Too many people make the mistake of assuming that the IRS will eventually “forget” about their old tax debts. On the contrary, the IRS has a full decade to collect overdue payments — and the longer your taxes go unpaid, the greater the financial penalties become. Depending on the circumstances, you could even be targeted for a criminal investigation. While it’s understandable to feel nervous about interacting with IRS agents, it’s extremely important that you take steps to start paying your back taxes and reenter tax compliance as soon as you can. In this blog post, US Tax Help will explain the differences between failure to pay and failure to file your tax return, different installment plan options if you can’t afford to pay what you owe, and how to make an OIC or offer in compromise to the IRS.
Penalties for Failure to Pay and Failure to File Taxes
Back taxes are simply taxes which you didn’t pay when they were due. However, there are important distinctions between failing to pay taxes which were filed, and the outright failure to file taxes in the first place.
Failure to file is considered the worse offense, and in turn, the potential penalties are more severe. Generally speaking, the penalties for failure to file may include:
- 5% of the unpaid tax, applicable to every month or even partial month where you were late on your filing. This penalty is capped at 25% of the total unpaid tax.
- If you were more than 60 days late, the minimum penalty increases to either 100% of the unpaid tax or a fine of $135 — whichever is smaller.
Of course, those are merely the civil penalties. If your failure to file is deemed “willful,” or intentional, you could even be criminally charged. If convicted, the penalties are staggering: a devastating $25,000 fine, plus up to a year in prison.
While somewhat less serious than failure to file, failure to pay is also a cause for concern. Civil penalties for failing to pay the taxes you owe can include 0.5% of the unpaid tax, applicable to every full or partial month where you were late on your payment. Again, this penalty is limited to 25% of the unpaid tax liability.
Fortunately, there are ways to help avoid facing these consequences. You can avoid failure-to-pay penalties if you (1) request a filing extension by the normal tax deadline, (2) pay 90% or more of what you owe by the original due date, and (3) pay the remaining balance by the extended due date. You must meet all of these terms.
Additionally, you may be able to avoid penalties for failure to pay and failure to file by demonstrating to the IRS that you had an honest and legitimate reason for being delinquent. The IRS calls this “reasonable cause.” As described in Section 188.8.131.52.2 of the Internal Revenue Manual, “Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining his or her tax obligations but nevertheless failed to comply with those obligations.”
While reasonable cause has a somewhat ambiguous definition and must be evaluated on a case-by-case basis, reasonable cause does not include “being too busy,” “being forgetful,” or raising moral, religious, or constitutional objections. In fact, numerous court cases have set precedents against taxpayers making such claims. These precedents are discussed in detail in a March 2014 IRS publication titled “The Truth About Frivolous Tax Arguments.”
IRS Installment Agreements and Payment Plans
While the IRS should not necessarily be trusted to keep your best legal or financial interests in mind, the agency will generally try to negotiate with taxpayers who make an honest effort to come back into compliance. As the IRS states, “If you cannot pay all the taxes you owe, you should still file your tax return on time and pay as much as you can, then explore other payment options. The IRS will work with you.” Remember, attempting to hide and “wait it out” will simply harm you in the end — you’ll need to address the situation eventually.
So, assuming you have filed the necessary tax returns, what sort of payment plan options are available? You may be eligible for an:
- Online Payment Agreement
- You must have filed all applicable tax returns.
- You cannot owe more than $50,000 (including penalties and interest).
- If you owe up to $100,000, you may be able to make a short-term online plan to help you get started.
- If you qualify, you cannot simply download a public form. You must create an IRS account and log in through their system.
Don’t qualify for the online payment agreement? Don’t panic. If you owe $50,000 or less, you may be able to use an alternate installment plan, but you’ll need to complete and submit the following two forms:
- Form 9465 (Installment Agreement Request)
- This form asks you for information like your number of dependents, how frequently you get paid, and what sort of vehicle and health insurance payments you make.
- Do not use this form if you’re already paying off your balance.
- Do not use this form if you can pay your balance within 120 days.
- Form 433-F (Collection Information Statement)
- This form asks you for information like your accounts and/or lines of credit, the sort of real estate you own, assets you hold, and what your living expenses are like.
- After you make your submission, the IRS might get in touch with you to request evidence and supporting documents.
If you’re using Forms 9465 and 433-F, you will also need to call the IRS at (800) 829-1040. Once again, taxpayers are advised against negotiating with the IRS without getting professional help. If you try to handle the situation on your own, you are likely to end up agreeing to a less favorable payment plan.
You should also be advised that interest (and other penalties) will continue to accrue until the balance you owe is paid in full. If you’re worried about going into default, you are in jeopardy of facing potential collection actions unless you take immediate steps to rectify the situation.
Making an Offer in Compromise (OIC)
As an alternative to the IRS’ installment plans, you may be able to settle your tax debt by making something called an “offer in compromise,” or OIC. This is a special type of payment agreement that will allow you to settle your debt for less than you actually owe — in many cases considerably less, reducing your tax liability to a fraction of its original cost.
However, while OIC offers tremendous financial relief, the eligibility requirements are demanding. In order to qualify, generally speaking you must have filed all necessary tax returns, and must also be current on all tax payments for the current year. As the IRS cautions in Topic 204 of the Topic 200 Collection, “Taxpayers who can fully pay the liabilities through an installment agreement or other means, will not be eligible for an OIC in most cases.”
The IRS also warns, “In most cases, the IRS will not accept an OIC unless the amount offered by a taxpayer is equal to or greater than the reasonable collection potential.” It’s very important to note that this “reasonable collection potential,” or RCP, includes not only the value of your actual assets and property, but also your potential income in the future (minus basic living expenses).
There are three types of scenarios in which the IRS may accept an offer in compromise:
- There is a “genuine dispute” regarding the amount you owe. As we discussed a little earlier, this does not mean that you have a constitutional objection to paying taxes, or that you were “too busy” to pay on time, but that there is a potential mathematical flaw in the financial calculations, resulting in an inaccurate bill.
- The IRS doesn’t think it will realistically be able to collect a full payment because your combined income, property, and assets are worth less than what you owe. This is known as “doubt as to collectibility.”
- In contrast to the two scenarios above, (1) there is no dispute, and (2) the IRS has calculated you can in fact pay your balance. However, even though you can theoretically pay, doing so would deplete your resources and burden you with excessive financial hardship. In this scenario, the IRS must also determine that this hardship “would be unfair and inequitable because of exceptional circumstances.” This situation is called “effective tax administration.”
To make an offer in compromise, documents you may need to submit include:
- Form 433-A (Collection Information Statement for Wage Earners and
- Form 433-B (Collection Information Statement for Businesses)
- Form 656-L (Offer in Compromise – Doubt as to Liability)
Be sure not to confuse Form 433-A mentioned here with Form 433-F mentioned earlier. Remember, Form 433-F is meant for installment agreements. Your financial adviser can help you determine what sort of payment you should initially offer. Even if the IRS rejects the initial number, you may be able to appeal the denial as long as you contact the IRS within 30 days of receiving your rejection notification.
While it’s highly inadvisable to let unpaid back taxes accumulate, rushing into IRS negotiations without the benefit of an experienced CPA can expose you to greater tax liability. Before you call the IRS, contact Ted Kleinman for assistance. Ted has 20 years of experience representing clients throughout the United States and abroad, including US expats in Canada, Mexico, and other nations, and offers free initial consultations. To schedule your free consultation with Ted, call US Tax Help at (800) 810-9312 today.