tax bill

The majority of taxpayers get tax refunds, according to the IRS. But not everyone is so fortunate. In fact, some people have to write checks to the U.S. Treasury at tax time.

It is painful enough to pay taxes throughout the year. But it hurts even more when you have to fork over additional cash when filing your tax return in the spring -- especially if you were not expecting to do so. What happens if you cannot afford your tax bill?

"If you can't pay your taxes, your points of action should be based on your current financial status and how much you owe," said Ted Kleinman, a certified public accountant and owner of US Tax Help. "The worst thing to do is (to) not take any action, or to react in a delayed fashion." 

Here are the steps you should take if you can't pay a tax bill.

1. File your tax return
Don't assume that if you don't file a tax return, the IRS won't know that you owe money. "The No. 1 thing you should not do is not file simply because you can't pay," said Bill Smith, the managing director of the national tax office at CBIZ MHM, an accounting provider. "It's a crime not to file a return." 

Plus, you will be charged a failure-to-file penalty of 5 percent on the amount you owe for each month your return is late, Smith said. However, the penalty won't exceed 25 percent of what you owe.

If you file but do not pay, you will be charged just a 0.5 percent penalty on what you owe each month until you pay in full. So by filing, you give yourself more time to pay with a reduced penalty. "At that point, you just owe money," Smith said. "You don't go to jail for owing money."

In either case, though, you will be charged interest on the amount you owe. The rate is determined quarterly and is based on the federal short-term rate plus 3 percent, and it compounds daily. 

2. Pay what you can
If you cannot pay your entire tax bill, pay a portion of it. "You can reduce additional interest and penalties by paying as much as you can with your tax return," according to the IRS.

Also, call the IRS at 1-800-829-1040 to explain your situation. The IRS might provide you with alternate payment options, depending on your ability to pay. 

Make sure to direct the IRS to apply any payment you send directly to your tax bill first, not to the penalty or interest, Smith said. Lowering the amount you owe limits the penalties and interest you have to pay.

3. Avoid paying with credit
Using a credit card might seem like the obvious solution if you cannot afford to pay your tax bill with a check. But going into debt on your card so you can pay taxes means you likely will end up owing a lot more than the original debt.

For starters, you will have to pay a fee to one of the payment processors the IRS contracts with to handle credit card transactions. The processing fees range from 1.87 percent to 2.25 percent.

So if you owe $1,000, the minimum processing fee of 1.87 percent would add $18.70 to your bill. Fees are even higher if you pay by credit using an integrated IRS e-file service provider.  

On top of that fee, you will pay interest on your credit card balance. And that rate is likely to be higher than the interest and penalties charged by the IRS for late payments. Plus, your credit score could fall if the amount you charge puts you near or at your credit limit.

4. Get on the IRS installment plan
The IRS allows taxpayers to make monthly payments through an installment plan if they cannot pay their balance in full when it is due. If you have filed your return and owe less than $50,000 in taxes, penalties and interest, you can apply for the IRS Online Payment Agreement. This allows you to avoid the hassle of calling the IRS or visiting a field office to apply.

Be aware that you might have to pay a fee to get on the installment plan. The IRS charges $52 for direct debit agreements tied to your checking account, and $120 for agreements not debited directly from your bank account. 

If your income is below a certain level, the fee is only $43. And you can avoid a fee altogether if you qualify for a short-term agreement to pay off what you owe in 120 days or fewer.

If you are ineligible for the online payment plan, you still can pay in installments. You will need to fill out Form 9465 and file it with your tax return (or separately, if you have already filed). 

5. Apply for an offer in compromise
If you truly cannot afford to pay taxes, you might be able to settle your bill for less than you owe through what is known as an "offer in compromise." You must file a Form 656 as well as a wage-statement form and pay a $186 application fee. Be aware that it is not easy to get an offer in compromise accepted, Smith said.

If your offer is accepted, you will be expected to avoid getting into a similar situation again. "The catch here is that you must file your tax returns and make payments on time for the next five years if your offer is accepted," Kleinman said.

If you fail to live up to this obligation, the IRS generally will try to work with you, Kleinman said. However, if you still to not comply after all relevant notices have been sent to you, the offer in compromise will be defaulted and the matter sent to collections, he said.  

6. Consider hiring a tax pro
Your tax bill might be bigger than necessary if you did not take advantage of all the tax deductions and credits you are entitled to receive. So if you prepared a return on your own and it shows that you owe money, consider hiring a professional tax preparer to review the return. Just make sure you meet with someone reputable, Smith said. 

Look for an enrolled agent -- a tax professional licensed by the IRS -- through the National Association of Enrolled Agents website. Or find a certified public accountant through your state's CPA society or state board of accountancy or through referrals from friends and family. 

What happens if you don't pay
Smith said that in most cases of failing to pay, you have a long time before anything particularly bad happens. "The IRS isn't an efficiency machine," he said. 

First, you will get a bill from the IRS stating what you owe, plus interest and penalties. If you do not pay up, you will get another bill.

If you do not pay after getting this second and final bill, the IRS will take collections actions. These range from applying subsequent years' refunds to what you owe until the balance is paid in full to seizing your property and assets. 

Smith said it could take up to a year after you get an initial bill to get a notice that the IRS is taking collections actions.

Don't get into the same situation next year
Smith said that often when people are faced with a tax bill they cannot pay in full, they cut back on other tax payments during the year by under-withholding, or skipping estimated tax payments so they have more money to cover their big bill. Then, they end up deeper in a hole. 

"At the end of the day, you have a gigantic problem," Smith said. "You really need to face the music, ask how you got into this problem and don't do it next year."

That might mean claiming fewer allowances on your W-4 so more tax is withheld from your paycheck -- and so you are less likely to owe in the spring. Or if you are self-employed, you might need to boost your quarterly estimated payments so you do not have to write another big check when filing your return.

Working with an enrolled agent or certified public accountant might also help you identify moves you can make during the year to lower your tax bill.

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