How to Deal with Huge Tax Debt
Owing taxes to the IRS can be overwhelming, but there are options to reduce or manage your debt. Understanding the collection process and knowing what steps to take can help prevent financial distress. Below is a summary of the available options to deal with tax debt.
Collection Process
When taxes aren’t paid by the filing deadline, the IRS sends a bill outlining the balance owed, including penalties and interest. This triggers the collection process, which continues until the debt is paid or the IRS’s ability to collect expires (usually within 10 years of assessment). While this debt accumulates daily interest (currently 3% + 8% for 2024) and penalties of up to 25%, options exist to manage or lower this burden.
Payment Options
- Credit Card or Bank Loan: While not typically ideal, paying tax debt using a credit card or bank loan could be more cost-effective than the IRS penalties and interest, depending on your bank’s rates.
- Levies and Liens: The IRS can seize assets to collect the tax debt. A levy allows the IRS to take wages, bank accounts, and other assets, while a lien is a legal claim to your property to secure payment, making it harder to sell or finance the property. Liens can be withdrawn if conditions are met, such as entering an installment agreement.
Payment Plans
For taxpayers who cannot pay the full amount upfront, the IRS offers various payment plans:
- Short-Term Payment Plan: This plan allows up to 180 days to pay off debt and is available for those owing less than $100,000 in combined tax, penalties, and interest.
- Installment Agreements: If more time is needed, taxpayers can apply for an installment agreement, which spreads payments over up to 72 months for debts under $50,000. For amounts between $25,000 and $50,000, direct debit is required.
The IRS allows taxpayers to apply for a payment plan online or by submitting Form 9465. Setup fees for payment plans are relatively low, ranging from $31 to $131, with possible waivers for low-income taxpayers. While on a payment plan, the IRS suspends collections, though failure to adhere to the plan may lead to default.
Offers in Compromise (OIC)
An Offer in Compromise is an agreement that allows taxpayers to settle their tax debt for less than the full amount owed, but it’s challenging to secure. The IRS will only accept an OIC if they believe you cannot pay the full amount through other means. To qualify, you must submit detailed financial information and meet several conditions, including filing all required returns and making any necessary estimated payments. There is a $205 application fee, though low-income taxpayers may be exempt. There are two types of offers: Lump Sum Cash (paid within five months) or Periodic Payment (paid over six to 24 months).
OICs are public records for one year, and the IRS may publish details about your case, including your name and the terms of the offer.
“Currently Not Collectible” Status
If you face severe financial hardship and cannot pay any of your debt, the IRS may temporarily report your account as “currently not collectible.” This status halts collection efforts but does not erase the debt, and penalties and interest accumulate. There are additional relief options in certain situations, such as for U.S. military members or spouses unaware of the tax debt.
Your Rights and Additional Help
If you disagree with an IRS decision, you can request a Collection Due Process (CDP) Hearing or an equivalent hearing within 30 days of receiving a notice. This allows you to challenge collection actions or propose alternative payment options. You may also request penalty abatement if this is your first offense or if other specific criteria are met.
The Taxpayer Advocate Service is an independent agency within the IRS that helps protect taxpayers’ rights. You can also consider private tax-debt services, though be cautious of fees for services that can be accessed directly from the IRS.
Example: Alex’s Experience
Alex, a taxpayer with a history of tax debt, faced a $30,000 debt four years ago and successfully negotiated an Offer in Compromise (OIC) to reduce it to $17,000. However, when his tax debt increased to $36,000 in 2022, the IRS denied his OIC request because of his prior history. He paid $11,000 on his credit card and entered a short-term payment plan to cover the remaining balance. By following this strategy, Alex avoided the harsher late payment penalties and cleared his debt by October 2023.
Conclusion
Owing taxes can be intimidating, but the IRS offers various options to help you manage or reduce your debt. Whether you choose a short-term payment plan, negotiate an Offer in Compromise, or request temporary relief, there are pathways to address tax issues without facing extreme penalties. Understanding your options and following the IRS guidelines is crucial for avoiding severe financial consequences.