What to do when you owe taxes and can't pay

It's not all bad news, though. If you can’t pay the taxes you owe, you may be able to get one of four collection alternatives the IRS offers for people to get in good standing with the IRS and avoid any unpleasant surprises.

What you need to know about dealing with tax debt

• You have real options if you can't pay your taxes. The IRS offers extensions to pay, installment agreements (payment plans), and two alternatives for people in financial straits: currently not collectible status and offers in compromise. Installment agreements are the most common solution, making up more than 90% of collection arrangements between taxpayers and the IRS.
• Penalties and interest can add up. If you don’t pay your taxes, you could face a failure-to-pay penalty of up to 25% of the tax you owe, plus interest. If you set up an installment agreement with the IRS, you could cut your failure-to-pay penalty in half. Plus—if you qualify, you can ask for penalty abatement.
• You may be able to reduce your taxes and penalties. For the tax years you still owe, you may be able to reduce your tax and/or penalties. There are several ways to do this, including asking for audit or CP2000 reconsideration, filing an original or amended tax return, or asking for penalty abatement– all depending on your situation.
• Paying the taxes or getting a collection alternative is the only way to avoid more serious problems. If you don’t pay or make arrangements, the IRS can eventually issue tax liens, levies, wage garnishment, and passport restrictions.
• You can expect a series of collection notices. The IRS sends a series of computer-generated notices (called the IRS collection notice stream) that starts with a request to pay and can end with a levy and/or lien.

Background on tax debt and IRS collection

How often does a person have tax debt and can’t pay the IRS?

It’s common. You are far from alone.

• Each year, about 9 million people file a tax return and can’t pay.
• As of 2020, there were almost 17 million individual taxpayers and 4 million businesses that owed the IRS back taxes.
• Each year, about 4 million people are in an IRS installment agreement, and hundreds of thousands more set up other collection alternatives.

How long does it take to resolve a tax issue?

One day to 12 months, depending on the collection solution. You can set up an extensions to pay online or by phone in 30 minutes. The most complicated option, the offer in compromise, can take up to a year.

What are the likely causes of tax debt?

Most people get into trouble when they earn income that doesn’t have taxes automatically withheld (like a small business owner or an investor) or they have a life event that has changed their normal filing/paying, such as a spike in income from selling a business.

IRS collection enforcement actions

When you don’t pay your taxes, the IRS eventually enforces collection through three common actions:

• A levy or a garnishment: This is when the IRS takes your assets and/or income. There are many types of levies, including wage garnishments—when the IRS takes part of your paycheck—bank or financial account levies, a Social Security benefits levy, state income tax refund levy, or an accounts receivable levy.
• A tax lien (Notice of Federal Tax Lien): The IRS files this notice in the public record when you owe past-due taxes. It basically puts the government first in line for your property, over other purchasers, secured creditors, and judgment liens. For example, if the IRS files a tax lien on your assets and you sell your home, the IRS will collect from your sales proceeds up to the amount on the lien.
• Passport restrictions: If you owe more than a certain amount of taxes ($55,000 for 2022), and you’re not in good standing with the IRS (with a payment agreement), the IRS can certify to the State Department that you have “seriously delinquent tax debt.” Then, the State Department can restrict your international travel by denying your passport renewal or revoking your passport.

Fortunately, you can easily avoid all of this.

• To avoid a levy/garnishment and passport restrictions, get into good standing with the IRS by paying the tax or setting up a collection alternative.
• To avoid a tax lien, you need to set up an agreement with the IRS that avoids a lien (generally, an extension to pay or a streamlined installment agreement).

Most popular ways to solve tax debt issues

Most people choose not to deal with the IRS and just pay the tax they owe. But in fact, of the 32 million people who file and owe every year, about 9 million people will end up needing a collection alternative.

Streamlined installment agreements

Out of the four collection alternatives, taxpayers most frequently choose the streamlined installment agreement (payment plan).

• The streamlined installment agreement is good for people who owe $50,000 or less.
• It allows you to pay over 72 months (or the collection statute of limitations, whichever is shorter).
• You can also avoid a tax lien by setting up a streamlined installment agreement in time.

Extensions to pay

You can ask the IRS for 180 days to get the funds to pay your entire tax bill.

• This option doesn’t cost you anything to get—but interest and the failure to pay penalty continue to add up.
• Many people use the 180-day extension to pay down their bill to less than $50,000 (the streamlined installment agreement limit)—and then set up a streamlined agreement to avoid a tax lien.

