. Where it differs is that you may not repay the entirety of your tax debt.
Under a PPIA you agree on a monthly repayment plan with the IRS which is affordable to you, but acceptable to them. But the important thing to remember is that the statute of limitations on tax collection is ten years.
So after ten years, any remainder of your tax debt is written off.
While this sounds great, it comes at a cost. A standard installment plan is easy to set up, but a PPIA will require full financial disclosure to the IRS. They’ll go through your records and use any liquid assets to pay down your debt. So while you may get some tax written off, you’ll have to jump through a lot more hoops to do so. If they consider you able to pay the full debt judging from your financial records, the partial payment option will be off the table.
Offer in Compromise
One way of avoiding paying the full amount is an Offer in Compromise. In essence, you promise to pay less than what is owed and the IRS writes off the rest.
Now, on the surface, this sounds great. But in reality, it’s not as simple as all that.
To qualify for an Offer in Compromise, the taxpayer has to prove that there’s no way collecting the debt in full is possible, or that if it were it would create unreasonable levels of hardship for the taxpayer.
The IRS recommends exploring all other channels before going down this route, as they will need you to prove beyond a doubt that there’s no way you can repay.
But if you have substantial back taxes, or your income level has dropped sharply, then it could be a viable route.
The other thing to remember is that typically you will start paying while they’re considering the offer, either a lump sum followed by installments, or monthly installments until they decide on your case.
Currently not Collectible
If you’re suffering immediate financial hardship, then applying for Currently not Collectible status could provide you with some much-needed room to maneuver. If you can prove that you have no money left over after paying for essentials, then the IRS will cease to attempt to collect any tax.
Bear in mind, however, that this is simply a deferral of payment, not a write-off.
The tax is still owed and will have to be repaid at some point.
It will still accrue interest and penalties, and the IRS will continue to withhold refunds.
It can be a laborious process, but if, as tax expert Charlie Mitchell says, “You’re willing and able to do the records” then you don’t need to bring the professionals.
This is an application you can handle on your own, so long as you’re on top of your finances.
Credit card debt settlement
It’s worth considering that the IRS considers settled or forgiven credit card or any other sort of debt (say a mortgage or a student loan) as income and therefore taxable.
So consumers who thought they’d written off that debt some time ago can find themselves being pursued by the IRS.
But it is possible to avoid this tax debt. It depends on how the debt was discharged. If it were due to a reason of insolvency or bankruptcy, or an agreement on student loans that’s paid up, it wouldn’t be pursued.
They will also drop it if the debt cancellation was a gift. Some other exceptions also apply. This is one where directly dealing with the IRS is ideal. Contact them about the reason your debt was cancelled to get that tax liability wiped off.
The nuclear option in terms of getting your tax written off is to file for bankruptcy. But this won’t necessarily be the end of your problems. Tax liabilities still count in bankruptcy, unless you can prove certain other criteria.
The debt needs to be over three years old, you must have filed a legitimate return, and the tax assessment needs to be at least 240 days old.
For most citizens, bankruptcy can bring a discharge of debts, but it’s an extreme length to go.
To file for bankruptcy is an expensive process, at least $800. The damage done to your credit score will take up to ten years to heal and finding any finance at all will be difficult for years to come.
Penalty relief or abatement
Finally, you may be able to reduce the tax bill by applying for Penalty relief or abatement.
You can only do so if:
- If your records are up to date and you’ve filed on time for the last three years
- if this is the first time you’ve ever had to file, if you’d asked for an extension of time to file or if you’ve already agreed to pay all outstanding tax
In both the above situations the IRS may choose to waive any penalties you may have occurred.
Think of it as money off for good behavior but if you don’t ask you don’t get!
Tax debt is a bad situation.
It’s best if at all possible to avoid it altogether.
Non-filing is one of the biggest problems facing the American taxpayer, so always file on time to prevent a lot of these challenges.
Even if you can’t pay your tax bill, the timely filing will avoid some penalties and sanctions.
If you have filed and just can’t pay, then talk to the IRS.
Communication is the key.
They will have some strategies to help you with the burden of tax debt.