What to Do When You Can't Pay Your Tax Bill

Tax  Form

It's April 15, you've just finished your income tax return and you owe more money than you can pay. Maybe you had unexpected income during the year that wasn't subject to withholding. Maybe your W-4 doesn't accurately reflect your current tax situation. Maybe you underestimated tip income or royalties.

Whatever the reason, you can't pay what you owe. Don't panic, many people find themselves in this unenviable position and manage to find a solution. The most important thing for you to do is file your return on time (there are substantial penalties for not filing -- usually five percent of your tax liability per month up to a maximum of 25 percent) and figure out exactly how you're going to pay your bill.

It's April 15, you've just finished your income tax return and you owe more money than you can pay. Maybe you had unexpected income during the year that wasn't subject to withholding. Maybe your W-4 doesn't accurately reflect your current tax situation. Maybe you underestimated tip income or royalties.

Whatever the reason, you can't pay what you owe. Don't panic, many people find themselves in this unenviable position and manage to find a solution. The most important thing for you to do is file your return on time (there are substantial penalties for not filing -- usually five percent of your tax liability per month up to a maximum of 25 percent) and figure out exactly how you're going to pay your bill.

Generally speaking, it's a good idea to start by including with your return a check for as much as you can afford on the amount you owe. If possible, consider negotiating a no-interest or low-interest loan from your family and friends. Even if you can borrow only a portion of what you owe, this might be a good idea. Paying as much as possible not only shows "good faith" on your part, but a smaller outstanding balance will accrue smaller interest charges and penalties.

After you file and pay what you can, the IRS will send you a notice of the balance due, including interest charges and a late payment penalty. Then it's up to you to pursue one of the following options.

Use a Credit Card to Pay What You Owe

The IRS accepts plastic...sort of. When you pay your tax bill using a credit card, you are actually making the payment through a service provider that handles the transaction and forwards your payment on to the IRS. The payment processing company charges a convenience fee based on the amount you charge. For example, if you owe the IRS $1,000 and the provider charges a 2.5 percent fee, you will pay an extra $25 for the privilege of paying with plastic. The IRS itself does not collect any fees on credit card payments.

Bear in mind that you will owe finance charges to the credit card company if you don't pay the balance in full when you receive your statement. With many credit card interest rates hovering around 20 percent, your tax bill could quickly escalate. Still, for many, not having the IRS as a creditor is worth the extra cost of paying their taxes with a credit card.

Ask the IRS for an Extension to Pay

You can request an extension of time to pay what you owe by completing IRS Form 1127. You must prove that paying the entire bill now would cause undue hardship, which entails providing statements of assets and liabilities and an itemized listing of all money you received and spent in the three months prior to making the request for an extension.

As printed on Form 1127, taxpayers rarely want this kind of extension because the legal requirements are so strict.

Enter into an Installment Plan with the IRS

You can request permission to make installment payments by attaching a letter to your return or by completing IRS Form 9465

You must keep your current tax liability paid up while you make installment payments on an earlier tax bill or the IRS can cancel the agreement and demand payment in full.

Make an "Offer in Compromise"

An offer in compromise is a request to pay a portion of what you owe and have the IRS accept that amount as payment in full. You have to prove that you do not have the resources to pay the full bill and you must keep the current year's taxes up to date. See Publication 594, The IRS Collection Process, for more information about offers in compromise.

It may take time to hear back from the IRS since they process many offers. If your offer is accepted, you may be able to make installment payments on what you finally owe in compromise.

Avoid Future Tax Bills

There are lots of ways to get out of a tax pinch, but the best approach is always to avoid getting into one in the first place.

If you end up owing the IRS, check your W-4 form on file with your employer. The tax bill you have is an indication that you may want to lower the number of withholding allowances you claim or even ask your employer to withhold more money from each paycheck. If you're self-employed, you may need to increase your quarterly estimated tax payments. Also, anyone who expects to owe at least $1,000 in taxes (after subtracting withholdings and credits) must pay quarterly estimated taxes.

Owing the IRS isn't pleasant, but it doesn't mean you have to change your name and move to a Caribbean island. It does mean you'll have to be proactive about paying your bill and avoiding the same situation in the future.