Other potential solutions to tax debt issues

Reduce your bill

You should always see if you can lower the amount you owe.

• If you owe because of an audit or CP2000 inquiry that isn’t correct, you can request audit or CP2000 reconsideration.
• If your filed return was incorrect, you can file an amended return (or an original return if the IRS filed a substitute for return).
• If you qualify, you can request penalty relief.

The full-pay nonstreamlined payment plan

The IRS offers payment plans for taxpayers who owe up to $250,000 to pay before their collection statute of limitations expires (10 years from the date the IRS assesses the tax). The one drawback is that the IRS will file a tax lien for this plan.

Ability to pay installment agreement

If you can’t meet the terms of the streamlined or full-pay nonstreamlined plan, you’ll need to figure out your ability to pay.

• The IRS will first look at your assets (like funds in your bank or retirement account).
• Then, the IRS will want to know how much you can pay with monthly payments.
• You would need to average your monthly income and your allowable necessary living expenses to see how much monthly disposable income you have, if any. In general, the IRS wants you to put all your monthly disposable income toward your tax bill until it’s paid, or the collection statute expires.
• Ability to pay plans can take some time to set up with the IRS. Taxpayers and the IRS often disagree about monthly disposable income.

Currently not collectible (CNC) status

This means that you can't pay your taxes based on your circumstances. The IRS looks at your financial information (IRS Form 433 and supporting documentation) and determines that you can’t pay with a lump sum from your assets (like a savings account) or through monthly payments.

Offer in compromise - doubt as to collectibility (OIC)

This option is for people in financial hardship situations with no hope of paying the IRS through their assets or monthly payments before the collection statute of limitations expires.  

• To request an OIC, you have to offer the IRS your “reasonable collection potential” as a settlement amount, called an offer.
• OICs are based on math. The IRS looks at your assets and income to decide whether you qualify for an OIC and compute your offer amount.

It’s rare for anyone to qualify for an OIC.  In 2021, the IRS accepted only 30% of OICs, largely because of errors taxpayers made in calculating their ability to pay and reasonable collection potential. That’s just 13,874 out of the 21 million individuals and businesses who owe the IRS.

Steps to resolve your tax debt issue

1. Get information from the IRS. Get three things from the IRS:
   • The balance you owe
   • Your collection enforcement status and deadlines
   • Your compliance status
   It also helps to get your IRS account transcripts, which show tax and penalty assessments, balances you owe, and some account activity. But you’ll usually need to contact the IRS to get specific information about enforcement activity and deadlines. Also, if you’re not sure whether you’ve filed all your required tax returns in the past, you’ll need to ask the IRS.
2. See if you have enough time to avoid collection enforcement (liens, levies, etc.). If the IRS is going to act on your tax bill soon, and you must take more steps to get your collection agreement (like filing past-due returns or weighing your options to pay), you may want to request an extension to pay or a collection hold. Contact the IRS directly to ask for a collection hold or an extension to pay. If you already have a levy or garnishment, you should ask the IRS for a levy release in exchange for a deadline to get into an agreement on the balances owed. If the IRS denies your extension or hold, consider appealing the decision or moving quickly to set up an IRS agreement and get your levy released.
3. Fix any immediate filing or payment issues. You can't get a collection agreement without being in filing and payment compliance.
   • Filing compliance means that you’ve filed all required tax returns (for individual filers, that usually means the current and past six years of returns).
   • Payment compliance means that you have enough withholding and/or estimated tax payments so that you won’t file and owe again for your next tax return.
4. Figure out your best option. You’ll need to consider your whole picture when deciding how to pay or get into an agreement for your tax debt. Look at your ability to pay, the amount you owe and how you can avoid collection enforcement.
5. Select and request your collection option.
   • You can quickly set up simple agreements like the extension to pay, streamlined installment agreement, and the full pay non-streamlined payment plan with few IRS forms. In many cases, you can set up an extension to pay or streamlined installment agreement online in less than 30 minutes.
   • Ability to pay agreements, such as the ability to pay installment agreement, currently not collectible status, and offer in compromise, are more complicated. You’ll need to supply the IRS with financial information (Collection Information Statements - Form 433 series) and other documents. You’ll probably interact with the IRS multiple times to answer questions and figure out final terms. Respond to the IRS quickly during this process to avoid collection enforcement (lien, levy).
6. Finalize terms of the agreement and appeal any disagreements. Look for an IRS notice confirming your agreement terms or review your IRS account transcripts. If you disagree with the terms of your agreement, collection enforcement actions, or a rejected OIC, you may need to appeal the IRS decision to get a second review of your circumstances and proposed solution terms.
7. Complete the terms of the agreement.
   • If your agreement is an extension to pay, pay before the due date or set up another collection alternative.
   • If the agreement is a payment plan, make the payments each month.
   • If the agreement is an OIC, complete the terms of payment and stay in filing and payment compliance for the next five years.
   • With CNC status, you don’t have to do anything. If you have a levy in place, make sure the IRS released the levy if that was in the terms of your agreement.
8. Stay compliant and watch future notices. Be sure not to file and owe and not pay in the future. Any new unpaid balance will default on an existing installment agreement. Unpaid balances in the next five years will also default on any approved OIC. If you owe taxes, you will always get an annual notice from the IRS showing the payments you made and the rest of the balance you owe. You’ll need to address any other notices right away to avoid defaulting on your agreement and possible enforced collection.

Tips for resolving tax debt issues

You can request all collection agreements online (if applicable) or by phone.

• Use the IRS online payment agreement application to request a streamlined installment agreement and set up direct debit payments from your bank account.
• Call the IRS to avoid confusion on ability to pay agreements. While you’re on the phone, you can fax documents to the IRS, including your direct debit payment authorization form (Form 433-D).
• The only major exception to requesting an agreement online or by phone is when you are requesting a guaranteed installment agreement. You can set up this agreement by attaching a Form 9465 with your filed tax return.

Conditional installment agreements allow you to use actual expenses instead of allowable expenses. If you can pay your tax bill within 72 months or the collection statute of limitations (whichever is shorter) and the full-pay non-streamlined payment plan does not work for you, the IRS will allow you to use your actual expenses to calculate your monthly payment. Actual expenses include items that it doesn’t normally allow in ability to pay agreements, such as extra housing costs or private school tuition. Typically, people who owe more than $50,000 and can pay by the deadline use conditional agreements, when they don’t want or don’t qualify for the full-pay non-streamlined payment plan.

If your situation changes, you can redo your agreement. For example, if you get a streamlined installment agreement for $500 a month and then lose your job, you can contact the IRS to provide new financial information and get an agreement that is a better fit, like an ability to pay agreement or CNC status.

Avoiding tax debt

Take a few precautions to avoid owing taxes in the future:

• Adjust your paycheck withholding and/or make estimated tax payments to avoid owing taxes and penalties.
• File accurate returns to avoid any IRS adjustments and more tax owed from an IRS audit or matching notice (CP2000).
• File your returns on time. If you owe taxes and file late, the penalty is 5% per month, up to 25% of the taxes you owe. This can be a costly addition to the taxes you owe.

Beware of scams

Keep an eye out for scams and fake emails claiming to be from the IRS. The IRS usually doesn’t contact taxpayers through email. However, scammers are mailing fake notices. Don’t use the address or call the phone number on a notice if you suspect it is fake. Instead, call the IRS at (800) 829-1040 to verify the authenticity of an IRS notice or letter before sending personal information or mailing a check.

How a Tax Pro can help

A Tax Pro can help you with options if you owe and can’t pay. Your Tax Pro will:

• Get your tax records from the IRS to fully understand your situation and compliance issues.
• Consult with you on your best options.
• Complete all forms and analysis to set up your agreement with the IRS.
• Negotiate with the IRS to set up the agreement.
• Confirm the agreement is in place and consult with you on how to stay in good standing with the IRS.

Resolving tax debt notices can take months, and your Tax Pro will navigate the issue for you and keep you informed along the way. At Jackson Hewitt, we have 40 years of expertise to help you manage your tax issues. Whether simple or complex, our team of licensed professionals are trained to work directly with the IRS, while keeping you updated every step of the way. Start for free today and learn about how we can help resolve your tax issues.

About the Author

Jim Buttonow, CPA, CITP, is the Senior Vice President for Post-Filing Tax Services at Jackson Hewitt. He’s been a leader in helping taxpayers and tax professionals resolve tax problems with the IRS, where he had worked for 19 years in various compliance-enforcement positions. Prior to his current role, Jim’s consulting practice focused on the areas of tax controversy and tax administration, which included leading product development on tax problem software for tax professionals, testifying before Congress, advocating for IRS transparency and efficiency, and proposing innovative large-scale solutions for taxpayers and tax professionals. Jim is also the author of Tax Problems and Solutions Handbook, a publication aimed at helping tax pros work more effectively in post-filing matters and resolving their clients’ most common tax problems.

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